Module 10: A more detailed analysis of the financial reports

1. Module 10: A more detailed analysis of the financial reports By jenniferkellner (Discount, Variety Stores Industry)

2. Target (in brief) • Similar to Walmart, but target a customer willing to spend more • Focus on the “shopping experience” • Refer to their customers as “guests” • Sales pretty evenly distributed; mainly in household essentials • Currently expanding (to continue within forecast horizon) • CityTargets • > SuperTargets (grocery) • Stores in Canada, U.S. • Recent data breach (December 2013) • Loss of trust • But updated security, focus on becoming leaders • Yields uncertainty in Target’s future

3. Visuals

4. Discount, Variety stores industry Target Dollar General Wal-Mart Costco *Costco is least comparable

5. Objective • To reformulate the financial statements by incorporating additional information • Address each section of the balance sheet, income statement where expansion is possible/necessary • Reclassify, add, etc. • By doing so, we can refine our EPAT and NEA estimates and therefore improve our forecasts

6. Sales/Revenue • Revenues recognized net of expected returns • Revenue includes: • Canadian and U.S. retail sales • Credit Card receivables (now from TD bank); no longer separate line item • Online and mobile sales (includes shipping revenue, not sales taxes) • Gift card sales (recognized upon redemption; “breakage” insignificant) • Discounts from REDcards deducted from sales ($833, $583 & $340 M from 2013 to 2011, respectively) • Note 10

7. Sales (Note 29) Separate by product category (percentage of sales): Separate by segment (limited, Canadian operations started 2013):

8. Cost of sales (note 3) • Refined • Vendor income (receivables) recorded as reduction in cost of sales • Additional implied, not much detail available

9. SG&A An umbrella term – encompasses many items

10. SG&A… • Data breach expenses (MD&A) net $17M • Advertising costs (Note 5) • Rent expense • Income from TD profit-sharing transaction (sale of credit card receivables) • Prior – separately revenue line item • Now – offsets SG&A Ultimately, it looked like this…

11. The Data breach • Significant impact on previous year and forthcoming results (both in dollar and qualitative ways) • Consumer confidence • Data breach expenses in SG&A includes: • Accrual related to expected payment card networks' claims • Costs to investigate the breach • Provide credit-monitoring services to guests • Increase staffing of call centers • Other legal and professional services. • $66M less $44M proceeds • Expect losses to be more as lawsuits settle, claims resolved, etc. 2013 10K:

12. Cash • 2011, 2012, 2013 holding very little cash (< 2% of sales) • Use all cash as part of enterprise activities • Why? • Target doesn’t need a lot of cash on hand • Note 9 “Cash Equivalents” says that amounts due from third party vendors (ex: Visa) “settle in less than 5 days” • Favorable terms due to Target’s position • Also have “highly liquid investments” • Others in the industry do the same • Also note how Target holds onto less cash over time:

13. Other current assets (note 11) Breakdown…

14. Other noncurrent assets (Note 13) • Assumed “Company-owned life insurance investments” are not part of enterprise activities

15. Goodwill & Intangible assets (Note 14) • Goodwill & intangibles are embedded in “Other Noncurrent Assets” • Goodwill: • Goodwill increased from $59 in 2012 to $151 million in 2013 due to three acquisitions: DermStore Beauty Group, CHEFS Catalog & Cooking.com • Big into e-commerce, online presence • Intangibles: • Leasehold Acquisition costs (legal fees, other associated expenses) • “Other” (primarily acquisition of customer lists & trademarks) • Expect impairment is zero going forward • If there was impairment now, it would be in the f/s (presumably) • Goodwill is very smallit will most likely not be material to NEA estimates

16. Accrued and Other Current liabilities (note 16) * * *Take out Dividends Payable and Interest Payable as Financing Liabilities (FL)

17. Income Taxes (Note 21) • Combined Federal & State to determine marginal rate each year (subject to revision)

18. Deferred Taxes (Note 21) • The DTA (embedded in Other Noncurrent Assets) ≠ footnotes DTA or DTL • Need to: • Add additional DTA and DTL • Add imputed DTL or DTA

19. … Add additional DTA (under Enterprise Assets) and Implied Assets in 2009 Add additional DTL (under Enterprise Liabilities) & Implied Liability

20. Other noncurrent liabilities (note 22) • Separate Pension and postretirement health care benefits into FLs • Expand the rest • Note: This is the only section on the face of the balance sheet where pension liabilities are recognized (besides AOCI)

21. … As Part of Enterprise Liabilities: As Part of Financial Liabilities: Is this all? Investigate Note 26: Pension and Postretirement Health Care Plans

22. Pension and Postretirement healthcare plans (note 26) • Target has… • Qualified defined benefit pension plans • Unqualified plans • Healthcare benefits Note: As of Jan 1, 2009 the U.S. qualified defined benefit pension plan was closed to new participants

23. … * * • Combined Benefit obligations at year end • Nonqualified and health care benefits insignificant • The two are coupled under one line item as demonstrated in Note 22

24. … • Net amount recognized should be the same • Add $3,267 M as both a financial asset and liability • Repeat each year

25. Also to consider… Note 28: Consider where growth is coming from when forecasting (Most growth in assets, expansion is coming from the Canadian segment) Page 43: Target’s capital expenditures for 2014, they give us an estimate High due to investment in chip technology, increasing security

26. Notes payable and lt debt (note 18) • Target has about $12,622M in debt they’re paying 5.1% on

27. … Has increased significantly, is there customer base increasing? …signals a more positive outlook for Target

28. Conclusion Reformulated Income Statement Red denotes expanded items

29. What I didn’t find/ideal Information • Expected Credit Card income from TD bank from profit sharing arrangement – can’t forecast because only one year • Separation between Postretirement pension and Postretirement healthcare • However, healthcare is seemingly insignificant • Only one year of Canadian results available, Target introduced starting just in 2013 • Better forecasts down the road • Needs time to mature • Page 49 signals possible material effect of breach • “We are unable to reasonably estimate a range of probable loss in excess of…”

30. Questions upon completing Mod 10… • What consists “other” in… • Note 13 “Other Noncurrent Assets” ? • Note 16 “Accrued and Other Current Liabilities” ? • Note 22 “Other Noncurrent Liabilities” ? • Workers’ compensation and general liabilities, to be included as enterprise liabilities? • Pension liabilities and postretirement healthcare benefits, to be added as FA and FL? • Tax rates, accumulate Federal, State rates? What about “other” ? • Impact of Postretirement benefit plan additions • Additional information in SG&A; mostly “implied” or not much identified

31. Questions?