目標百貨 (TGT) 2002 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation's third quarter earnings release conference call. During the presentation, all participants will be in a listen-only mode. Afterward, 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 1 on your telephone touch pad. As a reminder, this conference is being recorded Thursday, November 14, 2002. I would now like to turn the conference over to Mr. Bob Ulrich, Chairman and Chief Executive Officer. Go ahead, sir.

Good morning. Welcome to our 2002 third quarter earnings conference call. On the line with me today are Gerry Storch, Vice 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 discuss our third quarter results, Gregg will provide an update on Target's current business and outlook for the holiday season. Gerry will review the strategy of our credit card operations and finally I will wrap up our remarks and facilitate the question-and-answer session at the conclusion of our prepared remarks. In light of our recent analysts meeting in Minneapolis, we plan to keep our remarks today very brief. 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 any portion of this call is prohibited. This morning, Target Corporation announced third quarter net earnings of $277 million, an increase of 50.2 percent. Compared with earnings of $185 million in the third quarter of 2001. Diluted earnings per share increased 49.3 percent for the quarter to 30 cents from 20 cents a year ago.

As a reminder, last year's third quarter included a pre-tax charge of $67 million, or 5 cents per share, related to the impact of restoring our securitized accounts receivable to our financial statements. Analytically, we believe it's more appropriate to compare our EPS of 30 cents in this year's third quarter to 25 cents a year ago. On this basis, diluted earnings per share rose 21.7 percent. Our consolidated revenues grew by 9.3 percent in the third quarter driven by 11.8 percent year-over-year growth at Target stores. Our consolidated gross margin rate expanded 112 basis points in the third quarter to a rate of 31.9 percent. While our consolidated SG&A expense rate which excludes depreciation and expenses related to our credit card operations, was unfavorable to last year by 50 basis points. I'll address both of these issues in more detail in my remarks regarding each segment in a few moments.

Depreciation and amortization expense grew 8.5 percent for the quarter to $305 million. Reflecting increased capital spending for new stores and the necessary distribution and systems infrastructure to support this growth. Total interest expense increased $21 million from $124 million in third quarter 2001 to $145 million in the most recent quarter.

As a reminder, our total interest expense in the third quarter last year includes net interest expense as reported on the P and L combined with the payments made to holders of our securitized receivables for periods prior to August 22nd last year. About a quarter of our net year-over-year increase, or approximately $5 million, is due to the repurchase of $16 million of high interest rate debt at a premium. The remaining $16 million net increase is driven by the impact of higher average funded balances partially offset by the favorable effect of lower portfolio interest rates. Our weighted average interest rate paid on all of our debt in the quarter fell about 100 basis points compared with the same period a year ago.

Our effective tax rate for the third quarter was again 38.2 percent. Slightly higher than our 2001 rate of 38.0 percent. Now let's briefly review our results by segment.

On a combined basis, pre-tax segment profit for all three divisions rose 19.5 percent from last year's third quarter to $623 million. These results were driven by growth in pre-tax profit at all divisions.

At our Target stores division, pre-tax profit Rose 21.2 percent to $537 million from $444 million a year ago. Attributable to continued strong gross margin rate expansion partially offset by expense rate deterioration that was mainly the result of relatively low same-store sales growth.

Mervyn's pre-tax profit increased $5 million in the third quarter to $52 million. Also reflecting the benefit of substantial gross margin rate expansion. Operating expense rate deteriorated principally due to lower-than-expected sales.

And at Marshall Field's, pre-tax profit improved slightly to $34 million, compared to $31 million last year. -- reflecting improvement in both gross margin rate and expense rate. Finally, the "other" line of our pre-tax segment profit reconciliation table decreased slightly to $30 million of net expense this year from $33 million a year ago.

This, of course, is where we reflect the net of our business activity recorded outside of our three segments. No component of this line contributed any material variance from a year ago. Now let me turn to the balance sheet.

Inventory levels for the corporation at the end of the third quarter were 2.9 percent below prior year levels. This favorable inventory position is partially due to conservative inventory management and partially due to year-over-year changes in the timing of receipts. We believe our conservative inventory management will serve us well in terms of potential markdown risk in the fourth quarter.

Our decline in inventories combined with an increase in accounts payable resulted in payables leveraging of 88 percent at quarter end compared to 77 percent last year. We believe our inventories are well positioned as we head into the holiday selling season.

In our credit card operations, we ended the quarter with gross accounts receivable of $5.2 billion, an increase of $2.3 billion from the same point last year, and sequentially an increase of about $600 million from our second quarter balances. We continue to experience delinquency and net write-off trends within our anticipated range of reserves.

During the quarter, we again recorded bad debt expense well in excess of our net write-offs consistent with our reserving practices during periods of substantial growth and balances. As a result, our allowance for doubtful accounts at quarter end was $360 million, equal to 6.9 percent of receivables and 1.4 times our trailing 12-month net write-offs.

Overall, the contribution from our credit card operations in the third quarter was $138 million, up from $125 million in the same period the prior year. This performance reflects the fourth consecutive quarter since our national launch of the Target Visa card in which we have enjoyed annualized net portfolio yields in the range of 11 percent. Net portfolio yields is the return on capital invested in our credit card operations before funding costs and taxes. This financial performance not only continues to reflect a substantial spread to our marginal borrowing costs but is also net of $144 million of bad debt expense in excess of net write-offs recorded during this 12-month period.

In summary, we're very pleased with our third quarter financial performance and we remain optimistic about our prospects for the full year. On a trailing four quarters basis, we have generated earnings per share of $1.79, meaningfully above our own expectations and first call estimates at the beginning of this fiscal year. And in excess of our objective to deliver average annual earnings per-share growth of 15 percent or more over time. Due to the exceptional strength and outstanding performance of last year's fourth quarter, our outlook for this year's fourth quarter continues to represent more modest growth expectations than our actual year-to-date experience.

Specifically, we believe the current first call median estimate of 76 cents per share represents a reasonable single-point estimate from today's perspective. Marrying this estimate to our actual results for the nine-month period just ended suggests a full-year EPS of $1.82. Now Gregg will review target's results in a little more detail and describe our plans and outlook for the remainder of year. Gregg?

Thanks, Doug. Target stores delivered another quarter of outstanding results, particularly in light of the difficult sales environment. Total revenues increased 11.8 percent to $8.5 billion and comparable store sales increased one percent. This increase was attributable to higher average transactions amount partially offset by lower guest traffic. Target's pre-tax profit rose 21 percent in the quarter to $537 million and pre-tax profit margin grew by 49 basis points to 6.35 percent. This increased profitability was attributable to strong gross margin rate expansion due to both improved markup and better markdown performance as well as increased contribution from credit.

Target's operating expense rate was unfavorable in the quarter primarily due to a lack of sales leverage. Target's unwaivering commitment to deliver differentiation in value combined with our intense focus on inventory management are at the heart of our financial strength and momentum. As we described for you at our analysts' meeting several weeks ago, 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 brand, and use of lifestyle merchandising and seasonal events to create in-store excitement.

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

During the third quarter we completed our final cycle of store openings for 2002 adding a total of 49 new Target stores in October. Net of relocations and closings, these openings included 41 new stores consisting of 12 Super Targets and 29 discount stores. This brings our net square footage growth for the full year to 12 percent and our current store count to 1,148 stores in 47 states including 94 Super Target locations. In 2003, we expect to add net new square footage more consistent with our historical growth of 8 to 10 percent annually. This translates to approximately 100 total new stores, or approximately 80 stores net of relocations and closings.

As we have indicated since the beginning of this year, our fourth quarter sales and profits are conservatively planned and reflect only modest growth. Given the exceptional strength of last year's fourth quarter and the unfavorable holiday calendar this year, we expect comparable store sales for the quarter to be in the range of 0 to plus 2 percent with total revenues increasing approximately 11 to 12 percent. We expect Target's fourth quarter pre-tax profit including the favorable impact from our credit card operations to grow more slowly than our top line, resulting in modest profit margin compression compared with fourth quarter 2001.

In light of the current environment, we believe it is appropriate to continue to plan our business conservatively as we adhere to our core strategy of differentiation and value. In the past, we have demonstrated the success of this approach and we believe it remains a formula for achieving our overall growth objectives in the future. Now Gerry Storch will give you a brief update on our credit card operations. Gerry?

Thank you, Gregg. As Doug mentioned, our credit card operations and more specifically the Target Visa continued to enjoy strong growth in the third quarter. Our Target Visa receivables now exceed $3 billion and we have issued more than 8 million Target Visa cards since our national launch a year ago.

Importantly, our clear strategic direction and our conservative financial approach to managing our credit card operations continued to enhance our relationships with our retail guests as well as our overall profitability. From a strategic perspective, we are keenly focused on leveraging our credit card operations to strengthen the loyalty of our existing creditworthy retail guests. Our objective is to encourage them to shop more frequently at Target stores and purchase more on each visit. We have tailored both our approach to account acquisition and credit granting as well as the features of our Target Visa card to achieve this goal.

Specifically, our focus is on expanding our relationship with high credit quality guest, not obtaining new guests with a promise of credit. As a result, we are not soliciting new accounts through the use of pre-approved mailings but rather we are focused on attracting in-store applicants who are active Target guest cardholders. Because we view Target Visa as an affinity card, not as a pure financial product, and because we understand the additional risks inherent in these features, we do not offer teaser rates, balance transfers, convenience checks, or no-no-no offers. We have developed rewards programs that specifically appeal to Target's guests, reflecting their demographic profile and their desire for value. And also support our objecttives to drive increased sales through higher average ticket and greater guest frequency.

Both programs reward guests for their Target Visa card useage, take charge of education provides fundraising for schools and Target rewards provides guests with a 10 percent off coupon for use during future shopping trips to Target. Finally, we are investing in both hardware and software to leverage the potential benefits of smart chip technology and improve our one-to-one communications with our guests. We have already developed a database that will allow us to deliver more personalized offers to our guests by better understanding their individual shopping behavior the database contains billions of line item transactions and is updated on a realtime basis.

Beginning this quarter, we are also partnering with several of our key merchandise vendors including Proctor and Gamble, Unilever, Pepsi, Nestle Purina and Mattel to pilot electronic coupons and test the use of smart chip readers at point of sale, in store, web enabled kiosk and at home smart card readers. Each of these initiaives is designed to strengthen our relationships with our guests and contribute to our overall financial performance. As we have previously described, our credit card operations have been consistently and conservatively managed for many years and this discipline has produced fully satisfactory financial results. Our rate of delinquencies and net write-offs are well within the range envisioned in establishing our current balance sheet reserve.

Consequently, our annualized net portfolio yield of about 11 percent continues to appropriately reflect the favorable mix impact of growth in Target Visa and is consistent with improvement in our overall portfolio quality. We believe we will continue to enjoy a double-digit annualized net portfolio yield as our portfolio matures.

Consistent with our previous guidance for incremental receivables this year, we continue to expect to add slightly more than $2 billion, suggesting additional growth of about $400 million in the fourth quarter. In 2003, our current expectation include receivables growth in the range of $1 billion.

We believe that we have demonstrated the success of our disciplined approach and strategic direction to managing our credit card operations, and we remain confident that this business will be a Strong contributor to our overall earnings growth. And to our creation of shareholder value for many years to come. Finally, we continue to be very pleased with our progress on supply chain initiatives and with our record high level of in stocks on Target's top 2500 items.

Additionally, we handle the impact of delays at West Coast ports without significant disruption to our business and we are once again processing inventory at a normal level of service. As Doug indicated, we believe that our inventories are in excellent condition for the upcoming holiday season. Now Bob has a few final comments.

As Doug, Gregg and Gerry have just explained we are pleased with our results in the third quarter, particularly in light of our weaker-than-expected sales performance. This fourth quarter presents additional challenges due to the strength of our performance a year ago and the shortened holiday calendar but we believe that our strategies are sound, that we have planned our business appropriately, and that we are well positioned to gain substantial market share. For the full year we are on track to deliver strong earnings growth, in fact assuming that we achieve current fourth quarter estimates we will deliver approximately 17 percent growth for the full year. [INAUDIBLE] particularly satisfied with this performance in light of the challenges we have met this year. That concludes our prepared remarks. Now Gregg, Diane, Linda, Doug, Gerry and I will be happy to respond to your question.

Thank you, Mr. Ulrich. At this time we will begin our question-and-answer session using our polling feature. If you have a question you may press star 1 on your telephone touchpad and if you need to cancel your question or your question has already been answered, please press star 2. Once again, that's star 1 if you have a question and star 2 to cancel. One moment while the questions register. And our first question comes from Felipe [Dawsons] from Credit Suisse First Boston.

Yes. Good morning. [Philipe [Dawsons] from Credit Suisse First Boston Income Research] Two questions this morning. With regard to delinquencies, can you perhaps tell us how you track them at Target? Do you look at 60-day lagging, 12-month lagging and what your rationale is for the yardstick that you use, particularly if I use the 12-month lagging one, I come up with about slightly in excess of 10 percent. So I was kind of wondering how you track that one. And secondly, any initial guidance for Cap Ex for next year? Thank you.

At Target, we look at delinquencies in a variety of ways, certainly lagging delinquencys across different periods of time is one of the methods. But any statisic like that is inherently a shortcut method compared to the kind of granular portfolio analysis that takes place that we utilize to predict forward likely write-offs and delinquencies. Our modeling has been extraordinarily good despite the kind of credit card environment that we're operating in and, therefore, we can state with some degree of confidence that we expect to continue to generate double-digit portfolio yields in this environment. With respect to Cap Ex for next year, preliminarily, I would expect it to look a lot like this year's Cap Ex guidance, specifically likely in the range of 3.3 to $3.5 billion for the Corporation.

If I can just add one add-on question with regard to the credit card portfolio. Given that the contribution of the credit unit to earnings before taxes was up only 10 percent versus the 70 percent year-over-year growth in the balances, should we conclude from that, that perhaps you're a little bit more conservative with regard to tracking bad debt expense?

While I do believe that I would agree with your conclusion, I don't think it flows directly from the assumptions. I think what you would observe with lower credit card contribution growth than balance growth year to date is the fact that this is the final quarter in which we are cycling the sharply higher net portfolio yields reflected in our historic proprietary card portfolio. Beginning in the fourth quarter of this year, we will begin cycling a period in which our net portfolio yield is approximately today's yield, or range 11 percent, certainly double digits in any event. That means that inherently, once we receive the -- once we reach this point, we would expect to begin seeing much more substantial year-over-year flow-through of pre-tax, prefunding cost profitability in our card operations.

One comment. I have seen a number of commentaries where people are taking current charge-offs and dividing by year-ago receivables. Keep in mind we launched this Target Visa card, you know, a little over a year ago, last fall, so what you are essentially doing, not you personally but one is doing when one does that is almost dividing by zero because the card was just launched and we're very small balances built up a year ago on the cards. So it's a truly apples and oranges and very crude approach to do that in the case of a new product launch like this.

Okay, thanks very much.

Thank you. And our next question comes from Jeff [Klinefelter] from US Bancorp Piper Jaffray.

Yes. Two quick questions for you. One, Gregg maybe you can talk a little bit about apparel at Target. We're hearing that apparel is very strong across mass merchandising, discounting as well as specialty. Maybe talk a little bit about the strength there. What you're seeing, and anticipating going forward? Is this becoming a bigger percent of the overall mix and the gross margin implications? And then just a quick follow-up on the in stocks.

I understand that you have caught up with all the processing through the port. We continue to hear anecdotally around the industry that there are some key categories such as toys, electronics, and some of the seasonal trim-a-tree product that continues to lag a little bit in processing and just wondering, you know, what your current in-stock position is there and if you're not completely up to speed, when you anticipate being there. Thank you.

Jeff, as it relates to the apparel business at target, our third quarter, we're very pleased with our apparel business in the third quarter. As you know, the weather was much more conducive as it has been in the third quarter of prior year and even in earlier quarters this year. It grew essentially at the same rate as the store in total. And we enjoyed strong apparel business from very broadly throughout the store from ladies, kids business was good, footwear business was okay, and infants and toddlers was pretty healthy. Men's continued to lag a little bit but overall we're very pleased with it. And it really doesn't, I think, indicate a long-term trend. I mean, certainly we want to grow our apparel business as fast as we possibly can. But I don't think you can draw that conclusion from a strong third quarter.

As for the ports, we're essentially caught up at the ports at this point. There is a week or two delay in getting all the products, you know, from the ports to store. So there's some outages still there at highly imported categories but it's not a significant impact on our business at this point.

Overall we feel very good about in stocks in toys, electronics and seasonal. A few seasonal things are held up in the port but overall we're in very good shape.

Okay, thank you.

Thank you. And our next question comes from Steven Eisemann(ph) from Chilton.

Yeah, hi. Just a question. I was looking through the federal reserve call reports, and I noticed that the open to buy at the Target bank is 74 billion, which would -- if these numbers are correct, would create a utilization rate of around 6 percent on the Target credit card. You know, in the credit card industry, that's quite a low utilization rate. So I'm just wondering as to how you're managing that risk.

That's not a figure that we monitor very carefully. Obviously, the nature of our portfolio with millions and millions and millions of proprietary card accounts, includes a much larger portion of inactive accounts than comparisons to other portfolios that don't have similar attributes. I would speculate without having the knowledge that's at your fingertips that that is not a meaningfully different portfolio utilization rate than what you would find across the last several years.

It's very common on house cards, you know, proprietary cards good only at stores, for people to get them and just never use them or use them very rarely so that must be a big part of that number.

Thank you.

Thank you. And our next question comes from Bruce [Missent] from Morgan Stanley.

Hi, could--the inventory number's pretty impressive, down 2.9 percent. Could you talk a little bit either about category, how you got there, is this related to new distribution center efficiencies? Is it mix? Particularly, since you're -- since your in stock is better and maybe any way you can quantify in stock would be great.

I'll let Gerry address the specific in stock question, Bruce. But let me try to give a little color on the inventory position. We have tried and we have succeeded at being considerably more conservative in managing our inventory position at this instant this year than we were last year. Part of that is reflective of our outlook for the holiday season. Part of that's reflective of the fact that I feel better about where we are in some of our businesses than we were at this point last year. Additionally, and I don't want to miss this point, we intended in some categories, some very specific areas, to time deliveries in the fourth quarter this year that arrived in the third quarter last year. The -- you know, absent that second point, we probably would have been up a little bit year-over-year.

Okay.

But considerably lower than our sales growth. Gerry, do you want to comment on in stock?

Yeah. You know, as is often the case, higher quality can often be achieved at lower cost and with lower inventory. This is certainly true with in stocks. If you, you know, what we're doing reduces safety stock requirements, increases speed, you know, we hold product where it's most efficient whether that's upstream at vendors, in RDCs or in the stores so everything we're doing is designed to drive in stocks while reducing inventory.

Just because you're adding a number of DCs over the next couple of years, does this actually get better? Do you think you're sort of at a such a high efficiency level that maybe we're seeing the top of the process now?

Again, there are a lot of factors that go into inventory levels but the addition of the new distribution centers will allow us to roll out our existing programs and our planned programs which would have the tendency to increase stocks while reducing inventories. There is a lot of factors.

Okay.

On our import warehouses will also contribute to that. So we feel there's still opportunity to reduce inventories further while increasing in stock for the guest in the store.

Okay. Thank you very much.

Thank you. And our next question comes from George Strong from Goldman Sachs.

Thank you. I think we all appreciate the conservatism of the fourth quarter guidance of this environment and we all know that you're rounding on really tough gross margin comps in particular. But if we look at the gross margin improvement on the sequential basis, it would appear that your gains have been much stronger over the first nine months of this year than they were in the fourth quarter of last year. Does that imply that there's still some gross margin headroom in the quarter? And also, I think you had said we could see up to 5 percent -- up to 5-cent incremental credit contribution, I think we're now a 3. Is there still some upside there, as well?

George, certainly I think there is additional potential headroom for continued gross margin rate expansion, obviously as we begin cycling the substantial expansion experience and enjoyed in the fourth quarter last year, the year-over-year gains would be much more modest if they occur. Separately, the year-to-date calculation for the EPS contribution or EPS growth, growth in EPS contribution of our credit card operations, is a statistic that one needs to make some funding cost assumptions. When I calculated I would say that we're at this point at a bit less than that 3-cent figure but I understand how you got there.

Certainly, we have always envisioned that in terms of the year-over-year EPS contributions, the fourth quarter had sharply higher promise than the first, second or third again because it's the first period this year where we will cycle a period last year with roughly the same net portfolio yield. And therefore, year-over-year balance growth in excess of $2 billion at roughly the same portfolio yield means that that portfolio yield on the incremental balances will fall straight through to the pre-tax credit contribution line.

Thank you very much.

Thank you. And our next question comes from Daniel Barry from Merrill Lynch.

Good morning. I wanted to focus on your slowdown in comps in Target this year where they really held up quite well last year in the recession. At the same time as George pointed out your gross has been rising as you say part of that has been due to higher markup. Can you elaborate a little bit more on where the higher markup comes from, and do you think that's in any way adversely affecting your comps?

I'll address the first half of the question and let Gregg address the second half. Yes, our comps at Target stores have slowed down this year. So have Wal-mart's. Through October, the comp differential between Wal-mart and Target was 2 1/2 points last year and 2.6 points year to date. A 0.1 percent difference. So from our perspective, the slowdown in our comp store sales at Target has occurred in a parallel fashion to the slowdown in comps at Wal-mart. Gregg?

Yeah, as it relates to our initial -- the progress in initial market, we continue to be very focused on Wal-mart in terms of maintaining a competitive positioning. We shop them very aggressively on like and identifiable items, and have no way taken our eye off the ball as it relates to being price competitive. What we've done is we've worked really hard on the acquisition costs line and we have lowered those costs and at the same time have lowered retails to stay competitive or improve our competitive position versus both Wal-mart and Kmart.

So you're saying most of the gross markup is coming from improved sourcing?

Absolutely.

Okay, thanks.

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

Hi, good morning. Two questions. The first is what why your inventories on a comp store sales basis? And do you think to any degree you lose sales with inventories being down as much as they appear to be? Then a second question is: With the 80 percent growth in receivables year to year, what would the growth in the active accounts be? And I guess of the new Target Visa holders, or -- active accounts, how many of those had been Target proprietary cardholders? Thank you.

Just like to point out again, as we have mentioned, that even though comp store inventories are down, that is because we're becoming more efficient at where we hold merchandise and our in stocks are actually better than they were last year and we feel very, very good going into the fourth quarter. Could you repeat the credit card question? It wasn't clear to me.

The growth in the receivables are 80 percent and I think for a lot of folks, that implies higher risk. What I'm wondering is, of the active accounts, what is the growth in the active accounts? Obviously, receivables went up as you converted a lot of people from the proprietary card to the Target Visa.

Well, obviously, because the Target Visa carries sharply higher balances per account, the growth in active accounts is sharply lower than the growth in receivables. And as to the comment that this implies a higher risk to many people, those people would have to ignore the higher credit quality of the Target Visa portfolio to reach that erroneous conclusion.

Doug, can you be at all specific or give a range for the type of account growth you might be seeing, though?

Well, we've disclosed that we have issued 8 million Target Visa accounts, some portion of those are active, some portion isn't. We have disclosed for years in our annual report cards by portfolio so that the math is all out there publicly. You can calculate it from everything that's in the public domain.

The strong majority of those cards are -- were Target guest cardholders converted to the Target Visa card.

About 2/3 of that 8 million represent converted accounts as Gerry just said, about 1/3 are new freshly issued Visa cards without passing go in the Target's proprietary portfolio.

And to remind you our focus was on converting active Target guest card accounts, not inactive ones.

Okay. Thanks.

Thank you. And our next question comes from Emmy Kozloff from Sanford Bernstein.

Hi. Question for Doug or Gerry. On a monthly basis, where do you expect the loss ratio of the credit portfolio to go over the next few months? When will it peak and at what level? And also, what do you expect a normalized loss ratio to be for the portfolio as it becomes seasoned?

The best news I can tell you is the only reason I focus on any monthly statistics is because they have become something of an interesting guidepost externally. I'm going to address that question on a quarterly basis first. As I look forward into the fourth quarter, I think we will experience another sequential increase in write-offs in dollars roughly in line with the sequential increases you've seen as our portfolio continues to mature. I think you are also likely to see a sequential increase in a parallel fashion in the bad debt expense that runs through our P&L and therefore, I would expect that our reserve at year end will be higher in dollars than it is today.

Certainly, the statistic you talked about has a high degree of seasonality to it and I expect it to sequentially to continue to increase on a monthly basis as a result of seasonality and additionally as a result of our portfolio maturing. I think the important takeaway here is that all of that is contained in our modeling and all of that is envisioned in the mechanics of establishing how much expense we have run through the P&L already and, therefore, how much of a comfort we take from the size of our current balance sheet reserve. I think the profitability dynamics are directly reflective of the core underlying economics of our credit card business and I don't see anything in our credit card delinquencies, write offs, bankruptcy trends, what have you, that changes my point of view on that.

Certainly, our credit card operations aren't performing at the level that we would expect them to in a more benign credit card environment. The fact that we're being stress tested to this degree and continuing to be able to have this conversation reflects on consistent reporting dynamics is a direct result of our conservative reserving practices.

Agreed. But, uhm, are there there any plans to break out the performance metrics of the Visa like delinquencies or charge-offs or could you give us the magnitude of the differential between the Visa and the [store core] portfolio in terms of net charge offs.

Of course, at this point the proprietary portfolio is a more mature portfolio than the Visa portfolio. I'd quickly add, though, that unlike subprime portfolios, unlike portfolios that have sharply lower payment rates than our portfolio, we are reaching maturity consistent with the medium to higher credit quality bank card portfolios. We're reaching maturity much faster than lower card portfolios would. So I think that the annualized chargeoff rate that you see here in the third quarter is not as high as where it will settle out. But it isn't going to settle out much higher than this we'll reach reasonable maturity within a handful of quarters. Not one, two, three years from now.

One thing I want to stress, too. I can understand the focus on the delinquencies, but keep in mind this is a profitable product. We don't talk very much about the revenue side of the product. It's a profitable product and we forecast it will continue to be so.

Great. Thank you.

Thank you. And our next question comes from Linda Christianson from UBS Warburg.

Good morning. This is a question about trading down. And one of your -- Wal-mart talked about seeing some trading down in the food category. I was wondering if you were seeing any trading down in food or, for that matter, in any other categories, any other major categories?

Yeah, food represents a very small part of our mix, but we have not seen trading down in any part of our store in general, Linda, at this point.

Okay. Thank you.

And our next question comes from John Harris from Morgan Stanley.

Hi. I was wondering if you guys could be any more specific in terms of the categories that you delayed receipts for and in terms of just what the strategic reasoning for that is? Is that because you have better inventory performance or some other reason?

We did not delay receipts. It's not like we are telling the truck to circle the docks and not pull in we have just have cut down on our orders a very modest percent over time because we have got better mechanisms to get our merchandise quickly through the system and into the stores and so our in-stocks in the stores have improved. We have just been buying on a faster turnover basis. So the merchandise is flowing through the system more quickly. But we have no -- nothing in the works and have not done anything to, quote, delay receipts.

Our in stocks are very good and we can respond quite quickly. We promise not to sell out.

Okay. Thanks.

Thank you. And our next question comes from Sherry Eberts from JP Morgan.

Good morning, everybody. Gregg, I was wondering if you could talk a little bit more about the performance of Super Target in the quarter. Any comparisons versus the core Target business?

Yes. Super Target had another very good quarter. We continue to be pleased with its progress. Sales are growing slightly higher than the company in total, and margins are healthy. We are working on our expenses and reducing capital costs. So overall, we continue to be pleased and we had a real solid third quarter.

Okay. And I was hoping that you could comment on the promotional environment that you're looking for this holiday at Target as well as Mervyn's and Marshall Field's.

You mean our promotional activity or the promotional environment in general?

I guess they're related, right? I guess both.

You know, from our perspective, this holiday time frame in any given year is incredibly robust and aggressive, and we expect it to be every bit that and more this year, like it is every year. We expect there to be a lot of promotional activity, a lot of emphasis on price and values -- value and loss leaders and electronics and toys just like there's been every year. We will have very aggressive pricing on our merchandise like we had in prior years. We'll be very aggressive in our circular pricing and our use of broadcasts. And we know that we'll continue to -- that we'll have a good holiday season and pick up market share.

But we are not increasing marketing dollars as a percent to total, and you have to remember that the two biggest factors by part biggest Wal-mart and the second is us in this business, so basically, that promotional activity in terms of spending on marketing will, I think, be consistent with percent to total that's been there for several years.

Then at Mervyn's and Marshall Field's, as well?

I'll ask Linda and Diane to talk about that, as well.

At Mervyn's, we're a very promotional company as you know. We are offering traffic driving promotional activities through the fourth quarter. As Gregg has said, it is a very promotional time period in a normal year. So we are just planning on sticking with what we have done.

And at Marshall Field's, we are also planning significant traffic driving initiatives that we have going every weekend. We're approaching this holiday season knowing that the guest is looking for great values and she's also looking for newness so that's what we're emphasizing in our merchandising and marketing program for fourth quarter.

Okay. And just last question, Gregg, you mentioned that the operating margin at the Target division should be down a little bit in the fourth quarter given the tough comparison, is that just at the stores or does that include the benefit from credit, as well?

We would expect that including the benefit from credit, the Target stores performance that's consistent with the first call estimates that's out there. Inclusive of credit would reflect modest operating margin compression year-over-year.

Okay. Thank you very much.

Thank you. And our next question comes from David Cumberland from Robert Baird.

Good morning. Bob or Gregg, could you, please, comment on the pricing environment for commodities at Target where mix overlaps with other discounters and compare the environment year to date to last year?

The pricing environment is pretty much stable from a year ago. As you know, Wal-mart sets the pace in the everyday pricing and their behavior has been very rational, very consistent, it has not changed materially. What we have observed is we have observed Kmart is a little less competitive on a day in and day out basis, and slightly more competitive on a promotional basis. But Wal-mart's positioning in the market in total is pretty stable compared to what it has been earlier this year and fairly consistent from what it was a year ago.

Thank you.

Thank you. And our next question comes from Jordan [Hymowitz] from Cypress Funds.

Yes. Two questions, please, on credit. One, just regarding adequacy of reserves. Your reserves are at 6.7 percent -- or 6.9 percent, I apologize and on a one-year lag basis your charge-offs are running at 12.2. Most credit card companies have reserves equal to one year of losses. Why the difference for you guys.

Because we've grown and you're ignoring the growth and calculating the lag on that basis. We've grown by $2 billion over that period.

Shouldn't the reserve incorporate the loss therein?

Of course the reserve incorporates the growth. What am I missing here?

Okay. Let me ask the question a different way. Your yields are at 11 percent now approximately, you say?

Pre-tax, prefunding costs, yield on the portfolio, is approximately 11 percent. That's correct.

Okay. So if your losses are running at 12.2 on a lag basis, you know guys make money on your credit operation even before interest expense on G&A, it's only on a gross basis because the losses haven't caught up yet. I mean, isn't the entire credit card operation a money losing operation?

Absolutely not. Your analysis is ridiculous and flawed.

Thank you.

Thank you. And our next question comes from [Yoshi Jero Asuma] from Nomora Securities.

I have one question about the credit card. You increase credit card receivables significantly so that cause free cash to become negative. So I think [three reasons] [INAUDIBLE] Target may be downgraded by the rating agencies so do you plan to make the gross more [INAUDIBLE]? Do you give priority to the [INAUDIBLE] [credit] rating even if the Target becomes single a minus? Not single a but if... If it becomes [INAUDIBLE].

I'm not sure I understood all of the question. But you have to understand that we have a history on many of these people. They were already charging on Target and other Target cards and so they have been converted to the Target Visa. We have -- go ahead, Doug.

Thankfully, I believe that all of the agencies that rate our debt understand how to put these numbers together in a fashion that reaches responsible conclusions. As a result of that, we continue to enjoy our strongest credit ratings that we have enjoyed in a decade. And our outlook remains quite stable with all of the agencies that rate our debt. Certainly in the short run the combination of funding a 3.3 to $3.5 billion Cap Ex campaign and additionally fund year-over-year growth in the range of $2 billion in our accounts receivable causes our year-over-year interest-bearing debt to grow.

But the year-over-year yield improvement -- pardon me, the year-over-year profit improvement on the credit card portfolio continues to exceed and for the full year will likely substantially exceed the incremental funding costs to grow that portfolio and the agencies, of course, look very carefully at these portfolios on an on going basis for a variety of reasons one of which is that we continue to use accounts receivable securitizations as a means to fund part of our receivables growth.

I remain comfortable that the retail and credit card strategies that we have in place will continue to produce very strong results as they have so far this year and, therefore, I remain very confident that our credit ratings are not in jeopardy as a result of pursuing this strategy.

No, I mean that, uhm, I know [INAUDIBLE] if it becomes single a minus, I think it's possible if you [INAUDIBLE] tip to increase debt level so... In that case, do you plan to [INAUDIBLE]?

It remains an objective of ours to retain our current credit ratings. I don't think it's productive to engage in speculation about what we might do in the event that a hypothetical downgrade that doesn't appear to be in the cards were to occur.

Okay. Thank you.

Thank you. And our next question comes from Daniel Bender from Buckingham Research.

Good morning. A lot of questions have been answered already. Just a couple for you one, could you comment on how the store performance at the old Ward's stores are doing? And secondly, there's been a lot of talk about food deflation from your competitors. I'm just curious, realizing that it's a smaller piece of your total. Are you seeing it and what the impact is.

We have been delighted with the Ward's acquisition. Some of the stores are open. And there are still some to come where we may rework the properties significantly. But it's been an excellent acquisition for us.

And like you said, food is a very small part of our mix and we have not experienced any meaningful deflation in our food businesses.

Thank you.

Thank you. And our next question comes from Tom Lincoln from GE Asset Management.

Hi, guys. Great quarter. I just want to talk about the Cap Ex for a second. My understanding was that square footage growth for Target was going to moderate back to your more normalized nine to ten rate to the above 12 you were running and therefore I kind of thought Cap Ex might be less than the 3.4 this year in '03. Has anything changed there or...

No, nothing's changed at all. Certainly, I think I would reflect on the fact that we'll be a 12 percent larger chain next year and the fact that Cap Ex is constant in dollars means that Cap Ex is a percent of sales, for example, will certainly be falling consistent with the decline in our year-over-year footage growth rate from low double digits to high single digits.

And we do have additional distribution center capacity planned for next year, as well.

Next year. Okay. Thanks.

Thank you. And our next question comes from Michael Eckstein from Credit Suisse First Boston.

Good morning, gentlemen. Two quick questions. One on Mervyn's. How are you preparing for the entry to the West Coast and two, on the credit card, do you have an idea of what the split is between the receivables generated from the store -- store generated from Target division and what's outside the store?

I'll tackle the second half first. But I don't think we'll have a gentleman tackle your first question. The percentage of the activity on the Target Visa card reflected in sales in our store and cash activity on the card is in the rough order of magnitude of 25 to 30 percent. Diane?

We, as you all know, we compete with Kohl's in many other markets so as a total company we just continue to strengthen our position. We are doing quite a few things as a company to strengthen and one of them I had mentioned before was we're expanding our ready-to-wear area which actually was complete in California on November 3. We continue to offer aggressive promotional activity to drive traffic this fourth quarter and we will continue to that into Spring of '03. And then we are upgrading and remodeling and over the next three years, three quarters of all our stores. So we continue to get stronger as a company, and are specifically focused on Southern California.

Thanks a lot.

Thank you. And our next question comes from Christine Augustine from Bear Stearns.

Hi, good morning. I wondered, Gregg, if you could address the potential for further IMU opportunities as you look ahead into 2003 and if so, are there specific categories that you might be targeting for some IMU growth? And then related, on apparel, do you think there's an opportunity to get some additional national brands into the store, perhaps in the athletic or active area? Thank you.

Regarding your first question in terms of initial markup opportunity for 2003, certainly we are going to pursue a very aggressive strategy of lowering acquisition costs throughout the entire store and that goes from soft lines to hard lines. And whether or not that falls to the bottom line will be highly dependent upon the pricing environment in the Spring so at this point in time we're taking, you know, conservative position and saying that, you know, we're not exactly sure that that's going to drop to the bottom line and don't really want to forecast anything.

As it relates to the apparel question, we continue to see brand migration and we have talked to the branded athletic apparel companies and other companies in the mid tier to see if there would be a possibility to get together on a strategic basis and while we don't have anything in concrete at this time, we believe that eventually over the long term we'll have some type of relationship with one of the major athletic branded athletic companies and we'll look for other mid-tier brands to join in alliance with us, as well.

Thank you.

Thank you. And our next question comes from Deborah [INAUDIBLE] from Salomon, Smith, Barney.

Good morning. Two quick questions. One in terms of what we saw in halloween seasonal sales, this fall, will you do anything different in merchandising or setting up the stores for Christmas? And how is performance of private label and the exclusive line selling? Thanks.

Halloween, we were pleased with. And our early reads on Christmas look quite positive, as well. It's way too early, it's a much smaller percentage of the total sales so far, but we feel good about it.

And our private brand business throughout the store is doing quite well and continues to be a growing part of our business.

When will Isaac Mizrahi and Liz Lang hit?

Isaac will hit in Fall of '03 and Liz Lang will be in the first quarter of '03.

Great. Thanks so much.

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

Thanks, Jen. Thank you all for your participation. That concludes our third quarter earnings conference call. And if we don't talk to you before, have a wonderful holiday season.

Thank you very much for participating in today's Target teleconference call. You may now disconnect and have a great day.