Various commentators on Seeking Alpha have, in my view, recently made a few erroneous assertions with respect to JCPenney's (NYSE:JCP) current liquidity situation, as well as the company's Q4 2013 earnings report. Consequently, in order to clear up areas of apparent confusion regarding this subject, I would like take this opportunity to attempt to correct the following misconceptions:
Misperception #1: The $650MM revolving loan that is currently outstanding under JCP's revolving credit agreement matures on April 29, 2016. (Please note that the revolver, along with amendment 1 thereto, may be found here and here.)
Comment and Correction: Under the revolver, whenever JCP draws down a Revolving Loan, that loan will become due on the "Borrowing Maturity Date" for such loan. The Borrowing Maturity Date is the date that is, at the latest, 364 days after the date of funding thereof (or any sooner date, if designated by JCP in its borrowing request), unless the Maturity Date for the entire facility would occur prior to such 364th day, in which case the draw would be due on the Maturity Date (see Section 2.03 of the revolver and the definition of "Borrowing Maturity Date" therein). The Maturity Date for the revolver is April 29, 2016. However, the Borrowing Maturity Date for the original $850MM draw under the revolver was April 4, 2014, as disclosed on p. 7 of the 10-Q for Q2 2013, as well as in an 8-K filing from last April.
This explains why there were two different "maturity" dates set forth in the Q2 10-Q regarding the revolver and the $850MM draw. The first date (April 4, 2014) refers to the maturity of the $850MM (since reduced to $650MM) draw and the second date (April 29, 2016) refers to the maturity for the entire credit facility (i.e., unless the revolver Maturity Date is extended or the revolver is refinanced, JCP will not be able to make any further revolving draws after April 29, 2016, and must repay any outstanding draws by such date).
Misperception #2: The $650MM revolving loan that is currently outstanding under the revolver will need to be repaid in cash during JCP's current fiscal quarter (i.e., JCP will actually need to locate and send $650MM to its banks to repay the draw in order to re-draw this amount). The implication of this assertion is that this could somehow negatively "affect JCP's cash flows" or liquidity situation during Q1 of FY 2014.
Comment and Correction: JCP does not need to repay this outstanding borrowing during Q1 in order to redraw the same amount. Under Section 2.06 of the revolver, on or prior to the current Borrowing Maturity Date for the $650MM borrowing (which date I assume is still April 4, 2014), JCP will simply need to request a Refinancing Borrowing under the revolver for $650MM and this will automatically roll the outstanding amount for up to another 364 days. JCP does NOT have to repay the $650MM in order to reborrow it. Thus, there will be no negative impact on JCP's cash situation or liquidity either because of, or upon the occurrence of, the Borrowing Maturity Date (i.e., JCP will not have to find an extra $650MM in cash somewhere to repay this draw). In any event, as of the most recent earnings report on February 26, 2014, JCP had $1.515B in cash and cash equivalents on its balance sheet and over $2B in total liquidity (see here). This implies that on such date JCP had at least $485MM in current availability under its revolver, even with the $650MM still drawn. Therefore, as of February 26, 2014, JCP had the ability to repay the entire $650MM revolving loan if it so desired, even though there is no pressing reason to do so (since the loan can simply be refinanced without cash as noted above).
The applicable text of Section 2.06 of the revolver reads as follows:
In the case of each Refinancing Borrowing, the proceeds thereof shall be deemed to have been applied to repay the Borrowing or Borrowings specified as being refinanced thereby in the applicable Borrowing Request and no funds shall be required to be advanced by any Lender in respect of the making of any Loan included in such Refinancing Borrowing or by the applicable Borrower in respect of the repayment of any Borrowing being refinanced thereby.
Please note that the foregoing assumes that JCP is not in default, or has a Borrowing Base imbalance, under the revolver at the time the $650MM borrowing matures, either of which would prevent JCP from rolling the borrowing - see Section 4.02 of the revolver. Note also that it is possible that JCP has already rolled the $650MM for another 364 days since the date of the last 10-Q filing on December 5, 2013, in which case the Borrowing Maturity Date would now be sometime in late 2014 or early 2015.
Misperception #3: The $650MM loan outstanding is somehow not a draw under JCP's revolving credit agreement. It is a term loan or other kind of bank loan.
Comment and Correction: This misperception is mystifying, since JCP has repeatedly said that the $650MM draw is a revolver draw on numerous occasions. For example, see p.33 of the 10-Q for Q3: "On April 12, 2013, we borrowed $850 million under the 2013 Credit Facility of which $200 million was repaid during the third quarter of 2013. As of the end of the third quarter of 2013, $650 million of the borrowing remains outstanding." The only type of borrowings that are available under JCP's revolver are the following: a Revolving Loan, a Swingline Loan or a Protective Advance. Since the $650MM draw is clearly not a Swingline Loan or a Protective Advance, it clearly must be a Revolving Loan.
Misperception #4: JCP's interest rate will go up if and when it rolls (re-draw) the $650MM loan outstanding under revolving credit agreement.
Comment and Correction: Nothing in the revolver states that the interest rate on the $650MM revolving loan increases if this loan is rolled for an additional 364 days (or, if applicable, lesser number of days).
Misperception #5: JCP's adjusted earnings numbers of $(0.68) for Q4 2013 and $(5.74) for FY2013 somehow "missed" analysts' estimates or that JCP's calculation thereof fails to conform to "industry standards."
Comment and Correction: As a reminder, heading into the earnings release, analysts' estimates, as reported by First Call, were as follows: Q4 = ($0.82) and FY2013 = (6.11) (see here and here). JCP beat these estimates by $0.14 and $0.37, respectively. That, combined with JCP's favorable guidance for FY2014, has since sent the stock price skyrocketing, up approximately 40% since the earnings release. No reputable retail analyst has asserted that JCP either missed Q4 or FY 2013 estimates of adjusted EPS when they reported on February 24, 2014, or that JCP somehow did not calculate these numbers in accordance with "industry standards." For examples of analysts' responses to the earnings release, see here, here, here, here, here and here. None of these suggest even the slightest skepticism by such analysts with respect to the calculation by JCP of its adjusted EPS numbers.
Misperception #6: JCP must have been improperly monkeying around with its pension numbers in order to boost GAAP EPS for Q4, resulting in positive GAAP net income of $35MM for Q4.
Comment and Correction: Allow me to preface this response by saying that I am far from an expert in pension accounting, so the following should be taken with a grain of salt. We will need to see the 10-K in order to determine exactly how the Q4 pension numbers were arrived at.
Having said that, I believe that the positive adjustment resulting from the annual re-measurement of JCP's pension plan referenced in the Q4 earnings release was almost certainly caused by, at least in part, an increase in the discount rate used by JCP to measure its pension liabilities at year end 2013, due to interest rates rising during the year. (Note that many companies have increased their discount rates similarly - see for example, p. 105 of GM's 10-K filing for 2013, which states that the discount rate used to calculate GM's U.S. pension plan obligations increased from 3.59% at year-end 2012 to 4.46% at year-end 2013.)
The effect of this increase would be to reduce the present value of JCP's future pension liabilities, resulting in an actuarial gain that gets recorded in Other Comprehensive Income (i.e., not as regular income, since OCI is not included in GAAP net earnings). As stated on p. 59 of JCP's 2012 10-K filing, JCP "adjust[s] other comprehensive income/(loss) to reflect prior service cost or credits and actuarial gain or loss amounts arising during the period and reclassification adjustments for amounts being recognized as components of net periodic pension/postretirement cost, net of tax." The actuarial gain from the pension remeasurement furthermore appears to have created a tax expense (also recorded in OCI) equal to $270MM.
However, offsetting the $270MM OCI tax expense would, I believe, be a reversal of its tax valuation allowance in an amount equal to $270MM. Reversals of valuation allowances are recorded as regular income (not OCI), hence the addition of $270MM to the income statement in Q4. There would be no net effect under the statement of comprehensive income for Q4, though, since the $270MM gain under net income would be completely offset by the 270MM tax expense recorded in OCI.
The foregoing explanation appears to be consistent with the following excerpt from JCP's Q4 earnings press release:
In the fourth quarter, the Company recognized a tax benefit of $270 million primarily related to gains resulting from the annual re-measurement of the pension plan. This tax benefit was offset by tax expense recorded for such gains in other comprehensive income.
It is important to note that, regardless of how JCP arrived at the precise numbers with respect to the pension accounting, the $270MM gain in Q4 was a non-cash gain and has no impact on JCP's current liquidity (positive or negative). Clearly the focus for JCP has been, and will continue to be, the level of the company's cash burn, not non-cash items. However, a decrease in JCP's future pension obligations could result in lower future required contributions to its pension plan, thus benefiting JCP's liquidity situation in future periods.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.