J. C. Penney Q3 Earnings Call Transcript

123jump.com Staff
19 Nov, 2008
New York City

J. C. Penney, the department store chain reported sales declined 8.7% to $4.3 billion and net income plunged to $124 million or $0.56 per diluted share compared with $261 million and $1.17 for the prior year. The company guided earnings for the fourth quarter to be between $0.90 and $1.05 a share.

J. C. Penney Company, Inc. ((JCP))
Q3 2008 Earnings Call Transcript
November 14, 2008 9:30 am ET

Executives

Phil Sanchez – Director of Investor Relations
Kenneth C. Hicks - President
Robert B. Cavanaugh - Chief Financial Officer
Myron E. Ullman III - Chief Executive Officer

Analysts

Charles Grom - J.P. Morgan
Robert Drbul - Barclays Capital
Deborah Weinswig - Citigroup
Michael Exstein - Credit Suisse
Bernard Sosnick - Gilford Securities.
Uta Werner - Bernstein Global Wealth Management
Lizabeth Dunn - Thomas Weisel Partners
David Glick – Buckingham Research
Michelle Clark – Morgan Stanley

Presentation

Operator

Greetings and welcome to the J. C. Penney Company, Inc. third quarter earnings conference call. (Operator Instruction) At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. At that time if you’d like to ask a question please press “*1” on your telephone keypad. If at any time should you require operator assistance during the conference please press “*0” on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Phil Sanchez, Director of Investor Relations. Thank you, Mr. Sanchez, you may begin.

Phil Sanchez – Director Investor Relations

Thank you, Latania (ph) and thank you all for joining us on the call this morning, to review J. C. Penney’s third quarter earnings. We have scheduled this call to last about 45 minutes, which includes time for questions and answers. Before we begin, let me remind everyone that the discussion this morning includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which reflect the company’s current view of future events and financial performance. The words expect, plan, anticipate, believe, and similar expressions identify forward-looking statements. Any such forward-looking statements are subject to risks and uncertainties and the company’s future results of operations could differ materially from historical results or current expectations. For more details on these risks please refer to the company’s Form 10-K and other SEC filings. Also, please note that no portion of this call may be rebroadcast in any form without the prior written consent of J. C. Penney.

Replays of today’s webcast will be available for 90 days. For those listening after November 14, 2008 please note that this recording will not be updated and it is possible that the information discussed will no longer be current. On this morning’s call we have three speakers: Ken Hicks, President and Chief Merchandising Officer, will discuss our third quarter results and provide an update on some of our initiatives; Bob Cavanaugh, Executive Vice President and Chief Financial Officer, will add some more detail on operating results for the quarter and review our financial condition; and Mike Ullman, Chairman and Chief Executive Officer will make some concluding remarks before we take your questions.

Now, I will turn it over to Ken Hicks.

Kenneth C. Hicks -- President

Thanks Phil and good morning. This year’s third quarter marks the fifth consecutive quarter in which our customers have been dealing with the challenges of a deteriorating economic environment. With the benefit of J. C. Penney’s strong financial position, we have been able to continue focusing on the business initiatives that will best position J. C. Penney to gain market share, both in the current environment and when the situation improves in the future. Let me begin with a recap of the third quarter. Consistent with the update we provided in our October sales release this morning, we reported third quarter earnings of continuing operations of $0.55 per share. This reflects a number of factors, including a decline in sales stemming from the lower mall traffic levels and severely restrained consumer spending. On the brighter side, we made further progress in reducing our inventory levels to reflect both current and expected sales demand. We also continue to be successful in controlling our operating expenses in response to lower sales.

Total sales for the period decreased 8.7% and comparable store sales decreased 10.1% compared with the 2.4% comp decrease in last year’s third quarter. As noted in our October sales release, sales during the last week of the quarter were negatively impacted by a promotional shift that moved a significant event into this year’s November period from last year’s October period. From a geographic perspective the Northeast and Central regions had the best sales trends, while the Southeast and Southwest regions were the weakest, where the impact from soft housing markets has been most pronounced. On a positive note, J. C. Penney continues its leadership position in apparel, where our sales trends have been stronger than our competitors. For the third quarter women’s and children’s apparel and family shoes were our best performing divisions. By contrast, and consistent with both our recent results and those of the industry, our fine jewelry and home divisions continue to be our weakest businesses.

J. C. Penney’s industry leading Internet business, one of the largest general merchandise e-commerce sites, has also been impacted by the weakness in home division sales. For the quarter jcp.com sales decreased approximately .3 principal percent versus an 11.8% increase last year, as a result of home merchandise comprising a significantly larger portion of catalog and online sales than it does in our stores.

For the quarter our gross margin rate decreased by 120 basis points to 38.5% as a result of increased clearance activity in response to soft sales and to meet our inventory objectives. Our SG&A was very well controlled during the quarter and Bob will provide you with details on this topic in a moment. With respect to inventory management we continue to take significant action and as of the end of the quarter total inventory is down 5.6% despite the addition of 35 new stores since last year’s third quarter. We are satisfied with our inventory position, which is down approximately 9% on comparable store basis versus last year and in alignment with our expectations for sales trends over the remainder of the year. In the third quarter we opened 12 new stores, 11 of which were in our off-mall format. We have now completed our plan to open 35 new or relocated stores in 2008, which represents a 2.8% increase in gross square footage.

In addition to new stores, we have also completed 21 major renovations, 3 expansions, 90 store refurbishments and updates, and significant fixturing and store environment improvements in over 600 stores across the country. We also added 10 new Sephora inside J. C. Penney locations, which brings us to 91 locations. Sephora brings an industry-leading beauty concept to our customers and continues to be one of the strongest parts of our business. We will further expand this concept with 64 additional Sephora inside J. C. Penney locations planned to open next year. Overall, our third quarter results were not what we planned, but with the successful execution of our bridge plan we were able to take actions to protect earnings and still bring inventory levels to the appropriate level. Let me turn now to the initiatives we have underway to drive our business in the fourth quarter and into 2009.

First, I would like to cover what we are doing from a marketing perspective. We recognize the pressures facing our customers this holiday season and the unprecedented competitive environment for retailers. Customers want great style, they want lasting quality, and they want to give gifts that are memorable, special, and reflect thought and care; and they want it all at a very affordable price. As a result, we know it is especially important to communicate a clear, compelling message to our customers that reinforces all the reasons to shop with us. J. C. Penney has always been known for offering quality at great prices and now, more than ever, we have the style she’s looking for. We know that every day matters to our customers, especially in difficult times. The objective of our marketing is to clearly provide our customers with the answer to the question, “Why J. C. Penney?” To answer this we have planned an aggressive, integrated marketing campaign to explicitly show how we are making the joy of giving come alive in our stores, on jcp.com, and in our catalogues.

Our first holiday ads launched today and you will see them in various forms on television, in cinema, in print and even mobile messaging. They are charming, compelling, and show the great value in shopping with J. C. Penney. In addition to our strong marketing campaign, we also recognize the importance of having newness in our merchandise assortments. For this holiday season we have redoubled our efforts to provide our customers with a better-than-ever Red Box gift collection with distinctive, stylish gifts for every member of the family.

Along with our enhanced gift strategy, other examples of where we have introduced newness include the launches of Decree and Fabulosity in juniors, Flirtitude in intimate apparel, and Linden Street in home. All of these brands, some private and some exclusive, can only be found at J. C. Penney, which sets us apart in the market place. We also recently re-launched our highly successful private brands Worthington and Stafford, two of the largest career brands in the country. We have introduced updated styles and cuts that appeal to both our loyal private brand customers, as well as to our newer, younger customers, who have made it clear that they are looking for versatile and modern apparel and for spring 2009 we recently announced two exclusive brands that will add more excitement to our women’s apparel offering. I Heart Ronson is a complete women’s fashion sportswear line designed by Charlotte Ronson, one of today’s hottest designers. Charlotte is known as a favorite designer among celebrities and socialites and she is sure to bring an exciting collection of trendy apparel to J. C. Penney and speaking of trend, we are also pleased to have announced Allen B, a women’s fashion sportswear and dress collection, for the trendy lifestyle customer from master of trend, Allen B. Schwartz.

These are all examples of our efforts to provide compelling reasons for customers to visit our stores and keep coming back. Another reason J. C. Penney will be the first choice for holiday shopping this year is our great customer experience. Customer service has, and will continue to be, a true differentiator for us and we will capitalize on this advantage during the holiday season. We are also excited about our specially designated Red Box gift associates in easy to spot red aprons. We will be providing an extra level of service to customers to help them find that perfect gift. On top of extended store hours and additional services, another mark of convenience for us during this holiday, and all holiday, seasons is the fact that customers can shop with us online through our Christmas and special gift catalogues as well as in our stores in malls across America or our convenient off-mall locations. Taken together, our focus is on delivering a great customer experience through our merchandise, the budget-right price at which it is offered, the service in our stores, and the convenience of shopping across all of our channels.

We are fully aware of the challenges facing our customers this holiday season. We are confident that the initiatives we have put in place will allow us to compete effectively during this year’s fourth quarter.

With that, I will turn the call over to Bob Cavanaugh.

Robert B. Cavanaugh – Chief Financial Officer

Thanks Ken and good morning everyone. Our third quarter results reflect the difficult conditions for all retailers but also show how we have successfully taken multiple actions in response to the environment. Earnings per share from continuing operations of $0.55 were in line with our revised expectations for the quarter. This compares to EPS of $1.17 in last year’s third quarter that included $0.14 of tax credits.

Operating income for the quarter was $255.0 million compared with $411.0 million last year, or a decrease of 280 basis points to 5.9% of sales, compared to 8.7% last year. SG&A expenses continued to be well managed during the quarter, decreasing by $50.0 million, or 3.7%, versus last year. This decrease was achieved despite the addition of 35 new or relocated stores and a gross square footage increase of approximately 2.8% since last year’s third quarter. After store closures, including relocated stores, we have opened 26 net new stores during 2008. SG&A experienced some de-leveraging resulting from the total sales decline and, as a percent of sales, increased approximately 160 basis points to 30.1% versus 28.5% in last year’s third quarter. Our SG&A performance continues to reflect the positive impact on associate productivity from the alignment of inventory levels with sales trends as well as the ongoing benefit in store payroll expense from the use of our workforce management technology. This has been particularly effective as sales demand has decreased.

Total operating expenses decreased by $59.0 million, which included incremental depreciation expense of $8.0 million offset by an $8.0 million decrease in pre-opening expenses. On a year-to-date basis SG&A is $41.0 million less than last year and total operating expenses are $27.0 million lower. As noted in the release, the real estate and other line includes the benefit of approximately $0.02 per share from the sale of two, non-operating properties during the third quarter over and above our normal run rate for real estate operations. Interest expense for the quarter was $56.0 million and the income tax rate was 38.2%. We had 223 million average dilute shares for the quarter, including 1 million common equivalents. Net income, including $1.0 million from discontinued operations, was $124.0 million, or $0.56 per share, for the quarter.

Moving on to our financial condition, J. C. Penney is in a strong financial position with continued financial flexibility to support the key components of our bridge plan and we remain one of the best-capitalized companies in the retail sector. As of November 1 the company had cash investments of approximately $1.6 billion, which reflects the normal decrease from the second quarter balance associated with seasonal working capital needs. Also, as shown in the footnotes in this quarter’s financial statements, the cash and short-term investment balance now reflects amounts that we have reclassified, representing funds due from credit card settlements at the end of the quarter. These amounts were previously shown on the balance sheet as receivables and are normally collected the first business day following the quarter end. Our reporting is now consistent with industry practices. We ended the quarter with long-term debt of $3.5 billion.

Capital expenditures for the quarter were $242.0 million, in line with our bridge plan and we continue to anticipate full-year capital expenditures of approximately $1.0 billion. For the third quarter our cash flow metrics continued to improve as a result of inventory management and reduced capital expenditures relative to last year. On a year-to-date basis the contribution to cash flow, represented by cash flow from operating activities less the sum of capital expenditures and dividends, is approximately $250.0 million favorable to last year.

During the third quarter this metric was about $100.0 million better than last year. In the fourth quarter the year-to-date difference will decrease, due primarily to lower net income. Turning now to earnings guidance for the fourth quarter, as Ken mentioned, our inventory position continues to align with current sales trends and we anticipate the year-over-year trend in gross margin rate to improve from the 120 basis point decline experienced in the third quarter. However, total gross margin dollars are expected to decline due to lower total sales. And we anticipate our fourth quarter operating income, as a percent of sales, will be impacted primarily by pressure on operating expenses from sales de-leveraging. In addition, our guidance for the fourth quarter includes incremental expenses for depreciation, amortization, and pre-opening expenses, related to new stores open both this year and last year, of about $15.0 million, net interest expense of approximately $60.0 million for the quarter, and a tax rate expected to remain at approximately 38%.

We currently anticipate approximately 223 million average diluted shares, including about 1 million common stock equivalents, in the fourth quarter. As noted in the release, our guidance for the fourth quarter earnings is in the range of $0.90 to $1.05. Before I turn it over to Mike, let me address the pension expense issue that has the potential to have a significant impact on earnings per share for 2009. As we have discussed previously, we have one of the most successful and best-funded pension plans among U.S. companies generally and we were in the top 2% in terms of funded status coming into 2008. Since the plan’s inception in 1966, our average annual return on planned assets through this year’s third quarter has been approximately 9%. You may also recall that the plan’s funded status has been supported by our pre-tax contributions of $1.2 billion during the 2002 to 2006 period. At the same time, we are disadvantaged relative to most other companies due to the mark-to-market accounting methodology we use to value plan assets at each measurement date, which creates greater volatility in annual pension expense or income.

This method was chosen over 20 years ago and is consistent with the preferred methodology from the financial accounting standard for accounting rules, SFAS 87. As an example of this volatility, let me share with you what the calculation would have looked like if our pension expense were to be based on the plan asset values as of the end of this year’s third quarter. As of November 1, the asset values had declined from approximately $5.2 billion at the beginning of the year to approximately $4.0 billion. The return on planned assets as of November 1, 2008, since the beginning of the year, was about -22%, based largely on the increase in the amortization of the accumulated, unrecognized actuarial loss. Our pension expense under this scenario would be approximately $180.0 million. Relative to this year’s pension credit of $133.0 million, the negative swing, year-over-year, would be about $313.0 million, or about $0.87 per share. Keep in mind that this is only an illustrative example and that we will not know the actual impact from pension expense until the asset measurement date at the end of our fiscal year. Let me conclude this discussion by once again reminding everyone that the pension expense is a non-cash item and that even at 2008 third-quarter-ending asset values, our plan remains fully funded and under the Pension Protection Act funding rules, we do not expect to be required to make a contribution to the plan during 2009.

In summary, we continue to have the financial flexibility to support the strategies of the bridge plan. This will enable the company to strengthen its competitive and financial position and to be successful when the environment begins to improve.

Now I will turn the call over to Mike Ullman.

Myron E. Ullman III – Chief Executive Officer

Thank you, Bob and good morning. We feel good about our team’s execution of our bridge plan in a very tough climate. Everything we can control, we are controlling; the battle of the macro forces we can’t control. The pillars of our bridge plan, the four pillars, first, we effectively have control of our inventory with our comp store inventory levels now approximately 9% below last year. Having said that, our stocks are in good position for holiday within stocks and all our great gifts but at a level that reflects the sales trends we are experiencing. Second, we are aggressively managing expenses. As Bob said, we are $50.0 million in SG&A lower than third quarter of last year. Our store staffing expensing levels are appropriate, without taking away from customer experience. So we have been able to achieve savings with our workforce management technology and we are looking very carefully at our home office expenses and it is the focus of rigorous cost containment.

Third, we are being prudent with capital expenses this year and into 2009 and 2010. And fourth, importantly, we have one of the strongest financial positions in the retail industry. Of course, offsetting all of this are the impacts of forces we can’t control. The markets remain volatile despite the fact the election is over and home heating oil and gas prices have come down. Housing markets have not seen any improvement, particularly impacting Southern markets. Our home businesses are weak for us now, but it is important to understand that we are the leader in this area, which will be a critical advantage when the market turns. Our home assortments are edited and consistently getting better. Our new brand, Linden Street, appeals to younger families at popular prices and the customer response has been very positive. Our recent independent competitive score card of our five peers has us number one in home merchandise among five competitors—number one in The Brands I’m Looking For and number one in Selection.

Next, mall traffic is down. This is not a secret, but importantly for us, we are outperforming them all in our mall stores and traffic and sales trends with the right style, high-quality merchandise with very competitive prices, especially compared to other mall anchors and the specialty stores in the mall. As you know, regional malls are the center of activity during the Christmas shopping season. So we feel well positioned to take advantage of that. But we are also fortunate to have 400 off-mall stores, including over 130 in our new 100,000 square foot format. As you know, off-mall today is enjoying better trends than malls. Customers are more consistent in their shopping patterns in off-mall formats. It appeals to many customers the desire to pay discount store prices although they are also getting a department store experience in the same format. Sales at off-mall stores are more productive in the company as a whole and therefore accretive to our earnings.

Looking ahead, just a brief update on our bridge plan, we expect the environment to remain tough and we are planning our business accordingly. We are making less merchandise commitments up front. We think we have a competitive advantage with long-standing relationships with our suppliers in Asia that puts us in a strong position to react to positive trends from an inventory standpoint, supported by exceptional flow in our cycle time capabilities. Our in-house brand capability also makes an enormous contribution to our ability to read and react quickly. Another positive note is we don’t expect any inflationary cost increases in 2009, which is much better than our original expectations only six months ago and very good news for our customers that expect us to be at sharp price points, and we now expect to open 17 new and relocated stores in 2009 with a CapEx of approximately $600.0 million versus our $1.0 billion commitment in 2008. Let me highlight a few critical aspects of what we are doing to withstand the environment and emerge stronger.

First we think it is essential to be innovative and continue to offer exciting and inspirational merchandise. At J. C. Penney customers get the best of both, department store merchandise that customers are proud to give and get, but at very compelling price points. The ongoing strong performance of our apparel business, women’s and kids’ in particular, is confirmation that we are making trend-right merchandise with styles that customers find very compelling. It is important to note that women’s and kids’ are among the toughest categories to merchandise and we are outperforming the competition. Our women’s team, led by Liz Sweeney, for example, has been together for a number of years and their deep knowledge, expertise, and guidance has been instrumental in delivering the number three women’s market share of any retailer in the U.S. Additionally, our customer appeal extends very clearly to new brands to differentiate us from the competition. Newness and innovation continue to perform well for us. So we will continue to roll out compelling new merchandise offerings like Fabulosity, Decree, I Heart Ronson, and Allen B. As Ken mentioned, we continue to roll out our highly successful Sephora inside J. C. Penney concept.

As to American Living, Roger Farah, President of Polo Ralph Lauren, discussed on their call on November 5 that based on the launch in spring 2008 we have a year’s worth of customer knowledge that is allowing us to build up the early feedback we got and make the line truly great. Spring 2009 disturbance was the first to reflect this direct feedback. To quote Roger, he said, “There is a great deal of excitement by the J. C. Penney customer for the product, marketing, and brand positioning.” We think he is right. The holiday delivery of American Living merchandise looks great as well as the future deliveries we see for summer and next fall. So when the questioner ask themselves, “Why J. C. Penney?” we think we are answering that question clearly in our marketing, in our stores, with our catalogues, and jcp.com. As a matter of fact, jcp.com just crossed the $1.0 billion sales level at the end of the third quarter. So we feel very good about a record-setting fourth quarter. Consistent with our Every Day Matters positioning, our marketing shows our customers we understand their financial pressures.

As Ken discussed, our marketing message is designed to show the great value in shopping with us and the great style, lasting quality, and a price that makes sense for them and their family in these difficult times. We are aggressively marketing, particularly in areas such as markets where Mervyns locations are closing, to make sure the Mervyns customers know that J. C. Penney is their new shopping destination. So how do we measure success in this environment? We have three key constituencies: our customers, our associates, and our investors. We also have one of the strongest consumer research capabilities within the industry. So our focus is to listen, first to the customers. Customers continue to rank J. C. Penney number one in overall customer service. These results are directly correlated to the ongoing focus we have placed on engaging our associates, coupled with the success of our Customer First initiative. Just to give you an example of some of the areas that we rank number one when asking the customer about our service, we are number one Available Sales Associates, we are number one in Associates Treat Me With Respect, number one in Knowledgeable Associates, number one in Satisfactorily Answering Questions, and number one in Going Above and Beyond to Satisfy My Needs.

Our second major constituency is our associates. Over the last four years our associate engagement scores have increased ten full points to 76% in 2008, which makes J. C. Penney’s workforce one of the most engaged group of associates in the service sector, or in corporate America total. We are proud of that. Our associates have the authority and the training to deliver a great experience to our customers. As a matter of fact, in our recent survey, of which 91% of our associates participated, the question that went up the most was ‘I have the authority to do my job’ and the second most was ‘I have the training to do my job’. At this point I would just like to take a moment to thank all of our associates for their commitment in this very difficult time, particularly those facing our customers and we know how hard they will work during the Christmas season to deliver our results. Our management team is committed to supporting our associates in the important work that they do. The third constituency is our investors. To our investors we say we want you to understand we intend to continue to balance the near-term initiatives with our long-term strength of our business. We recognize that market conditions won’t reflect the efforts we are putting forth in the near-term but we are confident that through our strategic efforts J. C. Penney is well positioned to not only weather this storm, but come out as a stronger company with a strengthened market share position. As has been the case in virtually every previous downturn, the strong will get stronger and the weak will cease to exist.

And with that, we will now take your questions. 31:11

Question-and-Answer Session

Operator

(Operator Instructions) Thank you. We’ll now begin the question-and-answer session. If you’d like to ask a question, please press “*1” on the telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press “*2” if you’d like to remove your question from the queue. For participants using speaker equipment, it maybe necessary to pick up your handset before pressing the star key. Once again to ask a question, please press “*1” on your telephone keypad. Our first question comes from Charles Grom with J.P. Morgan. Please proceed with the question.

Charles Grom - J.P. Morgan

Thanks good morning everybody. If I can take up a question on pension, just a follow-up there when you look at 2009, given the headwind of $213.0 million, you are starting in a deep hole, given that it runs through SG&A. Are there buckets of opportunity on that front? Because if I run my model with comps down 7% and if I think gross profit margin is going to be flat, I calculate an EPS that is way below the street for 2009 and I’m not asking you talk about 2009 EPS but is there some stuff in SG&A that you guys think you can cut back on next year in addition to store hour payroll that you have done so well over the past couple of quarters?

Myron E. Ullman III

Chuck let me mention one aspect and that is we continue to see opportunities in the store support area. Our inventory visibility and our ability to re-engineer the way we handle the flow of merchandise from the dock to the floor we believe is a new opportunity. Our workforce management, as you know, has been successful and we continue to see minimum improvement there. I think it is important to note that what Bob said is a hypothetical example at the end of the third quarter. We really don’t know what the number is for the end of the fourth quarter and this is a non-cash accounting adjustment. So we actually look at the business from an operating point of view on the basis of what we can do in terms of central overhead and store staffing. But we are quite confident that we will continue to be rigorous about our expenses and that the dollars will be managed as carefully as possible.

Charles Grom - J.P. Morgan

Okay thanks and then plan assets of potentially $4.0 billion, your PBO at the end of last year was $3.8, you guys don’t expect to make another contribution in 2009?

Robert B. Cavanaugh

No, the assets, as I indicated Chuck, as of November 1, 2008, were $4.0 billion. The PBO at that point was $3.6 billion and so we are still about 10% asset to liability, 110% ratio. We will disclose that in our 10-Q, like many other companies. I would like to point out, too, though, as disclosed in our 10-K, from a longer-term perspective, since 1966 the pension accounting expense or income has been cumulatively in an income position through 2008 of roughly $40.0 million, as we disclosed in the 10-K at the end of 2007. So that is roughly $1.0 million of income per year in each of the last 40 years and the last time we were in this situation, you may or may not recall, was in 2001, 2002, and 2003. In 2001, just before the market declined, we had pension income of roughly $80.0 million and we had a negative swing in 2002 and 2003 and we ended 2003 with a pension expense of $130.0 million approximately, or a $210.0 million negative swing at that point. So we went from, in 2003, pension expense of negative $130.0 million to 2008, five years, of pension positive $133.0 million, or an expense swing of $263.0 million over the last five years. But from a longer-term perspective, we are in a net credit position, which is unique in U.S. industry.

So from that perspective, from a normalized perspective, this is very competitive, provides great long-term benefits for our associates and is a more cost effective expense dollar-for-dollar versus a 401K savings plan. But I will say this. You may also recall that to reposition from an associate’s perspective, value perspective, we did shut the plan to new associate entrance into the company at the beginning of 2007. So we do have a reducing liability going forward and the associates who have joined us since 2007 enjoy an enhanced 401K savings plan but they do not enter the pension plan. So, like many other companies, we have repositioned our benefits for the competitive environment and that will provide a benefit to us over time, but clearly not in 2009.

Charles Grom - J.P. Morgan

Great thanks very much for that. Just one quick follow up just on the balance sheet, can you provide us for the fourth quarter, can you share with what your inventory outlook is for the fourth quarter and also how you are planning receipts for this spring and what Peter is doing is doing for the fall for you guys? Thanks.

Myron E. Ullman III

Ken, can you take that?

Kenneth C. Hicks

Yeah, we continue to plan our inventory in line with the sales so we think it will be less than last year, in line with the sales forecast that we have and Peter is doing a good job in making sure that we continue our cycle time reduction efforts so we are being more responsive and also at the same time, as we said in the call, that we do not see any significant cost increases coming from overseas in 2009.

Myron E. Ullman III

I think there is another point that we have made over the last couple of years and that is our ability to deliver more frequent deliveries, smaller quantities at a time, and get more flow back, allows us to make less up-front commitments and react by getting back in the business of best sellers. So it’s a combination of being trend-right, smaller deliveries, and shorter cycle times that gives us a competitive advantage in the visibility to flow merchandise.

Kenneth C. Hicks

And with that, get that inventory in the right stores.

Charles Grom - J.P. Morgan

Great, thanks very much.

Operator

Our next question comes from Robert Drbul from Barclays Capital. Please proceed with the question.

Robert Drbul - Barclays Capital

Hi good morning.

Myron E. Ullman III

Good morning.

Robert Drbul - Barclays Capital

Two questions, the first one is for Ken. Ken, when you look at the sales mix that you have out there, can you comment a little bit about private label versus the branded merchandise and whether or not there is a mix shift and what the levels have been and your expectation in the fourth quarter and then the second question for Mike, Mike, given your seat on the Fed in Dallas, any macro thoughts you might be able to share with us that you found pretty insightful in your period there?

Kenneth C. Hicks

Okay I’ll go first. Within the sales our private label remains at about the 45% level that it has been. We have seen a slight increase in our proprietary label with the addition of some of the brands such as American Living. We haven’t seen a significant change in our private label and what we have seen is a decline in our secondary and tertiary brands that we had within the store and that has been replaced by our proprietary labels that we have added.

Myron E. Ullman III

To the overall monetary outlook or fiscal outlook for the U.S., clearly the level of confidence the financial institutions had six or eight months ago is very low and the risk to the economy was primarily the lack of liquidity and lack of credit availability and the collateral values underlying the financial institutions. As all of you know, the Federal Reserve has been very, very aggressive in reacting to those financial pressures. There has been less focus on the consumer up until the last 90 days. As the consumer has started to realize that their own situation is in jeopardy because of the value of their home, the value of their 401K, the employment picture, the cost increases that they perceive to be in food and in energy, obviously consumer confidence has plummeted. The Federal Reserve, on the monetary side, is not so involved in the consumer issues, that’s more of a fiscal policy issue, and I guess just on the observation, I think the new administration, it’s job one for them to try to understand how to get the consumer back in the game. It’s 70% of the economy. People with money are not spending as freely as they otherwise would because they are concerned about the lack of visibility into 09 and beyond. So I know that the new President and the administration sees that as a high priority. I know that the Federal Reserve, from a monetary point of view, is very supportive of making sure that the financial system is there to support the fiscal policy decisions that are made.

Robert Drbul - Barclays Capital

Thanks Mike. Good luck.

Operator

Our next question comes from Deborah Weinswig with Citigroup. Please proceed with the question.

Deborah Weinswig – Citigroup

Good morning.

Myron E. Ullman III

Good morning.

Deborah Weinswig – Citigroup

Can you talk about your marketing plan for holiday 2008 and how has that changed versus the original plan?

Myron E. Ullman III

I think one of the main changes, we were trying to balance our commitments in terms of expense to messaging to our customers with our desire to maintain as much of the bottom line as possible so the balance between driving sales and being able to deliver the bottom line. As mentioned, there has been a shift in terms of the type of media that we are using and also the type of messaging we are doing, making sure we reinforce Why J. C. Penney is in the customer’s mind. We know that she knows we have great quality and we know that she knows that we have great prices but we want to make sure we emphasize that. What many don’t know is we also have great style and so the combination of showing our innovation, showing the excitement of the Red Box gift programs, gifts throughout the rest of the store, and the excitement that Christmas brings is the messaging. We have a media launch next Monday in New York with all the media outlets to be sure they understand our messaging strategy. Ken you want to corroborate?

Kenneth C. Hicks

Yeah I think, when you look at the marketing there are two major changes. One is the focus on style and value that Mike was talking about. You will see more of that, both in our branded and our promotional messaging, so that there will be a strong effort there. And with regard to the advertising and marketing itself, we are working very hard to make it more effective, with the media we are using, using our standard media but also things like movie, e-mails, search, and better targeting of that media. So it really is talking to the customer that we want to talk to so that we make sure we get that emphasis across of the style that we have, with the value that we offer.

Deborah Weinswig – Citigroup

Without getting into the details I know that you sent out an annual Christmas book which we received a few months ago. Is there anything that you are doing to communicate with the customer again, to kind of remind of your presence and that you have great deals this holiday season?

Kenneth C. Hicks

You will see us on TV. You will see us when you go to the movies, starting today. Also, with our direct mail we are making stronger statements there with Christmas books and in our catalogue. We have changed the way that we have targeted our catalogue so we get to more people. And I think you are going to see a lot more online messaging.

Myron E. Ullman III

I think one of the advantages of the integration we did with the direct catalogue, online, and stores organizations, from a merchandising point of view, is just a more coordinated effort across all three channels as well as from the messaging point of view. So part of our messaging efficiency is actually making it more effective in front of the customer so we would have a duplication and to be stronger in what they do get.

Kenneth C. Hicks

And with that, more consistent assortment so that they will be talking about the same items and the customer won’t think it is two different companies. They will see it as one company.

Deborah Weinswig – Citigroup

And then my last question, on the store-opening front, I think you said planned stores are now 17 for 2009.

Myron E. Ullman III

Right.

Deborah Weinswig – Citigroup

Do you have any dry powder if there are opportunities as a result of consolidations, especially off-mall?

Myron E. Ullman III

Absolutely, as a matter of fact, just a comment on the 17, we had 20 original for 09 and because of certain projects where the developer hasn’t brought together the proper alignment of retailers or other factors regarding housing in those areas, we have been able to move those projects out to more appropriate time frames. But we will be aggressive in areas where we are under-represented. But keep in mind we are very strong in our footprint across the country and we’re not going to overpay for real estate. Lots of times when retailers fail it’s because there are a number of factors that made it a failure. Part of it might be where they are located or the configuration of the box. So overpaying for the wrong size and the wrong place is not a good strategy.

Deborah Weinswig – Citigroup

Well thanks so much and best of luck for the holiday season.

Myron E. Ullman III

Thanks. 45:26

Operator

Our next question comes from Michael Exstein with Credit Suisse. Please proceed with the question.

Michael Exstein - Credit Suisse

Thank you very much, gentlemen. Two quick questions for you, one is inventory levels and if you go back to 06 and you compare your sales and inventory levels, over the last two-year period, sales are down about 9% but inventories are still up 5%. Is there some goal, in terms of long-term, where you want to see the inventory to sales ratio? And how long do you think it might take to get there?

Myron E. Ullman III

I think there might be a shift in the way the cost inventory appears based on the pipeline that we have and the higher penetration of product that we develop ourselves. Our turns are improving. So the answer to your question is our long-term objective is to continue to improve the turn. We think the flow initiatives we have and shorter cycle times, more frequent and smaller deliveries has been the reason our turns are improving. Inventory utilization has also improved as you narrow the assortments and the less tertiary brands. So a brand like American Living coming into our assortment allows us to be more focused on big ideas. Decree, Ambrielle, Linden Street, A&A and American Living, these are all concepts that are getting more of our real estate and turning at a faster rate.

Michael Exstein - Credit Suisse

And then finally how are you doing in terms of culling brands? Because you keep adding a whole level of brands either in taste or fashionability, what’s the response from the consumer? Are you overshooting in any way?

Myron E. Ullman III

No, I think we have been very effective at getting rids of brands. The customer has been voting for some time that they’re not as important so we just use the opportunity to stay with the winners. I think in this environment where many of suppliers are feeling the pinch by having fewer brands to deal with and more and more important to, they know we are going to pay them, and they are not as strong obviously. The customer has voted.

Michael Exstein - Credit Suisse

Perfect. Thank you.

Myron E. Ullman III

Thanks

Operator

Our next question comes from Bernard Sosnick with Gilford Securities. Please proceed with the question.

Bernard Sosnick - Gilford Securities

Good morning. First I’d like to thank you for the clear outline of pension expense and profits going back over time, was very helpful. What percent does credit represent in relation to your total sales? And has it changed very much over the last several quarters?

Kenneth C. Hicks

With credit, what has changed recently is we see more debit cards and more cash. There hasn’t been a remarkable change in our own card credit. We expect that to change going forward as we re-evaluate how we are going to offer our own credit, at the end of our current agreement with our provider. So I would say it is a shift but it’s not so much anything we’ve done as much as the customer is using more convenient means of paying.

Bernard Sosnick - Gilford Securities

And in marketing, typically it has been very effective to market to your best customers, credit card customers. Have you given any thought to the merits of doing that? Of course it will still be useful, but could you explain a little bit more how you have shifted your marketing to address customers that may have been drifting away or sitting on the sidelines? There is a fight for the marginal customer and how are you addressing that?

Kenneth C. Hicks

Three things, one is we have the capability to communicate and talk with customers that use third-party credit and debit cards and checks. So we do talk to them and not just people who use our own credit cards. Second, with the new media that we are using, online, cinema, mobile, search, we are working to bring in new customers into the fold and continue to identify people who have not shopped with us in a while or have never shopped with us so that they can learn about the new offering and new brands that we have. The third thing that we have done is we have introduced a program called JCP Rewards, which allows us to recognize those customers who are loyal to us and encourage people who may not have been as loyal to us to become more loyal through a loyalty program. They benefit with information about our events, marketing, and discounts at certain times of the year and based upon their spend.

Myron E. Ullman III

Just as an observation Bernard, I think what you can learn from the past is during downturns it is very important to focus on your existing customers. Losing an existing customer is very expensive to get them back. So our primary focus is on the customers, that half of the families in America that currently shop with us, but as Ken said, the way we are attracting new customers is having them realize that style and the trend-rate merchandise we have is an interruption to their view or their perception of J. C. Penney. Many of them know that we have style in some of the more conservative lifestyles but they are not as aware of what we have in modern and trendy merchandise. So, as Ken said, we are trying to balance our inventory of core customers with offering attractions that bring in new customers.

Bernard Sosnick - Gilford Securities

Thank you. That was a lightning answer. Good luck in the field.

Myron E. Ullman III

Thanks Bennie.

Operator

Our next question comes from Uta Werner with Bernstein Global. Please proceed with the question.

Uta Werner - Bernstein Global Wealth Management

Good morning.

Myron E. Ullman III

Good morning.

Uta Werner - Bernstein Global Wealth Management

I wonder if you could tell us a little bit about these new stores you are planning for next year. How many of those might be net new and how many of those might actually be relocations out of existing mall locations you might have?

Myron E. Ullman III

Okay. We only have one relocation out of that 17, so they are virtually all new. The footprint continues to be in those markets where we are under-represented and with the highest return, calculation of the highest ROIC, and with developers that have performed the best in terms of bringing the projects together well-financed. You will see us have the same kind of scrutiny as we look at 2010. We are not going to try to lead out of the downturn by taking a lot of risks on projects that aren’t fully developed. We know that we are committed to free cash flow positive performance in 09 and 10 so we are going to act accordingly.

Uta Werner - Bernstein Global Wealth Management

Okay thank you.

Myron E. Ullman III

Thank you.

Operator

Our next question comes from Liz Dunn with Thomas Weisel. Please proceed with the question.

Lizabeth Dunn - Thomas Weisel Partners

Hi thank you. I guess can you address where you’re running for November so far? I know it’s difficult because of this shift in timing of the promotional event, but we have heard from a number of retailers that November is off to a horrible start. I was wondering, if you could address that?

Myron E. Ullman III

Maybe I can address it in this way. We won’t speak about our results, but it is clear that the worst week thus far in the fall from all traffic was the first week of October and I think the first week of November is also not up to expectations of major shopping spenders. So I would say that there is no one in their right mind, who would start commenting on what they think the specifics are going to be day-by-day or week-by-week in this environment, except to say that we feel that we will obviously represent ourselves well with the way our customers interact with our associates. We think we have the right merchandise, and we just need the customer, to feel better about themselves and get out and shop.

Lizabeth Dunn - Thomas Weisel Partners

Okay and then secondly can you discuss your overlap with Mervyns and whether or not you expect to pick up any business as they liquidate or any other retailers that are closing stores?

Myron E. Ullman III

Yes, currently of the 177 stores that are going to be closing, 36 of them we are already a co-tenant in the center. So obviously those are immediate opportunities and there are another 88 or so that are within five miles of our store. So we have a very specific targeted marketing program. We think, particularly with the diverse customer base they have, we are strong with the Hispanic customer, for example, in many of our stores so we feel that we have an attraction. Key vendors have made it clear that they want to maintain their business with those customers and those are vendors we have in our store as well. So I hate to say that we are good at this, but in other situations where people have left the market we have been able to retain a good portion of the business that was there by that merchant.

Lizabeth Dunn - Thomas Weisel Partners

Right, thank you.

Operator

Our next question comes from David Glick with Buckingham Research. Please proceed with the question.

David Glick – Buckingham Research

Yes sir, good morning. Just two quick questions, Ken I was wondering if you could give us an insight on the average ticket that you are seeing. It seems clear that consumers are trading down although a few retailers have surprised us with higher average tickets in the third quarter, and then Bob, some sense of where you see free cash flow for the year.

Kenneth C. Hicks

Overall, our average ticket David, is running about flat. We have got some mix changes as big ticket, furniture and jewelry have larger decreases, but within each of the businesses, we are running about flat to last year.

David Glick – Buckingham Research

Great thanks. And Bob?

Robert B. Cavanaugh

Sure. I think as you saw we are year-to-date David, $250.0 million better than last year and as I indicated in my remarks that we would be off in the fourth quarter, principally on a year-over-year basis due to the lower net income. In addition, there is actually a fourth quarter effect of de-leveraging on some of our working capital items because of, and this would be from kind of a second derivative change perspective on a year-over-year basis because of all the effective inventory management year-to-date, we actually go down a little bit on a year-over-year change, when you look at all the working capital items in totality in the fourth quarter. In addition, we have a dividend payment in the fourth quarter that we did not have last year of about a little over $40.0 million. Net-net, to answer your question, right now we are planning to end the year with about $250.0 million to $300.0 million negative free cash flow. About $100.0 million to $150.0 million lower than last year. But we would still end the year at about $2.0 billion in cash investments, well positioned going into next year and with the actions we have taken on our capital expenditure reduction, as Mike said, our bridge planning is to be free cash flow positive, even under the most stress-tested scenarios for earnings in 2009 and 2010.

David Glick – Buckingham Research

Great, thank you very much.

Operator

Our next question comes from Michelle Clark with Morgan Stanley. Please proceed with the question.

Michelle Clark – Morgan Stanley

Good morning, thank you. First I wanted to touch on your comp guidance to the fourth quarter, down 9% to 11%. If you look at it on a three-year basis that assumes a flat trend relative to third quarter. I’m just wondering why you are assuming a flat trend sequentially there and then second question is on marketing dollars, you spoke about getting more aggressive in terms of marketing for holiday. Just wanted to see if you can give us a sense of what marketing dollars would be versus a year ago in the fourth quarter? Thank you.

Myron E. Ullman III

I think, first of all, anybody that is as sensitive to the market conditions it’s hard to say that there is any reason to assume things are going to get dramatically better in the near term. I don’t see any driver of customer sentiment in the next quarter. If you look at employment, if you look at housing, if you look at the credit availability for consumers, one has to assume it is going to continue to be sluggish. As to our holiday marketing, as I think we mentioned earlier in the call, we are maintaining our commitment to marketing, but repurposing the dollars to make them more effective. And what the customer is going to see is going to look like a stronger message and more frequent message and more interruptive message, but in terms of its effects on SG&A one of the ways we have been keeping SG&A below last year is holding our marketing flat and being more effective and getting the productivity out of our store. The fact that our store customer service scores are going up at a time where we are able to be more effective in store payroll is an indication that technology and all the investment we have made in that area is paying off.

Michelle Clark – Morgan Stanley

Thank you.

Phil Sanchez

I think it is the last question, Latania.

Operator

At this time I would like to turn the call back to management for closing comments.

Myron E. Ullman III

I would just like to make one comment. Today is the 28th anniversary of Bob Cavanaugh’s 30th birthday, so we would like to wish him a happy birthday and we appreciate the questions today and know it’s going to be a difficult quarter but we feel we are well prepared for the season.

Phil Sanchez

Thank you.

Operator

This concludes today’s teleconference. You may disconnect your lines at this time. Thank you.