Target - 10-Q quarterly report FY

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).

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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

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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.

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(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 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:

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(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.

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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.

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(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 $75 million for the nine months ended November 1, 2008 and $73 million for the nine months ended November 3, 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.

Substantially all of our revenues are generated in, and long-lived assets are located in, the United States.

Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

Analysis of Results of Operations

Total revenues for the three and nine months ended November 1, 2008 were $15,114 million and $45,388 million, respectively, compared with $14,835 million and $43,496 million, respectively, for the same periods last year, an increase of 1.9 percent and 4.4 percent, respectively.

Net earnings for the three and nine months ended November 1, 2008 were $369 million, or $0.49 per share, and $1,605 million and $2.06 per share, respectively, compared with $483 million, or $0.56 per share, and $1,821 million and $2.11 per share, respectively, for the same periods last year. All earnings per share figures refer to diluted earnings per share.

As described in Notes 1 and 12, we changed our reportable business segments in the first quarter of 2008. Additionally, as described in Note 3, we changed our cost classification policy with respect to certain supply chain costs.

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Retail Segment

EBITDA is earnings before interest expense, income taxes, depreciation and amortization.

EBIT is earnings before interest expense and income taxes.

(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 and $75 million for the three and nine months ended November 1, 2008, respectively, and $24 million and $73 million for the three and nine months ended November 3, 2007, respectively, are recorded as a reduction to SG&A expenses within the Retail Segment.

Sales

Sales include merchandise sales, net of expected returns, from our stores and our online business, as well as gift card breakage.  Total sales for the Retail Segment for the quarter were $14,588 million, compared with $14,342 million for the same period a year ago, an increase of 1.7% percent. For the nine month period ending November 1, 2008, total sales for the Retail Segment were $43,861 million, compared with $42,132 million for the same period a year ago, an increase of 4.1 percent.  Total sales growth in the Retail Segment was positively impacted by our new stores, somewhat offset by a decline in comparable-store sales.

Comparable-store sales is a measure that indicates the performance of our existing stores by measuring the growth in sales for such stores for a period over the comparable, prior-year period of equivalent length.  The method of calculating comparable store sales varies across the retail industry. As a result, our calculation of comparable store sales is not necessarily comparable to similarly titled measures reported by other companies.

Comparable-store sales are sales from our online business and sales from general merchandise and SuperTarget stores open longer than one year, including:

·                         sales from stores that have been remodeled or expanded while remaining open

·                          sales from stores that have been relocated to new buildings of the same format within the same trade area, in which the new store opens at about the same time as the old store closes

Comparable-store sales do not include:

·                          sales from general merchandise stores that have been converted, or relocated within the same trade area, to a SuperTarget store format

·                         sales from stores that were intentionally closed to be remodeled, expanded or reconstructed

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In fiscal 2008, the decline in comparable store sales was driven by a decline in the number of transactions, partially offset by an increase in average transaction amount, which reflects the effect of a decrease in number of units per transaction partially offset by higher dollars per unit within the transactions.

Transaction-level metrics are influenced by a broad array of macroeconomic, competitive and consumer behavioral factors, and comparable-store sales rates are impacted by transfer of sales to new stores.

Gross Margin Rate

Gross margin rate represents gross margin (sales less cost of sales) as a percentage of sales. See Note 3 for a description of expenses included in cost of sales. In the third quarter of 2008, our gross margin rate was 30.6 percent compared with 30.0 percent in the same period last year, driven by increases in gross margin rates within categories that benefitted the rate (approximately 1.0 percent), partially offset by the mix impact of faster sales growth in lower margin rate categories (approximately 0.4 percent). Rate improvement within categories during the quarter was driven partly by an array of inventory control initiatives that minimized markdowns and by a favorable supply chain expense rate (0.2 percent), about half of which was driven by improved workers compensation expenses.  For the nine months ended November 1, 2008, our gross margin rate was 30.8 percent, unchanged from the same period last year. While our year-to-date gross margin rate was flat, we experienced increases in gross margin rates within categories that benefitted the rate (approximately 0.6 percent) that were entirely offset by the mix impact of faster sales growth in lower margin rate categories (approximately 0.6 percent).  The same factors that drove changes in our quarterly gross margin rate affected our year-to-date gross margin rate, except that the changes in sales mix on the gross margin rate fully offset the factors driving rate improvements within merchandise categories.

Selling, General and Administrative Expense Rate

Our selling, general and administrative (SG&A) expense rate represents SG&A expenses as a percentage of sales. See Note 3 for a description of expenses included in SG&A expense. SG&A expenses exclude depreciation and amortization. In the third quarter of 2008 and 2007, our SG&A expense rate was 22.1 percent.  For the nine months ended November 1, 2008, our SG&A rate was 21.3 percent compared with 21.5 percent in the same period last year. We were able to achieve these essentially flat expense rates due to continued productivity gains in our stores and disciplined control of expenses across the company.

Depreciation and Amortization Expense Rate

Our depreciation and amortization expense rate represents depreciation and amortization expense as a percentage of sales. In the third quarter of 2008, our depreciation and amortization expense rate was 3.2 percent compared with 3.0 percent  for the same period last year.  For the nine months ended November 1, 2008, our depreciation and amortization expense rate was 3.1 percent compared with 2.9 percent for the same period last year.  The rate unfavorability resulted from sales growing at a slower pace than capital expenditures.

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Store Data

During the quarter, we opened 45 new stores, including 37 general merchandise stores (28 net of store closings) and 8 SuperTarget stores.

(a) In thousands; reflects total square feet, less office, distribution center and vacant space.

Credit Card Segment

We offer credit to qualified guests through our REDcard products, the Target Visa and the Target Card. Our credit card program strategically supports our core retail operations and remains an important contributor to our overall profitability. Our credit card revenues are comprised of finance charges, late fees and other revenues. The substantial majority of credit card receivables earn finance charge revenues at rates tied to the Prime Rate. In addition, we receive fees from merchants who accept the Target Visa credit card.