Please critique the following with regard to the managment financial decisions a
ID: 2591223 • Letter: P
Question
Please critique the following with regard to the managment financial decisions and accoring practices in such crises:
Target Corporation. Trading on the New York Stock Exchange (NYSE) under the symbol TGT, the company has enjoyed many profitable years (including in 2015 and 2016) according to its financial statements. The exception? In 2014, Target Corporation reported a net loss of $1.6 billion (Target 2014 Annual Report, 2015).
The Management Discussion and Analysis of Financial Condition and Results of Operations section of Target’s 2014 Annual Report discusses two reasons for the rare loss. The first, and main, reason for the reported net loss is Target’s exit from Canada. The corporation reports that following a comprehensive assessment of Canadian operations, its Board of Directors approved a plan on January 14, 2015 to discontinue operating stores in Canada. As a result of this decision, the Target 2014 Annual Report (2015) continues that the company immediately filed for creditor protection, began liquidating its Canadian stores, and then recognized a $1.6 billion net loss for 2014. The second reason for the loss, reports Target, was due to $191 million of pretax expenses and $46 million of expected insurance proceeds (for net expenses of $145 million) to address a massive data breach in the fourth quarter of 2013. Expenses resulting from the data breach continued into January 2015, according to the annual report.
References:
Target 2014 Annual Report. (2015, April 27). Target Corporation corporate website. Retrieved from https://corporate.target.com/_media/TargetCorp/annualreports/2014/pdf/Target-2014-Annual-Report.pdf?ext=.pdf
Explanation / Answer
Executive Summary
Fiscal 2014 included the following notable items:
· GAAP earnings per share were $(2.56), including dilution of $(6.38) related to discontinued operations.
· Adjusted earnings per share from continuing operations were $4.27.
· Comparable sales grew 1.3 percent. Digital channel sales growth of more than 30 percent contributed 0.7 percentage points to 2014 comparable sales growth.
· We paid dividends of $1,205 million in 2014, an increase of 19.8 percent above 2013.
Sales from continuing operations were $72,618 million for 2014, an increase of $1,339 million or 1.9 percent from the prior year. Earnings from continuing operations before interest expense and income taxes in 2014 decreased by $636 million or 12.3 percent from 2013 to $4,535 million. Cash flow provided by continuing operations was $5,131 million, $7,519 million, and $5,568 million for 2014, 2013, and 2012, respectively. In connection with the sale of our U.S. credit card receivables, we received cash of $5.7 billion during 2013. Of this amount, $2.7 billion is included in operating cash flow provided by continuing operations and $3.0 billion is included in investing cash flow provided by continuing operations.
Earnings Per Share From Continuing Operations
Percent Change
2014
2013
2012 (a)
2014/2013
2013/2012
GAAP diluted earnings per share
$3.83
$4.20
$5.00
(8.8)%
(16.1)%
Adjustments
0.44
0.18
(0.23)
Adjusted diluted earnings per share
$4.27
$4.38
$4.76
(2.6)%
7.9%
· Note: Adjusted diluted earnings per share from continuing operations (Adjusted EPS), a non-GAAP metric, excludes the impact of certain matters not related to our routine retail operations and the impact of our discontinued Canadian 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 21.
· (a) Consisted of 53 weeks.
Canada Exit
On January 14, 2015, following a comprehensive assessment of Canadian operations, our Board of Directors approved a plan to discontinue operating stores in Canada. As a result of this decision, on January 15, 2015, Target Canada Co. and certain other wholly owned subsidiaries of Target (collectively Canada Subsidiaries), filed for protection (the Filing) under the Companies’ Creditors Arrangement Act (CCAA) with the Ontario Superior Court of Justice in Toronto (the Court). The Canada Subsidiaries comprise substantially all of our Canadian operations and our Canadian Segment. The Canada Subsidiaries have commenced an orderly liquidation process and stores in Canada will remain open during the liquidation. To assist with the exit plan, the Court approved the appointment of a monitor and certain other financial advisors.
As a result of the Filing, we no longer have a controlling interest in the Canada Subsidiaries. For this reason, we deconsolidated the Canada Subsidiaries effective January 15, 2015, resulting in a pretax impairment loss on deconsolidation and other charges, collectively totaling $5.1 billion. The pretax loss on deconsolidation includes the derecognition of the carrying amounts of the Canada Subsidiaries’ assets, liabilities and accumulated other comprehensive loss and the recording of our remaining interests at fair value.
Subsequent to deconsolidation, we will use the cost method to account for our equity investment in the Canada Subsidiaries, which has been reflected as zero in our Consolidated Statement of Financial Position at January 31, 2015 based on the estimated fair value of the Canada Subsidiaries’ net assets. Loans to and accounts receivable from the Canada Subsidiaries are recorded at an estimated fair value of $326 million. Our ultimate cash recovery on these claims is subject to the final liquidation value of the Canada Subsidiaries and could vary materially from our estimates.
Our Canada exit represents a strategic shift in our business. For this reason, our Canadian Segment results for all periods prior to the January 15, 2015 deconsolidation and costs to exit are classified as discontinued operations.
We have recognized a tax benefit of $1.6 billion in discontinued operations, which primarily relates to the loss on our investment in Canada and includes other tax benefits resulting from certain asset write-offs and liabilities paid or accrued to facilitate the liquidation. We have realized the majority of these tax benefits in the first quarter of 2015 and expect to realize substantially all of the remainder in 2015.
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). In 2014, we recorded $191 million of pretax Data Breach-related expenses and $46 million of expected insurance proceeds, for net expenses of $145 million. These expenses were included in our Consolidated Statements of Operations as Selling, General and Administrative Expenses (SG&A), but were not part of segment SG&A. 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.
As of January 31, 2015 we have incurred $252 million of cumulative Data Breach-related expenses, partially offset by $90 million of expected insurance recoveries, for net cumulative expenses of $162 million.
For more information about the Data Breach, see Note 17 of the Financial Statements.
Analysis of Results of Operations
Segment Results
(dollars in millions)
Percent Change
2014
2013
2012 (a)
2014/2013
2013/2012
Sales
$72,618
$71,279
$71,960
1.9%
(0.9)%
Cost of sales
51,278
50,039
50,568
2.5
(1.0)
Gross margin
21,340
21,240
21,392
0.5
(0.7)
SG&A expenses (b)
14,450
14,285
13,759
1.2
3.8
EBITDA
6,890
6,955
7,633
(0.9)
(8.9)
Depreciation and amortization
2,129
1,996
2,044
6.7
(2.4)
EBIT
$4,761
$4,959
$5,589
(4.0)%
(11.3 )%
Note: Effective January 15, 2015, we operate as a single segment which includes all of our continuing operations, excluding net interest expense, data breach related costs and certain other expenses which are discretely managed. Our segment operations are designed to enable guests to purchase products seamlessly in stores, online or through mobile devices. See Note 28 of our Financial Statements for a reconciliation of our segment results to earnings before income taxes.
(a) Consisted of 53 weeks.
(b) SG&A includes credit card revenues and expenses for all periods presented prior to the March 2013 sale of our U.S. consumer credit card portfolio to TD. For 2014 and 2013, SG&A also includes $682 million and $653 million, respectively, of profit-sharing income from the arrangement with TD.
Rate Analysis
2014
2013
2012(a)
Gross margin rate
29.4%
29.8%
29.7%
SG&A expense rate
19.9
20.0
19.1
EBITDA margin rate
9.5
9.8
10.6
Depreciation and amortization expense rate
2.9
2.8
2.8
EBIT margin rate
6.6
7.0
7.8
Note: Rate analysis metrics are computed by dividing the applicable amount by sales.
(a) Consisted of 53 weeks.
Comparable Sales
2014
2013
2012
Comparable sales change
1.3%
(0.4)%
2.7%
Drivers of change in comparable sales:
Number of transactions
(0.2)%
(2.7)%
0.5%
Average transaction amount
1.5%
2.3%
2.3%
Selling price per unit
3.2%
1.6%
1.3%
Units per transaction
(1.6)%
0.7%
1.0%
Contribution to Comparable Sales Change
2014
2013
2012
Stores channel comparable sales change
0.7%
(0.7)%
2.6%
Digital channel contribution to comparable sales change
0.7
0.3
0.1
Total comparable sales change
1.3%
(0.4)%
2.7%
Sales by Product Category
Percentage of Sales
2014
2013
2012
Household essentials (a)
25%
25%
25%
Hardlines (b)
18
18
18
Apparel and accessories (c)
19
19
19
Food and pet supplies (d)
21
21
20
Home furnishings and décor (e)
17
17
18
Total
100%
100%
100%
(a) Includes pharmacy, beauty, personal care, baby care, cleaning and paper products.
(b) Includes electronics (including video game hardware and software), music, movies, books, computer software, sporting goods and toys.
(c) Includes apparel for women, men, boys, girls, toddlers, infants and newborns, as well as intimate apparel, jewelry, accessories and shoes.
(d) Includes dry grocery, dairy, frozen food, beverages, candy, snacks, deli, bakery, meat, produce and pet supplies.
(e) Includes furniture, lighting, kitchenware, small appliances, home décor, bed and bath, home improvement, automotive and seasonal merchandise such as patio furniture and holiday décor.
Further analysis of sales metrics is infeasible due to 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.
TD offers credit to qualified guests through Target-branded credit cards: the Target Credit Card and the Target Visa 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 and free shipping 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 incremental purchases on our REDcards are also incremental sales for Target.
REDcard Penetration
2014
2013
2012
Target Credit Cards
9.7%
9.3%
7.9%
Target Debit Card
11.2
9.9
5.7
Total store REDcard Penetration
20.9%
19.3%
13.6%
Note: The sum of Target Credit Cards and Target Debit Card penetration may not equal Total REDcard Penetration due to rounding.
Gross Margin Rate
2012 GM Rate
29.7%
Vendor Contracts
0.2%
Other
0.1%
Integrated Growth Strategies
(0.2)%
Other
0.2%
Promotions
(0.6)%
2014 GM Rate
29.4%
Our gross margin rate was 29.4 percent in 2014, 29.8 percent in 2013, and 29.7 percent in 2012. The 2014 decrease is primarily due to promotional activity.
The 2013 increase was primarily the result of a change in vendor contracts regarding payments received in support of marketing programs resulting in more vendor consideration being recognized as a reduction of our cost of sales rather than a reduction of SG&A. Increases to the rate were offset by our integrated growth strategies of our 5 percent REDcard Rewards loyalty program and our store remodel program.
Selling, General and Administrative Expense Rate
2012 SG&A Rate
19.1%
Expense Optimization
(0.2)%
Comp Expense
(0.2)%
Credict Card Income
0.5%
Technology/ Sypply Chain
0.3%
Vendor Contracts
0.2%
Other
0.3%
2013 SG&A Rate
20.0%
Expense Optimization
(0.8)%
Technology
0.2%
Other
0.5%
2014 SG&A Rate
19.9%
Our SG&A expense rate was 19.9 percent in 2014, 20.0 percent in 2013, and 19.1 percent in 2012. The decrease in 2014 primarily related to company-wide expense optimization efforts, partially offset by investments in technology and other initiatives, none of which were individually significant.
The increase in 2013 resulted from a smaller contribution from our credit card portfolio, investments in technology and supply chain in support of multichannel initiatives, changes in merchandise vendor contracts described above, and other increases. Increases were partially offset by the benefit from our company-wide expense optimization efforts and favorable incentive compensation and store hourly payroll.
Store Data
Change in Number of Stores
2014
2013
Beginning store count
1,793
1,778
Opened
16
19
Closed
(19)
(4)
Relocated
—
—
Ending store count
1,790
1,793
Number of stores remodeled during the year
39
100
Number of Stores and Retail Square Feet
Number Of Stores
Retail Square Feet(a)
January 31,
2015
February 1,
2014
January 31,
2015
February 1,
2014
Expanded food assortment stores
1,292
1,245
167,026
160,891
SuperTarget stores
249
251
44,151
44,500
Target general merchandise stores
240
289
27,945
33,843
CityTarget stores
8
8
820
820
TargetExpress
1
—
21
—
Total
1,790
1,793
239,963
240,054
(a) In thousands, reflects total square feet less office, distribution center and vacant space.
back to Analysis of Results of Operations
Other Performance Factors
Other Selling, General and Administrative Expenses
In addition to segment selling, general and administrative expenses, we recorded certain other expenses during 2014 and 2013. For 2014, these expenses included $145 million of net Data Breach-related costs, $16 million of impairments related to undeveloped U.S. land and $13 million of costs related to previously announced plans to convert existing co-branded REDcards to MasterCard co-branded chip-and-PIN cards in 2015 to support the accelerated transition to chip-and-PIN-enabled REDcards. For 2013, these expenses included a $23 million workforce-reduction charge primarily related to severance and benefits costs, a $22 million charge related to part-time team member health benefit changes, $19 million in impairment charges related to undeveloped U.S. land, and $17 million of net Data Breach-related costs. Additional information about these items is provided within the Reconciliation of Non-GAAP Financial Measures to GAAP Measures on page 21.
back to Other Performance Factors
Net Interest Expense
Net interest expense from continuing operations was $882 million, $1,049 million, and $684 million for 2014, 2013, and 2012, respectively. Net interest expense for 2014 and 2013 included a loss on early retirement of debt of $285 million and $445 million, respectively.
back to Other Performance Factors
Provision for Income Taxes
Our effective income tax rate from continuing operations decreased to 33.0 percent in 2014, from 34.6 percent in 2013, driven primarily by the net tax effect of our global sourcing operations and the favorable resolution of various income tax matters. The resolution of various income tax matters reduced tax expense by $35 million and $16 million in 2014 and 2013, respectively. A tax rate reconciliation is provided in Note 21 to our Consolidated Financial Statements.
Our effective income tax rate from continuing operations increased to 34.6 percent in 2013, from 34.4 percent in 2012, driven by a lower year-over-year benefit from the favorable resolution of various income tax matters. The resolution of various income tax matters reduced tax expense by $16 million and $58 million in 2013 and 2012, respectively.
back to Other Performance Factors
Reconciliation of Non-GAAP Financial Measures to GAAP Measures
To provide additional transparency, we have disclosed non-GAAP adjusted diluted earnings per share from continuing operations (Adjusted EPS). This metric excludes the impact of the 2013 sale of our U.S. consumer credit card receivables portfolio, losses on early retirement of debt, net expenses related to the 2013 data breach and other matters presented below. We believe this information is useful in providing period-to-period comparisons of the results of our continuing operations. This measure is not in accordance with, or an alternative to, generally accepted accounting principles in the United States. The most comparable GAAP measure is diluted earnings per share from continuing operations. Adjusted EPS from continuing operations should not be considered in isolation or as a substitution for analysis of our results as reported under GAAP. Other companies may calculate non-GAAP adjusted EPS from continuing operations differently than we do, limiting the usefulness of the measure for comparisons with other companies. Prior year amounts have been revised to present Adjusted EPS on a continuing operations basis.
(millions, except per share data)
2014
2013
2012
Pretax
Net of Tax
Per Share Amounts
Pretax
Net of Tax
Per Share Amounts
Pretax
Net of Tax
Per Share Amounts
GAAP diluted earnings per share from continuing operations
$3.83
$4.20
$5.00
Adjustments
Loss on early retirement of debt
$285
$173
$0.27
$445
$270
$0.42
$ —
$ —
$ —
Data Breach-related costs, net of insurance receivable (a)
145
94
0.15
17
11
0.02
—
—
—
Reduction of beneficial interest asset (b)
53
32
0.05
98
61
0.09
—
—
—
Other (c)
29
18
0.03
64
40
0.06
—
—
—
Gain on receivables transaction (b)
—
—
—
(391)
(247)
(0.38)
(152)
(97)
(0.15)
Resolution of income tax matters
—
(35)
(0.06)
—
(16)
(0.03)
—
(58)
(0.09)
Adjusted diluted earnings per share from continuing operations
$4.27
$4.38
$4.76
· Note: The sum of the non-GAAP adjustments may not equal the total adjustment amounts due to rounding.
· (a) Refer to Note 17 of the Financial Statements.
· (b) Refer to Note 7 of the Financial Statements.
· (c) 2014 includes impairments of $16 million related to undeveloped land in the U.S. and $13 million of expense related to converting co- branded card program to MasterCard. 2013 includes a $23 million workforce-reduction charge primarily related to severance and benefits costs, a $22 million charge related to part-time team member health benefit changes, and $19 million in impairment charges related to certain parcels of undeveloped land.
back to Other Performance Factors
Analysis of Financial Condition
Liquidity and Capital Resources
Our period-end cash and cash equivalents balance was $2,210 million, compared with $670 million in 2013. Short-term investments of $1,520 million and $3 million were included in cash and cash equivalents at the end of 2014 and 2013, respectively. Our investment policy is designed to preserve principal and liquidity of our short-term investments. This policy allows investments in large money market funds or in highly rated direct short-term instruments that mature in 60 days or less. We also place dollar limits on our investments in individual funds or instruments.
Cash Flows
Our 2014 operations were funded by both internally and externally generated funds. Operating cash flow provided by continuing operations was $5,131 million in 2014 compared with $7,519 million in 2013. Net cash flow provided by continuing operations for 2013 includes $5.7 billion of cash received in connection with the sale of our U.S. consumer credit card receivables, of which $2.7 billion is included in operating cash flow provided by continuing operations and $3.0 billion is included in investing cash flow provided by continuing operations. In June 2014, we issued $1 billion of unsecured debt that matures in June 2019 and $1 billion of unsecured debt that matures in July 2024. Combined with our prior year-end cash position, these cash flows allowed us to repurchase $725 million of debt at a market value of $1 billion, pay current debt maturities, invest in the business and pay dividends.
Year-end inventory levels increased from $8,278 million in 2013 to $8,790 million in 2014. Accounts payable increased by $424 million, or 5.8 percent over the same period.
Share Repurchases
In January 2012, we began repurchasing shares under a $5 billion program authorized by our Board of Directors. Since the second quarter of 2013, we have not repurchased any shares on the open market. However, as described in Note 23 of the Financial Statements, we reacquired 0.8 million shares during 2014 upon the noncash settlement of prepaid forward contracts related to nonqualified deferred compensation plans. During the first half of 2013, we repurchased 21.9 million shares of our common stock for a total investment of $1,474 million ($67.41 per share).
Dividends
We paid dividends totaling $1,205 million in 2014 and $1,006 million in 2013, an increase of 19.8 percent. We declared dividends totaling $1,271 million ($1.99 per share) in 2014, a per share increase of 20.6 percent over 2013. We declared dividends totaling $1,051 million ($1.65 per share) in 2013, a per share increase of 19.6 percent over 2012. We have paid dividends every quarter since our 1967 initial public offering, and it is our intent to continue to do so in the future.
Short-term and Long-term Financing
Our financing strategy is to ensure liquidity and access to capital markets, to manage our net exposure to floating interest rate volatility and to maintain a balanced spectrum of debt maturities. Within these parameters, we seek to minimize our borrowing costs. Our ability to access the long-term debt and commercial paper markets has provided us with ample sources of liquidity. Our continued access to these markets depends on multiple factors, including the condition of debt capital markets, our operating performance and maintaining strong debt ratings. As of January 31, 2015, our credit ratings were as follows:
Credit Ratings
Moody's
Standard and Poor's
Fitch
Long-term debt
A2
A
A-
Commercial paper
P-1
A-1
F2
If our credit ratings were lowered, our ability to access the debt markets, our cost of funds and other terms for new debt issuances could be adversely impacted. Each of the credit rating agencies reviews its rating periodically and there is no guarantee our current credit ratings will remain the same as described above. Standard and Poor's lowered our long-term debt rating from A+ to A during 2014, but maintained our A-1 commercial paper rating.
As a measure of our financial condition, we monitor our ratio of earnings from continuing operations to fixed charges, which represents the ratio of pretax earnings from continuing operations before fixed charges to fixed charges. Fixed charges include interest expense and the interest portion of rent expense. Our ratio of earnings to fixed charges was 6.02x in 2014, 6.48x in 2013 and 7.10x in 2012. See Exhibit (12) for a description of how the gain on sale of our U.S. credit card receivable portfolio and loss on early retirement of debt affected the 2014, 2013 and 2012 calculations.
In 2014 and 2013, we funded our peak sales season working capital needs through internally generated funds and the issuance of commercial paper.
Percent Change
2014
2013
2012 (a)
2014/2013
2013/2012
GAAP diluted earnings per share
$3.83
$4.20
$5.00
(8.8)%
(16.1)%
Adjustments
0.44
0.18
(0.23)
Adjusted diluted earnings per share
$4.27
$4.38
$4.76
(2.6)%
7.9%
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