10-Q 1 tgt-20141101x10xq.htm 10-Q TGT-2014.11.01-10-Q


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, 2014
 
Commission File Number 1-6049
 
 
TARGET CORPORATION
(Exact name of registrant as specified in its charter)
Minnesota
 
41-0215170
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    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 $0.0833, outstanding at November 21, 2014 were 636,964,385.
.






TARGET CORPORATION
 
TABLE OF CONTENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 





PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

Consolidated Statements of Operations
 
 
 
 
 
 
 
 
Three Months Ended
 
Nine Months Ended
(millions, except per share data) (unaudited)
November 1,
2014

 
November 2,
2013

 
November 1,
2014

 
November 2,
2013

Sales
$
17,732

 
$
17,258

 
$
52,188

 
$
51,081

Cost of sales
12,555

 
12,133

 
36,787

 
35,441

Selling, general and administrative expenses
3,894

 
3,853

 
11,303

 
11,140

Depreciation and amortization
606

 
569

 
1,791

 
1,648

Gain on receivables transaction

 

 

 
(391
)
Earnings before interest expense and income taxes
677

 
703

 
2,307

 
3,243

Net interest expense
165

 
165

 
788

 
965

Earnings before income taxes
512

 
538

 
1,519

 
2,278

Provision for income taxes
160

 
197

 
515

 
827

Net earnings
$
352

 
$
341

 
$
1,004

 
$
1,451

Basic earnings per share
$
0.55

 
$
0.54

 
$
1.58

 
$
2.28

Diluted earnings per share
$
0.55

 
$
0.54

 
$
1.57

 
$
2.26

Weighted average common shares outstanding
 
 
 
 
 
 
 
Basic
634.0

 
631.3

 
633.6

 
636.0

Dilutive impact of share-based awards
5.6

 
6.1

 
5.1

 
7.0

Diluted
639.6

 
637.4

 
638.7

 
643.0

Antidilutive shares
2.3

 
2.4

 
4.2

 
2.3


 See accompanying Notes to Consolidated Financial Statements.

1




Consolidated Statements of Comprehensive Income
 
 
 
 
Three Months Ended
 
Nine Months Ended
(millions) (unaudited)
November 1,
2014

 
November 2,
2013

 
November 1,
2014

 
November 2,
2013

Net earnings
$
352

 
$
341

 
$
1,004

 
$
1,451

Other comprehensive income/(loss), net of tax
 

 
 

 
 

 
 

Pension and other benefit liabilities, net of taxes of $4, $8, $12 and $42
7

 
12

 
21

 
64

Currency translation adjustment and cash flow hedges, net of taxes of $1, $0, $2 and $7
(138
)
 
(12
)
 
(53
)
 
(141
)
Other comprehensive income/(loss)
(131
)
 

 
(32
)
 
(77
)
Comprehensive income
$
221

 
$
341

 
$
972

 
$
1,374

 
See accompanying Notes to Consolidated Financial Statements.

2




Consolidated Statements of Financial Position
 

 
 

 
 

(millions)
November 1,
2014

 
February 1,
2014

 
November 2,
2013

Assets
(unaudited)

 
 

 
(unaudited)

Cash and cash equivalents
$
780

 
$
695

 
$
706

Inventory
11,066

 
8,766

 
10,376

Other current assets
1,992

 
2,112

 
2,071

Total current assets
13,838

 
11,573

 
13,153

Property and equipment
 

 
 

 
 

Land
6,202

 
6,234

 
6,241

Buildings and improvements
30,906

 
30,356

 
30,257

Fixtures and equipment
5,664

 
5,583

 
5,535

Computer hardware and software
2,847

 
2,764

 
2,644

Construction-in-progress
454

 
843

 
958

Accumulated depreciation
(15,187
)
 
(14,402
)
 
(13,909
)
Property and equipment, net
30,886

 
31,378

 
31,726

Other noncurrent assets
1,737

 
1,602

 
1,494

Total assets
$
46,461

 
$
44,553

 
$
46,373

Liabilities and shareholders’ investment
 

 
 

 
 

Accounts payable
$
9,229

 
$
7,683

 
$
8,806

Accrued and other current liabilities
3,801

 
3,934

 
3,623

Current portion of long-term debt and other borrowings
495

 
1,160

 
2,122

Total current liabilities
13,525

 
12,777

 
14,551

Long-term debt and other borrowings
13,809

 
12,622

 
12,665

Deferred income taxes
1,279

 
1,433

 
1,466

Other noncurrent liabilities
1,475

 
1,490

 
1,535

Total noncurrent liabilities
16,563

 
15,545

 
15,666

Shareholders’ investment
 

 
 

 
 

Common stock
53

 
53

 
53

Additional paid-in capital
4,612

 
4,470

 
4,403

Retained earnings
12,631

 
12,599

 
12,353

Accumulated other comprehensive loss
 

 
 

 
 

Pension and other benefit liabilities
(401
)
 
(422
)
 
(468
)
Currency translation adjustment and cash flow hedges
(522
)
 
(469
)
 
(185
)
Total shareholders’ investment
16,373

 
16,231

 
16,156

Total liabilities and shareholders’ investment
$
46,461

 
$
44,553

 
$
46,373

 
Common Stock Authorized 6,000,000,000 shares, $.0833 par value; 634,378,337, 632,930,740 and 631,759,510 shares issued and outstanding at November 1, 2014, February 1, 2014 and November 2, 2013, respectively.
 
Preferred Stock Authorized 5,000,000 shares, $.01 par value; no shares were issued or outstanding at November 1, 2014, February 1, 2014 or November 2, 2013.
 
See accompanying Notes to Consolidated Financial Statements.

3




Consolidated Statements of Cash Flows
 
 
 
 
Nine Months Ended
(millions) (unaudited)
November 1,
2014

 
November 2,
2013

Operating activities
 

 
 

Net earnings
$
1,004

 
$
1,451

Adjustments to reconcile net earnings to cash provided by operations:
 

 
 

Depreciation and amortization
1,791

 
1,648

Share-based compensation expense
64

 
81

Deferred income taxes
(426
)
 

Bad debt expense(a)

 
41

Gain on receivables transaction

 
(391
)
Loss on debt extinguishment
285

 
445

Noncash (gains)/losses and other, net

 
3

Changes in operating accounts:
 

 
 

Accounts receivable originated at Target

 
157

Proceeds on sale of accounts receivable originated at Target

 
2,703

Inventory
(2,307
)
 
(2,461
)
Other current assets
236

 
(210
)
Other noncurrent assets
(8
)
 
32

Accounts payable
1,538

 
1,744

Accrued and other current liabilities
(170
)
 
(463
)
Other noncurrent liabilities
43

 
(27
)
Cash provided by operations
2,050

 
4,753

Investing activities
 

 
 

Expenditures for property and equipment
(1,570
)
 
(2,839
)
Proceeds from disposal of property and equipment
84

 
73

Change in accounts receivable originated at third parties

 
121

Proceeds from sale of accounts receivable originated at third parties

 
3,002

Cash paid for acquisitions, net of cash assumed
(18
)
 
(157
)
Other investments
88

 
111

Cash (required for)/provided by investing activities
(1,416
)
 
311

Financing activities
 

 
 

Change in commercial paper, net
305

 
107

Additions to long-term debt
1,993

 

Reductions of long-term debt
(2,062
)
 
(3,453
)
Dividends paid
(874
)
 
(734
)
Repurchase of stock

 
(1,461
)
Stock option exercises and related tax benefit
88

 
395

Cash (required for) financing activities
(550
)
 
(5,146
)
Effect of exchange rate changes on cash and cash equivalents
1

 
4

Net increase/(decrease) in cash and cash equivalents
85

 
(78
)
Cash and cash equivalents at beginning of period
695

 
784

Cash and cash equivalents at end of period
$
780

 
$
706

 
(a) Includes net write-offs of credit card receivables prior to the sale of receivables on March 13, 2013.
 
See accompanying Notes to Consolidated Financial Statements.

4




Consolidated Statements of Shareholders’ Investment
 
Common

 
Stock

 
Additional

 
 

 
Accumulated Other

 
 

 
Stock

 
Par

 
Paid-in

 
Retained

 
Comprehensive

 
 

(millions, except per share data)
Shares

 
Value

 
Capital

 
Earnings

 
Income/(Loss)

 
Total

February 2, 2013
645.3

 
$
54

 
$
3,925

 
$
13,155

 
$
(576
)
 
$
16,558

Net earnings

 

 

 
1,971

 

 
1,971

Other comprehensive income

 

 

 

 
(315
)
 
(315
)
Dividends declared

 

 

 
(1,051
)
 

 
(1,051
)
Repurchase of stock
(21.9
)
 
(2
)
 

 
(1,476
)
 

 
(1,478
)
Stock options and awards
9.5

 
1

 
545

 

 

 
546

February 1, 2014
632.9

 
$
53

 
$
4,470

 
$
12,599

 
$
(891
)
 
$
16,231

(unaudited)
 

 
 

 
 

 
 

 
 

 
 

Net earnings

 

 

 
1,004

 

 
1,004

Other comprehensive income

 

 

 

 
(32
)
 
(32
)
Dividends declared

 

 

 
(937
)
 

 
(937
)
Repurchase of stock
(0.6
)
 

 

 
(35
)
 

 
(35
)
Stock options and awards
2.1

 

 
142

 

 

 
142

November 1, 2014
634.4

 
$
53

 
$
4,612

 
$
12,631

 
$
(923
)
 
$
16,373


We declared $1.47 and $1.22 per share dividends for the nine months ended November 1, 2014 and November 2, 2013, respectively, and $1.65 for the fiscal year ended February 1, 2014.
 
See accompanying Notes to Consolidated Financial Statements.

5




Notes to Consolidated Financial Statements (unaudited)
 
1. Accounting Policies
 
These financial statements should be read in conjunction with the financial statement disclosures in our 2013 Form 10-K.  We use the same accounting policies in preparing quarterly and annual financial statements.  All adjustments necessary for a fair presentation 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.
 
2. Fair Value Measurements
 
Fair value measurements are reported in one of three levels based on the lowest level of significant input used: Level 1 (unadjusted quoted prices in active markets); Level 2 (observable market inputs, other than quoted prices included in Level 1); and Level 3 (unobservable inputs that cannot be corroborated by observable market data).
 
 
Fair Value Measurements - Recurring Basis
 
Fair Value at
(millions)
Pricing Category
November 1, 2014

 
February 1, 2014

 
November 2, 2013

Assets
 
 

 
 

 
 

Cash and cash equivalents
 
 

 
 

 
 

Short-term investments
Level 1
$
7

 
$
3

 
$
3

Other current assets
 
 

 
 

 
 

Interest rate swaps(a)
Level 2

 
1

 
2

Prepaid forward contracts
Level 1
42

 
73

 
72

Beneficial interest asset(b)
Level 3
50

 
71

 
76

Other noncurrent assets
 
 

 
 

 
 

Interest rate swaps(a)
Level 2
51

 
62

 
68

Company-owned life insurance investments(c)
Level 2
322

 
305

 
302

Beneficial interest asset(b)
Level 3
37

 
56

 
67

Liabilities
 
 

 
 

 
 

Other noncurrent liabilities
 
 

 
 

 
 

Interest rate swaps(a)
Level 2
28

 
39

 
43

(a)  See Note 8 for additional information on interest rate swaps.
(b)  Note 3 includes a rollforward of the Level 3 beneficial interest asset. A one percentage point change in the forecasted credit EBIT yield would impact our fair value estimate by approximately $12 million. A one percentage point change in the forecasted discount rate would impact our fair value estimate by approximately $3 million.
(c)  Company-owned life insurance investments consist of equity index funds and fixed income assets. Amounts are presented net of nonrecourse loans that are secured by some of these policies. These loan amounts totaled $780 million at November 1, 2014, $790 million at February 1, 2014 and $794 million at November 2, 2013.
 
Significant Financial Instruments not Measured at Fair Value (a)
(millions)
November 1, 2014
 
February 1, 2014
 
November 2, 2013
Carrying
Amount

Fair
Value

 
Carrying
Amount

Fair
Value

 
Carrying
Amount

Fair
Value

Debt (b)
$
12,332

$
13,779

 
$
11,758

$
13,184

 
$
12,754

$
14,155

(a) The carrying amounts of certain other current assets, accounts payable, and certain accrued and other current liabilities approximate fair value due to their short-term nature.
(b) The carrying amount and estimated fair value of debt exclude unamortized swap valuation adjustments and capital lease obligations.


6




3. Credit Card Receivables Transaction
 
In March 2013, we sold our entire U.S. consumer credit card portfolio to TD Bank Group (TD) and recognized a gain of $391 million. This transaction was accounted for as a sale, and the receivables are no longer reported in our Consolidated Statements of Financial Position. Consideration received included cash of $5.7 billion, equal to the gross (par) value of the outstanding receivables at the time of closing, and a $225 million beneficial interest asset.  Concurrent with the sale, we repaid the nonrecourse debt collateralized by credit card receivables (2006/2007 Series Variable Funding Certificate) at par of $1.5 billion, resulting in net cash proceeds of $4.2 billion.
 
TD now underwrites, funds and owns Target Credit Card and Target Visa consumer receivables in the U.S. TD controls risk management policies and oversees regulatory compliance, and we perform account servicing and primary marketing functions. We earn a substantial portion of the profits generated by the Target Credit Card and Target Visa portfolios. We classify this profit-sharing income in SG&A expense in the U.S. Segment.
 
Profit-Sharing Arrangement
Three Months Ended
 
Nine Months Ended
(millions)
November 1,
2014

 
November 2,
2013

 
November 1,
2014

 
November 2,
2013 (a)

Profit-sharing included in U.S. Segment EBIT
$
172

 
$
184

 
$
506

 
$
471

Reduction of beneficial interest asset (b)
(11
)
 
(36
)
 
(40
)
 
(82
)
Net impact to SG&A expense
$
161

 
$
148

 
$
466

 
$
389

(a) The U.S. Segment also earned credit card revenue prior to the close of the transaction.
(b) On a consolidated basis, profit-sharing income is offset by reductions of the beneficial interest asset.

The $225 million beneficial interest asset effectively represents a receivable for the present value of future profit-sharing we expect to receive on the receivables sold. Profit-sharing payments reduced the beneficial interest asset by $19 million and $58 million during the three and nine months ended November 1, 2014, respectively, and $28 million and $74 million during the three and nine months ended November 2, 2013. Revaluation adjustments increased the asset by $8 million and $18 million during the three and nine months ended November 1, 2014, respectively, and reduced the asset by $8 million during the three and nine months ended November 2, 2013. As of November 1, 2014 and November 2, 2013, a beneficial interest asset of $87 million and $143 million, respectively, remains and is recorded within other current assets and other noncurrent assets in our Consolidated Statements of Financial Position. 

4. Notes Payable and Long-Term Debt
 
We obtain short-term financing from time to time under our commercial paper program, a form of notes payable.
 
Commercial Paper
Three Months Ended
 
Nine Months Ended
(dollars in millions)
November 1,
2014

 
November 2,
2013

 
November 1,
2014

 
November 2,
2013

Maximum daily amount outstanding during the period
$
386

 
$
1,173

 
$
590

 
$
1,465

Average daily amount outstanding during the period
51

 
528

 
160

 
439

Amount outstanding at period-end
386

 
1,077

 
386

 
1,077

Weighted average interest rate
0.12
%
 
0.13
%
 
0.11
%
 
0.14
%
 
In June 2014, we issued $1 billion of unsecured fixed rate debt at 2.3% that matures in June 2019 and $1 billion of unsecured fixed rate debt at 3.5% that matures in July 2024. We used proceeds from these issuances to repurchase $725 million of debt at market value and for general corporate purposes, including the payment of $1 billion of debt maturities. We recognized a loss of $285 million on the early retirement, which was recorded in net interest expense in our Consolidated Statements of Operations.

Concurrent with the sale of our credit card receivables portfolio in March 2013, we repaid $1.5 billion of nonrecourse debt collateralized by credit card receivables (the 2006/2007 Series Variable Funding Certificate). We also used $1.4 billion of proceeds from the transaction to repurchase at market value an additional $970 million of debt during the first quarter of 2013. We recognized a loss on this early retirement of $445 million, which was recorded in net interest expense in our Consolidated Statements of Operations. Refer to Note 3 for more information on our credit card receivables transaction.


7




5. Property and Equipment

We review long-lived assets for impairment when events or changes in circumstances—such as a decision to close a store or discontinue software projects—indicate that the asset’s carrying value may not be recoverable.

Our U.S. Segment recognized impairment losses during each of the periods presented, primarily resulting from discontinued projects, store closures, and completed or planned land sales. As a result of the continued losses in our Canadian Segment, we reviewed our Canadian Segment long-lived assets for impairment during the three months ended November 1, 2014, resulting in a $16 million impairment loss for one store that continues to be operated.

Impairments by Segment (a)
Three Months Ended
 
Nine Months Ended
(millions)
November 1,
2014

 
November 2,
2013

 
November 1,
2014

 
November 2,
2013

U.S.
$
18

 
$
1

 
$
77

 
$
26

Canadian

 

 
2

 

Total segment impairments
18

 
1

 
79

 
26

Unallocated impairments (b)
16

 

 
31

 

Total impairments
$
34

 
$
1

 
$
110

 
$
26

(a) Substantially all of the impairments are recorded in selling, general and administrative expense on the Consolidated Statements of Income.
(b) For the three months ended November 1, 2014, represents impairment of one Canada operating store. For the nine months ended, this also includes the impairments of undeveloped land in the U.S. Activities giving rise to these impairments were centrally managed by individuals outside of core segment operations and excluded from the measure of segment profitability reviewed by management.

6. Data Breach

In the fourth quarter of 2013, we experienced a data breach in which an intruder stole certain payment card and other guest information from our network (the Data Breach). Based on our investigation to date, we believe that the intruder installed malware on our point-of-sale system in our U.S. stores and stole payment card data from up to approximately 40 million credit and debit card accounts of guests who shopped at our U.S. stores between November 27 and December 17, 2013. In addition, the intruder stole certain guest information, including names, mailing addresses, phone numbers or email addresses, for up to 70 million individuals.

Payment Card Network Loss Contingencies

In the event of a data breach where payment card data is or may have been stolen, the payment card networks’ contracts purport to give them the ability to make claims for reimbursement of incremental counterfeit fraud losses and non-ordinary course operating expenses (such as card reissuance costs) that the payment card networks believe they or their issuing banks have incurred as a result of the event. For us to have liability for such claims, we believe that a court would have to find that, among other things, (1) at the time of the Data Breach the portion of our network that handles payment card data was noncompliant with applicable data security standards in a manner that contributed to the Data Breach, and (2) the network operating rules around reimbursement of operating costs and counterfeit fraud losses are enforceable. While an independent third-party assessor found the portion of our network that handles payment card data to be compliant with applicable data security standards in the fall of 2013, the forensic investigator working on behalf of the payment card networks claimed in first quarter 2014 that we were not in compliance with those standards at the time of the Data Breach.

During the third quarter of 2014, three of the four major payment card networks, which between them represent a substantial majority of the payment cards potentially impacted by the Data Breach, made written claims against us, either directly or through our acquiring banks. We believe it is probable that the fourth major payment card network will also make a claim against us. We expect to dispute the claims that have been or may be made against us by the payment card networks, and we think it is probable that our disputes would lead to settlement negotiations consistent with the experience of other entities that suffered similar payment card breaches. We believe such negotiations would effect a combined settlement of the payment card networks' counterfeit fraud loss allegations and their non-ordinary course operating expense allegations. Our accruals for estimated probable loss discussed below include accruals for what we believe to be the vast majority of both actual and potential claims from the payment card networks.

8





Litigation and Governmental Investigations

In addition, more than 100 actions have been filed in courts in many states, along with one action in Canada, and other claims have been or may be asserted against us on behalf of guests, payment card issuing banks, shareholders or others seeking damages or other related relief allegedly arising out of the Data Breach. State and federal agencies, including State Attorneys General, the Federal Trade Commission and the SEC, are investigating events related to the Data Breach, including how it occurred, its consequences and our responses. Our accruals for estimated probable loss discussed below include accruals for what we believe to be the vast majority of both actual and potential claims from these matters.

Expenses Incurred and Amounts Accrued  

Data Breach Balance Sheet Rollforward
(millions)
Liabilities

 
Insurance receivable

Balance at February 1, 2014
$
61

 
$
44

Expenses incurred/insurance receivable recorded (a)
26

 
8

Payments made/received
(35
)
 
(13
)
Balance at May 3, 2014
52

 
39

Expenses incurred/insurance receivable recorded (a)
148

 
38

Payments made/received
(19
)
 
(7
)
Balance at August 2, 2014
$
182

 
$
70

Expenses incurred/insurance receivable recorded (a)
12

 

Payments made/received
(16
)
 
(8
)
Balance at November 1, 2014
$
178

 
$
62

(a) Includes expenditures and accruals for Data Breach-related costs and expected insurance recoveries as discussed below.

In the third quarter of 2014, we recorded $12 million of pretax Data Breach-related expenses, primarily related to legal and other professional services. These expenses were included in our Consolidated Statements of Operations as Selling, General and Administrative Expenses (SG&A), but were not part of our segment results.

During the nine months ended November 1, 2014, we recorded $186 million of Data Breach-related expenses, partially offset by expected insurance proceeds of $46 million, for net expenses of $140 million. Since the Data Breach, we have incurred $248 million of cumulative expenses, partially offset by expected insurance recoveries of $90 million, for net cumulative expenses of $158 million. Along with legal and other professional services, these expenses include an accrual for estimated probable losses for what we believe to be the vast majority of actual and potential breach related claims, including claims by the payment card networks. Our probable loss estimate is based on the expectation of reaching negotiated settlements, and not on any determination that it is probable we would be found liable for the losses we have accrued were these claims to be litigated. Given the varying stages of claims and related proceedings, and the inherent uncertainty surrounding them, our estimates involve significant judgment and are based on currently available information, historical precedents and an assessment of the validity of certain claims. Our estimates may change as new information becomes available, and although we do not believe it is probable, it is reasonably possible that we may incur a material loss in excess of the amount accrued. We are not able to estimate the amount of such reasonably possible excess loss exposure at this time because many of the matters are in the early stages, alleged damages have not been specified, and there are significant factual and legal issues to be resolved. The accrual does not reflect future breach-related legal, consulting or administrative fees, which are expensed as incurred and not expected to be material to our consolidated financial statements in any individual period.

Insurance Coverage

To limit our exposure to losses relating to data breach and other claims, we maintain $100 million of network-security insurance coverage, above a $10 million deductible and with a $50 million sublimit for settlements with the payment card networks. This coverage, and certain other customary business-insurance coverage, has reduced our exposure related to the Data Breach. We will pursue recoveries to the maximum extent available under the policies. Since the Data Breach, we have received $28 million from our network-security insurance carriers.


9




7. Income Taxes

Our effective income tax rate was 31.3 percent and 33.9 percent for the three and nine months ended November 1, 2014, respectively, and 36.6 percent and 36.3 percent for the three and nine months ended November 2, 2013. The rate decreased primarily from the favorable resolution of various income tax matters, which reduced tax expense by $30 million and $31 million for the three and nine months ended November 1, 2014, respectively, and $7 million and $11 million for the same periods in the prior year.

At November 1, 2014, we had Canadian deferred tax assets of $686 million, primarily related to net operating loss carryforwards (NOL) of $2,141 million. These NOL carryforwards primarily relate to the start-up operations of our Canadian Segment and expire between 2031 and 2034. After weighing all positive and negative evidence, including the pre-opening and operating losses in our Canadian Segment to date, we believe it is more likely than not that we will realize the full Canadian deferred tax asset.

8. Derivative Financial Instruments
 
Our derivative instruments primarily consist of interest rate swaps, which we use to mitigate interest rate risk. As a result of our use of derivative instruments, we have counterparty credit risk with large global financial institutions. We monitor this concentration of counterparty credit risk on an ongoing basis. See Note 2 for a description of the fair value measurement of our derivative instruments and their classification on the Consolidated Statements of Financial Position.
 
In June 2014, we entered into two interest rate swaps, each with a notional amount of $500 million, under which we pay a variable rate and receive a fixed rate. In March 2014, we entered into an interest rate swap with a notional amount of $250 million, under which we pay a variable rate and receive a fixed rate. We designated these swaps as fair value hedges. As of November 2, 2013, one swap was designated as a fair value hedge. No ineffectiveness was recognized during the three or nine months ended November 1, 2014 or November 2, 2013.
 
Periodic payments, valuation adjustments and amortization of gains or losses on our derivative contracts had the following effect on our Consolidated Statements of Operations:
 
Derivative Contracts - Effect on Results of Operations
(millions)
Three Months Ended
Nine Months Ended
Type of Contract
 
Classification of (Income)/Expense
November 1,
2014

 
November 2,
2013

November 1,
2014

 
November 2,
2013

Interest rate swaps
 
Net interest expense
$
(9
)
 
$
(6
)
$
(23
)
 
$
(21
)
 
The amount remaining on unamortized hedged debt valuation gains from terminated or de-designated interest rate swaps that will be amortized into earnings over the remaining lives of the underlying debt totaled $38 million, $52 million and $59 million, at November 1, 2014, February 1, 2014 and November 2, 2013, respectively.
 
9. Share Repurchase

We repurchase shares primarily through open market transactions and the noncash settlement of prepaid forward contracts related to nonqualified deferred compensation plans under a $5 billion share repurchase program authorized by our Board of Directors in January 2012. No shares were repurchased through open market transactions during the three and nine months ended November 1, 2014.

Share Repurchases
Three Months Ended
 
Nine Months Ended
(millions, except per share data)
November 1,
2014

 
November 2,
2013

 
November 1, 2014 (a)

 
November 2, 2013 (b)

Total number of shares purchased

 

 
0.6

 
21.9

Average price paid per share
$

 
$

 
$
55.36

 
$
67.41

Total investment
$

 
$

 
$
34

 
$
1,474

(a) All of the shares reacquired were delivered upon the noncash settlement of prepaid forward contracts. These contracts had an original cash investment of $34 million and an aggregate market value at their settlement dates of $34.7 million. These contracts are among the investment vehicles used to reduce our economic exposure related to our nonqualified deferred compensation plans. Note 10 provides the details of our positions in prepaid forward contracts.

10




(b) 0.2 million of the shares repurchased were delivered upon the noncash settlement of prepaid forward contracts. These contracts had an original cash investment of $14 million and an aggregate market value at their settlement dates of $17 million. Note 10 provides the details of our positions in prepaid forward contracts.

10. Pension, Postretirement Health Care and Other Benefits
 
Pension and Postretirement Health Care Benefits
 
We provide qualified defined benefit pension plans, unfunded nonqualified pension plans and certain postretirement health care benefits to eligible team members.

Net Pension and Postretirement
Health Care Benefits Expense
Pension Benefits
 
Postretirement Health Care Benefits
 
Three Months Ended
 
Nine Months Ended
 
Three Months Ended
 
Nine Months Ended
(millions)
Nov 1,
2014

 
Nov 2,
2013

 
Nov 1,
2014

 
Nov 2,
2013

 
Nov 1,
2014

 
Nov 2,
2013

 
Nov 1,
2014

 
Nov 2,
2013

Service cost
$
28

 
$
29

 
$
84

 
$
88

 
$
2

 
$
2

 
$
4

 
$
5

Interest cost
37

 
35

 
112

 
104

 

 

 
1

 
1

Expected return on assets
(58
)
 
(59
)
 
(175
)
 
(176
)
 

 

 

 

Amortization of losses
16

 
26

 
49

 
76

 
1

 
1

 
4

 
4

Amortization of prior service cost
(2
)
 
(3
)
 
(8
)
 
(8
)
 
(4
)
 
(4
)
 
(12
)
 
(12
)
Total
$
21

 
$
28

 
$
62

 
$
84

 
$
(1
)
 
$
(1
)
 
$
(3
)
 
$
(2
)
 
Other Benefits
 
We offer unfunded nonqualified deferred compensation plans to certain team members. We mitigate some of our risk of these plans through investing in vehicles, including company-owned life insurance and prepaid forward contracts in our own common stock, that offset a substantial portion of our economic exposure to the returns of these plans. These investment vehicles are general corporate assets and are marked to market with the related gains and losses recognized in the Consolidated Statements of Operations in the period they occur.
 
The total change in fair value for contracts indexed to our own common stock recognized in earnings was pretax income of $1 million and $3 million for the three and nine months ended November 1, 2014, respectively, and pretax losses of $7 million and pretax income of $5 million for the three and nine months ended November 2, 2013, respectively. During the nine months ended November 1, 2014 we made no investments in prepaid forward contracts in our own common stock. During the nine months ended November 2, 2013, we invested $11 million in such investment instruments. Adjusting our position in these investment vehicles may involve repurchasing shares of Target common stock when settling the forward contracts as described in Note 9. The settlement dates of these instruments are regularly renegotiated with the counterparty.
 
Prepaid Forward Contracts on Target Common Stock
November 1,
2014

 
February 1,
2014

 
November 2,
2013

(millions, except per share data)
 
 
Number of Shares
0.7

 
1.3

 
1.1

Contractual Price Paid per Share
$
42.88

 
$
48.81

 
$
46.52

Fair Value
$
42

 
$
73

 
$
72

Total Cash Investment
$
29

 
$
63

 
$
52



11




11. Accumulated Other Comprehensive Income
 
(millions)
Cash Flow
Hedges

 
Currency
Translation
Adjustment

 
Pension and
Other
Benefits

 
Total

February 2, 2013
$
(29
)
 
$
(15
)
 
$
(532
)
 
$
(576
)
Other comprehensive income before reclassifications

 
(30
)
 
28

 
(2
)
Amounts reclassified from AOCI
1

(a) 

 
12

(b) 
13

May 4, 2013
$
(28
)
 
$
(45
)
 
$
(492
)
 
$
(565
)
Other comprehensive income before reclassifications

 
(101
)
 

 
(101
)
Amounts reclassified from AOCI
1

(a) 

 
12

(b) 
13

August 3, 2013
$
(27
)
 
$
(146
)
 
$
(480
)
 
$
(653
)
Other comprehensive income before reclassifications

 
(13
)
 

 
(13
)
Amounts reclassified from AOCI
1

(a) 

 
12

(b) 
13

November 2, 2013
$
(26
)
 
$
(159
)
 
$
(468
)
 
$
(653
)
 

February 1, 2014
$
(25
)
 
$
(444
)
 
$
(422
)
 
$
(891
)
Other comprehensive income before reclassifications

 
61

 

 
61

Amounts reclassified from AOCI
1

(a) 

 
7

(b) 
8

May 3, 2014
$
(24
)
 
$
(383
)
 
$
(415
)
 
$
(822
)
Other comprehensive income before reclassifications

 
22

 

 
22

Amounts reclassified from AOCI
1

(a) 

 
7

(b) 
8

August 2, 2014
$
(23
)
 
$
(361
)
 
$
(408
)
 
$
(792
)
Other comprehensive income before reclassifications

 
(139
)
 

 
(139
)
Amounts reclassified from AOCI
1

(a) 

 
7

(b) 
8

November 1, 2014
$
(22
)
 
$
(500
)
 
$
(401
)
 
$
(923
)
(a) Represents gains and losses on cash flow hedges, net of $1 million of taxes, which is recorded in net interest expense on the Consolidated Statements of Operations.
(b) Represents amortization of pension and other benefit liabilities, net of $4 million of taxes for the three months ended May 3, 2014, August 2, 2014 and November 1, 2014, respectively, and $8 million for the three months ended May 4, 2013, August 3, 2013 and November 2, 2013.


12




12. Segment Reporting
 
We operate as two segments: U.S. and Canadian. Our segment measure of profit is used by management to evaluate the return on our investment and to make operating decisions.
 
Business Segment Results
Three Months Ended November 1, 2014
 
Three Months Ended November 2, 2013
(millions)
U.S.

 
Canadian

 
Total

 
U.S.

 
Canadian

 
Total

Sales
$
17,254

 
$
479

 
$
17,732

 
$
16,925

 
$
333

 
$
17,258

Cost of sales
12,171

 
386

 
12,555

 
11,849

 
284

 
12,133

Gross margin
5,083

 
93

 
5,177

 
5,076

 
49

 
5,125

Selling, general and administrative expenses (a)(f)
3,621

 
234

 
3,855

 
3,595

 
221

 
3,817

Depreciation and amortization
535

 
70

 
606

 
504

 
66

 
569

Segment profit
$
927

 
$
(211
)
 
$
716

 
$
977

 
$
(238
)
 
$
739

Data Breach related costs (b)(f)
 
 
 
 
(12
)
 
 
 
 
 

Reduction of beneficial interest asset (a)(f)
 

 
 

 
(11
)
 
 

 
 

 
(36
)
Impairments (c)(f)
 
 
 
 
(16
)
 
 
 
 
 

Earnings before interest expense and income taxes
 

 
 

 
677

 
 

 
 

 
703

Net interest expense
 

 
 

 
165

 
 

 
 

 
165

Earnings before income taxes
 

 
 

 
$
512

 
 

 
 

 
$
538


Business Segment Results
Nine Months Ended November 1, 2014
 
Nine Months Ended November 2, 2013
(millions)
U.S.

 
Canadian

 
Total

 
U.S.

 
Canadian

 
Total

Sales
$
50,868

 
$
1,321

 
$
52,188

 
$
50,387

 
$
694

 
$
51,081

Cost of sales
35,716

 
1,072

 
36,787

 
34,916

 
525

 
35,441

Gross margin
15,152

 
249

 
15,401

 
15,471

 
169

 
15,640

Selling, general and administrative expenses (a)(f)
10,410

 
669

 
11,078

 
10,437

 
621

 
11,058

Depreciation and amortization
1,584

 
207

 
1,791

 
1,488

 
160

 
1,648

Segment profit
$
3,158

 
$
(627
)
 
$
2,532

 
$
3,546

 
$
(612
)
 
$
2,934

Data Breach related costs, net of insurance receivable (b)(f)
 
 
 
 
(140
)
 
 
 
 
 

Reduction of beneficial interest asset (a)(f)
 

 
 

 
(40
)
 
 

 
 

 
(82
)
Impairments (c)(f)
 
 
 
 
(31
)
 
 
 
 
 

Card brand conversion costs (d)(f)
 
 
 
 
(13
)
 
 
 
 
 

Gain on receivables transaction (e)
 

 
 

 

 
 

 
 

 
391

Earnings before interest expense and income taxes
 

 
 

 
2,307

 
 

 
 

 
3,243

Net interest expense
 

 
 

 
788

 
 

 
 

 
965

Earnings before income taxes
 

 
 

 
$
1,519

 
 

 
 

 
$
2,278

Note: The sum of the segment amounts may not equal the total amounts due to rounding.
(a) Our U.S. Segment includes all TD profit-sharing amounts in segment EBIT; however, under GAAP, some amounts received from TD reduce the beneficial interest asset and are not recorded in consolidated earnings. 
(b) Refer to Note 6 for more information on Data Breach related costs.
(c) Refer to Note 5 for more information on impairments. Activities giving rise to these impairments were centrally managed by individuals outside of core segment operations and excluded from the measure of segment profitability reviewed by management.

13




(d) Expense related to converting co-branded card program to MasterCard.
(e) Refer to Note 3 for more information on our credit card receivables transaction.
(f) The sum of segment SG&A expenses, reduction of beneficial interest asset, Data Breach related costs, impairments and card brand conversion costs equal consolidated SG&A expenses.

Total Assets by Segment
 (millions)
November 1,
2014

 
February 1,
2014

 
November 2,
2013

U.S.
$
39,964

 
$
38,128

 
$
39,747

Canadian
6,348

 
6,254

 
6,483

Total segment assets
46,312

 
44,382

 
46,230

Unallocated assets (a)
149

 
171

 
143

Total assets
$
46,461

 
$
44,553

 
$
46,373

(a) Represents the beneficial interest asset and insurance receivable related to the Data Breach. Represents the beneficial interest asset at November 2, 2013.


14




Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Executive Summary
 
Third quarter 2014 includes the following notable items:

GAAP earnings per share were $0.55.
Adjusted earnings per share were $0.54.
Third quarter U.S. Segment comparable sales growth of 1.2 percent. Comparable sales reflect third quarter digital sales growth of more than 30 percent.
U.S. Segment transactions declined 0.4 percent, an improvement of more than 1 percentage point compared with the first half of the year.
Third quarter Canadian Segment sales increased 43.8 percent from third quarter last year, on comparable sales growth of 1.6 percent.
GAAP EPS includes a $0.05 benefit from resolved tax matters.
We paid dividends of $330 million in third quarter 2014, an increase of 21.4 percent from $271 million last year.

Sales were $17,732 million for the three months ended November 1, 2014, an increase of $474 million or 2.8 percent from the same period in the prior year. Cash flow provided by operations was $2,050 million and $4,753 million for the nine months ended November 1, 2014 and November 2, 2013, respectively. Cash flow provided by operations for the nine months ended November 2, 2013 included $2.7 billion of cash received in connection with the sale of our U.S. consumer credit card receivables.
 
Earnings Per Share
Three Months Ended
 
 

 
Nine Months Ended
 
 

 
November 1,
2014

 
November 2,
2013

 
Change

 
November 1,
2014

 
November 2,
2013

 
Change

GAAP diluted earnings per share
$
0.55

 
$
0.54

 
2.7
 %
 
$
1.57

 
$
2.26

 
(30.3
)%
Adjustments
(0.01
)
 
0.02

 
 

 
0.45

 
0.10

 
 

Adjusted diluted earnings per share
$
0.54

 
$
0.56

 
(2.9
)%
 
$
2.02

 
$
2.35

 
(14.2
)%
Note: Amounts may not foot due to rounding. We have disclosed adjusted diluted earnings per share ("Adjusted EPS"), a non-GAAP metric, which excludes the impact of certain matters not related to our ongoing retail operations. Management believes that Adjusted EPS is meaningful to provide period-to-period comparisons of our operating results. A reconciliation of non-GAAP financial measures to GAAP measures is provided on page 23.

Analysis of Results of Operations
 
U.S. Segment
 
U.S. Segment Results
Three Months Ended
 
 

 
Nine Months Ended
 
 

(millions)
November 1,
2014

 
November 2,
2013

 
Percent
Change

 
November 1,
2014

 
November 2,
2013

 
Percent
Change

Sales
$
17,254

 
$
16,925

 
1.9
 %
 
$
50,868

 
$
50,387

 
1.0
 %
Cost of sales
12,171

 
11,849

 
2.7

 
35,716

 
34,916

 
2.3

Gross margin
5,083

 
5,076

 
0.2

 
15,152

 
15,471

 
(2.1
)
SG&A expenses (a)
3,621

 
3,595

 
0.7

 
10,410

 
10,437

 
(0.3
)
EBITDA
1,462

 
1,481

 
(1.3
)
 
4,742

 
5,034

 
(5.8
)
Depreciation and amortization
535

 
504

 
6.4

 
1,584

 
1,488

 
6.5

EBIT
$
927

 
$
977

 
(5.2
)%
 
$
3,158

 
$
3,546

 
(11.0
)%
(a) SG&A includes $172 million and $506 million of profit-sharing income from TD Bank Group (TD) for the three and nine months ended November 1, 2014, respectively, and $184 million and $471 million for the three and nine months ended November 2, 2013.


15




U.S. Segment Rate Analysis
Three Months Ended
 
Nine Months Ended
 
November 1,
2014

 
November 2,
2013

 
November 1,
2014

 
November 2,
2013

Gross margin rate
29.5
%
 
30.0
%
 
29.8
%
 
30.7
%
SG&A expense rate
21.0

 
21.2

 
20.5

 
20.7

EBITDA margin rate
8.5

 
8.7

 
9.3

 
10.0

Depreciation and amortization expense rate
3.1

 
3.0

 
3.1

 
3.0

EBIT margin rate
5.4

 
5.8

 
6.2

 
7.0


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 digital sales channels, as well as gift card breakage.
 
Sales by Product Category
Three Months Ended
 
Nine Months Ended
 
November 1,
2014

 
November 2,
2013

 
November 1,
2014

 
November 2,
2013

Household essentials
27
%
 
26
%
 
27
%
 
27
%
Hardlines
15

 
15

 
15

 
15

Apparel and accessories
19

 
20

 
19

 
20

Food and pet supplies
21

 
21

 
22

 
21

Home furnishings and décor
18

 
18

 
17

 
17

Total
100
%
 
100
%
 
100
%
 
100
%
 
Comparable sales is a measure that highlights the performance of our existing stores and digital sales by measuring the change in sales for a period over the comparable, prior-year period of equivalent length. Comparable sales include all sales, except sales from stores open less than 13 months. Digital sales include all sales initiated through mobile applications and our conventional websites, including those of acquired entities from the date of acquisition. Digital sales may be fulfilled through our distribution centers or our stores. Comparable sales measures vary across the retail industry. As a result, our comparable sales calculation is not necessarily comparable to similarly titled measures reported by other companies.
 
Comparable Sales
Three Months Ended
 
Nine Months Ended
 
November 1,
2014

 
November 2,
2013

 
November 1,
2014

 
November 2,
2013

Comparable sales change
1.2
 %
 
0.9
 %
 
0.3
 %
 
0.5
 %
Drivers of change in comparable sales
 

 
 

 
 

 
 

Number of transactions
(0.4
)
 
(1.3
)
 
(1.5
)
 
(1.5
)
Average transaction amount
1.6

 
2.2

 
1.8

 
2.1

Selling price per unit
3.1

 
3.3

 
2.6

 
1.5

Units per transaction
(1.5
)
 
(1.1
)
 
(0.8
)
 
0.6

 
Contribution to Comparable Sales Change
Three Months Ended
 
Nine Months Ended
 
November 1,
2014

 
November 2,
2013

 
November 1,
2014

 
November 2,
2013

Stores channel comparable sales change
0.6
%
 
0.6
%
 
(0.2
)%
 
0.2
%
Digital channel contribution to comparable sales change
0.6

 
0.3

 
0.5

 
0.3

Total comparable sales change
1.2
%
 
0.9
%
 
0.3
 %
 
0.5
%

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.

16





TD offers credit to qualified guests through branded proprietary credit cards: the Target Credit Card and the Target Visa (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 when they use a REDcard at Target. We monitor the percentage of sales that are paid for using REDcards (REDcard Penetration) because our internal analysis has indicated that a meaningful portion of the incremental purchases on REDcards are also incremental sales for Target, with the remainder representing a shift in tender type.
 
REDcard Penetration
Three Months Ended
 
Nine Months Ended
 
November 1,
2014

 
November 2,
2013

 
November 1,
2014

 
November 2,
2013

Target Debit Card
11.2
%
 
10.4
%
 
11.2
%
 
9.5
%
Target Credit Cards
9.8

 
9.5

 
9.5

 
9.1

Total REDcard Penetration
21.0
%
 
19.9
%
 
20.7
%
 
18.6
%
 
Gross Margin Rate

For the three and nine months ended November 1, 2014, our gross margin rate was 29.5 percent and 29.8 percent, respectively, compared with 30.0 percent and 30.7 percent in the comparable periods last year. The decrease was primarily due to promotional activity.
 

17




Selling, General and Administrative Expense Rate





For the three and nine months ended November 1, 2014, our SG&A expense rate was 21.0 percent and 20.5 percent, decreasing from 21.2 and 20.7 percent in the comparable periods last year. The decrease primarily resulted from company-wide expense optimization efforts, partially offset by investments in technology and other initiatives, none of which were individually significant.
 
Store Data
 
Change in Number of Stores
Three Months Ended
 
Nine Months Ended
 
November 1,
2014

 
November 2,
2013

 
November 1,
2014

 
November 2,
2013

Beginning store count
1,795

 
1,788

 
1,793

 
1,778

Opened
6

 
9

 
16

 
19

Closed

 

 
(8
)
 

Ending store count
1,801

 
1,797

 
1,801

 
1,797

Number of stores remodeled during the period
13

 
32

 
39

 
100



18




Number of Stores and Retail Square Feet
Number of Stores
 
Retail Square Feet(a)
November 1,
2014

 
February 1,
2014

 
November 2,
2013

 
November 1,
2014

 
February 1,
2014

 
November 2,
2013

Expanded food assortment stores
1,294

 
1,245

 
1,245

 
167,291

 
160,891

 
160,891

SuperTarget stores
249

 
251

 
251

 
44,151

 
44,500

 
44,500

General merchandise stores
249

 
289

 
293

 
28,861

 
33,843

 
34,273

CityTarget stores
8

 
8

 
8

 
820

 
820

 
820

TargetExpress stores
1

 

 

 
21

 

 

Total
1,801

 
1,793

 
1,797

 
241,144

 
240,054

 
240,484

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

Canadian Segment Results
Three Months Ended
 

 
Nine Months Ended