TGT

Business Context and Reporting Period

This Form 10-Q covers Dayton Hudson Corporation (parent of Target, Mervyn's, and Dayton's, Hudson's, and Marshall Field's) for the quarterly period ended October 31, 1998. The company operates three primary retail segments: Target, Mervyn's, and DSD (Dayton's, Hudson's, and Marshall Field's). As of the reporting date, the company operated 851 Target stores, 268 Mervyn's stores, and 64 DSD stores.

Key Financial Metrics

Segment Performance (Nine Months): Target revenues were $15,458 million; Mervyn's were $2,831 million; DSD were $2,265 million. Target pre-tax segment profit increased 20% year-over-year, while Mervyn's declined 23%.

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 10.1% for the quarter and 10.7% for the nine-month period compared to the prior year. Comparable-store sales rose 3.7% (quarter) and 4.7% (nine months).
• Profitability: Net earnings before extraordinary charges increased to $183 million for the quarter (from $179 million) and $515 million for nine months (from $446 million). This was driven by strong performance at Target and DSD.
• Inventory and Payables: Merchandise inventories increased 15% ($604 million) year-over-year, primarily due to new store growth and strategic inventory builds at Target and Mervyn's. Accounts payable increased 19% ($538 million), funding much of the inventory growth.
• Capital Expenditures: Investing cash outflows for property and equipment rose to $1,237 million for the nine months, compared to $983 million in the prior year.
• Debt Activity: The company repurchased $16 million of high-coupon debt year-to-date, resulting in a $3 million after-tax extraordinary charge. New debt issuances included $400 million in long-term debt during the second quarter and a subsequent $200 million issuance in November 1998.

Guidance, Outlook, and Risks

• Outlook: Management expects mid-single-digit comparable-store sales growth at Target in the fourth quarter with pre-tax profit margins even with or slightly expanded over 1997. Mervyn's is expected to see slightly improved sales trends with profits in line with last year. DSD is projected to have low single-digit sales growth and a modest profit increase.
• Tax Rate: The effective income tax rate is expected to decrease in the fourth quarter and full year 1998 following a favorable court ruling regarding inventory shortage deductions for the 1983 tax year.
• Year 2000 Readiness: The company has expensed $12 million in 1998 for Y2K compliance and estimates an additional $35 million will be required to complete the program. Approximately 80% of hardware and 70% of applications are compliant. Risks include potential temporary shortages if key vendors fail to deliver due to Y2000 issues.
• Contingencies: The company faces risks related to increased competition, shifting consumer demand, and the impact of the Year 2000 date conversion on IT and non-IT systems.

Investor Verification Checklist

• Inventory Valuation: Verify the rationale for the 15% increase in merchandise inventories and the impact of the favorable tax court ruling on future tax provisions.
• Debt Structure: Confirm the terms of the new $200 million debt issued in November 1998 and the impact of debt repurchases on future interest expense savings.
• Segment Divergence: Analyze the contrasting performance between Target (strong growth) and Mervyn's (declining sales and profit) to assess portfolio risk.
• Y2000 Costs: Monitor the remaining $35 million estimated expenditure for Year 2000 compliance and potential operational disruptions.
• Cash Flow Quality: Review the reconciliation of net earnings to operating cash flow, noting the significant impact of changes in securitized receivables and inventory levels.