JC Penney Co Inc JCP
Q2 2012 Earnings Call Transcript
Transcript Call Date 08/10/2012

Operator: Greetings and welcome to the JCPenney Second Quarter 2012 Earnings Conference Call.

Ron Johnson - CEO: Good morning, everybody. Thank you for coming. Welcome. We've got a really nice update today. We're going to start with the financial update on the current quarter. We'll talk about technology trends as we promise. We'll talk about our new store design and we’ll then take some questions at the end, but let me thank you for coming on a interesting Friday at New York weather-wise. But before we get started the financial update, I thought I'd just share sort of my perspective on the first six months of leading JCPenney in the first period here of our transformation.

The first and most encouraging thing to me is I am completely convinced that our transformation is on track. We are making extraordinary progress in everything we’re doing. The teams are working hard and I can’t express more appreciation to tour team members, our vendors about the commitment they are making to our future, but our transformation is on track. But it’s very clear that withdrawing from our promotional model to a more everyday model has been harder than we anticipated, but it doesn't change our conviction that the promotional model had run its course and that we have a far better path forward and we’re committed to getting there.

As I mentioned we made extraordinary progress in so many areas, but in the past six months we've also made some mistakes and I’d like to talk about two of those in particular before we get started, and those relate to our pricing and our marketing efforts. When we started last January here, we talked about how in 2011 our company ran 590 unique promotions and the average item had 20 to 30 prices – different prices during the year, and so I figured going to three types of prices will be a lot simpler. A great everyday price, some items at a month long better value, and then clearance, which we call best price, but after going through 3 to 4 months of trying to communicate that to the customer it was clear it was confusing and what we wanted to deliver was great everyday value that the customer trust and understand and it's very clear that the three types of prices was confusing people, hence we got to fix that. The second thing on our marketing as much as it got a lot of attention and made people rethink JCPenney, in many ways it overreached our core customer and didn't do the hard work we needed to do. People find it entertaining, but it wasn't doing what it needed to do in the first six months to build our business, and in many ways we're trying to build the brand ahead of its time when we really needed to build the business, and we spent our marketing money in the wrong way, too much TV, not enough print and that had an impact on the business. So, we made some mistakes.

In mid-June I had one of these moments where I had to make a decision and it was a difficult one, but I decided that we were in an essence going to go dark on our marketing until we got it right. Sometimes we're not quite sure what to do. What I've learned in my career it's important to look at kind of what not to do, and I made the decision that we want to stop confusing our customer until we figure out exactly how to communicate our value message and who JCPenney is for the next decade in the right way. So, we made a tough decision.

We cancelled a July book that was printed and ready to go. We cancelled the July preprint, July week one that was printed and ready to go. We didn't run a preprint July week four. We turned off television. We made a lot of changes, but the whole goal was to pause, take a moment, rethink how do we communicate our extraordinary value strategy and how do we get the customer to love where we are headed, and we went through a lot of work and we thought deeply about those issues, and as I did that, the one thing we were heartened by was we went back to a lot of the company’s heritage, and I found a quote from 1920 which was some dance cash pending it said the following. We never overprice our goods, we never have special sales. As reasonable profit is all we desire and does not change for some special sale at 10%, 20% or 50% off. We do not believe in that system of business. This company was founded on everyday pricing strategy.

Sam Walton records as JCPenney as where he was inspired to build the Walmart business, and every brand if it's true to itself connects with its heritage can access its own DNA. And as we thought deeply about that we said the everyday business model is unique to us and in our DNA, but we haven’t fully embraced it. We have been courageous to simplify our pricing, but would have been courageous enough. Because we have left one element in our pricing strategy which was (indiscernible), which was a month long value, because the customers clearly told us if you have great everyday prices how can you have things on sale for a month called the month long value. There is something inherently inconsistent with that. How can you call it best price yet which was our name for clearance, if your everyday prices are so good.

So ultimately we didn’t have the courage to embrace our history to truly deliver on an everyday model and so we decided we are going to make a change and so on August 1 we simplified our pricing and today we have two types of prices, we have an unbelievably great everyday price and it's time to go away what we call clearance. And that change happened in our stores August 1.

For six weeks every merchant went through our entire assortment and we repriced their merchandise, because without the need for a month long value we could sharpen our everyday prices and we took all of the core essential items whether they are basic or a fashion essential for the season and price them even sharper to make sure when the customer walks in the store they tremendous everyday value on every item on the floor.

We took our marketing and we shifted our budget from brand building to business building. So, as an example, in the entire spring season we only ran 11 preprints in the newspaper. We have eight for August. We have 30 for the back half. We're reducing the money on television. We'll still run television and we're investing heavily in the traditional traffic driving median, so be in the newspaper and we think that's going to be good. And our preprints have changed. There is no lifestyle in them. They're all about brands, products and pricing, so the customer knows exactly what we're offering which is great style at a great value and you've seen that already in our stores.

We reedited all of our television from August in a called action. So, if you look at our television commercials, they announce things like free haircuts or they include the brands, the company we keep like Levi in our television ads. We've worked really hard. We retailed all our in-store presentation with signing and communication in how we do (indiscernible) the aisles and this all happened over a six-week period when we de-promoted to make sure we're doing things right and we launched one of these things as we launched free haircuts for every kid and (indiscernible) in America, because why, because our goal is to help Americans look better and live better, and we want every kid to make a great impression for back-to-school. That's mission. That's our heritage. It's about helping Americans live and look better. So, we made some changes, all right?

Now, in an effort because of all the change to be fully transparent as I'm going to talk to you about the first 10 days of our performance for back-to-school.

As you know, we've seen the spring results that came out, Ken will talk about those in a moment, but with all of our marketing changes, we're encouraged. We're in a period of the most intense promotion the JCPenney ever runs. Last spring there were four weeks when we had our most promotional value where the Sunday starts with people or Monday $10 off your first 10, on Wednesday to get another chance $10 off 25, friends and family events. We ran two of these in the first quarter and two of these in the second quarter.

Our best performance those weeks was down 31%. So, when you see our quarterly results, that's an impact of good weeks, bad weeks, but when we had the intense promotion, we were down in the 30%. Our traffic would be down anywhere from 14% to 20% during those intense promotional periods. Well, for the first 10 days with our new marketing, our traffic is down 7% to last year, which is a dramatic improvement, and our sales are running about 2% better than they ran over the spring period. Now, is that where we want to be long-term no? But remember, during these kind of periods during the spring we ran down over 30%. So, clearly our new marketing, our new message is getting through, we have more traffic in the stores, people are buying more, and we're encouraged by that, alright?

On the shop front, we have rolled our first shops, and as you know, we'll have 10 shops by September 1 and therefore forming exactly as we hoped. They are driving comp store revenue increases and higher averaging retails, and I'll talk to you about one. We put in a Levi's shop which many of you have seen, a whole new way to buy denim which includes broader assortments, it includes a denim bar and our trend in Levi's is up 25% over last year, over stores that don't have shops, because it's only about our largest 700 stores and over our (indiscernible).

So, immediately we've had a huge boost in the Levi business. But even more important is our average retail on jeans sold in Levi's is up over $5 to last year, which means the shop is helping us sell better fashion, better products. We're selling colors we never did in the past and we're very encouraged by that and we're seeing improved performance in Arizona as well and our Buffalo shop doesn't have a compare. But we're thrilled with our shop performance.

In haircuts, it's pretty incredible. Today we will cut on our tenth day of this effort to help Americans look better, help the kids look better. We'll do our 500,000th haircut, free haircut. And today customers will book their millionth appointment during the month of August to get a haircut. I received a letter this morning from a kid and one of the store manager said a kid came in, that had been to class yesterday for back-to-school and all the kids were talking about a haircut, and he didn’t have one and he said to mom, I want to go to JCPenney to get my haircut, and so it's having a nice impact.

We're now entering phase two of our transformation. In the spring all we could do is change the price on goods that were bought. We now have 50% of the content New Years Eve fast on the stores. The shops are rolling out. We got retail marketing and we're excited about where we are headed. But while we hope the change we make now produce better results, we are not going to plan on it for the fall season. It's really important you understand.

We're going to plan the business at the continued levels of spring, because the most important thing is to get our inventory in line with our sales trend. That’s what’s going to drive our profit and we’ve got to maintain a full-price business, that’s the price here, so we will not do anything in the short run to change that path we’re on. And so because we’re going to plan our business line with current trends, we made the decision to pull our guidance.

Every decision we’re making is totally in the interest long-term of our shareholders, our stakeholders, our employees and we’re not going to short-circuit a really strong business strategy for the sake of five months, because we’re five months from the finish line. It's August today. Our last promotion was run December week five. In January last year we were done as we started the transition to our February (indiscernible). So we’re seven months into our change, we’ve got five months to go, we’re not going to change. We fully expect to resume growth and profitable growth in fiscal year 2013 and we’re excited about it, and we can't wait to get there.

In January we laid out a four-year plan to transform this company. We said this will be a really tough year. Somehow I don’t think that message got through. Your expectations were much higher than ours, but transforming a company is a marathon; it’s not a sprint. It takes time. A lot of you thought it would be a sprint. It can’t be and it won’t be, and an interesting thing about running marathon is there are lot of ways to run. Some people start out fast and try to hold one and some people start out at a measured pace and have a strong kick, and we’ve got a clear path on how we’re going to get to the other side and how to become America’s store and we’re going to stick to that roadmap and today I’m going to talk to you about our technology platform that we talked about, we’re going to talk about new store design, but before I do that I want Ken to really walk through the financial performance of the quarter with a focus on our balance sheet and our cash position because there's been so much misunderstanding about that that we want you to walk away today very clear that we got a rock-solid balance sheet that's going to carry us through the next five months until we resume highly profitable growth in 2013.

So, let me turn it over to Ken right now. Welcome Ken Hannah, please.

Ken Hannah - CFO: Thanks Ron and good morning everyone. So, I know it's early. We set out these slides ahead of time, so that you'd have a chance to go through and see them before I went through them and also an attempt to be transparent and we know this is tough and our goal here is to make sure that you've got insight into what we are doing. What I want do today is, I want to walk you through the income statement. I want to talk a little bit about the charges that we took that we believe actually position us for a long-term position that will allow us to be successful. I want to walk through the balance sheet and the changes to-date and then also the cash flow statement, and when we are done in light of pulling the guidance, I would like to share with you what we see as our long-term business model.

So, sales, little over $3 billion for the quarter, that's down from $3.9 billion a year ago and down from $3.1 billion in the first quarter. The comps as Ron said negative 21.7%. When we look at our financial metrics, we talked about sales, the comps, the trend is down slightly from the first quarter and that's primarily representative of our decision to go dark in the back half of the quarter on the marketing. Our traffic, we're down 10% in the first quarter, down 12% in the second, so again directly tied to our decision to go dark in the back half of the quarter, so we could get the marketing message right.

Our conversion was actually up in the quarter at 21.9%, so a nice job by our stores and the people there converting that traffic into sales and then our average spend per visit was down about 3% which we would have expected going into the spring with a higher propensity of shorts and t-shirts.

So our reported gross margin was 33.2% now before all of you go and sell your stock let me walk you through what we did this quarter in order to position our self for success in the long term. So first of all you'll see an explanation in the press release regarding what we are calling transitional shop markdowns. These are not traditional seasonal markdowns these are not fashion items that we didn’t sell that we are marking down, these are specifically markdowns in a reserve that we took for the merchandise and brands that are going to be discontinued as part of rolling out our shop strategy so this is accounting for that merchandise that goes away with the August 1 shops that you all have seen.

Our September 1 shops that are going be coming and our shops going into the first part of next year. So this is a reserve today that we've taken to go ahead and markdown the value of that inventory for those brands and that merchandise that’s going to be discontinued. So this is not something that we should continue to see going forward of any material nature. It is different than the reserve that was taken last quarter to try to address the fact that as the new leadership and the new strategy came to fruition we took a reduction to account for the fact that we had access in aged inventory. So when you go through the release we try to lay that out in a way so you can see specifically the differences between the decision we made as a management team in Q1 and the decision that we've made here in Q2, so that's about 340 basis points. So, excluding that decision our gross margin would have been 36.6%. Now, that's still lower than the 38.3% that we reported the same quarter a year ago, so I'm going to walk you through a little bit about what's happening inside that gross margin.

So, for starters, our selling margin, which I've got three or four slides here to walk you through, is actually up 90 basis points. That's great news and that's simply the difference between our average unit retails and our average unit cost. We do have normal markdowns that we're taking as part of our retail accounting that deals with the fact that we have too much inventory and this is inventory that's been marked down that hasn't yet sold through. We also have a reduction in the cost concessions that we're getting from our vendors. So part of the fair and square pricing is how we're working with our vendors. So, we're seeing lower unit costs and we're no longer seeing those cost concessions coming in from the vendor. We're making an investment in RFID. So, this is an investment that we think will position us in the long-term to do – have lower shrink, to be able to track our inventory better for our associates in the store to be able to know when you come in and you're looking for a certain size to know exactly where that item is in our store. So these are investments that we're making to position us for the long-term and then we had some increases in shipping and handling as we lowered the minimum required on our dotcom business.

So, on an adjusted basis gross margin was 36.6%. So let me walk you through our selling margin. So last quarter, Mike began this journey of sharing this with you and I think there's a lot of insight here that will give you some comfort in terms of where this business is going and then at the end I've got couple slides on the business model and we would expect in terms of the mix and the gross margin in these areas.

So selling margin is simply our merchandise selling margin, it's the average unit retail that we're selling these goods for minus our average unit cost. So, if you look at the first quarter, we're up 90 basis points. So the selling margin is 42.5%, that's up 41.6% a year ago. If we break it down into the everyday and month long, the everyday category is actually up 380 basis points, so 51.2%. So we're very, very encouraged by what we're seeing on the everyday.

So if we look at clearance, so clearance a year ago the margin on our clearance was 13%. As we've rolled through this inventory we've seen a 710 basis point reduction in the margin associated with clearance. So this quarter the selling margin for those items that were cleared, was 5.9%. When you look at the percent of revenue, a year ago clearance was about 15% of our business. This quarter it was 200 basis points higher at 17%. So when you look at the mix impact of that 17%, the 90 basis points is actually 191 basis point impact on the 90 associated with the fact that not only was there a higher percentage, it was actually a lower percentage in terms of the gross margin.

Now mind you, the first quarter selling margin associated with clearance was some negative 27%. So while the 5.9% is lower than it was same quarter a year ago, it's considerably better than what we saw in the first quarter, so very, very encouraging.

SG&A came in a little over $1 billion to $193 million or almost 15.5% below where it was a year ago. So the actions that we've taken to restructure this business are coming through and we're seeing that savings and hopefully you could see this path, it was $120 million in the first quarter, up to almost $200 million here when we talk about this $900 million run rate exiting the year, you'd expect over the second half for that $200 million to continue to climb, so that when you see the number for 2013, we're well in excess of a $900 million reduction in our expenses year-over-year, so a lot of great work by the teams.

Here is the breakout of where the $193 million is coming from. Our home office and stores primarily through the severance as we have reduced our total headcount is $134 million reduction year-over-year. The exit of the outlet business in the CLAD and Grace contributes about $24 million, the marketing reduction in the back half is about $23 million in the quarter and we had some other miscellaneous items about $12 million. The charges associated with restructuring were $159 million for the quarter, so if you look the home office and store severance was $56 million; store fixtures, so as we brought in the new shops there has been a number of fixtures that were no longer going to be used. We’ve written those fixtures down by $42 million; our investment in software and systems, we've identified a number of systems that will no longer be used as we try to simplify our business, and we wrote those systems off. That was $36 million in the quarter and then supply chain we had some severance activity there that was $10 million and then management transition and other was another $15 million. So $159 million investment that allow us to go continue to take that SG&A number that we showed on the prior slide from $193 million to a number that we would expect to be over $250 million as we’re exiting the year.

So if you look at our reported earnings per share, we showed a loss of $0.67. We’re not wanting to take credit for the gain on the sale of the UPREIT items, and so we've added that $0.57 back into the number and then adjusted for the restructuring. So that was $0.45 for the quarter. We’re adding back the traditional shop markdowns or transitional shop markdowns, excuse me, of $0.29, and then the non-cash charges associated with our pension plan to get to a non-GAAP EPS of $0.37 loss for the quarter.

So let's take a moment here and talk about our balance sheet. I started with JCP the week of this meeting last quarter or the beginning of this quarter. I was really surprised to see the comments that we're coming out around the Company, liquidity, the balance sheet, and just over the last 90 days, we've come across a couple of things that I think as we explain today will help you understand one, why I joined the Company and why a number of the other people that we brought onboard joined the Company. They've seen this information. They've had it explained to them and there is no reason why we can't walk you through the same information.

So, if we take a look at our balance sheet, here is just a comparison of the assets and you all have a copy of this, so I won't go through these numbers. There are a few line items here that I'd like to pull attention to and talk about. One is cash. So, our cash is actually up $49 million from Q1 to Q2 and we'll walk through the cash flow statement in a moment and I'll share with you exactly how that happened.

Our merchandise inventory, it's down 16.2% year-over-year, so we're making progress it's not down in line with the 21.7% reduction that we saw in our sales, but we're making progress and we would hope that that as we exit this year that we're not standing up here talking about inventory as the reason why we are not achieving our goals and objectives.

Deferred income tax, this is an asset. This is actually a good thing. So, we've went through and identified an additional $211 million of deferred tax assets that we believe we'll be able to realize in the future. That's primarily the realization of NOLs that we're carrying forward. So this is an opportunity to convert this into cash as we move forward.

Our other assets you saw the announcement around the monetization of the UPREIT with Simon. So inside this other asset balance is $923 million. So what I will remind you it includes capitalized software, it includes intangible assets so last year when we bought the rights to the Liz Claiborne brand that intangible asset is in here. That’s why despite the reduction that you would have expected from Simon its actually net up year-over-year and then we have additional UPREIT ownership interest. We have a couple of leverage leases and we have regional mall partnerships that are here and we are going to continue to look at monetizing the non-core assets a lot of these have a very low tax basis and we believe there is several hundred million dollars of opportunity to turn these non-core assets into cash and continue to strengthen the balance sheet.

Here's the liabilities and equity side of the balance sheet.

Start with supplier payables. Despite all of the talk and rumors around extending terms our payables are actually down 27% year-over-year.

The current maturities of our long term debt, so beginning of August we had $230 million of our debt that was due, we've paid that off out of our current cash and so next quarter when you see that, $250 million will be $230 million less. Our long term debt its $2.9 billion. Our next maturity on this debt doesn't occur until 2015 and in 2015 we've got about a $300 million payment due.

Again, long-term deferred tax, so the tax asset is going up. The deferred tax liability is actually going down. So, if you recall, at the end of last year we revalued our pension plan and as we continue to experience the pension expense, this number continues – this liability continues to go down. I think from Q1 to Q2 it was down about $20 million.

So, cash flow; hopefully, in the attachment to the press release that we took the cash flow statement and we actually added the second quarter cash flow statement. So you don't have to go do the math to take the year-to-date and then go find your spreadsheet that has Q1 and back that out. We provided that to you. Then we also decided that we would expand the operating cash section. So, you don't have to wait until we file the 10-Q to go understand what's in this cash flow from operations and frankly, that's something that I didn't realize that we weren't providing that level of information. So, there's no reason for you have to wait until we file our 10-Q for you to understand what happened in the cash flow management.

Now, the good news is, we only used $32 million in cash from operations this quarter, that's $545 million better than the number that we reported to you last quarter. So I'd like to just walk you through and make sure that we understand what's included and what's not here. So from a GAAP net income standpoint, we reported a loss of $147 million. Again, that has the restructuring and all of the inventory charges. So we're adding back the non-cash portion of the restructuring charge. So $78 million of that restructuring charge is non-cash, so we're adding that back to the income. Our depreciation is $128 million, it's a non-cash charge. We've already paid cash for those items. Our inventory was down quarter-over-quarter, $91 million. We talked about the supplier payables, they were up $31 million and then other working capital was actually improved $29 million.

We're backing out the gain on sale of the UPREIT. So when we're going from income to cash, it's important that you understand that $32 million used has no benefit from the proceeds that we received from the sale of the UPREIT, that's not operating cash, you'll see that inflow show up when we look at the rest of the cash flow statements.

So here's the $32 million used from operations. We invested $132 million in the business for capital expenditures, and then inside the investing activities where you see the $248 million proceeds that we've received from the sale of the UPREIT. Our financing, we declared a dividend in Q1. We paid for that dividend in Q2, and so from a standpoint we used about $35 million of cash. So this is the walk to the $49 million increase in our cash from quarter one to quarter two. So I remind you we have $888 million of cash on our balance sheet.

Back in January this year, we actually entered into an agreement of bank line of $1.5 billion asset-backed line of credit. The line of credit is tied directly to the $3 billion of inventory that we have on our balance sheet and we have the ability to immediately go and extend another $250 million with an accordion feature in the way that it's structured. We could actually go borrow up to 80% of the value of that inventory. So, at $3 billion, that's access to some $2.4 billion of capital.

Now, we currently aren't using this line of credit at all. It's available if we would need it, but we're only using it for letters of credit and things like that, so we've not traditionally used this line of credit to fund our operations. And as we look at the rest of this year, I want to make sure you all understanding that even at current trends, and you heard what Ron talked about in terms of what we're seeing here in early, but even at the current trends that we've experienced year-to-date, we wouldn't expect to tap into this line of credit for the rest of the year. So, when we talk about funding this transformation out of our current operations, we're not anticipating that we're going to be required to go into this facility.

There aren't any covenants against this facility until we're 90% drawn, and then there's a fixed charge coverage covenant that kicks in, and so we would have to be 90% drawn on this $1.5 billion facility before there would be any covenants. So, it's actually the team did a great job in terms of negotiating this in a way where we have access, should we need it, and we could access it overnight, we could access it for a week, but that's not in our plan, okay. So from a liquidity standpoint and it's important to note that even when you look at some of the credit downgrades that have come through, it's not because of the Company's liquidity. It's a question as to whether or not we’re going to be able to execute the pricing and merchandising and shop strategy that we’re talking about, and hopefully you’ve got enough confidence from what you heard from Ron. We’re very, very excited about that piece of the business, and when he comes back up in a little while, you’re going to actually get to see exactly what he's talking about.

So I think it’s important to share our anticipation here is that we’re going to end the year in excess of $1 billion of cash on hand. That includes paying off the $230 million debt maturity that occurred last week. It includes us investing in excess of $800 million of capital in the business. Most of that yet to come in the back half of the year and it does not include the need for us to go monetize any of these non-core assets. Anything that we would do there would be just excess to this $1 billion number that we’re talking about.

Okay, so let's talk a little bit about the long-term business model. As Ron mentioned, we expect our sales to grow. We expect it to grow because we are adding new merchandise, new brands, the power, the shops and the experience that our customers are having, and our ability to focus our marketing, so that we’re driving traffic, driving footsteps into the store. The response from this back-to-school free haircuts has been really, really exciting.

Let's look at the gross margin model. So we talked about selling margin earlier. You saw that a year ago and even in the first quarter, we were split about 85%, 15% between our everyday margin and our clearance margin. We expect that the everyday margin will be in excess of 50%, that number has been over 51% for the last two quarters, so we are not putting something up here that's a wild stretch for us to achieve.

The challenge really lies in getting the inventory right and buying to what we think we're going to sell through and given ourselves the ability to chase, and so when you look at the margin on the clearance, the Company traditionally has run around 13% margin on its clearance. Through this transition, as we tried to get the inventory right, we were negative 27% in Q1 in this category. We saw it improve to 5.9% in Q2, and our hope is that as we get the inventory right, you will see that number continue to improve.

So, we're expecting to deliver a reported gross margin, so I don't have any intentions of standing up quarter-after-quarter and talking about – here is the reported number and then here is this other number if you back out all these other decisions that we made. So, what we wanted to do here is just share with you our desire and our goals and objectives allow us to deliver a gross margin in excess of 40%, and again that's a selling margin, that's at 44% plus and then we have got some buying and distribution and some retail accounting and those sorts of things that actually take out another 4%.

Expenses, we've talked a lot about this $900 million. So in 2011 we had $5.1 billion of expense. Our anticipation is that, that number will be down by over $900 million in 2013, and where is that coming from about $400 million of it is coming from our stores, it's about $350 million coming out of our home office and about $150 million coming out of our marketing. That marketing number when we reviewed this with you last quarter it was about $300 million. And you'll probably recall on July 10 we made an announcement to reduce the force and plano and in doing so that has freed up our ability to still deliver the $900 million plus reduction and redeploy some of that marketing money back into drive traffic.

So our financial model it says here, we expect our sales to grow, we expect our gross margin to be north of 40%. Our expenses are coming down by over $900 million and you'll really see the benefit of leveraging those expenses as that sales continues to grow. the self-funding of our investment so we are planning to fund our expansion in our shops and store environment out of the cash we generate from operations. So we are not planning to go utilize that $1.5 billion facility to go fund our expansion. We are going to take the money that we generate out of operations and that’s going to gauge the speed in which we could take these shops and roll them through.

And then we continue to work on inventory with the plan to reduce our inventory on hand below 13 weeks.

So, if I leave you with three things; one, one should understand how strong our balance sheet is and that our liquidity allows us to fund this transformation out of our current operations. Our expense reduction is ahead of schedule. The teams have done a fantastic job restructuring and realigning this business and we're very confident that you're going to see leverage in the expense line as our sales grow and our business model is intact.

So, with that, I'll turn it back over to Ron and let him walk you through the technology in the shops.

Ron Johnson - CEO: Thank you, Ken. My hope is you found that very helpful to – a little more detail to try to provide information on time. We're here to transform JCPenney not to improve JCPenney and we said each quarter we meet face-to-face to update you on progress we're making and today we're going to focus a little bit on our technology platform and then our new store design.

From a technology perspective, as you know, in 2011 we spent 2.4% of all of our revenue on technology. An industry standard would be to have a one in front, between 1 and 2, maybe 1.5%. We have overspent on technology as a Company. Part of that is because we have extraordinarily complex and an abundant number of applications to run the business. Mike shared last January, 492 unique applications, 88% of them are customized. I mean, we've done all of this hard work internally to make them unique to us and the challenge of that is 95% of the money we spend every year, $400 million was spent to maintain and support outdated applications which meant we only got to spend about 5% on strategic go-forward initiatives. If you think about that that's $20 million a year out of $400 million going to something new to improve the customer experience our ability to manage the business, and the balance going to maintain outdated legacy systems. That's a problem. If we're going to become America's favorite store and reinvent kind of the department store, we got to have money to invest in new things, and that's what we're focused on. The two goals are very simple. We want to simplify everything we do internally and we want to invest to transform the external experience for our customer, both online and in-store. So how we view that?

Well, we announced this quarter, and our teams has spent a lot of time in Northern California a major strategic partnership with Oracle to basically give a heart transplant to our systems and we are going to install Oracle Retail broadly and we're going to install it based on their technology and their innovation. We are not going to customize Oracle's applications. We're going to let them do the hard work to invent, and we'll utilize that invention as we go forward. It's going to take us a full three years to rollout the Oracle platform, but we're starting immediately, we're already working on the most important the merchandise planning and distribution systems.

So we have gone Oracle and it's a major initiative and that's going to change everything we do internally and over time our legacy systems go away and we have an abundant number of new. We believe we'll have 60% fewer apps. We'd love to get down to 100, we'll be under 200 in the very near future. But even more important we want to spent time with all of the leading companies in the technology space. We're going to work with Apple, PayPal, Cisco, Google Microsoft. These are just the top level and a lot of the small people to really create a way to reinvent the customer experience, as they come to our store. Let me highlight some the priorities we have.

Number one, we need a whole new digital platform for online store and our Steve Seabolt here, he's running it, It was announced in May. He's heavily involved with Kristen and the team to rollout a new digital platform for online store. We are very committed to Wi-Fi as a fundamental architecture for store. All stores will be complete with robust Wi-Fi networks within a month. Already today 700 of our stores have Wi-Fi networks installed. We're going to roll out mobile POS, just like Apple did, just like Nordstrom's doing, like others have. All stores will have some level of mobile POS this fall.

We're already in test phase, but most importantly, for spring 2013, every employee on the floor will be equipped with an iPod, it's an iPhone if you're looking closely, that they can use to check out the customer and run the business, and on this iPad will be over 18, is it 18 unique applications that include training and merchandise updates and planogram information and everything they need, and that will happen next spring.

The biggest investment we're making perhaps is in RFID. As Ken said, we're going to go full RFID for spring 2013. Shockingly, today one-third of our items are already equipped with RFID tags, and that's that investment you saw in reduction of our gross margin. But that pays off and incredible benefits of inventory control, inventory accuracy, in stocks that will drive our top line, but we're most excited is how we're going to use RFID to transform the customer experience.

So next spring we're rolling out personal check-out, so an addition to be able to check-out from any employee, anywhere, anytime. You will be able to check-out by yourself in our stores and we think customers are going to like it, and it's going to help our conversion and the customer experience and lastly, we're going to go paperless. Think imagine a retail store without any paper except the signs, because everything will be done digitally through iPods and iPads and those are our priorities and those are all priorities within the next 12 to 18 months.

Now the technology is fun and then going forward this is a pretty amazing thing. We will be spending starting fiscal year 2013, 35% of the money we spend on new forward-looking technology. That’s over a $100 million a year, each and every year focused on new initiatives. So we not only want to be good, we want to stay ahead on the technology front. The technology is a key to the store design, because if you don’t change your technology, you can’t reinvent the experience for the customer, and so we’ve made the technology decisions hand-in-hand with our vision for the store design.

As you know today or last year Penney’s was a promotional department store. There are couple of them; Kohl's and Penney’s, Mervyn's was one. Most of them have gone away. We believe the promotional model is outdated. We think there is a better way. So what are we going to become? We’re going to become entirely new class of department store that doesn't exist today. Now today there are discount department stores like target and Walmart, promotional like Penney’s and Kohl’s, there’s a traditional department store like Macy's which kind of plays in between the promotional model and a traditional department store model, and then you’ve got upscale department stores like Neiman Marcus and Nordstrom and Saks and Bergdorf and you know them. We’re going to create a new category that we call the specialty department store, and we think it’s going to be profound, and let me tell you about it. It’s got three components and we’re going to talk really about the store design, (and add) about the service initiatives. There is a major focus on people, we’re going to focus on the store design. There are shops, there are street, and a square, and let's start with the shops.

This is a layout of our new store prototype. We will open our first new store in fall 2013, so little over a year from now. We’ve already got the site picked out. We’re working closely with a developer, we've designed that store. It's about 130,000 square feet. If you look at this map, what you'll notice is this grey area is where the shops are, and you'll see it's divided and if you look here, the majority of the stores are shops. Everything I guess blue here is a shop and if you look really closely, you will see the dividers. So, we don't have a sea of racks like you see in a department store today even like in our store, everything is organized by shops just like mall is, alright.

Now, when we're done that store will have a 100 unique shops and there will be single-brand shops, there will be classification shops, but it will feel like just when you walk through the shopping mall, there are variety of things from which to buy. They will be organized in a way that's very straightforward. We'll have men's areas, women's areas, kid's areas and home, kind of the traditional categories that people come.

The shops will be of varying sizes. There will be as small as 500 square feet and as large as 1,400 square feet or more. Now remember when you compare this to a mall, though, there is no – we're not counting the stockroom space and the storefront space. So, 1,400 square feet inside a store like ours is much bigger than a retailer we get in the mall where a full 25% of the space is devoted to their inventory space, etc. These are pretty big spaces, and we will have shops for soft lines, traditional apparel. We have shops for hard lines. Some of those will be similar to what we carry today in home, but in our new environment there are no limits to the type of products we can carry, and you will see that when you look at the images, because when you go shop to shop, it feels very natural to move into a different type of category that we’ve never been in before. (And it is really) exploring new and exciting categories in our stores from what we carry today, which will provide incremental volume and (we've done on pretty limited) products.

We can have services for shops, just like today we have salon. We can do a lot of types of services in these shops. So there are no limits to the merchandise we offer, the service we deliver in a shop strategy. Now if you have been in our stores since August 1, you've started to see the shops emerge. Here's a picture of our Levi shop, now that is 2,500 square feet, but outside that was a heck of lot bigger than what 2500 square foot store would look like in a shopping mall.

Because its transparent its wide open and this shop as you know is dominant it's got a service element with iPads and denim bar and it is a unique environment, and I am going to tell you it is performing great. This Levi shop as I said we are selling 25% more revenue that’s comp store over last year at $5 average retails because of that experience we provide.

Shops are pretty interesting let me show you three others that are coming this is the Izod shop that’s coming to JCPenney will be in 700 stores September 1 its under construction today. When you look at that, that is not a little shop that’s got its own floor, its own fixtures its own branding, it's got illuminated graphics. It is 100% Izod. If you look closer even the point-of-sale signs are unique to the brand. This will provide 360 degree brand experience like you would find in a specialty store.

Here's our Arizona shop, that’s only 1,500 square feet it looks much larger. In September first we are going to launch our all new JCP shop which is a new brand for us it will get out the core essentials like one for women's and ones for men's.

Again you'll see unique flooring, unique fixturing, unique signing. So we are creating very unique differentiated shops to help people breakdown the mass of a large store to something much more understandable. Now when we are done we'll have 100 shops and you might say, well, what is 100 shops? Is that the remaining? Well, it's interesting. We had our area research people at JCPenney and the real estate team go through the malls we're in today that are 1 million square feet and calculate how many unique specialty stores we have. You know what's amazing? It's 100. So, we will have as many distinct shopping choices in our 130,000 square feet as you'll find in a 1 million square foot mall except you won't have to go from check out every time you leave a store. This will be a whole unique environment. So, this is an extraordinary achievement when done.

Now, you might wonder about the math. But what happens in a big mall of a 1 million square feet, about 600,000 square feet goes to the anchors and the common area which leaves about 400,000 square feet for the stores and the stores average 3,000 to 4,000 square feet. So, you run the math, you have about 100 to 120 stores in a typical mall we're in. We'll have just as many shops with inside JCPenney and that's what we call it a specialty department store. It's like a mall within a mall.

Now, what makes it fascinating though is not the shops. That's been done before, all right? We're inspired by Selfridges. Selfridges is the leading department store in the world. You ask any retailer what's the number one department store? They will all say Selfridges. Now, the shops we're building are much elaborate than Selfridges. We want to do an even more 360 degree brand experience. But there is something that Selfridges didn't do that we're going to do, which we call the street and what the street? It's this blue line. Now, you might say that's aisle, but it's actually expanded width where our typical aisles are 9 to 12 feet, this is nearly 15 feet wide.

It's nearly a half-mile lawn in this prototype and we're going to make it a place. The Street becomes a new retail interface, and as I learned from Steve at Apple, the way you change the customer experience it all starts with the interface. Now Apple did it with a mouse and the personal computer, it did with the scroll wheel of the iPod, it did it with the touchscreen with the phone.

When you change an interface or how someone interacts with the store or a product, you transform the experience. What is The Street? We call it an exciting store pathway and a place to relax, refresh, engage and get inspired. The Street will be a place. When we get down the road and customers think of JCPenney they won't think of the products, they'll think about The Street, because that's what's really, really unique.

Down in Texas, we've now built out a 17,000 square foot markup of our new store prototype. This isn't fancy, this is the existing 30-year-old store redone. This isn't a pipe dream and we've been taking people through this over the last three weeks. But that shows what a 14-foot-wide isle looks like, starting to be filled with activities that provide a new interface for the people. So what kind of things do we do on that Street?

We wanted to place discover (heaviest Americans) to pullout what's new and what's exciting and what are the trends. It's also a place to relax. You know, we used to have these things called cash wraps, where people checked out. As you know with our technology platform, that goes away. So on the area we used to have four or five cash wraps, we replace it with comfortable seating and with high speed Wi-Fi networks when you shop in pair, well someone shopping, you can just take a moment sit down and check your e-mail and we think it's going to keep people in stores longer.

It's a place to refresh and we're going to have coffee bars and juice bars and place to get food, that's 25-square feet of space, but by putting out a few tables that have no cost, where we used to have cash wraps, no one has to leave the store if they want to refresh, they can grab a cup of coffee while someone shops and continue to stay in the store and continue to shop. We'll have place to engage. We actually have tables built with iPads, so if someone wants to surf online or check things out, they can do that in the store. They are going to have just work with their phone, they can work with an iPad, and just like the Apple Store these things are incredibly popular.

And we have mobile check-out where customers can check-out on their own, all RFID no scanning. Just put the bag down and you're ready to go. And we have a place for everything else. We've got a bar. It's the JCP Bar and that's where people come for return, if they want to use cash, if they want to check-out in a traditional way, if they want to buy online pick-up and store, if they want to access a variety of new services, we'll have these bars located throughout the store. We intend there are four of them in a new store.

But when you're done, what we're creating is a place to belong and that's the big idea here, as we take an aisle, and by adding a mere four to five feet of width, and activating the technology, we can transform the experience from a shop to a new retail interface, and you can imagine a half mile of that, and in each area, we'll have different street activities, so if you're in kids, you'll have very different things to engage to the kids from what you see here in an adult mockup, and you can imagine the activities we do in home are very different from apparel.

When it's all set and done, we'll have 50 different unique activity points within our store. That's the street, but it all leads to the square. The square is a new interface. It’s the new center core for retail. Now, when we talked about the square in the January, we had lots of ideas to put it at. But as we did our design, we found that lot of those want to be in the streets. And so we've tightened up the square and what that’s going to become is a dynamic seasonal space. Every retailer wants to take advantage of the season, but it's really hard to do because most of your space is always consumed by the needs for the everyday business and (indiscernible) sprinkling of seasonal here, sprinkling of seasonal there, and nobody does seasonal right. You’ll remember the old days, I remember going down the days and the eighth floor was all about the season, the flower show, flower shop, flower shows, the Christmas things. So we’re going to have dynamic seasonal play. It will always include unique items. It will include light food and beverages, it will include engaging experiences for the customer. It’s going to be a place that everyone wants to come every time it changes, and let's look at a couple examples like in November-December we’ll focus on holiday and that's where you’ll find all the products for Christmas, for trim-a-tree and stockings and things you might use around the house, but you’ll always have an ability to have light food and beverages and that food and beverage will change (with each set). It will be a place for kids, to activities whether it's creating their own greeting cards or creating ornament to give away as part of an event, and it will clearly be a place to meet Santa, and just as we’re finding today when we have 0.5 million kids getting haircuts in our store, we’re making a great brand deposit where they fall in love with JCPenney that connects to our heritage and that’s what’s going to happen at holiday in the square.

But once Christmas end it’s time for something new, so what happens in January and February? Well, it’s time to keep your New Year’s resolution and the square becomes a place filled with all the great new activewear and weights and things you use to get in shape and we move from cookies to juice and beverages and things that are more healthy, and we actually host pilates classes and yoga classes right in the center of our store. People love to walk the malls and now they have other things they can do. Every two months we'll change the focus of the square to provide a new center core seasonal experience for our customers. We are really excited about it. So, when you put together 100 shops a half mile-long street to place with a new square you got a new interface to retail. Now, how do we get there in existing stores? Well, we told you this before, month-by-month, shop-by-shop. Each month sometimes in groups, we're rolling out our strategy, so it doesn't just wait for a new store prototype, all stores have changed simultaneously alright.

We began in February with two shops in a JCPenney store; we had Sephora store and a Mango store, you know that. As of September 1, we'll have 12. You can see them here. By next holiday we'll already be to 40 shops; 40 shops, 15 months from now. Now, you might go what does that feel like, why had this prepared? This is how many shops we had in a typical store February 1, this year when we began our transformation. This is what we'll have on September 1.

You've already seen in the store. If you walk through the store today, you will find a handful of shops, you'll see shops under construction. Imagine next holiday when store looks like this. This is 15 months from now. Nearly half the store we merchandise in shops and will have roll out the street in a good part of the store, because as we roll out home next spring, we're going to put it in the street. When we roll out kids next back-to-school, we're going to put in the street. So, the street will start to emerge next year in all stores as we go through the year. What we discovered when we're working down our mock-up site in Texas, is when you put in two shops that are about the size of the shop apart, you get a third shop for free. The negative space actually feels like a shop, so you'll see that on this diagram and so without having to build out the shops at the same level of expense we can get nearly to 80% of the store done next holiday.

So it's kind of an obvious discovery, but something interesting to learn. So 40% of the store will be completely updated by next holiday and we've got some great partners one of the biggest challenges I have in my job having to work with the teams to pick our shop partners there is a lot of demand. What's exciting is we have great shops that our current customer loves like we've done at Levi and Izod we announced a partnership with Carter's for kids this quarter that will come in next July. We announced major initiatives of Maidenform, Vanity Fair.

We also have some new things that are really going to be great. This quarter we announced our partnership with Joe Fresh. As you know its Canada's number one apparel retailer from first store five years ago to today it’s the number one apparel brand in Canada and its sold in grocery stores.

It's what Canada loves, the broad swath of people and its rolling out in the U.S. Joe Fresh will launch 700 stores in our Penney stores on April 1 next year. I want to talk about briefly because it shows the impact we can have on a brand. Joe Fresh today as you know has store on Fifth Avenue that opened recently. They have a handful of stores in Manhattan, their plan had been to rollout retail stores in the U.S. like everyone else does. It was going to take 15 years to get to 700 shops. They'll have 700 locations in United States next April 1 and they don't have to spend as much money building out the stores, they don't have to hire the teams.

All they have to do is design the inventory and we'll do the work for them and there are a lot of people interested in that kind of retail mall here in the United States. Joe Fresh is a great partner. Giggle, we announced this yesterday, (indiscernible) giggle is one of the great curators of baby stuff and we're good in kids. We've got a lot of apparel, but we don't have the categories that you gift as a gift. We don't do really well at strollers and diaper bags and books and things that people love to buy for kids. Well, we're going to be in the business next back-to-school with giggle which is one of the best incoming curators out there and it will be a great choice for our customer. Martha Stewart rolls out next March-April, next spring; Michael Graves, Terence Conran, Jonathan Adler, (indiscernible), Tun-O-Wash shops. So, we've got products that are really geared toward our core customer and things that our core customer would love, it will bring in new customers. And the key here is to balance this that we retain the core, take them on a journey and begin to have other people discover JCPenney. But we've got a lot of partners and it's really exciting and we're thrilled with that.

So, when we're done, we will have created a new class of department store. Just imagine what you see today in a promotional department store and what you'll next holiday in four years from now and we can't wait to open our first one. Now, there is nothing like seen that is believing and so on September 19 you are all invited to (plane out) to Dallas, Texas and we're going to give a tour of new store prototype and we want you to see it. We brought people through it, and everyone who walks through it, walks away saying, wow and because we're onto something really important here, and I want you to see it and we want to get you feedback. We're getting lots of feedback from our vendors. We've had 35 type vendors through recently, we've had customers through and we want you to be a part of that. We're going to invite you down to Dallas mid-quarter to see our new store design.

So that's a quick update on our technology, our store plans, and I am sure you might have a couple of questions, so I'd love to invite Ken back so we can take some questions right now.

Transcript Call Date 08/10/2012

Unidentified Analyst: Would you just give us a little bit more of a detailed bridge on your walk from the cash at the end of this quarter to $1 billion at year end, I mean, if you take $900 million that you have now, subtract the $250 million, you are at $650 million and I think you are going to spend about what, $500 million in CapEx or so in the back half of the year. So maybe you could just elaborate as it going to come from inventory reduction or give us a little color there? Thank you.

Ken Hannah - CFO: So we'll expect the normal holiday build the inventory in Q3 and then we'll see that liquidate in Q4 as those goods move through. So we're expecting inventory to be down about $500 million at the end of the year, so you are going to get about $0.5 billion of that improvement just with what we're doing. Mike's team is working with the inventory very, very hard.

Unidentified Analyst: Ron, you said in the (morning) earlier that traffic was down on the 7% on the first 10 days.

Ron Johnson - CEO: Yes.

Unidentified Analyst: But you said that sales were 2% better than the spring run rate, that’s the down 21%?

Ron Johnson - CEO: Let me try to explain it. For the spring season, we ran down about 20%. During the first 10 days we're performing a couple percent better, that through yesterday's store closing. And you might say that's not very impressive, but I want to remind you we are in an everyday model, where we're going through seasonal builds, up against the model last year where the sales went like this. Four times last spring, we put every promotional idea we knew to do, to drive the business, and each of those periods we ran our sales down 30% plus. 5 of the 10 days this quarter have been against the periods where we ran down 30 plus. And as you're aware, we're really worried, our biggest nervousness is how will we perform during the key shopping periods; Mother's Day, Father's Day, back-to-school, holiday, So the fact that we're only, that we're two points better than our entire trend against our most promotional activity in the peak of back-to-school. This is our highest volume week of back-to-school, is very encouraging to us. Now, we don't want to take that number and affect our long-term approach, so we're going to stick with very conservative. We're going to assume that we're not going to perform any better on the top line, than we were on all spring. But the point is, during the second – the only other big peak of the year besides holiday, we're running better than we had all spring against our highest promotional week. Make sense? That's all we're trying to say, and the traffic is materially better. The traffic is down 7%, as Ken showed it was down 10% to 12%, but during the promotional periods it was down as much as 20%. And we're down 7%. So we're just encouraged that our marketing changes are getting through and we see that in the numbers but we also hear it from our team on the floor.

Michael Binetti - UBS: Michael Binetti with UBS Michael. So could you go back to the Levi's numbers you gave, you said the up 25 since you’ve opened it? How much of that is a contribution from incremental square footage? How many stores is that? Is that a system-wide number?

Ron Johnson - CEO: So that’s great number. We put Levi stores I think at 683 - about 683 stores. We’re only comparing the 683 stores to the 683 stores last year, so it’s the same number of stores. That 25% is a comp store increase in the stores that have shops versus prior year. The square footage is about the same, so we didn't add square footage to Levi. We changed the experience of how to buy a pair of jeans, and we did that through fixturing, through the bars, through putting fitting rooms in the shops, and the customers responding. And it’s what we always believe that when you can prevent a truly unique and innovative experience that connects with the brand I mean that feels like you’re in a Levi store that people would buy differently, and what we’re finding is we used to only sell various shades of blue. We’re selling color, we’re selling a variety of things what we never did before. We’re selling much more fashion. I think our buyers and Levi's are surprised at the way customers are buying fast in that shop, and that’s been the dream that when you change the experience, you can change what you get to sell. And so our average retail on Levi is up $5 or more versus a year ago, but it's not just versus a year ago. We’re looking at Levi's right now in shops against non-shop stores because we’ve got 400 stores that don’t have a shop and we’re comping 25 points different there. And if you look at the shop stores and their trend from spring it's about 25 – anyway you look at it, we're running about 25% higher in revenue in Levi, and that's our hope. We want to be the best place to buy on America's favorite brands, all right? Now, one of the thought on these shops, it's really important to understand. We have two shops today, Sephora and Mango. Sephora has been comping really well ahead of the chain for the last four, five years that it's been in there. Our year-to-date performance of Sephora is very strong in spite of its de-promoting. Why is that happening? Well, the history of retail will tell you. If you open a new store, you get about five years until customers truly discover and find it, and so our shops will go through we believe a comp store trend of inertia like retail stores that when you open a store in a market. So, as we roll out shops, we hope that every shop like Levi's will get better and better and better as traditionally happens in the specialty stores in a mall. At the same time as we redo all of JCPenney, we hope that drives more traffic, all right? So, we think there is a multiplier from these shops over time that will provide extraordinary growth, but that addresses the Levi's numbers. Is that helpful?

Michael Binetti - UBS: It is. If I could follow it up, so that's 683 stores for Levi's and we haven't talked a lot about the small stores versus big stores. Any update on how the other stores should potentially come along for the ride?

Ron Johnson - CEO: Our current thinking, so we have about 400 stores that are smaller that are under 50,000 square feet on average, that are located generally in small towns, that continue to perform as well as our chains, so if you get a spring performance, they're performing as they have in the past. As we said before those stores generate very good cash flow and we love those stores for their cash flow, but we have to develop a strategy to make them win and we have got several ideas, but we haven't talked about those yet and we'll talk about those in near future, but we've got to make those stores really great as well, but initially we are not rolling our shops out in the stores because we are going to learn about the shop economics, so the shops are going generally into our 700 larger stores and the 400 stores are continuing to benefit from the merchandise changes, the product improvements, the pricing strategy, the marketing. But we haven’t detailed yet what we are going to do to make those store great and we'll do that in the near future.

Paul Lejuez - Nomura: Paul Lejuez at Nomura. Just a question on the markdown reserve, just thinking ahead about the home brands that are launching in the first quarter, does your markdown reserve account for any expected disposal of goods that are going to happen around the home launch in the first quarter?

Ron Johnson - CEO: The intent was for that to take into consideration all of the known shops that we have on our schedule, looking out at all the brands that have been decided to be discontinued. So yes the intent there was to take all of the shops that we are aware of that are coming into future and taking that reserve today.

Paul Lejuez - Nomura: What's the prevailing margin rate, when you take a markdown on inventory, what margins do you assume those goods get sold out?

Ron Johnson - CEO: Well if you look at our history, that it's been about 13% and then its moved down to as a negative number in Q1 and up to just under 6% in Q2. So I mean a lot depends on the strategy but are you referring to on those goods or what we would expect it to be in the future.

Paul Lejuez - Nomura: Just in general when you take a markdown you have to take a hit for a certain dollar amount, but you are still looking to sell the goods at some point. So do you write them to zero or do you write them down to.

Ron Johnson - CEO: We are writing it down based on the value that you think is going to be required to flow all of those goods through in a timely manner.

Paul Lejuez - Nomura: Then just one last quick one. Ron, I think you mentioned the JCPenney bar as a place where customers could go to purchase things in cash. Will that be the only place that they can go to purchase things in cash and what percentage of your business is done in cash?

Ron Johnson - CEO: Yeah, currently, we do about 25% to 35%, it varies by store, in cash. Now, as we transition away from the checkout, we want overnight just eliminate it. We'll retail – right now, we have 11 centralized checkouts. We'll transition there and take the customer on a ride, but there will be four of those in the store. So, we have 10 today because we (reduced) a couple, there will be four locations, one in home, men's, women's, kids very convenient for someone who wants to use cash. (You know around) place, can walk them right there. So, we are not at all worried about a customer is not ready for incoming ways to buy, but we'll cover that through the bars. On the home thing, just so you know, there is going to be a material change in home. Typically, we updated our assortment about 15% to 20% of the merchandise changes. The markdown reserve allows us to change about 60% of the merchandise in our home assortment and that's our number of opportunity category to get our business going because we've been struggling at home and we're really excited about that, but the reserve we talk about prepares for all of the change we plan to make next sprint in home.

Deborah Weinswig - Citigroup: Deborah Weinswig from Citigroup. So, can you discuss how your performance has been in fashion versus basics? Obviously, the customer who is buying basics is much more used to buying those items on sale. So, can you may be just talk about the go-forward in terms of how you might be communicating your value to the customer on those specific items?

Ron Johnson - CEO: That's a great question. One of the things Penney has been known for is great basics and one of our challenge in the spring is all of our marketing was fashion, it was lifestyle and we talked about it the first quarter that our fashion was performing better than our basics, and that trend continued all the way through the second quarter. We got to fix that. So number one, you got to price the goods right, which we've adjusted; number two, you got to present the goods better and if you walk in our stores, if you go down to Manhattan Mall and look at dress roots in underwear in men's for example, or women's intimates, you'll see the dramatic change in presentation, but more importantly we got to market it. So you've already seen direct marketing toward basics, right? So if you look at our preprints every week now, you'll see underwear and socks and brands like Maidenform and Levi heavily product-oriented presentation. We did it back-to-college preprint last Sunday and the items in the preprints are now starting to accelerate. So, it's a combination of everything you do, pricing, presentation, direct marketing that will improve our basic businesses. But they will continue to suffer relative to fashion throughout the year. Why? Because when you get 10 free dollars in a coupon you are going to buy something, and if you don't find the fashion, you're going to stock up on a towel, a pair of underwear, something for your kids. So, the decrease in coupons is the biggest driver of our basic challenge. We'll offset that by the reasons I talked about.

Deborah Weinswig - Citigroup: Then can you talk about how your might utilize your credit card going forward, whether it might be through gamification strategies or otherwise in order to drive traffic and also as a loyalty tool for your customer?

Ron Johnson - CEO: Yeah, I personally believe it's a very big opportunity. We do, in our peak we've done at about 40% credit card share, that's dropped a little bit, it gets down 2 points year-to-date. That's been a managerial change, but it's down. But if you look at traditional promotional market companies, whether it is Mervyn's and there are Kohl's, they all run as much as 60% on credit, right, and that's what drives their business, right. So we've got to build the loyalty program for credit card customers that becomes a must-have credit card to carry and we're going to tie that into our new interface, the streets and the square and the experiences you have and so we're on the process of redesigning that, but I think long-term, how we use our proprietary card is a big opportunity. I know there are few on the side, that we're not seeing because of the lights, so let's make sure we move around, why don't you go this way and then that way?

Bill Dreher - Newedge USA: Bill Dreher, Newedge USA. I want to applaud you for creating one of the most exciting stories in retail write-down. Talk about trying to create a favorite shop for the consumers that have some of their favorite brands. As we look at some of the brands that you brought in recently, not all of them are the top tier brand, many of them sort of sub brands within that vendor. Can you help us understand, how you consumer feels about that top brand versus the sub-tier brand. Maybe to put some meat on the bones, how were sales affected when you moved from Liz & Co. to Liz Claiborne for example. What was the difference there?

Ron Johnson - CEO: That's a good question. I don't know the specifics on Liz & Co. to Liz Claiborne. Well Liz has given me the thumbs up. But Liz Claiborne brand has been one of our highest performing women's apparel brands. We're putting a Liz shop that's really dramatic on September 1st, so Liz is saying it's gone up. I'm not personally aware of the data. I trust her completely, but I think the important thing is we've got to do shops that appeal primarily to our core customer. There was a mistake in impression from the shops we announced last time that we are trying to move somewhere where our core customers doesn't understand, and we think it's important to have some new ideas like we’ll have with (Markesan), Cynthia Rowley, these are all wonderful things. But the most important thing is the core, to be America's favorite place to buy things like Levi's, like Nike, things like that, and that's our top priority in our shop design, and we're working through lots of ideas with our vendor partners. As I mentioned my hardest job is having to say no to people who want to put a shop inside JCPenney from a vendor perspective, and with what we’ve launched in the last week or so, the interest in shops has exploded, because for the first time vendors and customers can see what this really means, and as they've come through Plano and seen our shops and our markup, the level of interest has expanded, as you'd expect it would, as you'll see on September 19, and so we've got to make that balance, but most of our new brands are not sub-brands. Bodum is Bodum, Michael Graves is Michael Graves, Jonathan Adler is Jonathan Adler, just like you find in his own shops like in Highland Park in Dallas. So, I don't agree with this connotation that we're – this idea that we're getting sub-brands. Joe Fresh is Joe Fresh. So, I think one-year – question is in air and I respect it because mostly we're getting our real brands, but secondly we’ve got to make sure we appeal to our core.

Bill Dreher - Newedge USA: As you move forward building on more shop-in-shops? Can you give us an idea at least directionally about the CapEx levels that you expect over the next few years and then the ROIC implications of rolling the shops out fully?

Ken Hannah - CFO: Let me take that one. When we originally embarked on this four-year journey, we talked about a number that was pushing $5 billion. The beauty of the markup that we’ve done in Plano is we've been able to look at a bunch of different variations where I think we had originally thought that these shops were all going to be in the $50, $60 a square foot range, and we have some beautiful shops that we've been able to do for $8, $9, $10 per square foot. So, there is a wide variety as you go through and look and Ron showed the difference between a boutique and a shop and a store, and obviously those will have different CapEx levels, but we're looking right now at how do we continue to push that down. We're well below the initial anticipation that was in that $5 billion number that would be north of $50 per square foot.

Ron Johnson - CEO: From an ROI perspective it's too early to call. And we are going to really pay attention to that. We've brought in new people with great financial backgrounds that own the shop strategy. We're looking at the return on investment of everything we make, because we’ve got to use our capital wisely, but I think the general sense is we can use less money to transform our existing stores than we thought in January based on our markup and our early feedback, yet still produce a very differentiated buying experience. And we have vendor contributions, right. So, our vendors are partners in the shop development and we're working closely with them from a capital perspective.

Ken Hannah - CFO: I think it’s key too, to follow-up on the question earlier about the smaller stores, your return on investment question, I mean that's what we're looking at is what level of investment can we afford to put into the 400 stores, because we’re very, very encouraged with the returns that we're seeing on these early reads on the shops and so we’ve got to figure that out.

Operator: (Adam Forste, Locust Wood Capital)

Adam Forste - Locust Wood Capital: Just a couple questions following up on Ron's comments. There were a few stories I think in some trade magazines about suppliers or vendors pushing back on the store-in-stores or at least hesitating a bit more perhaps looking to change some of the financial obligations or the mix in terms of what they're expected to fund. I think specifically they mentioned some of the 2013 openings. I'm wondering if you can just talk about that and then I had a follow-up.

Ron Johnson - CEO: I am not aware of any, so all of our shop partners and not a single one who has backed off from a shop (indiscernible) strategy. In fact, we've had vendors after they saw the Levi's shop, say pull the design, give us two weeks, we've got to create a better shop. So if anything the interest in shops has expanded. So that’s another one of those in the absence of information there is a lot of misinformation, but the vendor support of our shop strategy is extremely high. The challenge for vendors is this year of transformation. Because our sales are down and reducing inventory its really painful for them, year-over-year in their businesses as it is for us. So we are trying to work with them. We are retaining our payment terms. We are not making any changes in there as Ken mentioned we have reduced the level of vendor support that we traditionally collected. Because we don’t want to ride this transformation on the back of our vendors, we are trying to create a whole new way that vendors and retailers work together. We view ourselves as a connector between the creator, the partner and the customer. We are not the big retailer in the middle of all the power. Some retailers look at themselves in a better way. We are the partner of the vendor to connect a creator, like a Joe Fresh or a Levi with a customer in all new interface. And so our vendors love that vision. The year is hard because sales are down. But the interest in JCPenney is extraordinarily high and I hear that across the board in several of our teams.

Adam Forste - Locust Wood Capital: Just thinking about kind of the incremental buildout of the stores and kind of the distraction for the experience just tell us a little bit about how you think about that in terms of is it lost sales or is it deferred sales or just kind of how you think about kind of what the construction impact is on the business?

Ron Johnson - CEO: We learned a lot in July, so in late June started building our first shops and it took up a lot of space in the store. You look at it, it had to be somewhat distracting, it's pretty hard though to go through and do the math, while you had 7% of space under construction and it impacted the volume. But we do think it was a distraction. So our goal is to build these things quicker to spread them out more efficiently. So we can have more of the assortment on the floor at all times. We had a tougher back half of the quarter, we think that was mainly from going dark in marketing. It could have been a little bit from the imposition of the shops. So, we're learning on that, but it's too early really to have a read on that. All right, we have time for – let's do two more. We'll start here and then we'll go here because we're down to our last – at the end of our 90 minutes.

Matt Boss - JPMorgan: Matt Boss, JPMorgan. From a marketing standpoint, you talked about some of the changes more focused on the initiatives and the brands, but from a pricing standpoint, there has been talk around a low price best match guarantee. Can you kind of talk about some of the changes that we should anticipate from an education of the customer relating to the pricing change?

Ron Johnson - CEO: Yeah, we're very anxious to communicate our pricing to our customer and we have failed at that, right? They were confused. Now, we have a pricing strategy that they understand. We have done focused groups around the country over the last 30 days with our new pricing strategy and they all say, we get it, whereas before, they were confused. We're hearing that from our employees in the store. I was down in our store here to talk with every employee. I could see, tell me about the pricing. Customers get it. They understand every day. They understand clearance. We've got to help them understand it not from in the store but from home. So, we are working on new television spots that will air as soon as September that take that pricing message head on. You might be aware, I sent a note to 17 million of my closest friends last week on Monday really talking about the pricing and what we're trying to do and interestingly, that email that I sent had the highest open rate of any email JCP has ever sent, nearly 25%, 25% who have received an email opened it. They are very interested in connecting with us and understanding the changes we are making. So, we're going to do a lot to really communicate this pricing message over the next six months and I'm confident we get to next year everyone understand that we have great everyday value, that they trust the value and they find it to be a different way to shop.

Matt Boss - JPMorgan: Second, can you talk about the evolution of online, what you think the opportunities and how it fits into the vision longer term?

Ron Johnson - CEO: We have not been performing well online. It's on our big opportunities. Steve Seabolt is here on the front row. Steve took over the online store in May. We've uncovered a lot of issues, basic issues. We don't setup our items on time. We had items in our shops that weren't setup on line. Our navigation is kind of kludgy at times. We just don't have a state-of-the-art online site. So we're working to fix that right away. We expect to have our online site about where we want it to be by next spring at the latest, but we weren't look really fast to get that done. So we got a lot of opportunities.

Alex Fuhrman - Piper Jaffray: I'm Alex Fuhrman with Piper. As you've been rolling out a lot of these technologies to your stores wireless, Internet, iPads, Ron, what's your assessment been or how well your associates are utilizing the technology, and then as you gear up for the mobile POS rollout, I mean, are there any process changes you feel that need to be made to your organization whether its hiring or training or something else?

Ron Johnson - CEO: I really don't. We've rolled out Wi-Fi, but we really don't have a lot a use for it. So today we have a couple of iPads. So on the Levi shot, everyone's using the iPads, but that's one special set of time and customers. So we've got the network well ahead of when we'll deploy it to our teams. As we move through next spring, when every employee has one, we got a lot of training to do. But this isn't hard. Almost all of our employees have a smartphone like each of you do. This is a technology that they're comparable with, that they use every day as much as 4 to 5 hours a day. They're all familiar with apps. So when they open up a training app, they'll be able to use it. When they open up an app, they talks about a new receipt, they'll be able to use it. When they open up an app to look at their schedule I think they're going to understand it. So I think in many ways our employees are so far ahead of us, they are so tired of having to go find a piece of paper to figure out when they should work. But this technology is going to rollout really well. Our employees are ready for it they are excited about it and it will come, but we are going to train them really well. I think we did the Apple thing when we rolled out mobile POS back in 2005. The biggest problem was the customers were much ahead of our employees. Then our employees got out right away and we are going to be ready for it, so I have no fear about that and outside of this the other thing I am so impressed with our store teams and their morale if you go out there today they are so darn proud to be working JCPenney. Seeing the shops start to merge. Seeing the pricing get simplified has really changed the morale of our teams. Our average employee now is working 10% more hours than a year ago. Because you have natural retail turnover, we haven’t hired back. Because we want to have more people of more expertise more specialization on our floors and our employees are seeing more hours, moving back-to-school and then as we go forward we start to grow again, they have got a great career and so I am thrilled with our teams we'll get them trained for the new technology and they will provide an amazing customer experience for our customers. Thank you for coming we really appreciate it. Put on your schedule September 19 it will be late in the afternoon the 18 is a holiday I know for many of you don’t have to fly on that day and then we'll be back here in New York in November to have another face to face conversation.