TGT

Business Context and Reporting Period

Company: Target Corporation
Filing Type: Form 10-Q (Quarterly Report)
Reporting Period: Thirteen and thirty-nine weeks ended October 28, 2006
Business Overview: Target operates as a single business segment comprising general merchandise and SuperTarget stores. The company reported 1,494 total stores as of October 28, 2006, including 1,318 general merchandise stores and 176 SuperTarget stores.

Key Financial Metrics

Margins:
- Gross Margin Rate: 32.4% (13 weeks); 32.5% (39 weeks).
- SG&A Expense Rate: 24.0% (13 weeks); 23.4% (39 weeks).
- Effective Income Tax Rate: 37.4% (13 weeks); 37.9% (39 weeks).

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 11.2% for the quarter and 11.5% year-to-date compared to the prior year periods. This was driven by new store expansion, a 4.6% comparable-store sales increase for the quarter, and growth in net credit card revenues.
• Profitability: Net earnings rose 16.3% for the quarter ($506M vs. $435M) and 13.5% year-to-date ($1,668M vs. $1,469M). Diluted EPS increased from $0.49 to $0.59 for the quarter.
• Credit Card Performance: Credit card contribution to earnings before taxes (EBT) increased significantly to $176M for the quarter (up from $108M) and $507M year-to-date (up from $320M). This improvement was due to strong net interest income growth and a reduction in bad debt expense.
• Expense Trends: SG&A expense rates increased slightly due to the absence of a $27M Visa/MasterCard settlement gain recorded in the prior year, higher store payroll costs, and timing of facility pre-opening costs.
• Liquidity: Cash and cash equivalents decreased to $451M from $1,648M at the start of the fiscal year, primarily due to capital expenditures and share repurchases.

Guidance, Outlook, and Risks

Outlook for Fiscal 2006:
- Management expects a mid-to-high teen percentage increase in earnings per share for the full fiscal year (a 53-week year).
- Core retail operations are expected to contribute approximately 85% of consolidated EBT, with credit card operations contributing the remaining 15%.
- The annual effective tax rate is projected to be between 37.9% and 38.4%.

Share Repurchases:
- The company continues a $5 billion share repurchase program authorized in 2004 and expanded in 2005. As of October 28, 2006, approximately $1.57 billion remained available under the program. The company expects to complete the program by year-end 2008.

Risks and Contingencies:
- Accounting Changes: Adoption of SFAS No. 158 (pension accounting) is expected to reduce the prepaid pension asset by $360M-$385M and shareholders' investment by $220M-$235M in fiscal 2007.
- Legal Proceedings: The company faces two administrative actions regarding environmental matters with potential sanctions not exceeding $350,000. Management believes recorded reserves are adequate for other litigation.
- Market Risks: Risks include increased competition, shifting consumer demand, credit market changes, and general economic conditions.

Investor Verification Checklist

• Credit Card Asset Quality: Verify the sustainability of the reduced bad debt provision (down from $120M to $97M in the quarter) and the adequacy of the allowance for doubtful accounts ($514M).
• Capital Expenditure Efficiency: Review the return on the $3.0 billion in capital expenditures incurred year-to-date, driven by new store openings and remodels.
• Accounting Impact: Monitor the impact of the upcoming SFAS No. 158 adoption on the balance sheet and shareholders' equity in the next fiscal year.
• Debt Structure: Confirm the repayment schedule for the $955 million in commercial paper and the $500 million in Variable Funding Certificates issued in Q3.
• Comparable Sales Trend: Assess whether the 4.6% comparable-store sales growth can be sustained through the holiday quarter and into the next fiscal year.