JCPenney 2004 Annual Report Download - page 36

J.C. PENNEY COMPANY, INC.2 004 ANNUAL REPORT
Notes to the Consolidated Financial Statements
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pharmacy benefits management, mail order and specialty phar-
macy businesses. Proceeds from the sale are being used for com-
mon stock repurchases and debt reduction, as announced in
August 2004, and more fully discussed in Note 3.
The loss on the sale was $713 million pre-tax, or $1,433 million
on an after-tax basis. The relatively high tax cost is a result of the
tax basis of Eckerd being lower than its book basis because the
Company’s previous drugstore acquisitions were largely tax-free
transactions. Of the total after-tax loss on the sale, $1,325 million
was recorded in 2003 to reflect Eckerd at its estimated fair value
less costs to sell, and during 2004 the remaining $108 million was
recorded to reflect revised estimates of certain post-closing adjust-
ments and resulting sales proceeds. During 2004, the Company
paid $822 million of taxes due on the sale of Eckerd.
Additionally, $3.4 billion of the present value of operating lease
obligations (PVOL), an off-balance sheet obligation under GAAP,
was eliminated with the transfer of these leases to Coutu and CVS
upon the closing of the sale.
The Company established reserves at July 31, 2004 for estimat-
ed transaction costs and post-closing adjustments. Certain of
these reserves involved significant judgment and actual costs
incurred over time could vary from these estimates. The more sig-
nificant estimates relate to the estimated working capital adjust-
ment, the costs to exit the Colorado and New Mexico markets, sev-
erance payments to former Eckerd associates, assumption of the
Eckerd Pension Plan and various post-employment benefit obliga-
tions and environmental indemnifications. Management reviewed
and updated the reserves in the fourth quarter of 2004. While
adjustments were made to individual reserves, management
believes that, in total, the reserves remain adequate at year-end
2004. Cash payments for the Eckerd-related reserves are includ-
ed in the Company’s Consolidated Statements of Cash Flows as
Cash Paid to Discontinued Operations.
Management is currently negotiating with both CVS and Coutu
regarding the working capital adjustment as required in the sale
agreements, which could take several months to finalize. The two
sale agreements provide for an arbitration process between the
respective parties in the event that agreement cannot be reached
regarding the proper amount of adjustments.
As part of the Asset Purchase Agreement with CVS, it was
agreed that, with respect to the Colorado and New Mexico loca-
tions (CN real estate interests), at closing any of these properties
that were not disposed of would be transferred to CVS. On August
25, 2004, the Company and CVS entered into the CN Rescission
Agreement, whereby the Company received a one-time payment
from CVS of $21.4 million, which represented the agreed-upon limit
of CVS’s liability regarding the CN real estate interests plus net pro-
ceeds from dispositions as of August 25 minus expenses borne
and paid by CVS as of August 25 relating to the CN real estate
interests. Effective August 25, CVS transferred to the Company all
CN real estate interests not disposed of, corresponding third-party
agreements and liabilities. The Company has engaged a third-
party real estate firm and is working through disposition plans for
each individual property.
At the closing of the sale of Eckerd on July 31, 2004, the
Company assumed sponsorship of the Eckerd Pension Plan, the
Eckerd Contingent Separation Pay Programs and various other ter-
minated non-qualified retirement plans and programs. The
Company further assumed all severance and post-employment
health and welfare benefit obligations under various Eckerd plans,
employment and other specific agreements. The Company is eval-
uating its options with respect to these assumed liabilities, includ-
ing, but not limited to, termination of the agreements, plans or pro-
grams and/or settlement of the underlying benefit obligations.
As part of the Eckerd sale agreements, the Company retained
responsibility to remediate environmental conditions that existed at
the time of the sale. Certain properties, principally distribution cen-
ters, were identified as having such conditions at the time of sale.
Preliminary cost estimates have been established by management,
in consultation with an environmental engineering firm, for specifi-
cally identified properties, as well as a certain percentage of the
remaining properties, considering such factors as age, location
and prior use of the properties. Further studies are underway to
develop remediation plans and refine cost estimates, which could
vary from preliminary estimates.
Both CVS and Coutu entered into agreements with the Company
and the Company’s insurance provider in order to assume the obli-
gations for general liability and workers’ compensation claims that
had been transferred to the purchasers at closing. The agreement
with CVS was entered into concurrent with the closing, while the
agreement with Coutu was finalized in the third quarter of 2004. At
closing, the Company had approximately $64 million in letters of
credit pledged as collateral to its insurance provider in support of
general liability and workers’ compensation claims that were trans-
ferred to Coutu as part of the Eckerd sale. Upon the finalization of
the insurance assumption agreements, this amount was reduced to
approximately $8.5 million. Based on a separate agreement
between Coutu and the Company, Coutu will provide replacement
letters of credit to the insurance company no later than September
17, 2006, which will release the Company from any further poten-
tial obligation.
The Company is providing to the purchasers certain information
systems, accounting, banking, vendor contracting, tax and other
transition services as set forth in the Company’s Transition Services
Agreements (Transition Agreements) with CVS and Coutu for a
period of 12 months from the closing date, unless terminated earli-
er by the purchasers. One Transition Agreement with Pharmacare
Management Services, Inc., a subsidiary of CVS, involves the pro-
vision of information and data management services for a period of
up to 15 months from the closing date. Under the Transition
Agreements, the Company receives monthly service fees, which
are designed to recover the estimated costs of providing the spec-
ified services. To the extent actual costs to provide such services
exceed the estimates, any additional costs incurred are reflected in
discontinued operations.
Discontinued Operations in the Consolidated Statements of
Operations reflect Eckerd’s operating results for all periods pre-
sented, including allocated interest expense. Interest expense
was allocated to the discontinued operation based on Eckerd’s out-
standing balance on its intercompany loan payable to JCPenney,
which accrued interest at JCPenney’s weighted-average interest
rate on its net debt (long-term debt net of short-term investments)
calculated on a monthly basis.
Mexico Department Stores
In November 2003, the Company closed on the sale of its six
Mexico department stores to Grupo Sanborns S.A. de C.V. of
Mexico City and recorded a loss of $14 million, net of a $27 million
tax benefit. In 2004, the Company recognized a gain of $4 million
related to additional tax benefits realized.