Business Segment Comparisons (Millions of Dollars)   1998   1997   1996   1995*   1994   1993 Revenues Target $ 23,056 $ 20,368 $ 17,853 $ 15,807 $ 13,600 $ 11,743 Mervyn's   4,176   4,227   4,369   4,516   4,561   4,436 Department Store Division   3,285   3,162   3,149   3,193   3,150   3,054 Corporate and other   434   -   -   -   -   - Total revenues $ 30,951 $ 27,757 $ 25,371 $ 23,516 $ 21,311 $ 19,233 Pre-tax segment profit Target $ 1,578 $ 1,287 $ 1,048 $ 721 $ 732 $ 600 Mervyn's   240   280   272   117   198   172 Department Store Division   279   240   151   192   259   246 Total pre-tax segment profit $ 2,097 $ 1,807 $  1,471 $ 1,030 $ 1,189 $ 1,018 LIFO provision credit/(expense)   18   (6)   (9)   (17)   19   91 Securitization adjustments:    SFAS 125 gain/(loss),net   (3)   45   -   -   -   -    Interest equivalent   (48)   (33)   (25)   (10)   -   - Interest expense   (398)   (416)   (442)   (442)   (426)   (446) Mainframe outsourcing   (42)   -   -   -   -   - Real estate repositioning   -   -   (134)   -   -   - Corporate and other   (68)   (71)   (78)   (60)   (68)   (56) Earnings before income taxes and extraordinary charges $ 1,556 $ 1,326 $ 783 $ 501 $ 714 $ 607 Assets Target $ 10,475 $ 9,487 $ 8,257 $ 7,330 $ 6,247 $ 5,495 Mervyn's   2,339   2,281   2,658   2,776   2,917   2,750 Department Store Division   2,123   2,188   2,296   2,309   2,392   2,240 Corporate and other   729   235   178   155   141   293 Total assets $ 15,666 $ 14,191 $ 13,389 $ 12,570 $ 11,697 $ 10,778 Depreciation and amortization Target $ 496 $ 437 $ 377 $ 328 $ 294 $ 264 Mervyn's   138   126   151   150   145   146 Department Store Division   135   128   119   113   108   104 Corporate and other   11   2   3   3   1   1 Total depreciation and amortization $ 780 $ 693 $ 650 $ 594 $ 548 $ 515 Capital expenditures Target $ 1,352 $ 1,155 $ 1,048 $ 1,067 $ 842 $ 716 Mervyn's   169   72   79   273   146   180 Department Store Division   127   124   173   161   96   80 Corporate and other   9   3   1   21   11   2 Total capital expenditures $ 1,657 $ 1,354 $ 1,301 $ 1,522 $ 1,095 $ 978 Segment EBITDA Target $ 2,074 $ 1,724 $ 1,425 $ 1,049 $ 1,026 $ 864 Mervyn's   378   406   423   267   343   318 Department Store Division   414   368   270   305   367   350 Total segment EBITDA $ 2,866 $ 2,498 $ 2,118 $ 1,621 $ 1,736 $ 1,532 *Consisted of 53 Weeks Each operating division's assets and operating results include the retained securitized receivables held by Dayton Hudson Receivables Corporation and Retailers National Bank, as well as related income and expenses. Summary of Accounting Policies Organization Dayton Hudson Corporation is a general merchandise retailer. Our operating divisions consist of Target, Mervyn's and the Department Store Division (DSD). Target, an upscale discount chain located in 41 states, contributed 75 percent of our 1998 revenues. Mervyn's, a middle-market promotional department store located in 14 states in the West, South and Midwest, contributed 13 percent of revenues. DSD, a traditional department store located in eight states in the upper Midwest, contributed 11 percent of revenues. The Associated Merchandising Corporation and Rivertown Trading Company contributed 1 percent of 1998 revenues. Consolidation The financial statements include the balances of the Corporation and its subsidiaries after elimination of material intercompany balances and transactions. All material subsidiaries are wholly owned. Use of Estimates The preparation of our financial statements, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. Actual results may differ from those estimates. Fiscal Year Our fiscal year ends on the Saturday nearest January 31. Unless otherwise stated, references to years in this report relate to fiscal years rather than to calendar years. Fiscal years 1998, 1997 and 1996 consisted of 52 weeks. Revenues Finance charge and late fee revenues on internal credit sales, net of the effect of sold securitized receivables, were $447 million on sales of $4.5 billion in 1998, $459 million on sales of $4.2 billion in 1997 and $346 million on sales of $3.8 billion in 1996. Leased department sales were $188 million, $165 million and $162 million in 1998, 1997 and 1996, respectively. Earnings per Share Basic EPS is net earnings, less dividend requirements on the Employee Stock Ownership Plan (ESOP) preferred shares, divided by the average number of common shares outstanding during the period. Diluted EPS assumes conversion of the ESOP preferred shares into common shares and replacement of the ESOP preferred dividends with common stock dividends. Net earnings were also adjusted for expense required to fund the ESOP debt service, prior to repayment of the loan. References herein to earnings per share refer to Diluted EPS. All earnings per share, dividends per share and common shares outstanding reflect our 1998 two-for-one share split and our three-for-one share split in 1996. (Millions, Except per Share Data) Basic EPS Diluted EPS     1998   1997   1996   1998   1997   1996 Net earnings* $ 962 $ 802 $ 474 $ 962 $ 802 $ 474 Less: ESOP net earnings adjustment   (20)   (20)   (20)   (8)   (13)   (14) Adjusted net earnings* $ 942 $ 782 $ 454 $ 954 $ 789 $ 460 Weighted average common shares outstanding   440.0   436.1   433.3   440.0   436.1   433.3 Performance shares   –   –   –   .8   1.3   1.7 Stock options   –   –   –   5.5   3.9   2.4 Assumed conversion of ESOP preferred shares   –   –   –   21.0   22.4   23.5 Total common equivalent shares outstanding   440.0   436.1   433.3   467.3   463.7   460.9 Earnings per share* $ 2.14 $ 1.80 $ 1.05 $ 2.04 $ 1.70 $ 1.00 *Before extraordinary charges Advertising Costs Advertising costs, included in selling, publicity and administrative expenses, are expensed as incurred and were $745 million, $679 million and $634 million for 1998, 1997 and 1996, respectively. Impact of Year 2000 Year 2000 related costs, included in selling, publicity and administrative expenses, are expensed as incurred. In 1998 we expensed $27 million related to year 2000 readiness. Prior to 1998, we expensed approximately $5 million. Year 2000 capital expenditures are recorded at cost less accumulated depreciation. Mainframe Outsourcing In fourth quarter 1998, we obtained Board of Directors approval and announced our plan to outsource our mainframe computer data center functions. Subsequently, we finalized a contract with a vendor to provide us with these functions. As part of the plan, we will sell our mainframe equipment to the vendor and eliminate approximately 110 employee positions. The fourth quarter 1998 associated expenses were $42 million ($.06 per share) and are included in selling, publicity and administrative expenses. The expenses recognized in the fourth quarter include $36 million for the write-down of mainframe equipment, $4 million in one-time, incremental fees and $2 million in employee severance. We expect to complete the transition by third quarter 1999. Real Estate Repositioning In 1996, we recorded a pre-tax charge of $134 million ($.18 per share) for real estate repositioning at Mervyn's and DSD to strengthen competitive positions and achieve improved long-term results. The charge included $114 million for Mervyn's to sell or close its 25 stores in Florida and Georgia, and approximately ten other under-performing stores throughout the chain. Also included was a net pre-tax charge of $20 million for DSD's sale of its Texas stores and the closure of two other stores. As of year-end 1998, we have substantially completed our repositioning activities. Mervyn's has sold 24 stores and closed eight under-performing stores, while DSD has sold all stores included in the plan. Exit costs incurred in 1998 and 1997 (approximately $5 million and $17 million, respectively) were charged against the reserve. The reserve remaining at year-end 1998 was $20 million, representing the estimated costs that will be incurred to sell the closed stores. Start-up Expense In first quarter 1999, we will adopt SOP 98-5, "Reporting on the Costs of Start-Up Activities." The adoption will not impact total year start-up expense, but will shift approximately $15 million of start-up expense out of first quarter 1999 into the remaining quarters. Substantially all of this effect will be at Target. Cash Equivalents Cash equivalents represent short-term investments with a maturity of three months or less from the time of purchase. Retained Securitized Receivables Through our special purpose subsidiary, Dayton Hudson Receivables Corporation (DHRC), we transfer, on an ongoing basis, substantially all of our receivables to a trust in return for certificates representing undivided interests in the trust's assets. DHRC owns the undivided interest in the trust's assets, other than the sold securitized receivables and the 2 percent of trust assets held by Retailers National Bank (RNB), a wholly owned subsidiary of the Corporation that also services the receivables. Prior to June 1998, RNB held 5 percent of trust assets. The undivided interests held by DHRC and RNB, as well as related income and expenses, are reflected in each operating division's assets and operating results based on the origin of the credit sale giving rise to the receivable. During third quarter 1998, DHRC sold to the public $400 million of securitized receivables. This issue of asset-backed securities had an expected maturity of five years and a stated rate of 5.90 percent. Proceeds from the sale were used for general corporate purposes, including funding the growth of receivables. As required by SFAS No. 125, the sale transaction resulted in a $35 million pre-tax gain ($.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 was a $3 million (less than $.01 per share) reduction of 1998 finance charge revenues and pre-tax earnings. In 1997, DHRC sold to the public $400 million of securitized receivables, with an expected maturity of five years and a stated rate of 6.25 percent. This transaction resulted in a $32 million pre-tax gain. Additionally, 1997 results included a $13 million pre-tax gain attributable to the application of SFAS No. 125 to our 1995 securitization. Combined, these gains resulted in a $45 million ($.06 per share) increase in finance charge revenues and pre-tax earnings. As of year-end 1998, $800 million of securitized receivables have been sold to investors and DHRC has borrowed $100 million of notes payable secured by receivables. The fair value of the retained securitized receivables, classified as available for sale, was $1,656 million and $1,555 million at year-end 1998 and 1997, respectively. The fair value of the retained securitized receivables was lower than the aggregate receivables value by $156 million and $126 million at year-end 1998 and 1997, respectively, due to our estimates of ultimate collectibility. Write-downs have been included in selling, publicity and administrative expenses in our Consolidated Results of Operations. Inventories Inventories and the related cost of sales are accounted for by the retail inventory accounting method using the last-in, first-out (LIFO) basis and are stated at the lower of LIFO cost or market. The cumulative LIFO provision was $60 million and $92 million at year-end 1998 and year-end 1997, respectively. Property and Equipment Property and equipment are recorded at cost less accumulated depreciation. Depreciation is computed using the straight-line method over estimated useful lives. Buildings and improvements are depreciated over eight to 55 years. Furniture and fixtures are depreciated over three to eight years. Accelerated depreciation methods are generally used for income tax purposes. On an ongoing basis, as required by SFAS No. 121, we evaluate our long-lived assets for impairment using undiscounted cash flow analysis. Impairment losses due to mainframe outsourcing and real estate repositioning are described elsewhere in the Notes To Consolidated Financial Statements. Internal Use Software We adopted SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," in first quarter 1998. The adoption resulted in decreased expense, which increased pre-tax earnings by approximately $68 million, net of depreciation, for 1998 ($.09 per share), partially offsetting our other systems expenses. The annual impact of software capitalization will diminish significantly over the next few years. Software is depreciated over four years. Accounts Payable Outstanding drafts included in accounts payable were $519 million and $452 million at year-end 1998 and 1997, respectively. Inventory Shortage Tax Matter 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 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 in August 1998, the Appeals Court reversed the Tax Court decision. In November 1998, we received notification that the IRS did not appeal and the 1983 case had been closed. The beneficial effect resulting from the outcome of the 1983 case is $20 million ($.04 per share) and has been reflected as a reduction in the 1998 fourth-quarter and full-year effective income tax rates. Commitments and Contingencies Commitments for the purchase, construction, lease or remodeling of real estate, facilities and equipment were approximately $412 million at year-end 1998. We are exposed to claims and litigation arising out of the ordinary course of business. Management, after consulting with legal counsel, believes the currently identified claims and litigation will not have a material adverse effect on our results of operations or our financial condition taken as a whole. Acquisitions In first quarter 1998, we acquired The Associated Merchandising Corporation, an international sourcing company that provides services to our three operating divisions and other retailers, and we also acquired 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 in our pre-tax earnings reconciliation and were immaterial in 1998. Leases Assets held under capital leases are included in property and equipment and are charged to depreciation and interest over the life of the lease. Operating leases are not capitalized and lease rentals are expensed. Rent expense on buildings, classified in buying and occupancy, includes percentage rents that are based on a percentage of retail sales over stated levels. Total rent expense was $150 million, $143 million and $146 million in 1998, 1997 and 1996, respectively. Most of the long-term leases include options to renew, with terms varying from five to 30 years. Certain leases also include options to purchase the property. Future minimum lease payments required under noncancelable lease agreements existing at January 30, 1999 were: Future Minimum Lease Payments (Millions of Dollars) Operating Leases Capital Leases 1999 $ 115 $ 23 2000   94   22 2001   86   21 2002   78   21 2003   63   19 After 2003   564   142 Total future minimum lease payments $ 1000 $ 248 Less: interest*   (281)   (103) Present value of minimum lease payments $ 719 $ 145** *Calculated using the interest rate at inception for each lease (the weighted average interest rate was 9.0 percent). **Includes current portion of $9 million. Lines of Credit At January 30, 1999, two committed credit agreements totaling $1.6 billion were in place through a group of 31 banks at specified rates. There were no balances outstanding at any time during 1998 or 1997 under these agreements. Long-term Debt and Notes Payable At January 30, 1999, $100 million of notes payable were outstanding representing financing secured by the Dayton Hudson Credit Card Master Trust Series 1996-1 Class A variable funding certificate. This certificate is debt of DHRC and is classified in the current portion of long-term debt and notes payable in our Consolidated Statements of Financial Position. The average amount of secured and unsecured notes payable outstanding during 1998 was $715 million at a weighted-average interest rate of 5.7 percent. In 1998, we issued $200 million of long-term debt at 6.65 percent, maturing in 2028 and $200 million at 5.88 percent, maturing in 2008. We also issued $200 million of long-term debt maturing in 2010, which is puttable in 2000, and we sold to a third party the right to call and remarket these securities in 2000 to their final maturity. The proceeds from all issuances were used for general corporate purposes. Also during 1998, we repurchased $127 million of long-term debt with an average remaining life of 21 years and a weighted-average interest rate of 9.2 percent, resulting in an after-tax extraordinary charge of $27 million ($.06 per share). At year end the debt portfolio was as follows: Long-term Debt and Notes Payable   January 30, 1999 January 31, 1998 (Millions of Dollars) Rate* Balance Rate* Balance Notes payable 5.2% $ 100 5.7% $ 405 Notes and debentures:    Due 1998-2002 8.8   1,080 8.9   1,245    Due 2003-2007 7.4   965 7.4   966    Due 2008-2012 7.5   764 9.3   383    Due 2013-2017 9.6   70 9.6   70    Due 2018-2022 9.1   709 9.1   816    Due 2023-2027 7.2   575 7.2   575    Due 2028-2037 6.4   300 5.9   100 Total notes payable, notes and debentures** 7.9% $ 4,563 8.1% $ 4,560 Capital lease obligations   145   138 Less: current portion   (256)   (273) Long-term debt and notes payable   $ 4,452   $ 4,425 *Reflects the weighted-average stated interest rate as of year end. **The estimated fair value of total notes payable and notes and debentures, using a discounted cash flow analysis based on our incremental interest rates for similar types of financial instruments, was $5,123 million at January 30, 1999 and $5,025 at January 31, 1998. Required principal payments on long-term debt and notes payable over the next five years, excluding capital lease obligations, are $247 million in 1999, $389 million in 2000, $352 million in 2001, $192 million in 2002 and $464 million in 2003. Derivatives From time to time we use interest rate swaps to hedge our exposure to interest rate risk. The fair value of the swaps is not reflected in the financial statements and any gain or loss recognized upon early termination is amortized over the life of the related debt obligation. The fair value of existing swaps is immaterial. In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities," which is required to be adopted for fiscal years beginning after June 15, 1999. The adoption of this new statement is not expected to have a material effect on our earnings or financial position. Stock Option Plan We have a stock option plan for key employees. Options include Incentive Stock Options, Non-Qualified Stock Options or a combination of the two. A majority of the options vest annually in equal amounts over a four-year period. These options are cumulatively exercisable and expire no later than ten years after the date of the grant. We also have a non-qualified stock option plan for non-employee members of our Board of Directors. Such options become exercisable after one year and have a ten-year term. The typical frequency of stock option grants is once each fiscal year; due to a change in timing, two annual grant cycles fell into 1996. A performance share and restricted share plan exists for key employees although no grants have been made since 1995. Performance shares are issued to the extent certain financial goals are met over the four-year period from the date of grant. Restricted shares are issued four years from the date of grant. Once issued, performance shares and restricted shares generally vest only upon retirement. Options, Performance Shares and Restricted Shares Outstanding (Shares in Thousands) Options     Total Outstanding Currently Exercisable     Number of shares Weighted average exercise price Number of shares Weighted average exercise price Performance shares Restricted shares February 3, 1996 9,967 $11.09 5,372 $10.30 1,607 359 Granted 6,539 16.09         Canceled (145) 12.19         Exercised (1,751) 9.67         February 1, 1997 14,610 $13.48 4,782 $10.88 1,264 311 Granted 2,653 33.63         Canceled (346) 15.02         Exercised (2,450) 10.27         January 31, 1998 14,467 $17.69 4,860 $13.15 794 212 Granted 3,309 48.16         Canceled (173) 23.77         Exercised (2,023) 12.27         January 30, 1999 15,580 $24.79 5,685 $16.49 519* 123* *Represents shares issued subsequent to year end pursuant to the plan. Options Outstanding (Shares in Thousands) Shares Outstanding at January 30, 1999 Range of Exercise Price   6,274 $8.83 - $15.00   3,626 $15.00 - $25.00   2,371 $25.00 - $35.00   1,221 $35.00 - $45.00   2,088 $45.00 - $60.22 Total 15,580 $8.83 - $60.22 As of January 30, 1999, outstanding options had a weighted-average remaining contractual life of 7.7 years. The number of unissued common shares reserved for future grants under the stock option plans were 4,136,969 at January 30, 1999, and 7,143,228 at January 31, 1998. We apply Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," to account for our stock option and performance share plans. Because the exercise price of our employee stock options equals the market price of the underlying stock on the grant date, no compensation expense related to options is recognized. Performance share compensation expense is recognized based on the fair value of the shares at the end of each reporting period. If we had elected to recognize compensation cost based on the fair value of the options and performance shares at grant date as prescribed by SFAS No. 123, "Accounting for Stock-Based Compensation," net earnings would have been the pro forma amounts shown below. EPS calculated under SFAS No. 123 was unchanged from reported EPS. Pro Forma Earnings   1998 1997 1996 Net earnings — as reported $935 $751 $463 Net earnings — pro forma $934 $751 $462 The Black-Scholes method was used to estimate the fair value of the options at grant date based on the following factors:   1998   1997   1996   Dividend yield .7 % 1.0 % 1.7 % Volatility 30 % 25 % 25 % Risk free interest rate 4.6 % 5.4 % 6.3 % Expected life in years 5.6 5.6 5.6 Weighted average fair value at grant date $16.24   $10.52   $5.65   Income Taxes Reconciliation of tax rates is as follows: Percent of Earnings Before Income Taxes   1998   1997   1996   Federal statutory rate 35.0 % 35.0 % 35.0 % State income taxes, net of federal tax benefit 4.5   4.5   4.6   Dividends on preferred stock (.5)   (.5)   (.8)   Work opportunity tax credits (.2)   (.1)   –   Inventory shortage tax matter (1.3)   –   –   Other .7   .6   .7   Effective tax rate 38.2 % 39.5 % 39.5 % The components of the provision for income taxes were: Income Tax Provision: Expense/(Benefit) (Millions of Dollars) 1998 1997 1996 Current    Federal $497 $488 $344    State 110 99 72   607 587 416 Deferred    Federal (10) (55) (89)    State (3) (8) (18)   (13) (63) (107) Total $594 $524 $309 The components of the net deferred tax asset/(liability) were: Net Deferred Tax Asset/(Liability) (Millions of Dollars) January 30, 1999 January 31, 1998 Gross deferred tax assets: Self-insured benefits $132 $117 Deferred compensation 128 103 Inventory 72 46 Valuation allowance 64 52 Postretirement health care obligation 42 42 Other 132 115   570 475 Gross deferred tax liabilities: Property and equipment (374) (306) Other (63) (49)   (437) (355) Total $133 $120 Employee Stock Ownership Plan We sponsor a defined contribution employee benefit plan. Employees who meet certain eligibility requirements can participate by investing up to 20 percent of their compensation. We match 100 percent of each employee's contribution up to 5 percent of respective total compensation. Our contribution to the plan is invested in the ESOP. Through December 1998, ESOP preferred shares (401(k) preferred shares) were allocated to participants. In January 1999, we began providing new common shares to the ESOP to fund the employer match. In 1989, we loaned $379 million to the ESOP at a 9 percent interest rate. The loan was paid off during 1998. Proceeds from the loan were used by the ESOP to purchase 438,353 shares of 401(k) preferred shares. The original issue value of the 401(k) preferred shares of $864.60 per share is guaranteed by the Corporation. Each 401(k) preferred share is convertible into 60 shares of our common stock after giving effect to the 1998 and 1996 common share splits. Our contributions to the ESOP, plus dividends paid on all 401(k) preferred shares held by the ESOP, were used to repay the loan principal and interest. Our cash contributions to the ESOP were $17 million in 1998, $3 million in 1997 and $23 million in 1996. Dividends earned on 401(k) preferred shares held by the ESOP were $19 million in 1998, $21 million in 1997 and $22 million in 1996. The dividends on allocated 401(k) preferred shares were paid to participants' accounts in additional 401(k) preferred shares until June 1998. Dividends are now paid to participants in cash. Benefits expense, calculated based on the shares allocated method, was $29 million in 1998, $17 million in 1997 and $31 million in 1996. Upon a participant's termination, we are required to exchange at fair value each 401(k) preferred share for 60 shares of common stock and cash, if any. At January 30, 1999, 338,492 shares of 401(k) preferred shares were allocated to participants with a fair market value of $1,319 million. The 401(k) preferred shares are classified as shareholders' investment to the extent the preferred shares are permanent equity. The remaining 401(k) preferred shares of $24 million represent our maximum cash obligation at year-end, measured by the market value difference between the preferred shares and common shares, and is excluded from shareholders' investment. Pension and Postretirement Health Care Benefits We adopted SFAS No. 132, "Employers' Disclosures about Pensions and Other Postretirement Benefits" in 1998. The Statement only impacts disclosures of pensions and other postretirement benefits and does not change the measurement of expenses or recognition of the assets and liabilities associated with the plans. We have defined benefit pension plans that cover all employees who meet certain age, length of service and hours worked per year requirements. Benefits are provided based upon years of service and the employee's compensation. Retired employees also become eligible for certain health care benefits if they meet minimum age and service requirements and agree to contribute a portion of the cost. Change in Benefit Obligation   Pension Benefits Postretirement Health Care Benefits (Millions of Dollars) 1998 1997 1998 1997 Benefit obligation at beginning of year $ 610 $ 523 $  81 $  77 Service cost 35 27 1 1 Interest cost 45 39 6 5 Plan amendments – 2 – – Actuarial loss 65 59 5 5 Acquisitions 26 – – – Benefits paid (52) (40) (8) (7) Benefit obligation at December 31 $ 729 $ 610 $  85 $  81   Change in Plan Assets Fair value of plan assets at beginning of year $ 718 $ 587 $   – $   – Actual return on plan assets 106 118 – – Employer contribution 59 50 8 7 Acquisitions 25 – – – Benefits paid (49) (37) (8) (7) Fair value of plan assets at December 31 $ 859 $ 718 $   – $   –   Reconciliation of Prepaid/(Accrued) Cost Funded status $ 130 $ 108 $  (85) $  (81) Unrecognized actuarial gain (16) (32) (18) (23) Unrecognized prior service cost 2 2 3 3 Net prepaid/(accrued) cost $ 116 $  78 $ (100) $ (101) The benefit obligation and fair value of plan assets, for the pension plans with benefit obligations in excess of plan assets, were $34 and $0 as of December 31, 1998 and $26 and $0 as of December 31, 1997. Net Pension and Postretirement Health Care Benefits Expense   Pension Benefits Postretirement Health Care Benefits   (Millions of Dollars) 1998 1997 1996 1998 1997 1996 Service cost benefits earned    during the period $35 $27 $26 $1 $1 $1 Interest cost on projected    benefit obligation 45 39 37 6 6 6 Expected return on assets (58) (48) (44) – – – Recognized gains and losses 3 – 1 (1) (2) (1) Recognized prior service cost – 1 1 – 1 – Total $25 $19 $21 $6 $6 $6 The amortization of any prior service cost is determined using a straight-line amortization of the cost over the average remaining service period of employees expected to receive benefits under the plan. Actuarial Assumptions   Pension Benefits   Postretirement Health Care Benefits (As of December 31) 1998   1997   1996   1998   1997   1996   Discount rate 7 % 7¼ % 7¾ % 7 % 7¼ % 7¾ % Expected long-term rate of    return on plans' assets 9   9   9   n/a   n/a   n/a   Average assumed rate of    compensation increase 4   4¼   4¾   n/a   n/a   n/a   An increase in the cost of covered health care benefits of 7 percent is assumed for 1999. The rate is assumed to decrease to 6 percent in the year 2000 and remain at that level thereafter. The health care cost trend rate assumption has a significant effect on the amounts reported. A 1 percent change in assumed health care cost trend rates would have the following effects: (Millions of Dollars) 1% Increase 1% Decrease Effect on total of service and interest cost components of net periodic postretirement health care benefit cost $ - $   - Effect on the health care component of the postretirement benefit obligation $5 $(4) Quarterly Results (Unaudited) The same accounting policies are followed in preparing quarterly financial data as are followed in preparing annual data. Costs directly associated with revenues, such as cost of goods sold and percentage rent on leased stores, are allocated based on revenues. Certain other costs not directly associated with revenues, such as benefit plan expenses and real estate taxes, are allocated evenly throughout the year. The table below summarizes results by quarter for 1998 and 1997: (Millions of Dollars, Except Per Share Data)   First Quarter Second Quarter Third Quarter Fourth Quarter Total Year   1998 1997   1998 1997   1998 1997   1998 1997   1998 1997 Revenues $ 6,468 5,889 $ 7,056 6,293 $ 7,288 6,622 $ 10,139 8,953 $ 30,951 27,757 Gross profit (a) $ 1,741 1,636 $ 1,913 1,707 $ 1,955 1,807 $ 2,708 2,287 $ 8,317 7,437 Net earnings before extraordinary charges (b) (d) $ 160 126 $ 172 141 $ 183 179 $ 447 356 $ 962 802 Net earnings (b) (c) (d) $ 158 105 $ 172 130 $ 182 160 $ 423 356 $ 935 751 Basic earnings per share (b) (c) (d) (e) $ .35 .23 $ .38 .29 $ .40 .36 $ .95 .80 $ 2.08 1.68 Diluted earnings per share (b) (c) (d) (e) $ .33 .22 $ .36 .27 $ .39 .34 $ .90 .76 $ 1.98 1.59 Dividends declared per share (e) $ .09 .08 $ .09 .08 $ .09 .08 $ .09 .09 $ .36 .33 Common stock price (f)    High $ 44.81 23.00 $ 52.63 32.31 $ 48.25 32.75 $ 63.75 36.84 $ 63.75 36.84    Low $ 36.25 18.94 $ 42.50 23.19 $ 33.75 26.19 $ 42.69 30.78 $ 33.75 18.94 (a) Gross profit is revenues less cost of retail sales, buying and occupancy. The LIFO provision, included in gross profit, is analyzed each quarter for estimated changes in year-end inventory levels, markup rates and internally generated retail price indices. A final adjustment is recorded in the fourth quarter for the difference between the prior quarters' estimates and the actual total year LIFO provision. (b) Third quarter 1998 net earnings include a $35 million pre-tax gain ($.05 per basic and diluted share) related to the 1998 securitization and a $38 million pre-tax loss ($.05 per basic and diluted share) related to the maturity of the 1995 securitization. Third quarter 1997 net earnings include a $32 million pre-tax gain ($.04 per basic and diluted share) related to the 1997 securitization transaction. Total year 1997 net earnings include a $45 million pre-tax gain ($.06 per basic and diluted share) related to the 1997 and 1995 securitization transactions. (c) In 1998, first, third and fourth quarter net earnings include extraordinary charges, net of tax, related to the purchase and redemption of debt of $2 million, $ 1 million and $24 million ($.01, $.00 and $.05 per basic and diluted share), respectively. In 1997, first, second and third quarter net earnings include extraordinary charges, net of tax, related to the purchase and redemption of debt of $21 million, $11 million and $19 million ($.05, $.03 and $.04 per basic share and $.05, $.02 and $.04 per diluted share), respectively. (d) Fourth quarter and total year 1998 net earnings before extraordinary charges, net earnings and earnings per share include a mainframe outsourcing pre-tax charge of $42 million ($.06 per basic and diluted share) and the beneficial effect of $20 million ($.04 per basic and diluted share) of the favorable outcome of our inventory shortage tax matter. (e) Per share amounts are computed independently for each of the quarters presented. The sum of the quarters may not equal the total year amount due to the impact of changes in average quarterly shares outstanding and/or rounding caused by the 1998 two-for-one common share split. (f) Our common stock is listed on the New York Stock Exchange and Pacific Exchange. At March 19, 1999 there were 13,019 shareholders of record and the common stock price was $67.75 per share.   Go To Report Of Independent Auditors, Manangement, and Audit Committee