UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
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FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934.
For the quarterly period ended October 31, 1998
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Commission file number 1-6049
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Dayton Hudson Corporation
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(Exact name of registrant as specified in its charter)
Minnesota 41-0215170
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(State of incorporation or organization) (I.R.S. Employer Identification No.)
777 Nicollet Mall Minneapolis, Minnesota 55402-2055
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (612) 370-6948
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None
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(Former name, former address and former fiscal year,
if changed since last report.)
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 and (2) has been subject to such filing requirements for the past 90
days.
The number of shares outstanding of common stock as of October 31, 1998 was
440,824,935.
DAYTON HUDSON CORPORATION AND SUBSIDIARIES
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION
See accompanying Notes to Condensed Consolidated Financial Statements.
1
* The January 31, 1998 Consolidated Statement of Financial Position is condensed
from the audited financial statement.
See accompanying Notes to Condensed Consolidated Financial Statements.
2
Amounts in this statement are presented on a cash basis and therefore may
differ from those shown elsewhere in this 10-Q report. Cash paid for income
taxes was $427 million and $402 million during the first nine months of 1998
and 1997, respectively. Cash paid for interest (including interest
capitalized) in the first nine months of 1998 and 1997 was $267 million and
$360 million, respectively.
See accompanying Notes to Condensed Consolidated Financial Statements.
3
NOTES TO CONDENSED CONSOLIDATED Dayton Hudson Corporation
FINANCIAL STATEMENTS and Subsidiaries
ACCOUNTING POLICIES
The accompanying condensed consolidated financial statements should be read
in conjunction with the financial statement disclosures contained in our 1997
Annual Shareholders' Report throughout pages 25-36. As explained on page 35
of the Annual Report, the same accounting policies are followed in preparing
quarterly financial data as are followed in preparing annual data. In the
opinion of management, 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 the retail industry, quarterly earnings are not
necessarily indicative of the results that may be expected for the full
fiscal year.
INTERNAL USE SOFTWARE
We adopted Statement of Position (SOP) 98-1 "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" in first quarter
1998. The adoption resulted in expense savings which increased pre-tax
earnings by approximately $13 and $51 million, net of depreciation, for the
third quarter and first nine months of 1998, respectively ($.02 and $.07 per
share), which partially offset our other systems expenses.
PER SHARE DATA
References to earnings per share relate to diluted earnings per share.
*Before extraordinary charges
4
LONG-TERM DEBT
During the third quarter, we repurchased $4 million of high-coupon debt for
$5 million, resulting in an after-tax extraordinary charge of $1 million
(less than $.01 per share). The debt repurchased had an average interest rate
of 9.6 percent and an average remaining life of 13 years. Year-to-date, we
repurchased $16 million of high-coupon debt for $20 million, resulting in an
after-tax extraordinary charge of $3 million ($.01 per share). The
replacement of this debt with lower interest rate financing is expected to
result in future interest expense savings.
During the second quarter, we issued $200 million of long-term debt maturing
in June 2010, puttable in June 2000. In addition, we sold to a third party
the right to call and remarket these securities in June 2000 to their final
maturity. Also during the second quarter, we issued $200 million of long-term
debt with a coupon rate of 6.65%, maturing in August 2028.
SEGMENT DISCLOSURES (millions of dollars)
Revenues by segment were as follows:
Pre-tax segment profit and reconciliation to pre-tax earnings were as follows:
5
ACCOUNTS RECEIVABLE SECURITIZATION
During the third quarter, Dayton Hudson Receivables Corporation (DHRC), a
special-purpose subsidiary, sold to the public $400 million of securitized
receivables. This issue of asset-backed securities has an expected maturity
of five years and a stated rate of 5.90%. Proceeds from the sale were used
for general corporate purposes, including funding the growth of receivables.
In conjunction with this transaction, DHRC retained a $123 million issue of
subordinated Class B asset-backed securities, which is classified in Retained
Securitized Receivables. As required by Statement of Financial Accounting
Standards (SFAS) No. 125, the sale transaction resulted in a pre-tax gain of
$35 million ($.05 per share). This gain was offset by a $38 million pre-tax
charge ($.05 per share) related to the maturity of our 1995 securitization.
The net impact resulted in a reduction of third quarter finance charge
revenues and pre-tax earnings of $3 million.
ACQUISITIONS
In the first quarter of 1998, we acquired The Associated Merchandising
Corporation, an international sourcing company for our three operating
divisions and other retailers, and Rivertown Trading Company, a direct
marketing firm. Both subsidiaries are included in the consolidated financial
statements. Their revenues and operating results are included in "Corporate
and other" and were immaterial in the third quarter and first nine months of
1998.
SUBSEQUENT EVENTS
DEBT ISSUANCE
On November 3, 1998 we issued $200 million of long-term debt with a coupon rate
of 5.875%, maturing in November 2008.
INVENTORY SHORTAGE
We have historically deducted for income tax purposes the inventory shortage
expense accrued for book purposes in a manner consistent with industry
practice. With respect to our 1983 Federal income tax return, the Internal
Revenue Service (IRS) challenged the practice of deducting accrued shortage
not verified with a year-end physical inventory. In second quarter of 1997,
the United States Tax Court (Tax Court) returned a judgment on this issue in
favor of the IRS. We appealed the decision to the United States Court of
Appeals for the Eighth Circuit (Appeals Court) and on August 14, 1998, the
Appeals Court reversed the Tax Court decision. On November 16, 1998, we
received notification that the IRS did not appeal the August decision and the
1983 case has been closed. While final resolution of subsequent years depends
on further action, if any, by the IRS, the beneficial effect of the outcome
of the 1983 case will be reflected as a reduction in the 1998 fourth quarter
and full year effective income tax rate.
6
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF OPERATIONS AND FINANCIAL CONDITION
THIRD QUARTER 1998
ANALYSIS OF OPERATIONS
The improvement in net earnings for the third quarter and first nine months of
1998 was due to strong performance at Target and DSD. Third quarter and
year-to-date 1998 and 1997 net earnings were as follows:
REVENUES AND COMPARABLE-STORE SALES
Total revenues for the quarter increased 10.1 percent to $7,288 million
compared with $6,622 million for the same period a year ago. Total revenues
for the first nine months increased 10.7 percent to $20,812 million compared
with $18,804 million for the same period a year ago. Total comparable-store
sales (sales from stores open longer than one year) increased 3.7 percent and
4.7 percent for the three and nine-month periods, respectively.
Year-over-year changes in revenues and comparable-store sales by business
segment were as follows:
Target's revenue results reflect strong new and comparable-store sales
growth. Mervyn's revenues and comparable-store sales declined, primarily
reflecting weak sales of men's apparel in the quarter and lower than expected
sales in its West Coast stores year-to-date. DSD's revenue results reflect
modest comparable store sales growth in the quarter and strong
comparable-store sales growth year-to-date.
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PRE-TAX SEGMENT PROFIT
Pre-tax segment profit is first-in, first-out (FIFO) earnings from operations
before securitization effects, interest, corporate and other, and unusual
items. Our third quarter pre-tax segment profit increased 10 percent to $424
million compared with $387 million for the same period a year ago. Pre-tax
segment profit in the first nine months increased 13 percent to $1,232
million compared with $1,089 million for the same period a year ago.
Year-over-year pre-tax segment profit growth was as follows:
TARGET'S third quarter and nine-month pre-tax profit increased 18 and 20
percent, respectively, over the same periods last year, reflecting
comparable-store sales growth of 5.1 and 5.7 percent, respectively. During
the third quarter and first nine months, the gross margin rate improved
primarily due to favorable markdown performance. The operating expense rate
during the third quarter remained essentially unchanged from last year,
reflecting improved store productivity offset by higher wage rates. For the
first nine months, the operating expense rate was favorable to last year due
to productivity improvements, partially offset by higher wage rates. We
expect mid single-digit comparable-store sales growth at Target in the fourth
quarter, and a pre-tax profit margin even with, or slightly expanded over,
1997.
MERVYN'S third quarter and nine-month pre-tax profit decreased 22 and 23
percent, respectively, from the same periods last year, reflecting
comparable-store sales declines of 1.2 and 0.6 percent, respectively. The
gross margin rate declined during the third quarter and first nine months due
to unfavorable markdown performance. The operating expense rate increased in
both periods due to lower sales leverage. We expect a slightly improved sales
trend relative to our year-to-date performance at Mervyn's during the fourth
quarter and pre-tax profit essentially in line with last year's level.
DSD'S third quarter and nine-month pre-tax profit increased 11 and 19
percent, respectively, from the same periods last year, reflecting
comparable-store sales growth of 1.3 and 4.9 percent, respectively. The gross
margin rate improvement in the third quarter and first nine months was
primarily due to improved markup resulting from our strategic repositioning
efforts during the past few years. During the third quarter, the operating
expense rate was higher primarily due to enhanced guest service. The
operating expense rate year-to-date is slightly favorable to last year due to
strong sales leverage, offset by enhanced guest service. We expect low
single-digit comparable-store sales growth at DSD in the fourth quarter, and
a modest increase in pre-tax profit.
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OTHER PERFORMANCE FACTORS
Our proprietary guest credit programs strategically support our core retail
operations and are an integral component of each business segment. Therefore,
credit contribution is reflected in each business segment's pre-tax profit.
Net of all expenses, including bad debt expense, pre-tax contribution from
guest credit increased over the prior year, for both the quarter and
nine-month period, principally due to continued growth of the Target Guest
Card. We expect to continue to grow guest credit's contribution during the
fourth quarter of 1998 by acquiring new accounts, increasing participation in
our guest loyalty programs and controlling bad debt expense.
The last-in first-out (LIFO) provision, included in cost of retail sales, was
zero in the third quarter and first nine months of both 1998 and 1997. The
cumulative LIFO provision was $92 million at October 31, 1998 and January 31,
1998, and $86 million at November 1, 1997.
"Interest equivalent", as shown in our pre-tax earnings reconciliation on
page 5, represents payments to holders of our sold securitized receivables
and is included in our Consolidated Results of Operations as a reduction of
finance charge revenues and bad debt expense. We expect interest equivalent
of approximately $12 million in the fourth quarter of this year. For
analytical purposes, management includes the interest equivalent in interest
expense.
Combined interest expense and interest equivalent increased $2 million in the
third quarter compared to the same period last year due to higher average
funded balances, partially offset by portfolio rate favorability. For the
first nine months combined interest expense and interest equivalent decreased
$4 million compared to the same period last year due to a lower average
portfolio interest rate, partially offset by higher average funded balances.
For the balance of 1998, combined interest expense and interest equivalent is
expected to increase modestly above 1997 as somewhat higher average funded
balances are partially offset by continued portfolio rate favorability.
The estimated annual effective income tax rate was 39.5 percent in the third
quarter and first nine months of both 1998 and 1997. As noted on page 6, we
anticipate a reduction in the fourth quarter and full year 1998 effective
income tax rate.
YEAR 2000 READINESS DISCLOSURE
We began mitigating the risks associated with the Year 2000 date conversion
in 1993. In 1997 we established a corporate-wide, comprehensive plan of
action designed to achieve an uninterrupted transition into the year 2000.
This project includes three major elements: 1) information technology (IT)
systems, 2) non-IT, or embedded technology, systems and 3) relationships with
our key business partners. The project is divided into five phases:
awareness, assessment, renovation, validation and implementation. We have
completed the awareness and assessment phases for all three elements, and are
currently at different points in the renovation, validation and
implementation phases for each of the elements. We are using both internal
and external resources to implement our plan.
9
For our IT systems, we have assessed both existing and newly implemented
hardware and applications (software and operating systems), and have
finalized the development of plans to address all assessed risks.
Approximately 80 percent of our hardware is year 2000 compliant, and the
remainder is currently in the renovation phase. Approximately 70 percent of
our applications are compliant, with 30 percent in the renovation phase. We
anticipate completion of the validation, or testing, phase for our software
by early/mid 1999, and we intend to extensively test our key operating
systems, through simulation of the year 2000, in late 1998 and early/mid
1999. Our year 2000 readiness in this area has been significantly enhanced by
our recent, substantial common systems development initiatives through which
we have invested heavily in IT over the past two years.
We began addressing non-IT systems, or embedded technology/infrastructure,
risks at our stores, distribution centers and headquarters facilities early
in our initiative. Approximately 85 percent of our non-IT systems are
compliant and the remainder are currently in the renovation phase. Validation
and implementation are approximately 80 percent complete and we anticipate
substantial completion by early 1999.
We have identified our key business partners and have been working closely
with them to assess their readiness and mitigate the risk to us if they are
not prepared for the year 2000. We have installed the year 2000 compliant
version of Electronic Data Interchange (EDI) software and expect to finalize
testing of EDI and other electronic transmissions with key business partners
by mid/late 1999.
In planning for the most reasonably likely worst case scenarios, we have
addressed all three major elements in our project. We believe our IT systems
will be ready for the year 2000, but we may experience isolated incidences of
non-compliance. We plan to allocate internal resources and retain dedicated
consultants and vendor representatives to be ready to take action if these
events occur. Our contingency plans for non-IT systems are currently in
process, and we are simultaneously putting the required resources in place to
carry out those plans for key non-IT systems, such as those within our
stores. We are contacting many critical business partners to assess their
readiness and will finish developing appropriate contingency plans by mid
1999. Although we value our established relationships with key vendors,
substitute products for most of the goods we sell in our stores may be
obtained from other vendors. If certain vendors are unable to deliver product
on a timely basis, due to their own year 2000 issues, we anticipate there
will be others who will be able to deliver similar goods. However, the lead
time involved in sourcing certain goods may result in temporary shortages of
a few of those items. We also recognize the risks to us if other key
suppliers in areas such as utilities, communications, transportation, banking
and government are not ready for the year 2000, and are developing
contingency plans to minimize the potential adverse impacts of these risks.
In 1998 we have expensed $12 million related to year 2000 readiness. Prior to
1998, we expensed approximately $5 million. We estimate approximately another
$35 million will be expensed as incurred to complete the year 2000 readiness
program, with most of the spending occurring over the next nine months. In
addition, this program has accelerated the timing of approximately $30
million of planned capital expenditures. All expenditures related to our year
2000 readiness initiative will be funded by cash flow from operations and
will not materially impact our other operating or investment plans.
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ANALYSIS OF FINANCIAL CONDITION
Our financial condition remains strong. We continue to fund the growth in our
business through a combination of retained earnings, debt and sold
securitized receivables. The ratio of debt to total capitalization
attributable to our retail operations was 50 percent at the end of third
quarter 1998, compared with 53 percent a year ago and 45 percent at year-end.
Due to the seasonality of our business, quarterly comparisons will fluctuate,
but we expect our debt ratio to continue to be below last year for the
balance of 1998.
At October 31, 1998, working capital was $1,374 million, up 25 percent
compared with a year ago. Retained securitized receivables were essentially
even with last year. Compared with last year, merchandise inventories
increased $604 million, or 15 percent. This was primarily a result of new
store growth and the timing of inventory receipts at Target, as well as
Mervyn's planned investment in strategic categories and items, designed to
improve basic in-stock positions and support holiday merchandise programs.
The inventory growth was substantially funded by a $538 million, or 19
percent, increase in accounts payable.
Capital expenditures for the first nine months of 1998 were $1,237 million,
compared with $983 million for the same period a year ago; 82 percent of the
current year expenditures were made by Target, 10 percent by Mervyn's and 8
percent by DSD.
STORE DATA
During the quarter, we opened 23 net new Target stores and closed one
Mervyn's store. At October 31, 1998, Target operated 851 stores in 41 states,
Mervyn's operated 268 stores in 14 states and DSD operated 64 stores in eight
states.
Retail square footage was as follows:
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FORWARD-LOOKING STATEMENTS
The preceding Management's Discussion and Analysis contains forward-looking
statements regarding the Company's performance, liquidity and the adequacy of
its capital resources. Those statements are based on management's current
assumptions and expectations and are subject to certain risks and uncertainties
that could cause actual results to differ materially from those projected. As a
result, the Company cautions that the forward-looking statements are qualified
by the risks of increased competition, shifting consumer demand, changing
consumer credit markets and general economic conditions, hiring and retaining
effective team members, sourcing merchandise from domestic and international
vendors, preparing for the impact of year 2000, and other risks and
uncertainties. As a result, while management believes that there is a reasonable
basis for the forward-looking statements, undue reliance should not be placed on
those statements. Readers are encouraged to review Exhibit (99), filed with our
second quarter 1998 Form 10-Q, which contains additional important factors that
may cause actual results to differ materially from those predicted in the
forward-looking statements.
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PART II. OTHER INFORMATION
ITEM 5. OTHER INFORMATION
ANNUAL MEETING - ADVANCE NOTICE PROVISIONS AND DISCRETIONARY VOTING
Shareholders desiring to submit proposals for possible inclusion in the
Company's 1999 Proxy Statement must do so on or before December 14, 1998. Such
proposals should be sent to the Secretary of the Corporation at 777 Nicollet
Mall, Minneapolis, Minnesota 55402.
In addition, the Company's Restated Articles of Incorporation and By-Laws
establish advance notice provisions for shareholder proposals to be brought
before any meeting of shareholders without any discussion of the matter in
the proxy statement. The Restated Articles of Incorporation establish advance
notice provisions for shareholder proposals related to the nomination and
election of Directors and the By-Laws establish advance notice provisions for
all other shareholder proposals. If the Company does not receive timely
notice, the business will be excluded from consideration at the meeting.
The advance notice provisions in the Company's By-Laws were amended on
November 11, 1998. The amendment provides that if a shareholder desires to
bring business before our 1999 Annual Meeting that does not relate to the
nomination and election of Directors, written notice of such business must be
received by the Company's Secretary not less than 90 days prior to the first
anniversary of our 1998 Annual Meeting (which took place on May 20, 1998). As
a result, the written notice must be given to the Company's Secretary by
February 19, 1999, at the above address and be in proper form. These advance
notice provisions supersede the statutory notice period in the revised Rule
14a-4(c)(1) of the federal proxy rules, addressing the discretionary proxy
voting authority of the Board of Directors in connection with such
shareholder business. The 1999 Annual Meeting is expected to be held
Wednesday, May 19, 1999.
ON-LINE ANNUAL MEETING MATERIALS
For our 1999 Annual Shareholders' Meeting, Dayton Hudson is offering our
registered shareholders the opportunity to receive our Annual Report and Proxy
Statement over the Internet, RATHER THAN BY MAIL.
Shareholders wishing to take advantage of this opportunity are required to
complete an on-line consent form which is located at the following website
address:
http://www.vote-by-net.com/signup/dhc
To receive materials electronically, your consent must be received by March 26,
1999.
Instructions for accessing the on-line Annual Meeting materials will be sent to
consenting shareholders following our record date.
In addition to voting by proxy card or telephone, all shareholders will be able
to vote their proxies electronically for the 1999 Annual Shareholders' Meeting.
Information regarding this option will be available after March 26, 1999.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
27) Exhibits
b) Reports on Form 8-K:
Registrant did not file any reports on Form 8-K during the
quarter ended October 31, 1998.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DAYTON HUDSON CORPORATION
Registrant
Date: December 11, 1998 By /s/ Douglas A. Scovanner
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Douglas A. Scovanner
Senior Vice President and
Chief Financial Officer
Date: December 11, 1998 By /s/ J.A. Bogdan
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JoAnn Bogdan
Controller and
Chief Accounting Officer
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EXHIBIT INDEX
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