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Target 10-Q 2008

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

FORM 10-Q

 

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

 


 

 

TARGET CORPORATION

(Exact name of registrant as specified in its charter)

 

Minnesota

 

41-0215170

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

1000 Nicollet Mall, Minneapolis, Minnesota

 

55403

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s 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 registrant’s 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.

 


 

TARGET CORPORATION

 

TABLE OF CONTENTS

 

PART I

FINANCIAL INFORMATION

 

Item 1.

Financial Statements

 

 

Consolidated Statements of Operations

1

 

Consolidated Statements of Financial Position

2

 

Consolidated Statements of Cash Flows

3

 

Consolidated Statements of Shareholders’ Investment

4

 

Notes to Consolidated Financial Statements

5

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

12

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

20

Item 4.

Controls and Procedures

20

 

 

 

PART II

OTHER INFORMATION

 

Item 1.

Legal Proceedings

21

Item 1A.

Risk Factors

21

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

21

Item 3.

Defaults Upon Senior Securities

21

Item 4.

Submission of Matters to a Vote of Security Holders

22

Item 5.

Other Information

22

Item 6.

Exhibits

22

 

 

 

 

 

 

Signature

23

Exhibit Index

24

 

 



 

PART I.  FINANCIAL INFORMATION

 

Item 1.  Financial Statements

 

Consolidated Statements of Operations

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

Nov. 1,

 

Nov. 3,

 

Nov. 1,

 

Nov. 3,

 

(millions, except per share data) (unaudited)

 

2008

 

2007

 

2008

 

2007

 

Sales

 

$

14,588

 

$

14,342

 

$

43,861

 

$

42,132

 

Credit card revenues

 

526

 

493

 

1,527

 

1,364

 

Total revenues

 

15,114

 

14,835

 

45,388

 

43,496

 

Cost of sales

 

10,130

 

10,035

 

30,332

 

29,147

 

Selling, general and administrative expenses

 

3,245

 

3,191

 

9,436

 

9,124

 

Credit card expenses

 

403

 

222

 

1,023

 

574

 

Depreciation and amortization

 

469

 

429

 

1,352

 

1,225

 

Earnings before interest expense and income taxes

 

867

 

958

 

3,245

 

3,426

 

Interest expense, net

 

 

 

 

 

 

 

 

 

Nonrecourse debt collateralized by credit card receivables

 

60

 

41

 

126

 

98

 

Other interest expense

 

180

 

143

 

550

 

380

 

Interest income

 

(6

)

(7

)

(24

)

(11

)

Net interest expense

 

234

 

177

 

652

 

467

 

Earnings before income taxes

 

633

 

781

 

2,593

 

2,959

 

Provision for income taxes

 

264

 

298

 

988

 

1,138

 

Net earnings

 

$

369

 

$

483

 

$

1,605

 

$

1,821

 

Basic earnings per share

 

$

0.49

 

$

0.57

 

$

2.07

 

$

2.14

 

Diluted earnings per share

 

$

0.49

 

$

0.56

 

$

2.06

 

$

2.11

 

Weighted average common shares outstanding

 

 

 

 

 

 

 

 

 

Basic

 

753.5

 

845.6

 

776.4

 

850.8

 

Diluted

 

756.6

 

851.0

 

780.1

 

856.3

 

 

See accompanying Notes to Consolidated Financial Statements.

 

1



 

Consolidated Statements of Financial Position

 

 

Nov. 1,

 

Feb. 2,

 

Nov. 3,

 

(millions)

 

2008

 

2008

 

2007

 

Assets

 

(unaudited

)

 

 

(unaudited

)

Cash and cash equivalents

 

$

918

 

$

2,450

 

$

627

 

Credit card receivables, net of allowance of $765, $570 and $532

 

7,999

 

8,054

 

7,120

 

Inventory

 

9,050

 

6,780

 

8,746

 

Other current assets

 

2,272

 

1,622

 

1,841

 

Total current assets

 

20,239

 

18,906

 

18,334

 

Property and equipment

 

 

 

 

 

 

 

Land

 

5,727

 

5,522

 

5,387

 

Buildings and improvements

 

20,454

 

18,329

 

17,211

 

Fixtures and equipment

 

4,212

 

3,858

 

3,659

 

Computer hardware and software

 

2,610

 

2,421

 

2,361

 

Construction-in-progress

 

1,320

 

1,852

 

2,524

 

Accumulated depreciation

 

(8,798

)

(7,887

)

(7,536

)

Property and equipment, net

 

25,525

 

24,095

 

23,606

 

Other noncurrent assets

 

1,277

 

1,559

 

1,349

 

Total assets

 

$

47,041

 

$

44,560

 

$

43,289

 

Liabilities and shareholders’ investment

 

 

 

 

 

 

 

Accounts payable

 

$

7,590

 

$

6,721

 

$

7,852

 

Accrued and other current liabilities

 

3,057

 

3,097

 

2,812

 

Unsecured debt and other borrowings

 

2,849

 

1,464

 

1,899

 

Nonrecourse debt collateralized by credit card receivables

 

-

 

500

 

1,000

 

Total current liabilities

 

13,496

 

11,782

 

13,563

 

Unsecured debt and other borrowings

 

11,966

 

13,226

 

9,339

 

Nonrecourse debt collateralized by credit card receivables

 

5,478

 

1,900

 

1,900

 

Deferred income taxes

 

589

 

470

 

421

 

Other noncurrent liabilities

 

1,932

 

1,875

 

1,906

 

Total noncurrent liabilities

 

19,965

 

17,471

 

13,566

 

Shareholders’ investment

 

 

 

 

 

 

 

Common stock

 

63

 

68

 

70

 

Additional paid-in capital

 

2,725

 

2,656

 

2,636

 

Retained earnings

 

10,967

 

12,761

 

13,630

 

Accumulated other comprehensive loss

 

(175

)

(178

)

(176

)

Total shareholders’ investment

 

13,580

 

15,307

 

16,160

 

Total liabilities and shareholders’ investment

 

$

47,041

 

$

44,560

 

$

43,289

 

Common shares outstanding

 

752.8

 

818.7

 

845.0

 

 

See accompanying Notes to Consolidated Financial Statements.

 

2



 

Consolidated Statements of Cash Flows

 

 

Nine Months Ended

 

 

 

Nov. 1,

 

Nov. 3,

 

(millions) (unaudited)

 

2008

 

2007

 

Operating activities

 

 

 

 

 

Net earnings

 

$

1,605

 

$

1,821

 

Reconciliation to cash flow

 

 

 

 

 

Depreciation and amortization

 

1,352

 

1,225

 

Share-based compensation expense

 

43

 

59

 

Deferred income taxes

 

(32

)

(72

)

Bad debt provision

 

751

 

311

 

Loss on disposal of property and equipment, net

 

33

 

34

 

Other non-cash items affecting earnings

 

165

 

82

 

Changes in operating accounts providing / (requiring) cash

 

 

 

 

 

Accounts receivable originated at Target

 

(313

)

(260

)

Inventory

 

(2,270

)

(2,492

)

Other current assets

 

(322

)

(164

)

Other noncurrent assets

 

5

 

4

 

Accounts payable

 

869

 

1,277

 

Accrued and other current liabilities

 

(270

)

(297

)

Other noncurrent liabilities

 

4

 

58

 

Other

 

160

 

-

 

Cash flow provided by operations

 

1,780

 

1,586

 

Investing activities

 

 

 

 

 

Expenditures for property and equipment

 

(2,827

)

(3,418

)

Proceeds from disposal of property and equipment

 

26

 

53

 

Change in accounts receivable originated at third parties

 

(383

)

(978

)

Other investments

 

(179

)

(189

)

Cash flow required for investing activities

 

(3,363

)

(4,532

)

Financing activities

 

 

 

 

 

Change in commercial paper, net

 

1,382

 

578

 

Additions to short-term notes payable

 

-

 

1,000

 

Reductions of short-term notes payable

 

(500

)

-

 

Additions to long-term debt

 

3,557

 

3,650

 

Reductions of long-term debt

 

(1,254

)

(1,254

)

Dividends paid

 

(345

)

(324

)

Repurchase of stock

 

(2,815

)

(1,071

)

Stock option exercises and related tax benefit

 

34

 

204

 

Other

 

(8

)

(23

)

Cash flow provided by financing activities

 

51

 

2,760

 

Net decrease in cash and cash equivalents

 

(1,532

)

(186

)

Cash and cash equivalents at beginning of period

 

2,450

 

813

 

Cash and cash equivalents at end of period

 

$

918

 

$

627

 

 

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.

 

3



 

Consolidated Statements of Shareholders’ Investment

 

 

 

 

 

 

 

 

 

 

Accumulated Other
Comprehensive
Income / (Loss )

 

 

 

(millions, except footnotes)

 

Common
Stock
Shares

 

Stock
Par Value

 

Additional
Paid-in
Capital

 

Retained
Earnings

 

Pension and
Other Benefit
Liability
Adjustments

 

Derivative
Instruments
and Other

 

Total

 

February 3, 2007

 

859.8

 

$

72

 

$

2,387

 

$

13,417

 

$

(247

)

$

4

 

$

15,633

 

Net earnings

 

-

 

-

 

-

 

2,849

 

-

 

-

 

2,849

 

Other comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Pension and other benefit liability adjustments, net of taxes of $38

 

-

 

-

 

-

 

-

 

59

 

-

 

59

 

Unrealized losses on cash flow hedges, net of taxes of $31

 

-

 

-

 

-

 

-

 

-

 

(48

)

(48

)

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

2,860

 

Cumulative effect of adopting new accounting pronouncements

 

-

 

-

 

-

 

(31

)

54

 

-

 

23

 

Dividends declared

 

-

 

-

 

-

 

(454

)

-

 

-

 

(454

)

Repurchase of stock

 

(46.2

)

(4

)

-

 

(2,689

)

-

 

-

 

(2,693

)

Premiums on call options

 

-

 

-

 

-

 

(331

)

-

 

-

 

(331

)

Stock options and awards

 

5.1

 

-

 

269

 

-

 

-

 

-

 

269

 

February 2, 2008

 

818.7

 

68

 

2,656

 

12,761

 

(134

)

(44

)

15,307

 

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net earnings

 

-

 

-

 

-

 

1,605

 

-

 

-

 

1,605

 

Other comprehensive income Reclassification adjustment

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

for gains recognized into net earnings, net of taxes of $2

 

-

 

-

 

-

 

-

 

6

 

(3

)

3

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

1,608

 

Dividends declared

 

-

 

-

 

-

 

(351

)

-

 

-

 

(351

)

Repurchase of stock

 

(66.8

)

(5

)

-

 

(3,048

)

-

 

-

 

(3,053

)

Stock options and awards

 

0.9

 

-

 

69

 

-

 

-

 

-

 

69

 

November 1, 2008

 

752.8

 

$

63

 

$

2,725

 

$

10,967

 

$

(128

)

$

(47

)

$

13,580

 

 

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.

 

4



 

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

 

Future adoptions

 

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.

 

5



 

The following table illustrates the primary costs classified in each major expense category:

 

Cost of Sales

 

Selling, General and Administrative Expenses

Total cost of products sold including:

·      Freight expenses associated with moving merchandise from our vendors to our distribution centers and our retail stores, and among our distribution and retail facilities

·      Vendor income that is not reimbursement of specific, incremental and identifiable costs

Inventory shrink

Markdowns

Outbound shipping and handling expenses associated with sales to our guests

Terms cash discount

Distribution center costs, including compensation and benefits costs

 

Compensation and benefit costs including:

·      Stores

·      Headquarters

Occupancy and operating costs of retail and headquarters facilities

Advertising, offset by vendor income that is a reimbursement of specific, incremental and identifiable costs

Pre-opening costs of stores and other facilities

Other administrative costs

The classification of these expenses varies across the retail industry.

 

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.

 

 

 

Basic EPS

 

Diluted EPS

 

 

 

Three Months Ended

 

Nine Months Ended

 

Three Months Ended

 

Nine Months Ended

 

 

 

Nov. 1,

 

Nov. 3,

 

Nov. 1,

 

Nov. 3,

 

Nov. 1,

 

Nov. 3,

 

Nov. 1,

 

Nov. 3,

 

(millions, except per share data)

 

2008

 

2007

 

2008

 

2007

 

2008

 

2007

 

2008

 

2007

 

Net earnings

 

$

369

 

$

483

 

$

1,605

 

$

1,821

 

$

369

 

$

483

 

$

1,605

 

$

1,821

 

Adjustment for prepaid forward contracts

 

-

 

-

 

-

 

-

 

-

 

(3

)

-

 

(11

)

Net earnings for EPS calculation

 

$

369

 

$

483

 

$

1,605

 

$

1,821

 

$

369

 

$

480

 

$

1,605

 

$

1,810

 

Basic weighted average
common shares outstanding

 

753.5

 

845.6

 

776.4

 

850.8

 

753.5

 

845.6

 

776.4

 

850.8

 

Incremental stock options,

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

performance share units and

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

restricted stock units

 

-

 

-

 

-

 

-

 

3.1

 

5.7

 

3.7

 

6.3

 

Adjustment for prepaid forward contracts

 

-

 

-

 

-

 

-

 

-

 

(0.3

)

-

 

(0.8

)

Weighted average common
shares outstanding

 

753.5

 

845.6

 

776.4

 

850.8

 

756.6

 

851.0

 

780.1

 

856.3

 

Earnings per share

 

$

0.49

 

$

0.57

 

$

2.07

 

$

2.14

 

$

0.49

 

$

0.56

 

$

2.06

 

$

2.11

 

 

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



 

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.

 

7.  Contingencies

 

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.

 

8.  Debt and Derivative Financial Instruments
 

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

 

7



 

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.

 

8



 

  Call Option Repurchase Details

 

 

 

 

 

 

 

 

 

 

 

Number of

 

 

 

(amounts per share)

 

Total Cost

 

  Series

 

Options Exercised

 

Exercise Date

 

Premium (a)

 

Strike Price

 

Total

 

(millions)

 

  Series I

 

10,000,000

 

April 2008

 

$11.04

 

$40.32

 

$51.36

 

$514

 

  Series II

 

10,000,000

 

May 2008

 

10.87

 

39.31

 

50.18

 

502

 

  Series III

 

10,000,000

 

June 2008

 

11.20

 

39.40

 

50.60

 

506

 

  Total

 

30,000,000

 

 

 

$11.04

 

$39.68

 

$50.71

 

$1,522

 

(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.

 

Net Pension Expense and Postretirement Healthcare Expense

 

 

 

 

 

 

 

 

 

 

 

 

Pension Benefits

 

Postretirement Health Care Benefits

 

 

 

Three Months Ended

 

Nine Months Ended

 

Three Months Ended

 

Nine Months Ended

 

 

 

Nov. 1,

 

Nov. 3,

 

Nov. 1,

 

Nov. 3,

 

Nov. 1,

 

Nov. 3,

 

Nov. 1,

 

Nov. 3,

 

(millions)

 

2008

 

2007

 

2008

 

2007

 

2008

 

2007

 

2008

 

2007

 

Service cost

 

$

24

 

$

24

 

$

70

 

$

73

 

$

1

 

$

1

 

$

3

 

$

3

 

Interest cost

 

29

 

26

 

87

 

78

 

2

 

2

 

6

 

6

 

Expected return on assets

 

(41

)

(38

)

(121

)

(114

)

-

 

-

 

-

 

-

 

Recognized losses

 

4

 

10

 

12

 

29

 

-

 

-

 

-

 

-

 

Recognized prior service cost

 

(1

)

(1

)

(3

)

(3

)

-

 

-

 

-

 

-

 

Total

 

$

15

 

$

21

 

$

45

 

$

63

 

$

3

 

$

3

 

$

9

 

$

9

 

 

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 plan’s 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:

 

9



 

Nonqualified Plan-Related Investments

 

Nov. 1,

 

Feb. 2,

 

Nov. 3,

 

(millions)

 

2008

 

2008

 

2007

 

Company owned life insurance (a)

 

$

438

 

$

578

 

$

581

 

Prepaid forward contracts (b)

 

86

 

128

 

142

 

Total

 

$

524

 

$

706

 

$

723

 

(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.

 

10



 

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.

 

Business Segment Results

 

Three Months Ended Nov. 1, 2008

 

Three Months Ended Nov. 3, 2007

 

 

 

 

 

 

Credit

 

 

 

 

 

 

 

 

 

Credit

 

 

 

 

 

(millions)

 

Retail

 

 

Card

 

 

 

Total

 

 

Retail

 

 

Card

 

 

Total

 

 

Sales/Credit card revenues

 

$

14,588

 

 

$

526

 

 

$

15,114

 

 

$

14,342

 

 

$

493

 

 

$

14,835

 

 

Cost of sales

 

10,130

 

 

-

 

 

10,130

 

 

10,035

 

 

-

 

 

10,035

 

 

Bad debt expense

 

-

 

 

314

 

 

314

 

 

-

 

 

130

 

 

130

 

 

SG&A expenses (a)

 

3,221

 

 

113

 

 

3,334

 

 

3,167

 

 

116

 

 

3,283

 

 

Depreciation and amortization

 

465

 

 

4

 

 

469

 

 

425

 

 

4

 

 

429

 

 

Earnings before interest expense and income taxes

 

772

 

 

95

 

 

867

 

 

715

 

 

243

 

 

958

 

 

Interest expense on nonrecourse debt collateralized by credit card receivables

 

-

 

 

60

 

 

60

 

 

-

 

 

41

 

 

41

 

 

Segment profitability

 

$

772

 

 

$

35

 

 

807

 

 

$

715

 

 

$

202

 

 

917

 

 

Unallocated (income) and expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other interest expense

 

 

 

 

 

 

 

180

 

 

 

 

 

 

 

 

143

 

 

Interest income

 

 

 

 

 

 

 

(6

)

 

 

 

 

 

 

 

(7

)

 

Earnings before income taxes

 

 

 

 

 

 

 

$

633

 

 

 

 

 

 

 

 

$

781

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

(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.

 

11



 

Business Segment Results

 

Nine Months Ended Nov. 1, 2008

 

Nine Months Ended Nov. 3, 2007

 

 

 

 

 

 

 

Credit

 

 

 

 

 

 

 

 

Credit

 

 

 

 

 

(millions)

 

 

Retail

 

 

Card

 

 

Total

 

 

Retail

 

 

Card

 

 

Total

 

 

Sales/Credit card revenues

 

$

43,861

 

 

$

1,527

 

 

$

45,388

 

 

$

42,132

 

 

$

1,364

 

 

$

43,496

 

 

Cost of sales

 

30,332

 

 

-

 

 

30,332

 

 

29,147

 

 

-

 

 

29,147

 

 

Bad debt expense

 

-

 

 

751

 

 

751

 

 

-

 

 

311

 

 

311

 

 

SG&A expenses (a)

 

9,361

 

 

347

 

 

9,708

 

 

9,052

 

 

335

 

 

9,387

 

 

Depreciation and amortization

 

1,339

 

 

13

 

 

1,352

 

 

1,213

 

 

12

 

 

1,225

 

 

Earnings before interest expense and income taxes

 

2,829

 

 

416

 

 

3,245

 

 

2,720

 

 

706

 

 

3,426

 

 

Interest expense on nonrecourse debt collateralized by credit card receivables

 

-

 

 

126

 

 

126

 

 

-

 

 

98

 

 

98

 

 

Segment profitability

 

$

2,829

 

 

$

290

 

 

3,119

 

 

$

2,720

 

 

$

608

 

 

3,328

 

 

Unallocated (income) and expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other interest expense

 

 

 

 

 

 

 

550

 

 

 

 

 

 

 

 

380

 

 

Interest income

 

 

 

 

 

 

 

(24

)

 

 

 

 

 

 

 

(11

)

 

Earnings before income taxes

 

 

 

 

 

 

 

$

2,593

 

 

 

 

 

 

 

 

$

2,959