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J.C. Penney Company, Inc. (NYSE:JCP)

Q4 2013 Results Earnings Conference Call

February 26, 2014, 4:30 pm ET

Executives

Kristin Hays - Senior Vice President of Investor Relations and Communications

Mike Ullman - Chief Executive Officer, Director

Ken Hannah - Chief Financial Officer, Executive Vice President

Analysts

Matthew Boss - JPMorgan

Neely Tamminga - Piper Jaffray

Heather Balsky - Bank of America Merrill Lynch

Brian Nagel - Oppenheimer

Robert Drbul - Nomura Securities

Paul Trussell - Deutsche Bank

Paul Lejuez - Wells Fargo

David Glick - Buckingham Business Group

Oliver Chen - Citigroup

Bernard Sosnick - Gilford Securities

Operator

Good day, ladies and gentlemen, and welcome to the JCPenney Company Earnings Conference Call. My name is Celia and I will be your operator for today. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today, Kristin Hays. Please proceed.

Kristin Hays

Thank you. Good afternoon, everyone. As a reminder, the presentation this afternoon includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, which reflects 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 presentation may be rebroadcast in any form without the prior written consent of JCPenney. For those listening after February 26, 2014 please note that this presentation will not be updated and it is possible that the information discussed will no longer be current.

With that, I will now turn the call over to our CEO, Mike Ullman.

Mike Ullman

Good afternoon and thank you all for joining us today. Our Chief Financial Officer Ken Hannah, I am glad to be with you. Today, we will update you on the status of JCPenney's turnaround, take you through our fourth quarter and full year results and then discuss some of our expectations for next phase of turnaround in 2014. Following that, we will look forward to answering your questions.

Let me start by saying, I am extremely proud of the company and its 116,000 associates. We are working extremely hard to restore JCPenney to its rightful place in retail. We know it isn't always easy, but we are well on our way. When I returned to JCPenney last April, the management team and I identified a variety of things that needed to be fixed in order to turn this company around and repositioned us for profitable growth.

We also realized this turnaround would come in three phases, the immediate stabilization phase, followed by a phase rebuilding and then the go forward phase positioned JCPenney for long-term growth. Over the last 10 months, we completed the first two phases of our turnaround in a very tough and highly competitive environment and this year progressing [go-forward] phase.

Before we set out our priorities for 2014, I would like to take a few moments to discuss the accomplishments in the first two phases of the company's turnaround. First, we knew we had to stabilize the business financially and operationally.

Over the first several months, we reinforced our relations with key domestic and international suppliers and we met with leaders across the enterprise and shared our turnaround priorities. This worked to restore call and clarity of purpose within the company and our supplier markets. During that time, we also restored our company's financial position, which enabled us to end the year with more than $1.5 billion in cash and $2 billion in total available liquidity, consistent with our expectations.

Next we shifted our focus to rebuilding JCPenney from the inside out, starting with the management team and the merchandising and marketing strategies that would enable us to reconnect with our core customer. For example, we undertook a difficult and expensive task of rebuilding our merchandise assortments in stores and jcp.com. We invested in inventory ahead of back-to-school and again with holiday in order to meet anticipated customer demand. We brought back key item basics and popular private brands that customers wanted while editing out unproductive brands that weren't resonating. These steps cost us gross margin in the short-term, but they were the right things to do for the long-term.

We also fixed jcp.com by improving merchandise assortments, restoring inventory levels and enhancing the online experience. We realigned merchandising and marketing teams for .com to support our omnichannel approach to the business. We still have more work to do but we are pleased with how quickly the business came around with just these few strategic adjustments. We also built a marketing strategy for the back half of 2013 that focused on traffic and driving promotions, in-store visuals to support the marketing events and delivered a successful marketing strategy during holiday.

In the end, in spite of the significant headwinds facing all retailers this winter, we delivered on our promise to generate positive comparable store sales in the fourth quarter. That included continued growth on jcp.com which saw 26.3% increase in sales versus the same period last year. These are important accomplishments, particularly given the condition of the company when I returned in April 2013 and given the competitive retail environment during holiday. Today, the most challenging and expensive parts of the turnaround are behind us and the work we did in 2013 has laid a foundation for continued progress in 2014.

Before looking ahead to the priorities for the go-forward phase of our turnaround, I would like to highlight some of the key metrics from the fourth quarter. Comparable store sales rose 2% for the quarter, a sequential improvement of 680 basis points over the third quarter of fiscal 2013. For the holiday period, the combined nine week November and December period, the company reported comparable sales growth of 3.1% over the same period last year. Gross margin improved 460 basis points to 28.4% of sales when compared to the same quarter last year.

The improvement, notwithstanding, gross margins in the fourth quarter were negatively impacted by our strategic decision to discontinue several brands that were not part of the company's go-forward merchandising strategy. These brands include JCP Men's, Stafford Prep, JOE by Joseph Abboud, William Rast, Joe Fresh Kids and jcp Everyday. We are also right sizing of the brands such as Joe Fresh in women's apparel, Michael Graves Design, Conran and some other brands in home. Having taking the hit to our margins in the fourth quarter, we do not anticipate a negative impact in 2014 first quarter margins associated with these discontinued brands. Looking ahead, we anticipate further improvement in gross margin for the first quarter as well as significant improvement for the full year 2014.

As part of ongoing examination of store performance, we recently announced we would be closing 33 underperforming stores across the country. The stores will be closed by the beginning of May of this year. This is the toughest decision any leader has to make because they are impacting customers and associates but we need to take these steps to improve our profitability.

Meanwhile we are excited to be moving forward with our plans to open new store location this fall at the Gateway II development in Brooklyn, New York. We plan to host an Analyst Day around that time of the opening to share JCPenney's store of our future as well as provide you an opportunity to connect with our leadership team and get an update on our progress.

With that, I would like the currently call on Ken to take you through the details of our fourth quarter and full-year results.

Ken Hannah

Thank you, Mike and good afternoon, everyone. Welcome to our fourth quarter 2013 financial report. As Mike mentioned, our business continues to show steady improvement and we are very pleased to achieve positive comp store sales in the fourth quarter. In particular, our top line sales performance exceeded our expectations during the critical weeks between Black Friday and Christmas Day demonstrating the progress and success of our merchandising and marketing initiatives. While January was tough for all retailers, our progress continued as the month delivered our best two-year sales back performance for fiscal 2013.

With that, let us walk through the results. Comparable store sales increased 2% for the quarter. This record represents an almost 680-basis point sequential improvement versus the third quarter this year and indicates market share gains relative to some of our competitor performance.

As mentioned previously, we delivered 3.1% sales increase during the nine-week November and December period, despite a very challenging and competitive environment. Excluding the 53rd week of $163 million, total enterprise sales increased 1.6%, including the 53rd week, total enterprise sales for the quarter decreased 2.6% to $3,782 billion for the quarter compared to $3,884 billion in the same quarter last year.

Online sales through jcp.com continued to show significant improvement this quarter, contributing $381 million in sales. Online sales for the quarter increased 26.3% from the same period last year, excluding the 53rd week. Similar to our overall performance, the Online sales trend improved sequentially over the third quarter and the month of January was up almost 45% to last year.

Now, turning back to stores, our traffic trends versus the industry has improved sequentially versus the third quarter, while still negative traffic has outpaced the industry for the last four months as a result of our traffic driving promotions and early successes of our marketing strategy. It is worth noting that total mall traffic was estimated to be down 15% for the quarter.

Our store conversion, average transaction size and units per transaction for the quarter were all up versus last year. This is due in large part to our focus on restocking basics and private branded product, the items customers expect to find in JCPenney, as well as the return of key promotional marketing events.

We have also seen great performance among a number of our national brands. This improvement in conversion and spend could not have been achieved without the tireless efforts and great customer service of our motivated associates throughout all of our stores. Our customer service scores remain at all-time highs.

For the fourth quarter, gross margin was 28.4% of sales, compared to 23.8% of sales in the same period last year, representing a year-over-year improvement of 460 basis points. Our gross margin for the quarter included a negative 190-basis point impact associated with discontinued brands that are not part of the company's go forward merchandising strategy. This includes a 90-basis point impact related to the devaluing of discontinued brand merchandise included in our inventory at year-end.

We made a conscious decision to discontinue these brands now to put past decisions behind us, so that we can focus on establishing a clear path to normal gross margin levels going forward.

Gross margin was also negatively impacted by higher than anticipated clearance markdowns taken late in the quarter. Despite the competitive nature of the industry is important to note that our merchandise margin on our regular and promotional business is running ahead of the margin was generated on those goods in 2011 for both, the fourth quarter as well as the full year.

As we have said before, the higher penetration of clearance in our mix and a negative margin on those goods has continued to put pressure on our gross margin. As I mentioned earlier, the margin impact of the discontinued brands had a negative 190-basis point impact on the quarter.

As these discontinued brands are clear from our inventory, our mix of clearance is expected to return to more normalized levels. As we look forward, we continue to restore a compelling mix of private, exclusive and national brand merchandise that better resonates with our customer and results in fewer markdowns at the end of the selling season.

Based on the improvements we are seeing in merchandise margin on our regular and promotional business, as well as our efforts to move through the difficult merchandise that remained from the previous strategy, we expect our gross margin to continue to improve year-over-year in the first quarter of 2014.

Our SG&A was $1,004 billion in the fourth quarter. That is down $205 million or 17% from the same period last year. The teams continue to do a great job managing expenses throughout the business, with net SG&A savings of almost $1 billion versus 2011 levels.

We are very pleased with the continued attention to expenses and specifically the stores focused on selling and not selling productivity. Continuing with operating expenses, our primary pension expense was $25 million in the quarter, down from last year. Our pension plan remains fully funded and the annual re-measurement process has resulted in our primary pension plan impact on the P&L moving from an expense to income in 2014 driven by asset performance in 2013 as well as prevailing interest rates. Real estate and other was an income of $38 million, reflecting a net gain on the continued sale of non-core assets in the fourth quarter.

Depreciation and amortization expense was $161 million in the quarter, up $4 million from the fourth quarter a year ago. We incurred $50 million in restructuring charges during the quarter, $22 million of which was related to our previously announced store closures, $5 million in management transition expenses and $23 million of other cost related to previous management strategies. Our operating loss for the quarter was $138 million compared to a loss of $745 million last year, an 81.5% improvement.

In the fourth quarter, we have recognized a tax benefit of $270 million primarily related to the change in deferred taxes as a result of the annual re-measurement of the pension plan and the associated genes. This resulted in a favorable impact to earnings per share of $0.88. Our reported GAAP earnings per share is a positive $0.11 for the quarter. Adjusted for the charges we took in the quarter for restructuring, the net gain on the sale of non-operating assets, adding back the pension expense and adjusting for the tax benefit resulting from the pension valuation impact on deferred taxes, we had a loss per share of $0.68.

Now moving to the balance sheet. Cash and cash equivalents at the end of the fourth quarter of 2013 were $1,515 million, an increase of $288 million from the end of the third quarter. Our merchandise inventory is $2,935 million. This is above our previous guidance, primarily based on the timing of merchandise receipts taken in January on go-forward product that carries little markdown risks. As we think about our inventory positioning going forward, we expect working capital to be a source of funds in 2014.

Property and equipment is $5,619 million, up from $5,353 million in the fourth quarter a year ago. This increase is primarily associated with the capital investments we have been making in our stores. Our supplier payable balance at quarter-end was $948 million. Short-term borrowings are $650 million, representing the outstanding borrowings on our existing ABL facility. Long-term debt is up $1,971 million, primarily due to the issuance of our $2.25 billion senior secured term loan facility in the second quarter of this year.

Our operating cash flow for the fourth quarter was a positive $383 million. Our capital expenditures totaled $137 million for the quarter, offset by the proceeds from the sale of additional non-core assets of $55 million. Financing cash flow was a use of $13 million and overall, we experienced an increase of $288 million in our cash and cash equivalents in the quarter. With our fourth quarter cash balance of $1,515 million and the unused portion of our current credit facility, the company had total available liquidity of $2,024 million at the end of the quarter.

As we think about our cash flow and liquidity position going forward, we have visibility of positive free cash flow results under our existing strategy and we have access to the resources we need under our existing agreements to complete our turnaround. We believe we will end the year with an excess of $2 billion in liquidity and believe that our strong liquidity position will be in excess of $1 billion.

With that, I will turn it back over to Mike.

Mike Ullman

Thank you, Ken. On behalf of very one at the company, I would certainly like to thank Ken for his contributions. We are particularly grateful for his help to stabilize the company financially during a very difficult time, as well as staying through to March 24 to ensure a smooth transition. We certainly wish him well and all the best going forward.

We are heading into the final phase of our turnaround. We know that work must be done and we have plan in place to position the company for a long-term profitable growth. During this go-forward phase, we are laser focused on refining our merchandising and marketing strategies in order improve our gross margins and steadily grow sales while continuing to tightly manage expenses and will leverage our expense base.

This year, we are remerchandising many parts of the store, including home part of women apparel and [to enhance] the shopping experience and increased purchase conversion.

We have a marketing campaigns resonating with the right customer segments through the right channels and we have renewed focus on customer research and segmentation our omnichannel strategy, which is focused on creating seamless customer experiences between JCPenney stores and jcp.com.

The long-term goal is to return to historical gross margins and silly grow our sales volume to regain market share, leverage expenses and return to profitable growth. It will take time. We have a realistic plan in place to once again a JCPenney, a leader in American retail.

At this point I would like to provide an update on a few areas that are critical to our long-term success.

First, our merchandise assortments, it is more important than ever that the customer finds the merchandise, she expects to find at JCPenney, including key private and national brands.

We also know that in order to be more profitable, our assortments must grow to be narrow and deep, which means making compasses move away from underperforming brands in order to invest in others.

One important component of our turnaround strategy has been the restoration of key private brands such as St. John's Bay, a.n.a., Ambrielle and Xersion. Customers have strong connection to this strong connection to these brands, which also represent margin opportunities for us.

Just importantly, we need to be the best department stores by key national brands that resonate with customers. In the fourth quarter, we are very encouraged to the continued increases in some of our largest national brands, such as Levi's, Nike, Carter's, Haggar and Dockers, Alfred Dunner and Van Heusen.

We attribute this to the strength of our assortments and the appealing shopping around these brands. Just a few weeks, we will be completing new look our home store. This includes the extensive remerchandising the Home Department has been that underway.

Renewed focus on bedding and bath small electrics, as well as decorative accessories will offer the best value and home furnishings anywhere for the range of merchandise will better fit our customers' budget and their lifestyle.

We are going to call Home Collections of JCPenney. We will also build on our highly successful partnership with Sephora, opening approximately 46 new Sephora inside JCPenney locations, bringing the total number of locations at JCPenney to 492 at year-end and we will continue to introduce exciting new merchandise that we believe can help differentiate us from our competition.

We have new brands we will be launching in men's and women's apparel this spring, as well as in home. In addition, we are ramping up our efforts to localize assortments to meet style, size and climate differences in various parts of the country.

Finally, a word of our suppliers. Over the last 10 months, this group is been tremendously supportive every step of the way. We are grateful to them and [seen their] business with us grow as our turnaround advances.

Next, we continue to improve the look and feel importantly the ROI and our marketing. The progress we made in our marketing efforts during the fourth quarter was encouraging. We have a strong team in place and we are very excited about the work in the pipeline for 2014.

It is of course critical that we fight for and win customer attention, but marketing agreement and communication to cut through the noise and leave and enduring impression that JCPenney will be the customers' needs and wants by filling her size, her wallet, occasions and her lifestyle.

We know it will take time to completely restore that association, who were making great strides. Our marketing efforts will continue this weekend during the Academy Awards, during which will air six new marketing spots that support our When it Fits, You Feel it, campaign.

Next, we intend to accelerate our growth on jcp.com and begin to establish leadership with our omni-channel experience. jcpenney.com continues to perform extremely well in the fourth quarter and throughout our turnaround.

This is due to the reintegration of store and online buying and planning and allocation teams, the improvement in our merchandise assortments and being back in stock across sizes and styles.

We have also reconfigured many the user interfaces on the site to make it easier to shop. All I believe future retailer is omni-channel and we are committed to leading our sector in omni-channel functionality. To help us get there, we brought in Mike Rodgers as Senior Vice President of Omni-Channel Strategy and Execution.

Mike's [responsibility as] EVP, Chief Information Officer of Saks Fifth Avenue, he will help us integrate digital capabilities and marketing between stores in jcpenney.com. Customer experience from marketing, to browsing to check-out has to be seamless across channels and that's what we are working toward. As a pioneer in online retail, we believe JCPenney can and will help lead the way in the development of true omnichannel experience.

In summary, this year we are executing a plan that is designed to improve gross margins and steadily grow sales while continuing to tightly manage and ultimately leverage the expenses. For this strategy, we see a path back to generating positive free cash flow and consistently improving our financial performance. We are truly making solid progress but there is still work to be done. Our strategic plan calls for enhanced performance across all key drivers of our business, merchandising, marketing, store experience, jcp.com, our teams and our operations. The goal is to deliver consistently improved financial results and reestablish JCPenney as a leader in American retail.

With that, we would be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Matthew Boss, JPMorgan. Please proceed.

Matthew Boss - JPMorgan

On the gross margin side, Mike, could you break down some of the pockets of opportunity embedded in the 2014 guidance? And at one point this year, will you fully cycle the issues of the past?

Mike Ullman

Well, as Ken and I both mentioned, we feel that the impact of discontinued brands and so we are not going forward with. It's behind us. Having said that, we still are obviously completing the turnaround. So they did get weaker in gross margin in the first part of the year and in the back half. The key components are the restoration of the full implementation of our private brand assortments. Our private brands are well known by our customer. They deliver terrific value to the customer. At the same time, they deliver the most profitable contribution to our gross profit. Also we are editing out some of the things that do not resonate, allowed us to improve margin in that part of the mix. And our national brands sell-throughs are contributing to better margins for national brand. So we feel good about the three pillars, the private brand, the national brand, as well as the attractions.

Matthew Boss - JPMorgan

Great, and then to circle back to Ken's liquidity comment. I think you did a nice job of walking through that. Are you saying you believe JCPenney can self fund the long-term turnaround from here and at what point is positive free cash flow feasible?

Ken Hannah

I would say, that what we mentioned was that we felt that we would have the availability of excess of $2 billion, as we said, this year, which imply that we have visibility for free cash flow going forward.

Matthew Boss - JPMorgan

Okay. Great.

Operator

The next question comes form the line of Neely Tamminga, Piper Jaffray. Please proceed.

Neely Tamminga - Piper Jaffray

Hi, thank you. I was just wondering if you guys could give us a little color on how you are looking at conversion rates in traffic expected level for Q1 and the first half of the year? And also, what accounts for the delta in your CapEx projections? You said in the release, today, you are expecting $250 million for the year and I think you guys indicated $300 million on the Q3 call. Is it from deferred projects? Maybe a change in the Sephora build out schedule?

Ken Hannah

Okay, to your first point, let me answer the CapEx piece first. As a team, we went through the CapEx priorities, as we felt that there were opportunities to more or less paginate the CapEx in such a way that it would benefit us. So we did not back off on our original commitments of Sephora stores for the year, but some our merchandising projects, we would probably conserve capital in the way we merchandise home and some of the other areas in women's apparel and intimate. We have been able to do it without a lot of CapEx. So it wasn't a major shift nor was it a change in our point of view.

I am sorry. Your first question was what?

Neely Tamminga - Piper Jaffray

If you could give us some more color on the conversion, your expected conversion rates?

Ken Hannah

Traffic and conversion. Our experience versus the industry based on the industry information we have from ShopperTrak and so forth, we ran about 900 basis points favorable to the industry traffic during the fourth quarter. So that's quite encouraging to us. Obviously traffic versus last year is very hard for us to compare since we were running a different strategy last year. So I think it is more relevant look at the traffic in terms of the industry. Our conversions have been largely positive. There have been times when conversion wasn't positive during the worst of the weather, but frankly we have been encouraged by the conversions of the last eight or nine months.

Neely Tamminga - Piper Jaffray

Thank you.

Operator

The next question comes from the line of Lorraine Hutchinson, Bank of America Merrill Lynch. Please proceed.

Heather Balsky - Bank of America Merrill Lynch

Hi. Good evening. This is Heather Balsky calling for Lorraine. I was hoping you could address expense sending for the full year. How much you think you need to spend incremental on customer-facing activities and where is everyone proceeding? Thanks.

Mike Ullman

I think, what I would say about expenses, we have done very effective job of getting our expense structure down to what it needs to be to take care of the customer, taking nearly $1 billion dollars of an expense in the last year or so.

As we look forward, we see that we have not done crazy things to get expense down. We have added expense back in certain cases in order to get the right kind of staffing and we have done that by editing out other expenses that we felt were not customer-facing, so I think your specific question the customer, we don't believe that customer is going to see an expense disciplined evident to them that when they interact with us.

Our customer service of course has been as good as it's ever been and we believe we have done that in a smart way of engineering the staffing. Our Libby terminals that are handheld about a third of the sale devices in each store. The terminals were carried, but sales associate to help great lines when they establish and really make it very easy to shop, so availability of assistance is the speed of checkout.

Those are two scores that have gone way up, knowledge of merchandise has gone way up, for his service and assistance, so we feel really good about our expense structure, we feel really good about how we are delivering to the customer.

Heather Balsky - Bank of America Merrill Lynch

Thank you.

Operator

The question from the line of Brian Nagel, Oppenheimer. Please proceed.

Brian Nagel - Oppenheimer

Hi. Good afternoon. First I have is on cash as well. Just need a couple points of clarification, so you indicated you expect in 2014 in excess of $2 billion in cash are there assumed any type of asset sales that (Inaudible).

Then the second question I have, I think, Ken mentioned in this prepared comments that you expect trough level cash, so you would be $1 billion dollars. The quay is that the same - that the amount of cash you have to have or you need to have on the balance sheet to run the business or is that that required cash is lower than $1 billion.

Mike Ullman

I will let Ken answer that, because he knows it of course.

Ken Hannah

Yes. The $2 billion and $1 billion was the total liquidity, so the cash balance in the $2 billion that we have today is $1.5 billion, so we look across the year and get to the trough, what we said is there would be in excess of $1 billion.

We think that is more than an adequate amount to be able to run the business and so we are not going to have to forgo anything that would constrain the turnaround in order to do that, so I think we are trying to just be prudent.

There has been a lot of discussion that's out about the company's, burning $1 billion-plus in the cash and that certainly is not in our plans, and that's not something that we would expect to happen, so we wanted to give folks some level of comfort that says, we do see a path forward to generating free cash flow and we shouldn't expect the liquidity situation where the company is today and where we would expect it to be at the end of next year given everything that we have access to be vastly different. We do not have any material asset sales assumed in that $2 billion.

Brian Nagel - Oppenheimer

Okay. Just a follow-up on that, so is there a minimum amount of cash you have to have as to run the business?

Mike Ullman

$1 billion, $2 billion liquidity available and you only get as low as $1 billion. I would assume that the pressure point of the peak payables, you have invested $1 billion dollars for the top liquidity availability.

Brian Nagel - Oppenheimer

Okay. Thanks.

Operator

The question is from the line of Robert Drbul, Nomura Securities. Please proceed.

Robert Drbul - Nomura Securities

Hi. Good evening. Just a couple of questions on the cash flow side of it, in terms of giving guidance for '14, what's the normalized level of inventory based on the plans for mid single-digit comps and what percentage of the inventory that you have? Is there a number on the clearance level of inventory?

Ken Hannah

I would just say as we look at inventory for 2014, we are back to a normalized way of running the business, so obviously the inventory fluctuates based on these most promotional activity and we expect to get back to the normal proportion of clearance versus right price and promotional selling, so it is not remarkable compared to what we were seeing in 2010 and 2011. The things that happened in 2013 obviously were extraordinary. I mean we completely changed the assortment of the store and as a result the things that didn't resonate had to be cleared, and in many cases it had to be cleared under cost and that had a very damaging effect to the arithmetic in gross margin.

Robert Drbul - Nomura Securities

And then the second question just on the SG&A spend, are you looking around a dollar number on the sales guidance that you are giving? Or should we think about it around like the percentage of sales? How are you thinking about it going forward?

Ken Hannah

We gave some first quarter guidance where we basically said we thought it would be slightly below the prior year. We don't expect the total year to be vastly different than what we had in 2013. So I think as Mike said earlier, we are continuing to see productivity in the stores. We are continuing to see productivity and return on investment from our marketing spend. And so those are the two big buckets inside that SG&A and we are pleased with the improvements we are seeing and believe that you will start to see leverage in 2014.

Robert Drbul - Nomura Securities

Great. Thank you very much. Good luck.

Ken Hannah

Thank you.

Operator

A question from the line of Paul Trussell, Deutsche Bank. Please proceed.

Paul Trussell - Deutsche Bank

Well, good afternoon. It sounds like a big part of the story for 2014 will be your removal of some of these brands that were underperforming. Can you just give us a little bit more color about the brands and the categories that you will then be emphasizing and putting in that place and also give a better description, maybe some more details on the new home store? What do we have to look for?

Mike Ullman

I think it is very, very easy to our emphasize the strength of our private brands which if you want to look at the proportionality of this is, our private brands used to be 50% of our business, and it dropped to 30% of our business, when we added transformation strategy and that 20% had been invested in national brand, we might have had a better result, but it was invested in new ideas that as it turned out didn't resonate with the customer. So the best way to say as Arizona, Liz Claiborne, Worthington, Stafford, St. John's Bay, a.n.a. Xersion, Royal Velvet, these are brands that are being taken back to the proper levels of assortment. And if you look at the national brands like Levi, Nike, Dockers, Dunner, Van Heusen, Carter's 's, IZOD, Lee, Haggar, these are brands that have been intensified. So we are investing our inventory where the customers are basically saying, we expect to see headquarter assortments when you come to the store. So in merchandising, narrower and deeper is a much more effective strategy than being very, very wide with the less than full assortments. We think that will accentuate the essential categories and the basics the customers want with plenty of fashion and plenty of lifestyle differences within the assortment.

Paul Trussell - Deutsche Bank

Are there any metrics you can provide around that, because that's helpful color, but just in terms of 2% comp in fourth-quarter, what's your key private label brands, how they performed versus some of the other categories?

Mike Ullman

For the fourth quarter it would be very difficult to talk about only because we have the discontinuation in the mix. So I prefer to talk about the go-forward. On go-forward basis, we know that since half the businesses are private brands, those are going to be the ones most successful and the biggest volume. I think two or three of our biggest private brands are bigger than any national brand that we have. Obviously Sephora is an attraction that has a variety of brands inside Sephora that supports a terrific trend and a great differentiator for us. So we don't give competitive information in terms of which brands are the most successful. But I think the customers are very savvy. St. John's Bay is something we walked away from and they have been very vocal about their excitement about it coming back.

Paul Trussell - Deutsche Bank

Okay, and lastly for me, just to go back on the fourth quarter gross margin performance. It did miss your initial guidance of being enough sequentially. Is that at all due to this discontinuation of the brands? Was that not a part of the guidance or not a part of your plans going in to the quarter?

Mike Ullman

We decided after we had given the guidance that as we thought about the go-forward phase, if we really want to finish off the rebuilding phase, let's put behind us the things that the customer really doesn't expect to see in JCPenney. So that did affect our margin and that explains the difference.

Paul Trussell - Deutsche Bank

Thank you.

Operator

Your next question comes from the line of Paul Lejuez, Wells Fargo. Please proceed.

Paul Lejuez - Wells Fargo

Thanks, guys. I am a little confused on the free cash flow comment. Can you just reiterate do you expect to be free cash flow positive in 2014, or are you saying in 2014, you will be able to see a path that when you can be free cash flow positive.

Ken Hannah

We anticipate to complete the turnaround in 2014, and if we completed well, we would [see] free cash flow positive. I think it is too early to be very, very specific, but I think the liquidity guidance we gave you gives you the comfort that we are not burning cash in the process of finishing the turnaround.

Paul Lejuez - Wells Fargo

That would imply that you would be free cash flow positive in '14?

Ken Hannah

I think, I answered the question successfully.

Paul Lejuez - Wells Fargo

Okay, and how long, Ken, do you think you can run the business below that $300 million of level? Is there some pent-up CapEx that you think you need to take place over the next few years as the turnaround take hold?

Ken Hannah

I would say since we spent almost $1 billion in CapEx last year, one would argue that we have not under spent in our store environment, so I think we can live on a diet for a little while. Does not have to be to 250, it could be 350 or 500, but [tailor] to the opportunities we have as merchandise well with the customer.

Paul Lejuez - Wells Fargo

Got you. Then just longer-term, how you think about the right number of stores for business? You are closing 33 in the next few months. What you do think is the right number to have on a go forward basis to run this business profitably?

Mike Ullman

First of all, let's assume that the very, very close to ones we think run profitable, so the ones that are left, we see as profitable, but every year, we go do the same exercise every other retailer does to determine whether net present value of the store warrants of being open or really should we take care of the real estate and move on, so interestingly, some of our smallest stores are most profitable, so it is not easy to assume that just because something is smaller and small town, particular location somehow it's performing well, so we are pretty happy with the portfolio we have now. We constantly look at it, but I would not expect for us to have any big announcements, until next January if there are and we will do the same exercise we did this year.

Paul Lejuez - Wells Fargo

Then just last one for me. Your assumptions behind the 3% to 5% comp guidance, stores versus the e-com has each play into that in traffic versus ticket. Thanks, guys.

Mike Ullman

Well, I think it is fair to say that every person, every retailer is more retailer season, the Internet piece growing faster the stores that were not assuming that we have a major decrease in store. We think we have lots of upside person embracing more as well as jcpenney.com, but we do not break that out prospectively.

We are optimistic about both businesses. If you think about the challenges we faced of taking a clearly different character of inventory and swapping into the next to generation JCPenney with the customer resonates that's a pretty major shift in the merchandise and I think that that shop value we had to work through in 2013.

We are beyond that now, I think what we are showing as guidance shows progressive improvement in comps. If you think about for just a second, no one wants to sit down and order in 10% or 20% more merchandise hoping somebody will come. Turnaround is about disciplined progressive improvement and that's what we call the go forward base.

Paul Lejuez - Wells Fargo

Thanks, guys.

Operator

The next question comes from the line of David Glick, Buckingham Business Group. Please proceed.

David Glick - Buckingham Business Group

Thank you. Just a quick follow-up for Ken, on our liquidity just to make sure I understand it. You are defining liquidity as $2 billion as cash plus that roughly $500 million availability on the revolver. There are no additional sources of liquidity that you are incorporating into that projection.

Ken Hannah

Exactly. We are including cash plus what's currently available to you. We did indicate that we do have an incremental $500 million of capacity available under all of our current agreements, so what if there was need to access that, we have been in discussions with number the banks and we have got full support there, so I think as Mike said we put our plan together this year and we had a clear path to free cash flow number and believe that as we go throughout the year we will make all the necessary adjustments to move the business forward and did not believe that liquidity and cash burn is something that needs to the as top of mind as it has been and we need to focus more on the day-to-day operating results of the business.

David Glick - Buckingham Business Group

Great. Thank you for the clarification. Then Mike, just on the home business in the fourth quarter, I don't know if you are willing to quantify this, I am wondering how much the home division was a drain on the gross margin? The reason I ask is, just looking at the apparel and accessories areas, well certainly there is a lot of clearance, just observing the price points and walking the stores it didn't feel like a gross margin level that you guys put up in the fourth quarter. And I am wondering was their disproportionate drain on your gross margin from home and is that really have the biggest opportunity that you have in 2014 not only from gross margin, but from sales as you expand the soft home square footage and part of your assortment.

Mike Ullman

The simplest answer is yes. Yes, it was the discontinuation of the brands and home was disproportionate to that area. It will be the most benefited by the go-forward and our launch in early March. So as you point out, the relaying of the merchandise assortments saw the softest, larger than hard and the traditional is larger than modern and the opening price points are there and the categories the customer say they missed are there. The great brands are there. And while some of the ideas that we put in the store in the original concept were very attractive, at the end of the day, what matters is what the customer really wants to see in our store. So we want to be the best home store in our space and we intend to grow our business in that direction.

David Glick - Buckingham Business Group

I think it would be helpful for investors to understand just how far below that home gross margin was from your total if you are willing to share that with us.

Mike Ullman

Materially. I think it's very difficult because the mix of the discontinued brands was so high at one point, it varied by month and quarter. But I would like to put it this way, we were quite surprised when we took those plastic down last year and saw the home store in its new form. It was really not aligned with the customer's expectation. It took most of the rest of the year to get ourselves to a better place. I am pleased to say we have a very strong team at this point. Very strong vendor support. I think you are going to like what you see and we are planning to be promotionally very, very clear about the strengths of home store.

David Glick - Buckingham Business Group

So it's fair to say that the apparel and accessories gross margins were well under the 30s and relative to home?

Mike Ullman

We don't break it out that way, as you probably know, but it's fair to say that we know how to buy and sell apparel merchandise.

David Glick - Buckingham Business Group

Okay, great. Thank you very much for the clarification. Good luck.

Operator

A question from the line of Oliver Chen, Citigroup. Please proceed.

Oliver Chen - Citigroup

Hi. Thanks for the detail. Regarding your strategy to restore initial markups necessary to support the return the promotional types of atmospheric, where are you in that journey? And also on that topic of networking capital and the inventory needs, as we model your guidance what should we think about for inventory cash needs in third quarter in terms of a dollar amount of outflow that may be?

Ken Hannah

To your first point, well, specifically, what do you want to know about the first point? Just to answer the right question?

Oliver Chen - Citigroup

In terms of what percentage of your portfolio you are comfortable with at this point in terms of the initial markups in terms of how you source regarding the offering a promotion, if there is a particular quarter as you will see more and more progress there?

Ken Hannah

I would say, progressively second, third and fourth quarter our markup came very close to what we want to be for optimal execution of our promotional strategy. We were a bit too timid in markup. When I first came back, I think we, maybe wrongly, but we didn't probably have enough markup to run the promotional strategy that was going on in the industry. So we took action, but as you know it cycled through the inventory but we feel good about where we are with markup now.

As to the CapEx, in terms of network CapEx, you mentioned?

Oliver Chen - Citigroup

I as just talking about the inventory line in terms of investment you will need as you get ready for holiday and third quarter?

Ken Hannah

It would not be remarkably different than any other holiday period. We peak our inventory obviously going in to November. We paid for the inventory in the middle of November and we saw the inventory at the end of November and in December

I think the curve that you would draw would be the same as everything we did for making 2005 through 2011, so I think last year was a bit strange, because we didn't have our promotional strategy in 2012, so I would say that would be the year that was not normal.

Oliver Chen - Citigroup

Thank you. Other retailers have commented on volatility in February pre-and-post Valentine's Day. Have you been noticing similar trends in your business and do you feel like you have a grasp of where the normalized kind of curve is relative to your guidance?

Mike Ullman

We are not going to comment by week. I think, we are not immune to the weather. We heard there were 300 stores closed during a period of time one place or the other, so I would say that we felt good about Valentine's Day, we will feel even better when you get to (Inaudible).

Oliver Chen - Citigroup

Thank you. Best regards.

Mike Ullman

Thanks.

Operator

We have the final question come from the line of Bernard Sosnick, Gilford Securities. Please proceed.

Bernard Sosnick - Gilford Securities

Thank you. With regard to .com sales in January, there was a big step up in the rate of increase and I am wondering whether or not it was a anomalies or perhaps an indication of a faster rate of growth going forward, particularly to indicate strange coming from our home goods that might imply good response in the stores when the reset occurs in March.

I think that is a fair comment. We have been pleased as you know, home is a very large proportion of our .com business. That was a historically very important part of our big catalog business back within the catalog business, so we feel very good about - as I said we think the prospects for home are positive and .com, actually since .com didn't have a lot of the physical attributes of what the year remodeled stores look .com for home has been good for some time.

We are very committed to the internet business, so we think the customer I think is traumatized to a degree of all the bad weather and probably it was a particularly excited by shopping even online during parts of the bad weather, but we are encouraged by our online business and continue to invest in it.

Bernard Sosnick - Gilford Securities

Just one other point, following your return and a return to promotions, there was difficulty in getting the promotional cadence up to the strength of that you would have desired for reasons, private brands weren't fully available, the initial markups wasn't high enough. When it comes to, let's say Easter and going forward, would you say that the promotional intensity would be where you would have wanted it to be all along?

Mike Ullman

I think, Bernard, it is fair to say that no retailers probably gone through the trauma, of potentially turning around and going the other direction and expecting it to be seamless, okay, so we in fact did make mistakes.

I think that the rumor that we somehow gave the goods a way during the fourth quarter that we over promoted, I am very pleased to say our forecasting in terms of how we saw holiday, we ran the promotion we planned to run. We ran them effectively and came out with positive, kept the promise despite all presentation went on during the quarter, so the answer your specific questions. We expect to run our promotions effectively all through '14, do not see a disconnect of what we are doing versus how we are planning it.

If anything we are doing a better job of aligning where we should invest by event, occasion and by week to be a better productivity out of our dollars as Ken mentioned, so I would say that is one that I would put in the finished during the building phase. We are now just executing going forward.

Bernard Sosnick - Gilford Securities

Thank you very much.

Mike Ullman

With that, I think our call is finished. We appreciate you joining us on the call and look forward to working with you in the coming year. We are truly excited about the go-forward initiatives and our team is very motivated to see it to fruition. Thank you very much.

Operator

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.

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