JCPenney 2004 Annual Report Download - page 19

J.C. PENNEY COMPANY, INC.2 004 ANNUAL REPORT
Management’s Discussion and Analysis of Financial Condition and Results of Operations
17
rebuilding the customer franchise and restoring the profitability
of the Company to competitive levels on a sustainable basis.
Competitive operating profit margins are necessary to restore
the Company’s return on invested capital and return on stock-
holders’ equity to retail industry standards and thereby improve
the Company’s access to the capital markets. Until the
Company’s credit ratings improve to investment-grade levels,
access to the capital markets for cash needs will retain an ele-
ment of uncertainty. As such, management intends to maintain
sufficient cash investment levels to ensure support for strategic
and operational business needs, long-term debt maturities, div-
idends and contingency items.
To manage financial risk, management utilizes scenario
analysis and “stress testing” in the planning process.
Contingency plans are developed to ensure financial flexibility
and liquidity levels are maintained during periods of deteriorat-
ing economic conditions, potential shortfalls in profits and cash
flow and limited access to the capital markets.
Longer term, a strong financial position is dependent on the
Company achieving a competitive level of profitability on a sus-
tainable basis. As a result, management is focused on moving
from successfully executing a turnaround to achieving top quar-
tile performance within the department store sector.
•Internal Control —The Company is responsible for maintaining
effective internal control over financial reporting in order to
provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements
for external purposes. Under Section 404 of the Sarbanes-
Oxley Act of 2002, effective as of year-end 2004, management is
required to report publicly on the effectiveness of the
Company’s internal control over financial reporting and has
included Management’s Report on Internal Control over
Financial Reporting on page 23. Additionally, the
Company’s external auditors are required to express an
opinion on management’s assessment as well as on
the effectiveness of the Company’s internal control over
financial reporting. KPMG LLP’s report is included on page 24.
Ineffective internal control over financial reporting would not
allow the Company to adequately prevent or detect
misstatement of its financial statements or adequately
safeguard the use of its assets.
In preparation for the initial reporting under Section 404, the
Company established a SOX Steering Committee to oversee the
Company’s progress and status. During 2004, the Company
dedicated significant internal resources in order to ensure that
both its internal controls and the related documentation were suf-
ficient and to test the effectiveness of identified key controls. As
discussed previously, going forward, the Company will continue
to dedicate full-time resources in order to ensure that its internal
control over financial reporting remains effective and adequate-
ly documented. Further, the Internal Audit group is in the
process of reviewing and making recommendations for further
enhancement of the Company’s fraud controls.
Operational
•Merchandise Selection and Allocation — Key to the
Company’s success is having merchandise in the styles, sizes
and colors that the Company’s customers want when they want
it. Over the past few years, professionals have been hired with
expertise in buying and sourcing for each merchandise division
under a centralized business model. Additionally, as discussed
previously, systems and logistics centers have been rolled out to
better allocate and flow inventory to stores and better track
sales trends to enable prompt replenishment and manage pricing.
In addition to the Company personnel, processes and sys-
tems, the key to merchandise selection is listening to the cus-
tomers. The Company conducts ongoing consumer research to
determine attitudes and perceptions of the Company and its
offerings versus its competitors. This has led to significant edit-
ing of assortments, enhancements to key private brands, such
as the Arizona apparel line, and the development of new private
brands, such as the Chris Madden for JCPenney Home
Collection, Turning Home into Haven.
The end of quotas is changing the foreign sourcing process
for all retailers. With private brands representing about 40% of
total sales in 2004, the Company has an extensive worldwide
sourcing organization that has been preparing for the end of
quotas for several years. The Company has implemented con-
tingency plans that include the identification of alternate
sources for product and the uninterrupted access to product.
The Company could be impacted by logistical or other issues
faced by suppliers or have an interruption in one of its own store
distribution centers. However, the Company has a diversified
supplier base, both domestic and foreign, and is not depend-
ent, to any material extent, on any single supplier. Additionally,
the Company has business continuity plans in place for all mer-
chandise distribution centers that would provide rerouting of
merchandise allocations to have uninterrupted flow of merchan-
dise to both stores and direct to customers.
•Systems —The Company’s operations are dependent upon
the integrity, security and consistent operation of various
systems and data centers, including the point-of-sale systems
in the stores, data centers that process transactions,
communication systems and various software applications
used throughout the Company to track inventory flow, process
transactions and generate performance and financial reports.
The Company seeks to minimize operational risk associated
with communication and information systems through the devel-
opment of back-up systems and emergency plans. The
Company has disaster prevention and recovery plans in place
should events occur that could interrupt operations. Ongoing
assessment and testing is being conducted to minimize current
and future risk. There is a process in place to provide regular
associate training, operating instructions and site visits to help
limit operational defects or mistakes.
Consumer Market
•Reputation —The Company’s success depends not only on its
ability to attract and retain target customers by consistently