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TGT > SEC Filings for TGT > Form 10-Q on 21-Nov-2012All Recent SEC Filings

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Form 10-Q for TARGET CORP


21-Nov-2012

Quarterly Report


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

Executive Summary

Consolidated revenues were $16,929 million for the three months ended October 27, 2012, an increase of $527 million or 3.2 percent from the same period in the prior year. Consolidated earnings before interest expense and income taxes for third quarter 2012 increased by $107 million or 10.1 percent from third quarter 2011 to $1,164 million. Cash flow provided by operations was $3,348 million and $2,975 million for the nine months ended October 27, 2012 and October 29, 2011, respectively. Diluted earnings per share in the third quarter increased 17.6 percent to $0.96 from $0.82 in the same period a year ago. Adjusted diluted earnings per share, which we believe is useful in providing period-to-period comparisons of the results of our U.S. operations, increased 4.3 percent to $0.90 in third quarter 2012 from $0.86 in the same period a year ago.

Earnings Per Share            Three Months Ended                         Nine Months Ended
                          October 27,      October 29,               October 27,      October 29,
                                 2012             2011    Change            2012             2011     Change
GAAP diluted earnings
per share                $       0.96     $       0.82      17.6 %  $       3.06     $       2.84        7.9 %
Adjustments(a)                  (0.06 )           0.04                      0.06             0.09
Adjusted diluted
earnings per share       $       0.90     $       0.86       4.3 %  $       3.12     $       2.93        6.8 %

Note: A reconciliation of non-GAAP financial measures to GAAP measures is provided on page 22.

(a) Adjustments represent the diluted EPS impact of our planned 2013 Canadian market entry, the gain on receivables held for sale and favorable resolution of various income tax matters.

Our financial results for the third quarter of 2012 in our U.S. Retail Segment reflect increased sales of 3.4 percent over the same period last year due to a 2.9 percent comparable-store increase combined with the contribution from new stores. Our third quarter 2012 U.S. Retail Segment EBITDA margin rate decreased slightly from the prior period, primarily due to a lower gross margin rate driven by the impact of our 5% REDcard Rewards program and our store remodel program. Our EBIT margin rate remained consistent with the prior year.

In the U.S. Credit Card Segment, we experienced a decrease in segment profit due to annualizing over a significant reserve reduction in the prior year and lower finance charge revenue resulting from a smaller portfolio, partially offset by lower interest expense.

During the three and nine months ended October 27, 2012, loss before interest expense and income taxes in our Canadian Segment totaled $96 million and $221 million, respectively, comprised of start-up costs and depreciation, compared to $35 million and $81 million during the three and nine months ended October 29, 2011, respectively.

Credit Card Receivables Transaction

On October 22, 2012, we reached an agreement to sell our entire consumer credit card portfolio to TD Bank Group (TD) for cash consideration equal to the gross
(par) value of the outstanding receivables at the time of closing. The sale, which is subject to regulatory approval and other customary closing conditions, is expected to close in the first half of 2013. Following close, TD will underwrite, fund and own Target Credit Card and Target Visa receivables in the U.S. TD will control risk management policies and regulatory compliance, and we will perform account servicing and primary marketing functions. We will earn a substantial portion of the profits generated by the Target Credit Card and Target Visa portfolios. We expect to apply the proceeds from the sale in a manner that will preserve our strong investment-grade credit ratings. Specifically, we expect to apply approximately 90 percent of net transaction proceeds to reduce our net debt position, including repaying the 2006/2007 Series Variable Funding Certificate at par, with the remainder applied to our current share repurchase program over time.

With this agreement, our receivables are now classified as held for sale and recorded at the lower of cost (par) or fair value. We recorded a gain of $156 million outside of our segments in the third quarter of 2012, representing the net adjustment to eliminate our allowance for doubtful accounts and record our receivables at lower of cost (par) or fair value. This transaction is expected to be accounted for as a sale upon closing, and the receivables will no longer be reported on our Consolidated Statements of Financial Position. At closing, we expect to recognize a gain of approximately $350 million to $450 million related to consideration received in excess of the recorded amount of receivables. Consideration received will include cash equal to the par value of the receivables and the fair value of a beneficial interest asset. The beneficial interest effectively represents a receivable for the present value of future profit-sharing we expect to earn on the receivables sold. Based on historical payment patterns, we estimate that the beneficial interest


asset will be reduced over a four year period, with larger reductions in the early years. As a result, a portion of the profit-sharing payments we receive from TD in the first four years of the arrangement will not be recorded as income.

Beginning with the fiscal quarter in which this transaction closes, income from the profit-sharing arrangement, net of account servicing expenses, will be recognized within SG&A expenses in our U.S. Retail Segment, and we will no longer report a U.S. Credit Card Segment.

Analysis of Results of Operations



U.S. Retail Segment



U.S. Retail Segment
Results                          Three Months Ended                              Nine Months Ended
                        October 27,     October 29,    Percent        October 27,     October 29,    Percent
(dollars in
millions)                      2012            2011     Change               2012            2011     Change
Sales                 $      16,601   $      16,054        3.4   %  $      49,589   $      47,529        4.3   %
Cost of sales                11,569          11,165        3.6             34,406          32,874        4.7
Gross margin                  5,032           4,889        2.9             15,183          14,655        3.6
SG&A expenses(a)              3,553           3,433        3.5             10,315           9,988        3.3
EBITDA                        1,479           1,456        1.6              4,868           4,667        4.3
Depreciation and
amortization                    516             525       (1.7 )            1,526           1,527       (0.1 )
EBIT                  $         963   $         931        3.4   %  $       3,342   $       3,140        6.4   %

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

EBIT is earnings before interest expense and income taxes.

Note: See Note 12 to our consolidated financial statements for a reconciliation of our segment results to earnings before income taxes.

(a) Loyalty program charges were $78 million and $74 million for the three months ended October 27, 2012 and October 29, 2011, respectively, and $217 million and $189 million for the nine months ended October 27, 2012 and October 29, 2011, respectively. In all periods, these amounts were recorded as reductions to SG&A expenses within the U.S. Retail Segment and increases to operations and marketing expenses within the U.S. Credit Card Segment.

U.S. Retail Segment Rate Analysis           Three Months Ended               Nine Months Ended
                                        October 27,    October 29,     October 27,    October 29,
                                               2012           2011            2012           2011
Gross margin rate                              30.3  %        30.5  %         30.6  %        30.8  %
SG&A expense rate                              21.4           21.4            20.8           21.0
EBITDA margin rate                              8.9            9.1             9.8            9.8
Depreciation and amortization
expense rate                                    3.1            3.3             3.1            3.2
EBIT margin rate                                5.8            5.8             6.7            6.6

Rate analysis metrics are computed by dividing the applicable amount by sales.

Sales

Sales include merchandise sales, net of expected returns, from our stores and our online business, as well as gift card breakage. See Item 1 in our Form 10-K for the fiscal year ended January 28, 2012 for a description of our product categories.

Sales by Product Category        Three Months Ended               Nine Months Ended
                             October 27,    October 29,     October 27,    October 29,
                                    2012           2011            2012           2011
Household essentials                  26  %          26  %           26  %          26  %
Hardlines                             14             15              15             17
Apparel and accessories               20             20              20             20
Food and pet supplies                 21             20              21             19
Home furnishings and décor            19             19              18             18
Total                                100  %         100  %          100  %         100  %


Comparable-store sales is a measure that highlights the performance of our existing stores by measuring the change 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 comparable-store sales calculation is not necessarily comparable to similarly titled measures reported by other companies.

Comparable-Store Sales                      Three Months Ended               Nine Months Ended
                                        October 27,    October 29,     October 27,    October 29,
                                               2012           2011            2012           2011
Comparable-store sales change                   2.9  %         4.3  %          3.7  %         3.4  %
Drivers of change in
comparable-store sales:
Number of transactions                          0.5            0.3             1.0            0.4
Average transaction amount                      2.4            4.1             2.7            3.1
Selling price per unit                          1.2            1.6             1.6            0.2
Units per transaction                           1.2            2.5             1.0            2.9

Comparable-store sales are sales from our online business and stores open longer than one year, including sales from stores that have been remodeled or expanded while remaining open (including our current store remodel program) and 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 or sales from stores that were intentionally closed to be remodeled, expanded or reconstructed.

The collective interaction of a broad array of macroeconomic, competitive and consumer behavioral factors, as well as sales mix, and transfer of sales to new stores makes further analysis of sales metrics infeasible.

Credit is offered to qualified guests through our branded proprietary credit cards: the Target Visa Credit Card and the Target Credit Card (Target Credit Cards). Additionally, we offer a branded proprietary Target Debit Card. Collectively, we refer to these products as REDcards®. Guests receive a 5 percent discount on virtually all purchases at checkout every day when they use a REDcard at any Target store or on Target.com.

We monitor the percentage of store sales that are paid for using REDcards (REDcard Penetration), because our internal analysis has indicated that a meaningful portion of the incremental purchases on our REDcards are also incremental sales for Target, with the remainder representing a shift in tender type.

REDcard Penetration                         Three Months Ended               Nine Months Ended
                                        October 27,    October 29,     October 27,    October 29,
                                               2012           2011            2012           2011
Target Credit Cards                             8.0  %         6.9  %          7.6  %         6.5  %
Target Debit Card                               6.0            2.6             5.2            2.1
Total store REDcard penetration                14.0  %         9.5  %         12.8  %         8.6  %

Gross Margin Rate

For the three and nine months ended October 27, 2012, our gross margin rate was 30.3 percent and 30.6 percent, respectively, decreasing from 30.5 percent and 30.8 percent in the comparable periods last year. These decreases are the result of our integrated growth strategies of our 5% REDcard Rewards program and our store remodel program, which impacted the rate by nearly 0.4 percent in each period, partially offset by underlying rate improvements within categories.

Selling, General and Administrative Expense Rate

For the three and nine months ended October 27, 2012, the SG&A expense rate was 21.4 percent and 20.8 percent, respectively, as compared to 21.4 percent and 21.0 percent in the comparable periods last year. For the three and nine months ended October 27, 2012, we experienced improvement in store hourly payroll expense. For the three month period, this improvement was offset by technology and multichannel investments.

SG&A expenses exclude depreciation and amortization, as well as expenses associated with our credit card operations, which are reflected separately in our Consolidated Statements of Operations.


Depreciation and Amortization Expense Rate

For the three and nine months ended October 27, 2012, our depreciation and amortization expense rate was 3.1 percent in both periods, compared with 3.3 percent and 3.2 percent in the respective prior year periods.

Store Data



Change in Number of Stores      Three Months Ended            Nine Months Ended
                             October 27,   October 29,   October 27,   October 29,
                                    2012          2011          2012          2011
Beginning store count              1,772         1,762         1,763         1,750
Opened                                10             6            22            21
Closed                                 -             -            (1 )           -
Relocated                             (1 )          (1 )          (3 )          (4 )
Ending store count                 1,781         1,767         1,781         1,767

For the first three quarters of 2012, we remodeled 252 stores, compared with 394 in the comparable prior year period.

Number of Stores and              Number of Stores                     Retail Square Feet(a)
Retail Square Feet      October 27 , January 28 , October 29 , October 27 , January 28 , October 29 ,
                              2012         2012         2011         2012         2012         2011
Target general
merchandise stores             395          637          640       47,038       76,999       77,349
Expanded food
assortment stores            1,130          875          875      146,087      114,219      114,218
SuperTarget stores             251          251          252       44,500       44,503       44,681
CityTarget stores                5            -            -          514            -            -
Total                        1,781        1,763        1,767      238,139      235,721      236,248

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

U.S. Credit Card Segment

Credit is offered to qualified guests through the Target Credit Cards, which support our core retail operations and are important contributors to our overall profitability and engagement with our guests. Credit card revenues are comprised of finance charges, late fees and other revenue, and third party merchant fees, which are amounts received from merchants who accept the Target Visa Credit Card.


U.S. Credit Card Segment
Results                           Three Months Ended           Three Months Ended
                                   October 27, 2012             October 29, 2011
                                             Annualized                   Annualized
(dollars in millions)             Amount        Rate(d)        Amount        Rate(d)
Finance charge revenue          $    265           18.0 %    $    279           18.1 %
Late fees and other
revenue                               44            3.0            47            3.1
Third party merchant fees             19            1.3            22            1.4
Total revenue                        328           22.3           348           22.5
Bad debt expense                      46            3.1            40            2.6
Operations and marketing
expenses(a)                          138            9.4           143            9.2
Depreciation and
amortization                           3            0.2             4            0.3
Total expenses                       187           12.7           187           12.1
EBIT                                 141            9.6           161           10.4
Interest expense on
nonrecourse debt
collateralized by credit
card receivables                       3                           18
Segment profit                  $    138                     $    143
Average receivables funded
by Target(b)                   $   4,393                    $   2,427
Segment pretax ROIC(c)              12.5 %                       23.6 %

U.S. Credit Card Segment
Results                           Nine Months Ended            Nine Months Ended
                                   October 27, 2012             October 29, 2011
                                             Annualized                   Annualized
(dollars in millions)             Amount        Rate(d)        Amount        Rate(d)
Finance charge revenue          $    801           17.9 %    $    849           18.0 %
Late fees and other
revenue                              126            2.8           133            2.8
Third party merchant fees             59            1.3            66            1.4
Total revenue                        986           22.1         1,048           22.2
Bad debt expense                     141            3.2            67            1.4
Operations and marketing
expenses(a)                          409            9.2           405            8.6
Depreciation and
amortization                          11            0.2            13            0.3
Total expenses                       561           12.5           485           10.3
EBIT                                 425            9.5           563           11.9
Interest expense on
nonrecourse debt
collateralized by credit
card receivables                       8                           55
Segment profit                  $    417                     $    508
Average receivables funded
by Target(b)                   $   4,557                    $   2,443
Segment pretax ROIC(c)              12.2 %                       27.7 %

Note: See Note 12 to our Consolidated Financial Statements for a reconciliation of our segment results to earnings before income taxes.

(a) See footnote (a) to our U.S. Retail Segment Results table on page 16 for an explanation of our loyalty program charges.

(b) Amounts represent the portion of average credit card receivables, at par, funded by Target. These amounts exclude $1,500 million and $1,395 million for the three and nine months ended October 27, 2012, respectively, and $3,754 million and $3,843 million for the three and nine months ended October 29, 2011, respectively, of receivables funded by nonrecourse debt collateralized by credit card receivables.

(c) ROIC is return on invested capital, and this rate equals our segment profit divided by average credit card receivables, at par, funded by Target, expressed as an annualized rate. This measure has decreased significantly, primarily due to our voluntary retirement of our 2008 series securitization in January 2012, increasing the average receivables funded by Target.

(d) As an annualized percentage of average credit card receivables, at par.


Spread Analysis - Total Portfolio        Three Months Ended              Three Months Ended
                                          October 27, 2012                October 29, 2011
                                                    Annualized                        Annualized
(dollars in millions)                     Amount          Rate              Amount          Rate
EBIT                                  $      141          9.6% (c)    $       161          10.4% (c)
LIBOR(a)                                                  0.2%                              0.2%
Spread to LIBOR(b)                    $      138          9.3% (c)    $       158          10.2% (c)




                             Nine Months Ended              Nine Months Ended
                             October 27, 2012                October 29, 2011
                                       Annualized                       Annualized
(dollars in millions)         Amount         Rate              Amount         Rate
EBIT                      $      425         9.5% (c)    $       563         11.9% (c)
LIBOR(a)                                     0.2%                             0.2%
Spread to LIBOR(b)        $      415         9.3% (c)    $       552         11.7% (c)

Note: Numbers are individually rounded.

(a) Balance-weighted one-month LIBOR.

(b) Spread to LIBOR is a metric used to analyze the performance of our total credit card portfolio because the majority of our portfolio earns finance charge revenue at rates tied to the Prime Rate, and the interest rate on all nonrecourse debt collateralized by credit card receivables is tied to LIBOR.

(c) As an annualized percentage of average credit card receivables, at par.

Our primary measure of segment profit is the EBIT generated by our credit card receivables portfolio less the interest expense on nonrecourse debt collateralized by credit card receivables. We also measure the performance of our overall credit card receivables portfolio by calculating the dollar Spread to LIBOR at the portfolio level. This metric approximates overall financial performance of the entire credit card portfolio we manage by measuring the difference between EBIT earned on the portfolio and a hypothetical benchmark rate financing cost applied to the entire portfolio. The interest rate on all nonrecourse debt collateralized by credit card receivables is tied to LIBOR.

Total revenue decreased primarily due to lower average receivables resulting in reduced finance charge revenue. Segment expense increases were driven by higher bad debt expense primarily attributable to annualizing over a significant reduction in the reserve from the prior year. Interest expense on nonrecourse debt declined from last year due to a decrease in nonrecourse debt collateralized by credit card receivables.

Receivables Rollforward Analysis               Three Months Ended             Nine Months Ended
                                           October 27,    October 29,    October 27,    October 29,
(dollars in millions)                             2012           2011           2012           2011
Beginning credit card receivables, at
par                                          $   5,905      $   6,202      $   6,357      $   6,843
Charges at Target                                1,456          1,205          4,142          3,348
Charges at third parties                         1,143          1,283          3,488          3,886
Payments                                       (2,902)        (2,784)        (8,837)        (8,577)
Other                                              234            238            686            644
Period-end credit card receivables, at
par                                          $   5,836      $   6,144      $   5,836      $   6,144
Average credit card receivables, at par      $   5,893      $   6,181      $   5,952      $   6,287
Accounts with three or more payments
(60+ days) past due as a percentage of
period-end credit card receivables, at
par                                               2.8%           3.3%           2.8%           3.3%
Accounts with four or more payments
(90+ days) past due as a percentage of
period-end credit card receivables, at
par                                               1.9%           2.2%           1.9%           2.2%


Allowance for Doubtful Accounts                Three Months Ended            Nine Months Ended
                                           October 27,    October 29,    October 27,    October 29,
(dollars in millions)                             2012           2011           2012           2011
Allowance at beginning of period               $   365        $   480        $   430        $   690
Bad debt expense                                    46             40            141             67
Write-offs(a)                                     (95)          (122)          (326)          (448)
Recoveries(a)                                       29             33            100            122
Segment allowance at end of period             $   345        $   431        $   345        $   431
As a percentage of period-end credit
card receivables, at par                          5.9%           7.0%           5.9%           7.0%
Net write-offs as an annualized
percentage of average
credit card receivables, at par                   4.5%           5.7%           5.1%           6.9%

(a) Write-offs include the principal amount of losses (excluding accrued and unpaid finance charges), and recoveries include current period collections on previously written-off balances. These amounts combined represent net write-offs.

Period-end and average credit card receivables, at par, have declined because of an increase in payment rates and a decrease in Target Visa Credit Card charges at third parties, partially offset by an increase in charges at Target. The decrease in charges on our credit cards at third parties is primarily due to the fact that we no longer issue new Target Visa accounts.

Canadian Segment

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