目標百貨 (TGT) 2002 Q2 法說會逐字稿

Welcome to the Target Corporation's second quarter earnings release conference call.

During the presentation, all participants will be in a listen-only mode.

Afterwards, you will be invited to participate in a question-and-answer session.

At that time, if you have a question, you will need to press star one on your telephone.

As a reminder, this conference is being recorded, Thursday, August 15, 2002.

I would now like to turn the conference over to Mr. Bob Ulrich, Chairman and CEO.

Please go ahead, sir.

Good morning.

Welcome to our 2002, second quarter earnings conference call.

On the line with me today are Gerry Storch, [technical difficulties] Chairman;

Gregg Steinhafel, President of Target Stores;

Diane Neal, President of Mervyn's;

Linda Ahlers, President of Marshall Field's; and Doug Scovanner, Executive Vice President and Chief Financial Officer.

This morning Doug will review the second quarter results then Gregg will provide an update on Target's current business and outlook for the remainder of the year.

Gerry will update us on the growth and the performance of our credit card operations and describe current developments in our web-based strategies and supply chain initiatives and finally I will wrap up our remarks and facilitate the question-and-answer session at the conclusion of our prepared remarks.

Now Doug will review our results, which were released earlier this morning.

Thanks, Bob.

As a reminder, we're joined on this conference call by investors and others who are listening to our comments today, live, via webcast.

Also please note that any forward-looking statements we make in our remarks this morning should be considered in conjunction with the cautionary statements contained in our SEC filings.

In addition, any reproduction or rebroadcast of this call is prohibited.

This morning, Target Corporation announced second quarter net earnings of $344 million.

An increase of 26.8% compared with earnings of $271 million in the second quarter of 2001.

Diluted earnings per share increased 26.2% for the quarter to 38 cents from 30 cents a year ago.

This represents our third consecutive quarter of very strong and above-planned earnings growth after four quarters of more muted growth.

Our consolidated revenues grew by 12.6% in the second quarter, driven by 16.2% year-over-year growth at Target stores.

Our consolidated gross margin rate expanded 133 basis points in the second quarter to a rate of 32.2% while our consolidated SG&A expense rate, which excludes depreciation and expenses related to our credit card operations, was unfavorable to last year by 51 basis points.

I will address both of these issues in more detail in my remarks regarding each segment in a few moments.

Depreciation and amortization expense grew 13.8% for the quarter to $295 million, reflecting increased capital spending for new stores and the necessary distribution and systems infrastructure to support this growth.

Total interest expense, that is our net interest expense as reported on the P&L combined with the payments made to holders of our securitized receivables for periods prior to August 22, 2001, increased $32 million from $122 million in second quarter 2001, to $154 million in the most recent quarter.

Let's analyze this increase more carefully.

About half of the increase or $16 million, is due to our repurchase of $46 million of high interest rate debt at a premium.

You will recall that earlier this year we adopted FAS-145, which now requires gains and losses from the extinguishment of debt to be classified as interest expense, rather than as an extraordinary item as they were in the past.

The remaining $16 million net increase in interest expense is driven by a $30 million impact of higher average funded balances, partially offset by a $14 million favorable effect of lower portfolio interest rates.

Viewing this $16 million net increase another way, about $12 million is related to financing our receivables growth and the remaining $4 million is associated with our retail operations.

During the second quarter, we refined our estimate of our 2002 effective tax rate and now expect our total year rate to be 38.2%, slightly higher than both our 2001 rate and our previous 2002 expectation, each of which were 38.0%.

As a result of this revision, our year-to-date tax expense was adjusted in the quarter to reflect the new rate.

Now let's briefly review our results by segment.

On a combined basis pretax segment profit for the three divisions rose 31.4% from last year's second quarter, to $785 million.

These results were driven by exceptional growth in pretax profit of 35.5% at our Target division to $708 million from $522 million a year ago.

This quarter Target enjoyed strong sales and exceptional growth margin rate expansion, partially offset by slight expense rate deterioration.

Mervyn's pretax declined.

Down $1 million to $59 million as the benefit of substantial gross margin rate expansion was offset at the bottom line by the lower than expected sales.

Operating expense rate deteriorated principally due to the sales issue.

And at Marshall Field's pretax profit improved slightly to $18 million, compared to $16 million last year.

Finally, the other line of our pretax segment profit reconciliation table increased to $72 million from $37 million a year ago.

Driving over half of our increase in consolidated operating expense rate.

This line, of course, is where we reflect the net of our business activity recorded outside of our three segments.

While no single issue dominates this change, the largest factor is our continued reformatting of some of our non-qualified plan benefits in the second quarter.

Similar to our first quarter experience, the economic effect of these actions on the Corporation was neutral, or slightly favorable, but the accounting effect is an acceleration in the timing of expense that otherwise would have been reflected in the future.

Now, let me turn to the balance sheet.

Cash and cash equivalents were about $1 billion higher at quarter end than last year, because we accelerated debt issuance into the quarter in advance of meeting all of the proceeds operationally.

This is likely only a temporary phenomenon.

Inventory levels for the Corporation at the end of the second quarter were 3.2% above prior year levels on a total basis, primarily reflecting new store growth at Target and down modestly from prior year on a per square foot basis.

This growth in inventories of $141 million was more than fully funded by the $452 million increase in accounts payable, resulting in payables leveraging of 92% at quarter end, compared to 85% last year.

Inventories are well positioned for our transition to the third quarter.

In our credit card operations we ended the quarter with gross accounts receivable of $4.6 billion, an increase of just under $2 billion from the same point last year, and sequentially an increase of $390 million from our first quarter balance.

We continue to experience delinquency and net writeoff trends consistent with our anticipated levels.

We, again, recorded bad debt expense well in excess of our net writeoffs.

In line with our historical reserving practices during periods of substantial growth in balances.

As a result our allowance for doubtful accounts at quarter end was $332 million, equal to 7.2% of receivables, and 1.5 times our trailing 12-month net writeoffs.

Overall, the contribution from our credit card operations in the second quarter was $129 million, up from $103 million in the same period the prior year.

This $26 million increase compares favorably to our estimated $12 million increase in funding costs for these operations, and demonstrates that the rollout of Target visa is now beginning to deliver expected bottom line results.

Consistent with our previous guidance and assuming a continuation of current trends in delinquency and writeoffs we continue to expect Target visa to contribute 5% of EPS for the full year.

In summary we're very pleased with our second quarter performance and remain optimistic about our future earnings growth prospects.

Specifically, we are comfortable with the first call median estimate of $1.83 for the full year, marrying our actual year-to-date performance of 75 cents to existing future estimates.

Given reasonable sales performance, we should be able to achieve the 31-cent median first call estimate for the third quarter which reflects an increase of about 24% over last year's comparable EPS.

As you know, recent sales trends have been below our plans and obviously if softer sales trends were to continue, the 31-cent figure could be at risk by a penny or two.

On the other hand, we have just completed our third consecutive quarter of substantial gross margin rate expansion and our Target visa program has begun to produce bottom line benefits as well.

So I think it's a bit premature to adjust this expectation just yet.

In any event our fourth quarter outlook is consistent with the 77 cent first call estimate, representing much more modest growth expectations due to the exceptional strength and outstanding performance of last year's fourth quarter.

Finally, we disclosed in our press release today that Bob and I intend to sign and file the required certifications with the SEC when we file our second quarter 10-Q in September, following the review by the audit committee and our board of directors.

Now, Gregg will review Target's results and merchandise initiatives, as well as our plans and outlook for the remainder of the year.

Gregg?

Thanks Doug.

Despite the pessimism reflected in the capital marks, Target stores delivered another quarter of outstanding results.

Total revenues increased 16.2% to $8.5 billion, reflecting substantial contribution from both our new stores and our credit card operations.

Additionally, comparable store sales increased 4.4%, reflecting slightly higher contribution to growth from guest traffic and average ticket.

Target's pretax profit rose 35.5% in the quarter to $708 million, and pretax profit margin grew by 118 basis points to 8.3%.

This increase profitability was attributable to substantial gross margin rate expansion, due to both proved markup and better markdown performance and contribution from credit.

Target's unwavering commitment to deliver differentiation and value combined with the intense focus on inventory management are at the heart of our financial strength and momentum.

We continue to differentiate our assortment through the introduction of new brands and license arrangements.

Expansion of our relationships with renowned designers, broader development of our own brands, and use of lifestyle merchandising and seasonal events to create in-store excitement.

For example, our fall season assortment in domestic, stationery and home decor includes hundreds of items from Todd Holdham that are aimed at our teen and young adult guests as they go back to school and back to college.

The collection, consisting of furnishings and accessories and supplies is centered around several themes, including stars, multi-colored stripes, camouflage and vintage varsity with prices that range from 99 cents to $59.

In electronics our exclusive line of Sony live products including CD players, alarm clocks, radios and a universal remote compliments the aesthetics of the Todd Oldham designs and offers Target guests the unique quality of Sony quality, unique color and style and exceptional value.

In apparel, our fall assortment for young men includes a new line called Physical Science.

Developed in collaboration with Mark Echo.

This assortment is designed to appeal to young men with men in interest from skateboarding to football and from alternative rock to hip hop.

For young men looking for a more collegiate look we have repositioned our Massamo [ph] Red collection.

Key items include khaki and cargo pants, stone-washed denim, rugby shirts, hooded sweatshirts and distressed graphic t-shirts.

To address our guests' demand for more versatility and easy to coordinate items, we recently relaunched our Morona [ph] brand for women and men to provide updated wear-to-work classics.

This season Morona [ph]for men is featuring fine-gauged sweaters, dress pants, poplin shirts, and suede jackets, while the women's collection features trousers in light-weight tweed, paisley shirts, argyle sweaters, and stretch poplin blouses.

Several other brand new introductions this fall include Thomas the Tank Engine toys and Schwinn bicycles.

We also recently announced a new partnership with Oshkosh for an exclusive collection of children's play wear called Genuine Kids to be offered in the beginning of fall 2003.

In addition we remain keenly focused on price and value throughout the merchandise assortment and remain dedicated to balancing inventory liquidity with in-stock reliability.

We know that great merchandising, exclusive brands and unique designs create excitement for our guests, we do not underestimate the importance of being priced right, being in-stock, and being able to respond quickly to changing sales trends.

This perspective governs how we manage our day-to-day business.

We continue to monitor and refine our pricing throughout our store to ensure the proper balance of opening and better price points.

We continue to invest in technology and supply chain initiatives to improve our flow of goods and optimize in-stock levels and we continue to increase our efficiency in utilizing existing systems, resulting in shorter inventory lead times improving our ability to adapt merchandise trends and inventory levels to our guests' shopping behavior and reducing markdowns.

Importantly, it helps us deliver on our expect more, pay less promise to our guests and generate incremental sales and profits as well.

During the quarter Target opened a total of 33 new stores.

Net of relocations and closings, our second quarter openings included 26 new stores, consisting of 7 SuperTargets and 19 discount stores.

At quarter end we operated 1,107 stores in 47 states, including 82 SuperTarget locations.

We are very pleased with the performance of our SuperTarget stores and believe this formula is an important component of our future growth, representing between 25 and 40% of our net new square footage annually.

Our strategy for SuperTarget is clear and consistent with the strategy for our traditional Target stores.

Expect more, pay less.

We are continually looking for ways to delight our guests with new products, innovative merchandising, and exceptional value.

Just as in our Target discount stores, we differentiate our assortment by offering brands like Tupperware, Starbucks and California Cheesecake and by partnering with renowned chefs like Ming Si [ph] and famous wine expert Andrea Immer [ph].

This fall we are adding Einstein Bagels to our bakery offering and Cinnabon products to both our frozen and bakery assortments.

We also continue to expand our own brand of Archer Farms adding more than 280 new items this year and introducing the best of the assortment into our general merchandise stores.

And we remain committed to delivering value by expanding our opening price point offering through owned brands such as Market Pantry and by maintaining price parity with Wal-Mart on like items locally.

From a financial perspective, SuperTarget is generating sales that are 50 to 100% higher than a comparable Target discount store with 80% of the total sales being generated from products we carry in our traditional stores.

SuperTarget is producing strong, top-line growth driven by substantially increased traffic and modestly higher average ticket compared with a Target discount store.

And SuperTarget is delivering a return on invested capital that remains on-par with the return for a Target discount store of same -- of the same age.

Reflecting a somewhat lower return on sales and a commensurately higher investment turnover.

We are confident in our SuperTarget strategy and in its contribution to our future growth and profitability.

While we are obviously pleased with Target's year-to-date performance and remain optimistic in our outlook for the remainder of 2002, we remain conservative in our planning, especially in light of the softer sales trends we have experienced in the past five weeks.

We continue to expect our comparable store sales for the total year to increase around 4%.

Both comparable store sales growth and this year's fourth quarter is expected to be somewhat lower, given the exceptional strength of last year's fourth quarter and the unfavorable holiday calendar this year.

Similarly, excluding the favorable impact from our credit card operations, we are planning for slight profit margin expansion in the third quarter, and modest compression in the fourth quarter, reflecting the relative performance differential in last year's base periods.

In light of the current environment, we believe it is appropriate for us to continue to plan our business conservatively.

Control our expense levels and maintain inventory liquidity as I described earlier.

In the past we have demonstrated the success of this approach and we believe it continues to be the formula for achieving our corporate earnings growth objectives in the future.

Now, Gerry Storch will give you an update on our credit card operations, Target supply chain efforts, and the corporation's eCommerce initiatives.

Gerry?

Thanks, Gregg.

As Doug mentioned, our credit card operations and more specifically, the Target visa, continued to enjoy strong growth in the second quarter.

We exceeded $2.5 billion of Target visa receivables in the quarter and have issued about 7 million Target visa cards.

We continue to focus on initiatives that strengthen our relationships with our guests.

And drive increased sales and profits.

During the second quarter, we moved forward with our installation of smart chip readers at point of sale and in store kiosks.

We expect to proceed with this installation throughout the remainder of the year.

By partnering with several of our key merchandise vendors, including Procter & Gamble, Unilever, Pepsi, Nestle, Purina and Mattel, we are prepared to offer electronic coupons to our guests and thereby launch the first real smart chip application in the U.S.

Additionally, in an effort to broaden the number of guests who can enjoy the benefits of the Target visa card, we are currently offering approximately 1 million of our best target guest card holders the opportunity to upgrade to Target visa.

These individuals meet or exceed our long-standing credit granting criteria and have now demonstrated an excellent payment record with Target for a sufficient time to receive this enhanced credit offer.

This action is similar to our initial conversion of accounts a year ago and consistent with both our conservative business practices and our more aggressive pursuit of credit-strategic benefits.

The credit quality in each of our portfolios remains very good.

And our overall portfolio quality is improving, reflecting the favorable mixed impact of growth in Target visa.

We continue to expect substantial growth in Target visa receivables for the full year, adding an estimated $2 billion or more at the higher end of our previous guidance for incremental receivables.

We remain confident that our credit card business will be a strong contributor to our overall earnings growth in 2002, and well beyond.

Now, a brief update on our Internet initiatives.

Earlier this week, we unveiled a new comprehensive web site that integrates our offerings from Target, Mervyn's, and Marshall Field's with a full assortment of books, music and movies from Amazon.com.

The site, which is powered by Amazon.com, offers guests the benefits of Amazon's technology platform, including personalization, product recommendations, search functionality and one-click shopping.

At the same time, it affords guests the convenience of purchasing their favorite items from Waterford to Mossamo [ph], to a C.D. by the band U-2 in a single transaction and allows them to shop the entire assortment, regardless of whether they type in target.com, field.com, or Mervyn's.com.

Compared with a year ago, our online traffic for the first six months has doubled.

And sales have increased by more than 50%.

We are delighted with this performance and expect our newly upgraded web site to build on these results, while providing greater service, merchandise selection and shopping convenience for our guests.

Finally, Target has invested in supply chain initiatives for many years to deliver the right goods at the right price and the right time.

To meet our guests' demands and drive profitable sales we've enhanced our systems and technology, shortened our inventory lead times, reduced our costs and improved our in-stock consistency.

Today we are operating at record high levels of in-stock performance and have one of the best supply chains in retailing.

But, in order to maintain this competitive advantage, we know that we must continue to be proactive and continue to position our supply chain for the future.

As a result, we are pursuing several initiatives that will help us provide a superior level of service to our guests, and produce improved financial performance for the Corporation.

To support our new store growth, handle increasing carton volumes resulting from smaller more frequent shipments, and improve service levels for all of our stores particularly during peak volume time periods, we are aggressively investing in distribution center capacity.

By the current year-end we expect to have 15 regional distribution centers in operation and one import warehouse.

Over the next three years we plan to add 14 more facilities, including three additional import warehouses.

Like the first import warehouse in Southern California, these additional import facilities are expected to provide greater flexibility in managing the flow of our imported, typically seasonal product.

They allow to us allocate merchandise to specific regions of the country based on guest demand for the item.

The result is greater guest satisfaction, increased sales, and lower markdown levels.

We also continue to pursue a number of other initiatives that remain an important element of our supply chain strategy.

These include item segmentation, which relates to distributing product based on an item's physical attributes and rate of sale.

Our top 2500 program, which focuses on our most popular, fastest moving items.

Predist [inaudible] agreements which through vendors customize cartons to an individual store's needs, vendor performance measurement which holds vendors accountable for timely, accurate deliveries, and opportunities to disaggregate various components of our supply chain to optimize each component.

In addition to these efforts, we continue to look for new applications of technology and to employ new approaches to retail fundamentals to further strengthen our competitive position.

And we are confident that our investments will contribute to profitable growth for many years.

Now, Bob has a few final comments.

As Doug, Gregg and Gerry have just explained we are very pleased with our performance in the second quarter and believe we are well-positioned to deliver strong earnings growth for the remainder of this year and well into the future.

We firmly believe that the investments we are making today will help us better serve our guests in the future and will allow to us generate substantial value for our shareholders.

That concludes our prepared remarks and now Gregg, Diane, Linda, Doug, Gerry and I will be happy to respond to your questions.

At this time, we will begin our question-and-answer session, using our polling feature.

If if you have a question, please hit star one and star 2 to cancel.

Once again that's star one and star 2 to cancel.

One moment while the questions register.

And our first question comes from Jeff Kleinfelter with U.S.

Bancorp, Piper Jaffray.

Congratulations on a strong quarter.

A couple of questions.

One for Gregg on SuperTarget.

Can you give us a sense of how the comps are trending in that particular division?

Are you planning on breaking those out from the rest of the Company?

And then with your, you know, current relationship on the perishable distribution, how is that is impacting your ability to start leveraging your growth going forward.

Meaning, are you getting better costs in that area with your distributors?

And then, Gerry, I have a follow-up question on the credit card.

Well, our SuperTarget comps are running slightly better than our overall store comps and as it relates to the distribution aspect, as we've said in the past, we're very pleased with the distribution arrangements we have with both Fleming and Supervalue.

They're providing very high quality levels of service.

They're in-stock rates and fill rates are very, very, good and at this point in time we have no plans to do any self-distribution in perishables.

Over the long term we'll continue to self-distribute some of the dry groceries that we had in the past like cereal and other products like snacks and juices and things that we are currently doing.

Okay.

Thank you.

And Gerry on the credit card, could you give us a sense for how the writeoffs are trending on a monthly basis, kind of year-over-year, I think we are at a seasonal high point right now, but how is that looking relative to prior years?

We are very pleased with the performance of all of our credit card portfolios.

They are trading almost precisely where we forecasted they would be at this juncture.

Okay.

Thank you.

Thank you.

Our next question comes from Daniel Berry, with Merrill Lynch.

Good morning.

Congratulations on a great quarter.

I have more of a general question.

You indicated that sales have been soft the last five weeks.

Maybe a little softer earlier than others.

Some people have said the problem was a shortage of clearance merchandise.

Some people said the weather, some say it's the economy.

We're sitting behind a desk.

It's hard for us to judge.

From your , what is it -- from your perspective, what is going on?

Is the consumer really slowing down?

As we said, sales have been a little softer over the last five weeks and we've gone through these periods in the past.

It's been a little slow and then all of a sudden, for a reason we don't know why either, things will pick up a little bit more.

I'm optimistic, they'll pick up shortly, and particularly as we get into September, as you know, with the tragic events last year in September there was a softness in sales there and we certainly would look to see a pickup in the September and October periods.

But as to why it's been a little slower lately, I simply don't have any idea.

Are you seeing this slowness in the SuperTargets as well?

Well, SuperTargets, as Gregg mentioned are doing better than our overall mature sales.

By category, most recently, the apparel categories have been softer than the rest of the business.

Okay.

Fine.

Thank you.

Thank you.

And our next question comes from Emmy Kozlov with Sandford Bernstein.

Along the lines of these sales trends, Gregg, can you give us a little bit more color on the performance of back-to-school categories, what other than apparel is not moving as well as you expected at this point and what is moving well?

And then finally on the gross margin, can we get a little more color on the composition of the margin improvement, how much was higher I.M.U.s versus lower markdowns.

Thanks.

Well, as you know we're still not in the heat of the battle of back-to-school so it's a little premature to say what's doing better than other categories because we really have the peak weeks ahead of us.

But to this juncture, anyhow, the apparel seems to be performing slower than basic back-to-school supplies which have been performing pretty decent up to this point.

So we really expect the -- you know, the peak to occur over the next four weeks, as we get closer to the back-to-school season.

So that's where we are there.

And as it relates to gross margin, performance, it's almost equally divided between initial markup and strong markdown control, and the -- we're getting strong markup through to our differentiated strategy, the fact that the pricing environment has been somewhat stable, and the fact that we've been able to improve on our acquisition costs.

And markdowns have been a reflection of, you know, the tight inventory control that we addressed in our conference call remarks and we'll continue to make sure that we stay very focused on managing our inventories through third and fourth quarter.

Great.

Thanks.

Thank you.

Our next question comes from David Cumberland with Robert Baird.

Good morning, and congratulations.

With the shorter holiday shopping season this year, I'm wondering what your experience has been historically in your divisions when the calendar has been similar and what you can do this year to offset a compressed season?

Yes.

I think that looking at history here does provide some insight, but it is not a complete picture.

Certainly one can see statistically that fourth quarter sales in total, in same-store sales terms are somewhat softer, appear to be somewhat softer when the calendar shifts the way it did this year, specifically as you know there are six fewer shopping days between Thanksgiving and December 25.

I think the bigger issue in our case in looking forward to the fourth quarter is the robust performance we enjoyed in last year's fourth quarter, particularly the gross margin rate expansion in sales performance at our Target sales division.

The calendar is an issue but it's a much smaller issue than cycling the very strong numbers from last year.

Thank you.

Thank you.

Our next question comes from George Strawn with Goldman Sachs.

Thank you very much.

On the question of, you know, the slowdown that we've seen in comps in recent weeks, obviously the environment's not helping here, but I'm just wondering if there's a perception issue here as well.

You obviously have very sharp pricing on commodities.

A big emphasis on opening price points and in-stock initiatives.

Do you think that the marketing and the store fixturing and the signage may, at this point be stressing the "expect more" part of the equation and it may be a little bit -- maybe a little bit needs to be done on the marketing side and the signage side in store to get the "pay less" message across?

Not really, George.

I mean, we feel that we've struck the appropriate balance between both the expect more and the pay less portion of our strategy and really don't see us making any significant changes to that balance at this time.

And we certainly haven't changed anything in the last x many weeks, so we don't feel that has any bearing on current trends.

Just thinking back to the mid'90s when things slowed I remember you introduced the pay less signage and really stressed some of the price points a little bit more.

There would be no intention of doing that here.

We have ongoing efforts to heighten our value awareness to the circular.

Certainly our broadcast campaign, right now, we're talking about our prices being so low you don't have to hold back.

We have a strong value commitment through our end caps and our mini seasonal area, we're shouting value on bonus buy items and some of the very core back-to-school items as you know are very, very, competitive in the pricing there.

We shout out very loudly.

So we have a very strong presence in the store right now with opening price point and value that we're -- we know our shoppers are seeing.

We just -- like everybody else, have experienced a slowdown and there's a temporary hesitation by the consumer to really go out and spend and we think that, you know, as time goes on the consumer will bounce back and we'll start to see sales level bounce back to normal period -- normal levels.

We know the value is there, and congratulations on really a terrific quarter.

Thank you.

Thank you and our next question comes from Mark Miller with William Blair.

Hi, good morning.

Can you talk about how many of the Ward stores you acquired that are already open and what's the time frame for the rest of them to open, and do you have any preliminary read on how those stores are doing versus expectations?

Ward stores I think probably a third of them are open, virtually all of them will continue to open through the -- actually about half of them are open now, and the rest will open pretty much by the balance of the year, and so far we're very pleased with the results we're seeing.

They're basically opening as normal, Target stores would open.

Okay.

And then one more follow-up on the gross margins.

I mean, some of the improvement here, you could identify as being near-term factors, but how much of the improvement could be longer lasting, something would you consider to be sustainable?

I guess on the markdowns, what you are doing with import warehouses, I would think should help you for sometime.

And then also on the higher I.M.U., how much of that is coming from these vendor alliances which, again, I would think should be more than just the current periods?

Thanks.

There isn't any element of our gross margin rate expansion that doesn't appear to be sustainable.

Obviously, as we cycle through periods, when we enjoyed strong gross margin rate expansion, the year-over-year performance won't be as robust but I don't know any reason why we can't sustain the current levels of gross margin rates.

My question is sustained increases.

I mean as you add more import warehouses, more of the seasonal product will be held centrally and pushed out to the stores as it's sold.

Perhaps.

Certainly that's our expectation.

Let's all remember, of course that part of that issue is -- reflects itself in our financial statements in expanded gross margin rate due to the markdown in sales issues off -- partially offset by increases in SG&A rate where we reflect distribution expense.

Thanks.

Thank you.

And our next question comes from Jeff Stinson from Midwest Research.

Good morning.

Doug, I was wondering if you could talk about the SG&A performance in the second quarter and how we may see that trend through the back half of the year.

Well, with any period of time as short as a quarter, certainly there are timing anomalies in SG&A expense and this quarter is no exception.

I think our year-to-date performance probably provides a little clearer picture.

Year-to-date Target's expenses as a percentage of sales are about even with last year.

It could go through a set of issues that have -- contribute to increases and an equal set of issues that contribute to decreases at Mervyn's, our expenses are very well controlled in dollars but are suffering on a rate basis, because of softer sales.

At Field's, we are continuing to enjoy the benefits of some of the substantial work that we've performed across the last year in controlling expenses.

Expenses are very, very, well under control at Fields's.

Despite softer sales.

Field's actually experienced a benefit from a rate standpoint both in the quarter and year-to-date.

The key issue here, I think to talk about that's in the current results but may not be in the future results is some of the drivers on the other line.

As we disclosed, as I talked about in our first quarter conference call remarks and as we disclosed in detail in our first quarter 10-Q, some of what is driving that figure are the non-qualified pension and survivor benefits reformatting work that we've done.

That's work that's purely discretionary.

The accounting is black and white once we do it.

But I would not expect future periods to likely contain nearly as much of that as the first and quarter quarter did.

Doug, and as you look at adding the D.C.s over the next three years what should we expect that to do to capital spending?

It's already embedded in all of our numbers.

As you know, we invested a bit over $3 billion last year in the aggregate.

We expect to invest $3.3 to $3.5 billion this year.

I doubt that our annual figure in any of the next several years will be meaningfully higher or lower than this year's estimate.

Thank you.

Thank you.

Our next question comes from Tom Lincoln from G.E.

Asset Management.

Hi.

The earnings growth here looks obviously very strong, particularly considering you've accelerated some of the recognition of expenses in both the benefits that you talked about and, I guess, if I heard you right, it was almost 3 cents that was absorbed into the number.

What is the expectation?

Will we see more of this -- this one-off timing differences are are we going to see more normalized numbers in both the other and interest expense lines?

Well, first in the case of debt repurchase, we have executed opportunistic, economically-driven debt repurchase transactions in nearly every one of the last seven years.

We will always buy back debt when it makes economic sense to do so, regardless of the short-term reporting dynamics of doing that.

But if I -- if I heard you right, Doug, before that would have been, I guess, with the previous accounting that would have been shown just as early extinguishment of debt below the line.

Correct.

It would have been shown as an extraordinary item and under the new accounting standard which we adopted in the first quarter of this year, others have a little more time left before everyone is forced to adopt that, under the new accounting charges for the early extinguishment of debt, roll-through interest expense and our attempt here today is to be very careful to disclose what that effect is with precision so one can model that as one wishes.

But going forward, do you expect in the next couple of quarters that both the benefit recognitions and the interest expense will be kind of more normalized in the next couple of quarters?

What I said a few minutes ago is that I expect that most, if not all, of the benefits issue is behind us, and what I'm trying to convey here is the thought that we will always take advantage of economically-driven debt repurchase opportunities and therefore that one is impossible to predict.

It could be done of it in the current quarter, could be three times as much in the current quarter as occurred in the second quarter, depending upon the debt that's offered to us and the price that -- at which it's offered.

Okay.

Thanks.

Thank you.

And our next question comes from Bruce Mossett from Morgan Stanley.

My congratulations kind of lean a lot towards the Cinnabon thing but I will ask other questions.

Your in-stock is obviously up a lot, and going into the fourth quarter, could you give us some idea as to what the differential might be in any general way and is it positive, neutral or negative to gross margin.

And then my other question towards Gerry would be, you're expanding D.C.s pretty rapidly over the next three years, what strategically will we see that do for the business.

You know, it's difficult to use an inside measure that's universally understood.

But I will say that our instocks are up several hundred basis points over where they would have been, say, a year to a year and a half ago.

So it's quite -- it's quite measurable and most importantly it's most most noticeable in the most rapidly moving items.

In that regard, although it's always difficult to calculate, I believe the impact on the gross margin rate is positive and at worst neutral because what we're seeing is higher sales in these categories that move very quickly from owning them, and being able to actually -- actually sell them to the guests.

Over the long term, the purpose of an aggregate distribution centers, you could say they are twofold, one is to catch up where perhaps we didn't move quickly enough in the past, and the other is to make sure that we have the capacity to make the strategic moves that I talked about in my remarks which in some cases require additional capacity upstream from the stores.

Whenever possible, we'd like to do the work upstream than in the stores.

That will save us money over the long term and ensure greater in-stocks.

Could you -- is there any way to quantify or even just generally give us some sense as to the benefit of the in-stocks at this point into comp store sales.

I think it's almost impossible to do.

I think it's very important that we be a reliable supplier to our guests of the items they need the most and over the long term, you just have to believe that builds both a brand of Target, as well as our guests' loyalty and frequency of visits to our stores.

Terrific.

Thank you.

Thank you.

And our next question comes from Sherry Ebers from J.P. Morgan.

Good morning.

Gregg, you mentioned that the square footage growth from SuperTarget would be about 25 to 40% of the square footage growth going forward.

I thought I had remembered you talking about 50% growth.

Is there a change there or am I just not remembering correctly?

Sherry, I don't think you are remembering correctly.

We, for quite some period of time, have been talking about that 25 to 40% range and I don't think we ever really talked about it ever being 50%.

What you -- what may have happened is that it may have been almost that much in one particular round of store openings.

That might have led to the store conclusion.

Okay, but over, sort of, on a run rate annually should be about 25 to 40% going forward?

Correct.

Yeah.

About the right range.

Okay.

And then second question, Gregg, you mentioned that at the Target stores in the fourth quarter, the pretax segment profit margin rate would be down slightly, excluding credit.

Do you think it will be up if you include the credit?

I think that's --

I think that in all likelihood it will be even or up somewhat, inclusive of credit and obviously Gregg's comment is the way that we plan our business.

We have well-exceeded our planned gross margin rate at the Target stores in each of the last three quarters.

That's correct.

Okay.

Thank you.

Thank you.

Our next question comes from Linda Christiansen from UBS Warburg.

Thank you.

Good morning.

In terms of the share repurchase when do you think you might resume that?

And secondly, can you give us some idea of what the receivables growth Target visa receivables that is, what growth might post for 2002.

We have no current plans to re-activate our share repurchase program, and picking up on Gerry's comment that we are now of the belief that we're operating toward the higher end of our previous guidance this year, in other words $2 billion or more in receivables growth this year, I think that's preliminarily a reasonable way to think about annual '03.

Similar dollar growth, much smaller percentage growth.

Okay.

Thank you.

Thank you.

And our next question comes from Deborah Weinswig from Salomon Smith Barney.

Good morning.

Gerry, you had talked about on the reserving practices because your'e being somewhat conservative as you continue to see bad debt expense well in excess of net writeoff.

Can you talk about the change in the reserve rate from Q1 to Q2 and what we might expect going forward?

I will let Doug answer that question.

Conceptionally there's no change whatsoever in our reserving practice in Q2, versus Q1.

One of the dynamics that is moving, of course that as the visa portfolio ages, in conjunction with our policy, our long-standing policy of writing off receivables for which no payments had been received in the last 180 days ,you do see an acceleration in the second quarter, a natural acceleration in writeoffs but our reserving practice remains unchanged.

A couple of comments on the statistics that we release, as a percentage of receivables serviced, you will likely see our reserves begin to modestly fall over time because of those sharply higher credit quality of the Target visa receivable.

So it's improving in credit quality due to mix.

The other key statistic that we released is reserves as a multiple of prior 12 months writeoffs.

Similarly you should expect to see that statistic begin to fall modestly all's being equal.

Again a similar issue as the portfolio ages formal writeoffs will catch up with the account receivable balances and if light of the considerably higher credit quality of the visa portfolio, you should expect to see that fall somewhat.

And one last question, not to be too picky but in terms of the higher tax rate, can you tell what's difference than what you originally planned for that?

Yeah, very quick background we used a 38.5%, last year we used a 38.0% rate, we're now suggesting -- we are now of the belief that 38.2 is the right rate for this year.

Two issues at play here.

One is the so-called permanent differences, things that are different in our tax return compared to book income, things that, for example, create book expense, but there's no corresponding tax deduction.

It's a very hard set of issues to predict with precision over the long term.

Separately, our mix of state income tax rates net of the federal tax benefit that state income taxes is slightly adverse this year compared to last year.

Great.

Thanks so much.

Thank you.

Our next question comes from Michael Eckstien of Credit Suisse First Boston.

Good morning, everyone.

Could you sort of update us on strategies at Mervyn's and department stores.

I know they are not the focus of your business but still are pretty integral to some of the cash flow numbers out there and just talk about what's going on, whether you see any stabilization in their sales trend and they've done a great job on the expense side but any stabilization there?

Thanks.

Let's start out with Diane Neal on Mervyn's and then we'll move to Linda on Marshall Field's.

Diane?

Actually, we do see stabilization of our sales.

We have quite a few things going this fall that we didn't have in place last fall.

One is we have quite a few brands that we have introduced in our assortment this fall, we have Columbia Outerwear across all genders, Norton McNaughton in women's, Access by Liz Claiborne, Men in Company by Jones, Savan pants in the men's area, Stiffle [ph] lighting, lighting is a whole new category for us in the home area and then we're introducing Oshkosh which rolls out in December in our children's area.

Something else we have been way underpenetrated or underspaced in our ready-to-wear area so we are expanding 90 stores this fall, starting in September.

Our ready-to-wear area by about 15 to 20%, depending on the size of the store.

This expansion will allow to us expand some of our key growth strategies, petite's, juniors and some of the junior plus size businesses and we have also increased our promotional activities this fall season.

You will see that change pretty dramatically.

Thanks, Diane.

Linda on Marshall Field's.

One of the things that we have been working on in Marshall Field's is rebalancing our assortment for price and quality.

And layering back in some of the opening price point strategies by division.

And we're seeing some good success there, especially in certain categories like children's, which is performing well for back-to-school and our juniors area.

So we're seeing the success of that and as we continue to expand that in other divisions we are looking for sales improvement there also.

We're also working to revitalize our trend in seasonal merchandise and we have a major campaign for back-to-school that adds a lot of excitement and energy, as well as some new merchandise categories that we previously have not carried like a backpack category that has price points everywhere from $14.99 to $49.99 and layered in some new brands like Columbia for us and that's also performing well, and, again, giving some excitement to the store.

We're also increasing the use of targeted marketing and for the fall season we'll be somewhat more promotional, really focused on driving traffic into our stores and while our average sale is down somewhat to last year, because of this focus on some of the more opening price points, we are seeing a slight improvement in our traffic counts and this is a significant reversal of a trend of decreasing traffic counts that we've experienced so we're real pleased to see that as - especially as we go into the third and fourth quarters.

Thank you.

And our next question comes from Yoshiro Nozoromo from Omora Securities.

Hello.

I have a very, very, brief question.

Again this quarter your free cash flow was negative about $900 million.

The main reason was the increasing of account receivables.

So how do you expect -- how do you plan to funding?

In order to increase that Target piece of receivables?

Yes, your correct that the key issue from a cash flow standpoint that's different this year from last year is the growth year-to-date in accounts receivable.

I mentioned in my remarks that we're in a rather unique position compared to our history of having prefunded via borrowing a lot of our future cash needs.

Year over year there's a little more than a billion dollars of cash equivalents on our balance sheet at quarter end that hasn't historically been there.

Part of the answer to your question is we have already funded a substantial -- a substantial portion of our expected receivables growth for the balance of the year.

Separately, we're approaching the whole funding equation in a bit more conservative posture, given capital markets, conditions, and given our funding needs, and you shouldn't -- one should not be surprised to see us prefunding in the future as well.

Okay.

Thank you.

Thank you.

And our next question comes from Wayne Hood from Prudential Securities.

Doug, my questions relate to the credit operation.

I was just looking at the net interest margin.

If you could tell me a little bit about what went on with portfolio yield and the funding rate which came in line or better than you expected.

Well, I think overall virtually every element of our credit card operations performance is right in line with our expectations.

Certainly, one of the changes from a portfolio yield standpoint is that our gross yield; that is, finance, charge, revenue, and merchant fee income is a percentage of average receivables is falling modestly, consistent with the higher credit quality of the visa receivables, similarly our expenses, principally bad debt as a percentage of average receivables falling as well.

Not falling as fast as our writeoff experiences because of our consistent practice of more conservatively reserving up front, given the kind of nature of rapid receivables growth, but as the credit quality improves both the gross yield and the net yield should fall modestly, of course, our funding costs in today's environment are sharply lower than they were a year or two ago.

And so this quarter was the first time since the rapid rollout began in the fourth quarter of last year that bottom line results, profitability from our card operations after funding costs and taxes begin to show up on the bottom line, about a penny of EPS in the current quarter given by that dynamic.

And Doug, looking at the trend in that delinquency rate and your reserving practices, if that thing matures and this question came up a minute ago, would it be fair to assume that you could be overreserved by as much as 70 to 100 basis points?

I don't believe we are overreserved at all.

It is certainly true that what we expect to occur is a continuation of existing delinquency and writeoff trends which if it were -- delinquency and writeoff trends, which, if it were to occur, will yield a slowdown in our reserving and dollars to where the expenses that we incur, will move to become more in line with then current writeoff experience but I don't believe it's appropriate even if that occurs to think of ourselves as being overreserved.

I think that it means that our growth in -- in reserves will slow down rapidly if the dynamics that I just outlined occur.

And my final question, what is it -- the if you look at the Target visa card, what is the average balance right now relative towards the year-end, just the growth in that.

It's several times the average balance in our Target guest card portfolio, as we expected it would be but we don't release the actual dollar statistics in each of the subelements of our portfolio.

Thank you, Doug.

Thank you. the next question comes from Todd Slater from Lessard.

Could we circle back to SuperTarget for one sec?

I'm just curious about any other categories that might be decelerating a bit other than apparel, and if you look at the rate of slowdown in apparel, either relative to your plan or to last year, is the slowdown at SuperTarget any less than or greater than the slowdown at the core Target stores in apparel?

As we said before the SuperTarget mature rate of increase is slightly better than the chain so it is stronger than the chain and the other thing we mentioned is that obviously across the board sales have been somewhat softer in the last five weeks and the softest categories of all certainly have been the apparel categories.

As Gregg said earlier 80% more or less of our SuperTarget revenue is driven by skus we sell in the rest of the chain.

So from a category mix standpoint and as the business ebs and flows SuperTarget behaves a whole lot like at rest of the discount stores.

Great.

Thank you.

And our next question comes from Filipe Gossens from Credit Suisse First Boston.

Yes, good morning. [Inaudible] fixed income research.

I know this question has been asked in the past, but I will throw it out one more time.

With the department stores continuing to lose market share to the discount store segment we had the two leaders report their sixth consecutive quarters of negative same store sales.

And if you know that one of the leaders is sitting on a ton of cash on their balance sheet at the end of the quarter, any change in your thinking as to where you might eventually still monetize your assets in that market?

We remain committed to all of our major divisions.

As we have indicated in the past, we think that there's a lot of synergy among the divisions that helps the total.

They carry a portion of the expense load.

They generate additional cash for investment in Target and their profit, as we pointed out, has been improving.

So, no, we remain committed to our Marshall Field's division.

Okay.

Could you perhaps also give us an update in terms of what you are doing differently at Mervyn's in preparation for the arrival of Kohl's in California?

Well, as we said before, we are doing a lot of things to strengthen our overall position, and every time we're -- excuse me, we're always evaluating, refreshing our stores and doing remodels and so there's a certain amount of that going on, but we are not making any major directional changes.

We are familiar with Kohl's they have come in to our markets in Texas, in Colorado, in Michigan, and in Minnesota.

We know what to expect when they arrive and we are not doing anything unusual.

Okay.

And final question, with the Chapter 7 of Ames, do you see any opportunities to pick up some attractive real estate or the box is a little bit too small for what you are looking for?

The boxes at Ames in general are very, very, small.

It's highly unlikely that there would be many opportunities.

There may be one or two.

Thank you very much.

Thank you.

At this time, I show no further questions and would like to turn the conference back over to you, Mr. Ulrich for any final comments.

Thank you all for your participation.

That concludes Target Corporation's second quarter earnings conference call.

Thank you very much for participating in today's conference call.

Have a great day.