Target 10-Q 2008
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended November 1, 2008
Commission File Number 1-6049
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code: 612/304-6073
Former name, former address and former fiscal year, if changed since last report: N/A
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer (as defined in Rule 12b-2 of the Act).
Large accelerated filer x Accelerated filer o Non-accelerated filer o Smaller Reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
Indicate the number of shares outstanding of each of registrants classes of common stock, as of the latest practicable date. Total shares of common stock, par value $.0833, outstanding at December 3, 2008 were 752,780,059.
See accompanying Notes to Consolidated Financial Statements.
See accompanying Notes to Consolidated Financial Statements.
Amounts presented herein are on a cash basis and therefore may differ from those shown in other sections of this Form 10-Q. Consistent with the provisions of Statement of Financial Accounting Standards (SFAS) No. 95, Statement of Cash Flows, cash flows related to accounts receivable are classified as either an operating activity or an investing activity, depending on their origin.
See accompanying Notes to Consolidated Financial Statements.
Dividends declared per share were $0.16 and $0.14 for the three months ended November 1, 2008 and November 3, 2007, respectively, and $0.46 and $0.40 for the nine months ended November 1, 2008 and November 3, 2007. For the fiscal year ended February 2, 2008, dividends declared per share were $0.54.
See accompanying Notes to Consolidated Financial Statements.
1. Accounting Policies
The accompanying unaudited consolidated financial statements should be read in conjunction with the financial statement disclosures contained in our 2007 Form 10-K. The same accounting policies are followed in preparing quarterly financial data as are followed in preparing annual data. In the opinion of management, all adjustments necessary for a fair statement of quarterly operating results are reflected herein and are of a normal, recurring nature.
Due to the seasonal nature of our business, quarterly revenues, expenses, earnings and cash flows are not necessarily indicative of the results that may be expected for the full year.
During the first quarter of 2008 our Chief Executive Officer (CEO), Robert Ulrich, who was our chief operating decision maker (CODM) as defined in SFAS No. 131, Disclosure about Segments of an Enterprise and Related Information (SFAS 131), retired, and he was succeeded by Gregg Steinhafel. As a result of this change and in light of the anticipated sale of an undivided interest in approximately one-half of our credit card receivables, we reevaluated the provisions of SFAS 131. Based upon our review performed in the first quarter of 2008, we determined that we have two reportable segments, which reflects how our new CODM reviews our results in terms of allocating resources and assessing performance. These two reportable segments are based on our different products and services: Retail and Credit Card. As a result, prior period disclosures reflect the change in reportable segments. Refer to Note 12 for more information.
Our Retail Segment includes all of our merchandising operations, including our stores and our fully integrated online business. Our Credit Card Segment offers credit to qualified guests through our REDcard products, the Target Visa and the Target Card.
2. New Accounting Pronouncements
In December 2007, the FASB issued SFAS No. 141(R), Business Combinations (SFAS 141(R)), which changes the accounting for business combinations and their effects on the financial statements. SFAS 141(R) will be effective at the beginning of fiscal 2009. The adoption of this statement is not expected to materially affect our consolidated net earnings, cash flows or financial position.
In December 2007, the FASB issued SFAS No. 160, Accounting and Reporting of Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (SFAS 160). SFAS 160 requires entities to report non-controlling interests in subsidiaries as equity in their consolidated financial statements. SFAS 160 will be effective at the beginning of fiscal 2009. The adoption of this statement is not expected to materially affect our consolidated net earnings, cash flows or financial position.
In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133 (SFAS 161). SFAS 161 requires enhanced disclosures about derivatives and hedging activities. SFAS 161 will be effective at the beginning of fiscal 2009. The adoption of this statement will not affect our consolidated net earnings, cash flows or financial position.
3. Cost of Sales and Selling, General and Administrative Expenses
During the first quarter of 2008, we reviewed our Consolidated Statements of Operations cost classification policy, primarily related to distribution and other supply chain costs that were previously classified within Selling, General & Administrative Expenses (SG&A). The review was prompted by changes within our supply chain processes and infrastructure, primarily the opening of our own food distribution network. As a result of this review, we have reclassified certain costs within our Consolidated Statements of Operations. The most significant change is that distribution center costs are now presented within cost of sales, as opposed to SG&A. We have reclassified all prior periods to conform to the current year presentation.
The following table illustrates the primary costs classified in each major expense category:
4. Earnings Per Share
Basic earnings per share (EPS) is net earnings divided by the weighted average number of common shares outstanding during the period. Diluted EPS includes the incremental shares assumed to be issued upon the exercise of stock options and the incremental shares assumed to be issued under performance share and restricted stock unit arrangements.
For the November 1, 2008 and November 3, 2007 computations, 13.7 million and 4.3 million stock options, respectively, were excluded from the calculation of weighted average shares for diluted EPS because their effects were antidilutive.
5. Cash Equivalents
We held cash equivalents (including money market investments) with market values of $397 million, $1,851 million and $2.5 million at November 1, 2008, February 2, 2008 and November 3, 2007, respectively. The market values of these investments are determined based upon quoted market prices (Level 1 inputs as defined by SFAS 157).
6. Credit Card Receivables
Credit card receivables are recorded net of an allowance for expected losses. The allowance, recognized in an amount equal to anticipated future write-offs, was $765 million at November 1, 2008, $570 million at February 2, 2008 and $532 million at November 3, 2007. We estimate future write-offs based on delinquencies, risk scores, aging trends, industry risk trends and our historical experience. Substantially all accounts continue to accrue finance charges until they are written off. Total receivables past due ninety days or more and still accruing finance charges were $336 million at November 1, 2008, $235 million at February 2, 2008 and $197 million at November 3, 2007. Accounts are written off when they become 180 days past due.
As a method of providing funding for our accounts receivable, we sell on an ongoing basis all of our consumer credit card receivables to Target Receivables Corporation (TRC), a wholly owned, bankruptcy-remote subsidiary. TRC then transfers the receivables to the Target Credit Card Master Trust (the Trust), which from time to time will sell debt securities to third parties either directly or through a related trust. These debt securities represent undivided interests in the Trust assets. TRC uses the proceeds from the sale of debt securities and its share of collections on the receivables to pay the purchase price of the receivables to Target.
In the second quarter of 2008, we sold a 47% interest in our credit card receivables to an affiliate of JPMorgan Chase. This transaction was accounted for as a secured borrowing. The accounting guidance for such transactions, SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities (a replacement of SFAS No. 125), requires the inclusion of the receivables within the trust and any debt securities issued by the trust or a related trust in our Consolidated Statements of Financial Position. Notwithstanding this accounting treatment, the receivables transferred to the trust are not available to general creditors of Target. Upon termination of the securitization program and repayment of all debt securities issued from time to time by the trust, or a related trust, any remaining assets could be distributed to Target in a liquidation of TRC. The payments to JPMorgan Chase are made solely from the assets of the trust and are nonrecourse to the general assets of Target.
We are exposed to claims and litigation arising in the ordinary course of business and use various methods to resolve these matters in a manner that we believe serves the best interest of our shareholders and other constituents. We believe the recorded reserves in our consolidated financial statements are adequate in light of the probable and estimable liabilities. We do not believe that any of the currently identified claims or litigation will materially affect our results of operations, cash flows or financial condition.
We obtain short-term financing from time to time under our commercial paper program, a form of notes payable. Notes payable under this program totaled $1,382 million and $578 million at November 1, 2008 and November 3, 2007, respectively, and are included in current portion of unsecured debt and other borrowings on the Consolidated Statement of Financial Position. There were no amounts outstanding under our commercial paper program at February 2, 2008.
Our derivative instruments primarily consist of interest rate swaps that hedge the fair value of certain debt by effectively converting interest from a fixed rate to a floating rate. The majority of these instruments qualify for hedge accounting, and the associated assets and liabilities are recorded in the Consolidated Statements of Financial Position. The changes in market value of an interest rate swap, as well as the offsetting change in market value of the hedged debt, are recognized within earnings in the current period. Ineffectiveness would result when changes in the market value of the hedged debt were not completely offset by changes in the market value of the interest rate swap. At the end of the third quarter of 2008, we had three interest rate swaps designated as hedges of fixed rate borrowings, with aggregate notional amounts of $950 million, and there was no ineffectiveness recognized related to these swaps during the three and nine months ended November 1, 2008 and November 3, 2007. At the end of the third quarter of 2008, we also held two $500 million notional amount interest rate swaps that were not designated as hedges. During the quarter, we recorded a net mark-to-market loss of $0.9 million related to these swaps.
During the first quarter of 2008, we terminated interest rate swaps with a combined notional amount of $3,125 million for cash proceeds of $160 million, which are classified within other operating cash flows in the
Consolidated Statements of Cash Flows. Additionally, in lieu of terminating one other interest rate swap, we entered into an interest rate swap with a notional amount of $500 million that is intended to economically realize the value of the existing swap (these two swaps are referred to in the last sentence of the preceding paragraph). All of these previously existing swaps were designated as hedges, and concurrent with the first quarter 2008 transactions, we were required to stop making market value adjustments to the associated hedged debt. As a result of these transactions, each previously hedged borrowing is now being amortized to par value over its remaining life. During fiscal 2008, we expect to amortize approximately $49 million of these hedged debt valuation adjustments into earnings as a reduction of interest expense $42 million related to the terminated interest rate swaps and $7 million related to the previously existing swap that is no longer being accounted for as a hedge. Of the $49 million reduction to interest expense that will be recorded in 2008, $13 million was recognized in the third quarter and $37 million was recognized during the nine months ended November 1, 2008.
Unamortized hedged debt valuation gains from terminated and de-designated interest rate swaps totaled $206 million at November 1, 2008 and $15 million as of November 3, 2007.
In the first quarter of 2008, we adopted SFAS 157 for financial assets and liabilities. SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. For assets and liabilities measured at fair value on a recurring basis, the reporting entity must disclose information that enables users of its financial statements to assess the inputs used to develop those measurements. Our interest rate swaps are recorded at fair value, and they are defined as Level 2 assets and liabilities because their fair value is measurable using inputs other than quoted prices that are observable (for example, interest rates and yield curves observable at commonly quoted intervals). At November 1, 2008, February 2, 2008 and November 3, 2007, interest rate swaps were outstanding in notional amounts totaling $1,950 million, $4,575 million and $4,575 million, respectively. The market value of these outstanding interest rate swaps were assets of $88 million, $223 million and $64 million at November 1, 2008, February 2, 2008 and November 3, 2007, respectively.
9. Income Taxes
We file a U.S. federal income tax return and income tax returns in various states and foreign jurisdictions. With few exceptions, we are no longer subject to U.S. federal, state and local or non-U.S. income tax examinations by tax authorities for years before 1998.
We accrue for the effects of open uncertain tax positions and the related potential penalties and interest. There were no material adjustments to our recorded liability for unrecognized tax benefits during the three and nine months ended November 1, 2008. It is reasonably possible that the amount of the unrecognized tax benefit with respect to certain of our unrecognized tax positions will increase or decrease during the next 12 months; however, we do not expect the change to have a significant effect on our consolidated results of operations or financial position.
10. Share Repurchase
During the quarter ended November 1, 2008, we repurchased 2.5 million shares of our common stock, for a total cash investment of $140 million (average price per share of $54.93), and for the nine months ended November 1, 2008, we repurchased 66.8 million shares of our common stock, for a total cash investment of $3,380 million (average price per share of $50.54). Included in the total cash investment in the three and nine months ended November 1, 2008 were prior period cash outlays of $140 million and $453 million, respectively. Since the inception of our current share repurchase program, which began in the fourth quarter of 2007, we have repurchased 93.3 million shares of our common stock, for a total cash investment of $4,826 million (average price per share of $51.70).
Our share repurchases during the nine months ended November 1, 2008, included 30 million shares that were acquired through the exercise of call options.
(a)Paid in January 2008.
All the shares reacquired during the quarter ended November 1, 2008 were delivered upon settlement of prepaid forward contracts. The prepaid forward contracts settled during the quarter had a total cash investment of $140 million and an aggregate market value of $143 million at their respective settlement dates.
At November 1, 2008, we held long positions in prepaid forward contracts for 2.3 million shares of our common stock, for a total cash investment of $95 million, or an average price per share of $41.11.
In light of our current business outlook, in November 2008 we announced a temporary suspension of our open-market share repurchase program.
11. Pension, Postretirement Health Care and Other Benefits
We have qualified defined benefit pension plans covering all U.S. employees who meet age and service requirements. We also have unfunded, nonqualified pension plans for team members with qualified plan compensation restrictions. Benefits are provided based on years of service and team member compensation. Upon retirement, team members also become eligible for certain health care benefits if they meet minimum age and service requirements and agree to contribute a portion of the cost.
We also maintain nonqualified, unfunded deferred compensation plans for approximately 4,000 current and retired team members whose participation in our 401(k) plan is limited by statute or regulation. These team members choose from a menu of crediting rate alternatives that are the same as the investment choices in our 401(k) plan, including Target common stock. We credit an additional 2 percent per year to the accounts of all active participants who are not executive officers, in part to recognize the risks inherent to their participation in a plan of this nature. We also maintain a nonqualified, unfunded deferred compensation plan that was frozen during 1996, covering 13 current and 50 retired participants. In this plan, deferred compensation earns returns tied to market levels of interest rates plus an additional 6 percent return, with a minimum of 12 percent and a maximum of 20 percent, as determined by the plans terms.
We control some of our risk of offering the nonqualified plans by investing in vehicles that offset a substantial portion of our economic exposure to the returns of the plans. These investment vehicles include company owned life insurance on approximately 4,000 highly compensated team members who have given their consent to be insured and prepaid forward contracts in our own common stock. The fair value of these assets was as follows:
(a)Company owned life insurance investments largely comprise investments in index funds and other investments. The market values of these investments are determined based upon quoted market prices (Level 1 inputs as defined by SFAS 157). The amounts are shown net of loans that are secured by some of these policies. The loan balances were $441 million, $379 million, and $380 million as of November 1, 2008, February 2, 2008 and November 3, 2007, respectively.
(b) The values of prepaid forward contracts are determined by reference to the market prices of Target common stock (Level 2 inputs as defined by SFAS 157).
All of these investments are general corporate assets that are marked-to-market with the related gains and losses recognized in the Consolidated Statements of Operations in the period they occur. The gains and losses recognized on these investments effectively offset the gains and losses associated with the returns earned by participants in our deferred compensation plans. These amounts include the change in fair value of the prepaid forward contracts indexed to our own common stock recorded in earnings as a pre-tax gain of $29 million and $1 million for the three months ended November 1, 2008 and November 3, 2007, respectively, and a pre-tax gain/(loss) of $(2) million and $7 million for the nine months ended November 1, 2008 and November 3, 2007, respectively. For the nine months ended November 1, 2008 and November 3, 2007, we invested approximately $207 million and $127 million, respectively, in prepaid forward contracts in our own common stock, and these investments are included in the Consolidated Statement of Cash Flows within other investing activities. Adjusting our position in these investment vehicles may involve repurchasing shares of Target common stock when settling the forward contracts.
During the quarter ended November 1, 2008, we settled outstanding prepaid forward contracts and received 2.5 million shares of our common stock. By November 1, 2008, these contracts were replaced with prepaid forward contracts for 2.3 million shares of our own common stock for a cash investment of $95 million (average price per share of $41.11). The terms of the new contracts significantly reduce the counterparty credit risk associated with these agreements.
12. Segment Reporting
Prior to 2008, we operated as a single business segment. As described in Note 1, the change in our chief operating decision maker has resulted in a change to our reportable segments.
The accounting policies of the operating segments are the same as those described in Note 1.
Our measure of segment profitability for each segment is a measure that management considers analytically useful in measuring the return we are achieving on our investment in each segment.
(a) New account and loyalty rewards redeemed by our guests reduce reported sales. Our Retail Segment charges the cost of these discounts to our Credit Card Segment, and the reimbursements of $24 million in the third quarter of 2008 and $24 million in the third quarter of 2007 are recorded as a reduction to SG&A expenses within the Retail Segment and an increase to SG&A expenses within the Credit Card Segment.