目標百貨 (TGT) 2004 Q1 法說會逐字稿

Hello and welcome to the Target Corporation's first 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.

As a reminder, this conference is being recorded Thursday, May 13, 2004.

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

Sir, you may begin.

Good morning, welcome to our 2004 first quarter earnings conference call.

On the line with me today are Gerry Storch, Vice Chairman;

Doug Scovanner, Executive Vice President and Chief Financial Officer;

Gregg Steinhafel, President of Target Stores;

Diane Neal, President of Mervyn's; and Linda Ahlers, President of Marshall Field's.

This morning, Doug will review our results for the first quarter of 2004 and describe our outlook for the second quarter.

Then Gregg will provide an update on Target's recent business and our plans for the remainder of the year.

Gary will update you on the growth and performance of our credit card operations and describe other initiatives and developments that are contributing to the Corporation's overall results.

And then I will wrap up our remarks and we will open the phone lines for a question and answer session.

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.

Separately in response to request from a number of you, we again plan to keep today's call to no more than 60 minutes, including our Q&A session.

If any of you still have questions when the call has ended, please feel free to follow up Susan Kahn or me directly.

This morning, Target Corporation announced results for the first quarter of 2004.

For the period, net earnings grew 25% to $438 million.

Producing 48 cents of diluted earnings per share.

Total revenues in the quarter grew 12.3% to $11.6 billion, reflecting a 12.7% increase in consolidated merchandise sales.

Growth in our credit card operations is consistent with our outlook in the guidance we have provided since the beginning of 2003.

More details on credit card results in a few minutes.

The first quarter, consolidated gross margin rate improved modestly, reflecting markdown improvements at all three divisions, while expense rate was slightly unfavorable to the prior year.

As you recall in the third quarter of 2003, we refined our first quarter 2003 implementation of EITF 02-16, which resulted in a financial statement reclassification between year-to-date cost of goods and year-to-date selling, general, and administrative expenses.

But this had no impact on sales, net earnings, cash flows or financial position.

The portion of this reclassification attributable to the first quarter of 2003 was $36 million and for consistency and ease in comparing our year-over-year performance, prior year cost of sales have been reduced by $36 million and SG&A has been increased by a like amount in our first quarter 2004 financial statements.

Separately, beginning in the first quarter of 2004, we're reclassifying certain costs relating to our global sourcing efforts as cost of sales from SG&A and we have, again, reclassified prior year for consistency.

The effect of this reclassification on first year 2004 is to increase cost of sales and reduce SG&A by $36 million.

Impact on prior year is to increase cost of sales and reduce SG&A by $30 million.

Total interest expense in the quarter increased $2 million from 1 -- from $142 million a year ago to $144 million this year.

This increase is due to a much higher loss on debt repurchase in 2004, substantially offset by a lower average portfolio interest rate and slightly lower average funded balances.

Our effective income tax rate for the quarter was 37.8%, 20 basis points lower than our rate in the first quarter of 2003.

Our inventory position at the end of the quarter reflected excellent planning and control at all three divisions and year-over-year growth in inventories overall of 9.0% or $443 million.

This growth was more than fully funded by the $563 million increase in accounts payable, resulting in payables leveraging of 92% at quarter-end compared to 89% last year.

During the quarter, we refined our methodology for recording our inventory of merchandise that is sourced directly through AMC.

This change resulted in somewhat higher inventory at each of our divisions at quarter-end, and somewhat lower inventory levels recorded in our unsegmented other line.

Over the past 12 months, we've grown net assets by approximately $1 billion, principally due to investments in new Target Stores, in the related infrastructure to support our store expansion, and in the maintenance and remodeling of existing assets to keep them fresh.

On a net basis, we have funded all of this growth with cash flow provided by operations.

In fact, over the past 12 months, we've generated even more cash than needed to fund our growth, resulting in about a $900 million reduction in debt compared to this time last year.

While a sizeable portion of this reduction is due to timing issues, the fact that it's down at all reflects the strength of our ability to self-sustain our current rate of growth.

Turning to our credit card operations, we ended the quarter with net accounts receivable of just under $5.4 billion, in line with our expectations.

About $400 million below the level at year-end 2003, reflecting normal seasonality.

And about $100 million higher than this time last year.

Our annualized net portfolio yield was 11.2% in the quarter, slightly above the high end of our guidance of 10 to 11%, and overall quite robust, especially given today's relatively low funding costs.

Net writeoffs in the quarter were $128 million, reflecting another quarter of sequential improvement, as the level of both aged writeoffs and bankruptcy writeoffs improved.

Delinquencies, a strong leading indicator of future writeoffs, also improved in the quarter to 3.7%, our lowest level since second quarter 2002.

Our overall allowance for doubtful accounts as a percent of first quarter-end receivables was 7.1%, in line with our reserves for each of the first three quarters of last year.

In summary, we remain extremely pleased with the performance of our receivables portfolio.

From a financial perspective, as always, these operations continue to be stable, predictable and appropriately profitable.

Gerry will provide a bit more insight to our credit card strategy in a few minutes.

Finally, let me review the first quarter results in each of our three segments and provide some perspective on our outlook for the second quarter.

Target Stores, our first quarter was characterized by better-than-expected sales growth, resulting in strong profit performance.

Comparable store sales grew 7.3% in the quarter, contributing to total revenue growth of 14.0% and on this top line growth, pretax segment profit rose 17.9%, reflecting an improvement in quarterly profit margin to 8.6% this year from 8.3% a year ago.

The primary factor in this profit margin improvement was gross margin rate expansion.

At both Mervyn's and Marshall Field's, our first quarter performance represents a solid improvement over the performance we delivered at these segments a year ago.

Mervyn's pretax profits increased $15 million, or 63%, to $39 million.

And Marshall Field's pretax profits rose $3 million, or 13%, to $22 million this year.

As you know, Target Corporation announced in mid-March that we were beginning a strategic review of Mervyn's and Marshall Field's that was expected to take several months to complete.

Additionally, we said at that time that this review would include an evaluation of the possible sale of one or both of these divisions as ongoing businesses to existing retailers or other qualified buyers.

To date, this process is progressing according to our initial expectations and timetable.

As we reach important milestones in this process, we will broadly disclose pertinent information to our investors, team members, guests, and members of the communities we serve.

Finally turning to our outlook for the rest of the year, as we indicated 90 days ago, we continue to expect our pattern of quarterly earnings growth to be the mirror image of 2003 quarterly results, with stronger year-over-year performance in the first half, when comparisons are somewhat easier, and more modest growth in the second half, particularly in the fourth quarter when the comparison becomes for difficult.

Of course, we'll be able to provide greater clarity for the second half, once our strategic review is complete.

Much more specifically for the second quarter, our outlook assumes the likely continued ownership of both Mervyn's and Marshall Field's throughout the period.

The current First Call estimate for our second quarter is 47 cents per share, which reflects a growth rate of approximately 20%.

And as of today that appears to be reasonable.

Our second quarter ends on July 31, and we currently expect to report our results on August 12.

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

Gregg?

Thanks, Doug.

Our first quarter results exceeded our expectations and we are pleased with our performance.

Comparable store sales increased 7.3% during the quarter against a modest increase of 1.1% a year ago.

This same-store sales growth was attributable to slightly more strength in guest traffic and in average transaction amount, reflecting our continued focus on driving frequency.

Merchandise categories, such as consumables, pharmacy, health and beauty aids, household chemicals, and other frequency -- frequently purchased commodity products that support our frequency strategies were among our strongest performers during the quarter.

In addition, we enjoyed strong sales growth in our apparel and seasonal categories, both of which generate stronger than average profitability.

Our total revenues during the first quarter increased by 14% to $10.1 billion due to growth in comparable sales and contributions from new stores.

We managed our inventories well during the quarter and are comfortable with the mix, balance, and level of our inventories as we head into the second quarter.

Target's first quarter pretax profit rose faster than consumer growth, increasing 17.9% to $866 million and resulting in 29 basis points of expansion in pretax profit margin to 8.6%.

Our gross margin rate in the quarter improved versus last year, primarily reflecting lower markdowns.

Target's expense rate was slightly unfavorable to the prior year, principally due to higher marketing expense caused by a timing shift.

During the first quarter, we opened a total of 25 new Target Stores.

After relocations, this included 23 discount stores, one Super Target store.

At quarter-end, we operated a total of 1,249 stores in 47 states, including 119 Super Targets.

During the second quarter, we plan to open a total of 27 new stores, including 16 new discount stores net of relocations, 7 Super Targets.

The strength of our first quarter financial performance continues to affirm our Expect More Pay Less strategy.

Our guests choose Target because they prefer our offering of differentiated merchandise and our outstanding values.

They enjoy Target's clean, bright atmosphere, are excited about our presentation and signing, and appreciate the speed and convenience of our shopping environment.

More guests are even more delighted by the enhanced design and the added features of our new P 2004 store prototype.

Early results from our most recent store openings in March are better-than-expected.

Given our confidence in this format and the benefit it provides our guests, we are moving quickly to incorporate the essential elements into all remodels going forward.

Additionally, last fall, for a modest per-store cost, we retrofitted about 80 stores that were not yet eligible for a full remodel, incorporating only the basic P 2004 merchandising and design features that drive frequency.

And in 2004, we plan to retrofit approximately 130 additional stores.

In addition to these retrofitted stores, we expect to have about 200 Target Stores by year-end, including complete remodels and new stores, that fully reflect our P 2004 prototype.

Super Target also continues to deliver on our brand promise.

We remain pleased with the performance of these stores and as with our traditional discount stores, we continue to look for opportunities to create for more excitement for our guests, to capture a higher share of our guest's food purchases, and to drive more profitable sales overall.

In 2004, we are increasingly focused on refining our assortment to reflect local market food preferences and current food trends, and communicating more effectively with our guests through improved marketing and more direct in-store signing and on more efficient food distribution.

We have already made significant progress in increasing our penetration of our brand.

Archer Farms and Market Pantry.

And we continue to leverage our partnerships with key culinary players, such as Andrea Immer and Ming Tsai.

We have previously indicated Super Target continues to be a critical component of our future growth plan.

Offering a exceptional value to our guests remain an important strategic priority at Target, as well.

As a result, we are unwaivering in our long standing commitment to match Wal-Mart's prices on like items in local markets, subject only to our rounding rules.

Execute this strategy, we competitively shop thousands of items on a rotating basis throughout the year with about 80% of the relevant items being shopped every 30 to 90 days.

Additionally, we are working diligently to communicate this pricing parody to our guests with our distinctive marketing.

Finally, let me share our current outlook for the balance of 2004.

We told you 90 days ago we expect somewhat stronger growth in sales and profits in the first half of the year than in the second half.

Primarily reflecting tougher back half comparisons, particularly in the fourth quarter.

Our year-to-date results certainly appear to reinforce this belief.

For the full year, we have planned an increase in our comparable store sales in the range of 4 to 5%, with total revenue expected to grow in the low teens.

Because we are beginning to experience some inflationary trends in raw materials, such as steel and petroleum, we don't expect retail price deflation in 2004 to be as significant as in 2003.

For the full year, pretax profit is expected to rise essentially in line with our top-line growth, resulting in a pretax margin profit margin that is essentially unchanged from 2003.

Given the recent favorable trends, it is possible to envision a scenario in which we exceed these expectations, however, consistent with our long-standing practice, we have planned our business conservatively, we believe we can adapt quickly, capture incremental market share and profits if the current sale strength continues.

Now, Gerry Storch will give you an update on our credit card business, our Internet initiatives, Target supply chain efforts.

Gerry?

Thanks, Gregg.

As Doug mentioned, our credit card operations continue to contribute to our overall profitability in the first quarter and the credit quality in each of our portfolios remains very good.

Pretax profits rose slightly more than 10% due to lower bad debt expense, resulting from favorable trends and net write-offs and delinquencies.

Net accounts receivables were approximately $5.4 billion at the end of the quarter, in line with our expectations.

Overall, we are pleased with the performance of our credit card operations and continue to believe that our credit cards are an important contributor toward our objective of strengthening our guest relationships.

Not only do our credit cards provide sales building opportunities through loyalty programs and 10% off savings certificates, but when combined with our guest relationship management initiatives, we believe the potential for building incremental sales is even greater.

Target Direct is also an integral component of our strategy, providing an additional vehicle to communicate with our guests, deepen our relationships with them, and drive more sales.

In the first quarter, traffic to our Internet site increased nearly 80% and online sales grew more than 70%, compared to a year ago.

Our strongest performing merchandise categories during the quarter included home furniture, for both indoor and outdoor living, baby furniture and accessories, domestics and housewares.

And our overall results continue to be fueled by our differentiated merchandise offering and the appeal of our Club Wed and Lullaby Club gift registries.

Target.com now ranks among the top four shopping sites, behind eBay, Amazon, and in a virtual tie with Wal-Mart in the number of unique visitors.

Additionally, among all web sites, including search engines, portals, news information sites, and shopping sites, Target.com currently ranks 39th.

We are very pleased with our performance and with our strong pace of growth.

Finally, I'd like to provide a brief update on some of the supply chain objectives and initiatives that we have described previously for you.

Maintaining sufficient distribution capacity and improving the level of service to all of our stores remains a top priority.

As a result, we plan to open three new regional distribution facilities next month, including one each in Kansas, Texas, and Ohio.

This will bring our 2004 year-end total to 22 regional DCs and 3 import warehouses.

We continue to rollout our automated receiving technology across our distribution network, achieving even higher than expected improvements in productivity and speed.

Maintaining high in-stock levels in our stores is also an important strategic objective and our increased focus continues to produce consistent in-stock levels that are among the best in our history.

We continue to look for opportunities to improve processes and apply technology that will allow us to sustain this performance.

As an example, we are currently developing new, intelligent, exception-based reporting that we plan to roll out later this year.

This information will help us systematically diagnose and resolve in-stock issues.

Our effort to convert indirect purchases to direct are moving forward as planned.

Import penetration over the past 6 to 12 months has grown substantially.

And we expect this rate to increase further as this year progresses.

We also continue to better integrate our three import warehouses into our supply chain and effectively increase their utilization.

We are increasingly trapping product to provide -- to improve our process of seasonal transitions.

Trapping, which involves holding merchandise related to a specific event or store set in our distribution centers, reduces early product flow to our stores, resulting in more efficient use of back room space and lower handling expense.

In 2004, we plan to trap nearly three times the number of events we trapped in 2003.

These were only a few examples of the strategic investments we continue to make in our supply chain to support our new store growth, to increase our productivity and to improve our store service levels.

We believe that continuous improvement throughout our organization is imperative to sustain our competitive advantage and we are working diligently to achieve world class performance.

We're not standing still in financial services, in our supply chain, on the Internet, or anywhere else; and we are confident that our efforts will contribute to continued profitable growth at Target Corporation for many years.

Now, Bob has a few final comments.

As you've just heard in detail, we are pleased with our overall results in the first quarter, and we remain confident that Target is on track to deliver another year of strong growth and outstanding performance in 2004.

At both Mervyn's and Marshall Field's, we are actively engaged in a strategic review, and as Doug indicated, we will share updates on our progress as we reach important milestones in the process.

Importantly, our long-term outlook for Target Corporation remains bright.

We remain dedicated to generating average annual earnings per share of 15% or more over time, and we remain committed to delivering superior value to our shareholders.

That concludes our prepared remarks.

Now Doug, Gregg, Diane, Linda, Gerry and I will be happy to respond to your questions.

Thank you.

At this time, if you have a question, please press star 1.

If you are using speaker equipment, you may need to lift your handset prior to pressing star 1.

If you wish to withdraw your question, simply press star 2.

And your first question comes from Deborah Weinswig from Smith Barney.

Good morning.

Question on the gross margin improvement that we saw at all three divisions, which, I think on the call you guys discussed reflected better markdowns.

How much of that is driven by what you see in a Profit Logic at Marshall Field's, and how much of that is driven by, basically, leaner inventory levels and any other initiatives you guys have on the plate right now?

Well, we're pleased with the results at Marshall Field's of Profit Logic, Marshall Field's, of course, is the only business in which we've implemented Profit Logic, and it's so small compared to our total that it wouldn't be sound to describe Profit Logic as the cause for our corporate consolidated gross margin rate improvement.

We enjoyed strong markdown improvement at both Target and Mervyn's, where Profit Logic is not deployed, we have our own proprietary system of Smart Markdown Management in those businesses.

Okay, and then in terms of -- and I know it's still early with the rollout of the proto 2004, but in terms of frequency of visit, can you maybe just discuss or give us additional details in terms of what you've seen at, maybe those new store openings versus what you've seen in the past?

As we said, we're very pleased with the -- with the progress to date.

Of course, they've only been open a few months, but sales are very positive and the number of visits that we're experiencing in those stores are positive, as well.

So, we're very encouraged.

Overall, transaction count or frequency was responsible for a bit more than half of Target's same-store sales performance in the quarter.

Okay.

Great.

Thank you so much.

Thank you.

And your next question comes from Emme Kozloff from Sanford Bernstein.

Hi, question on SG&A.

Was part of the expense deleverage due to a mix shift back towards the higher expense rate Mervyn's and Marshall Fields divisions?

And also, can you give us some color on why the comps there deteriorated so dramatically in April?

It seems to be significantly worse than what most of the department store competition experienced.

And then finally, I'm just curious about inventories at Marshall Field's.

You were saying you're very comfortable with inventory levels, but Marshall Field's grew at twice the rate of sales.

So, what makes you continue to be comfortable?

Thanks.

I will tackle a couple of those and leave the sales comment to others.

First of all, no, Marshall Field's revenue in the quarter grew 4%.

Mervyn's declined 1.4%.

Our overall revenues grew 12.3.

So, therefore the importance of Mervyn's and Marshall Field's in the mix declined again in the quarter.

So, expense rate issues were not driven by any increased importance at Mervyn's and Marshall Field's in a numerical sense.

From an inventory perspective, I mentioned in my complements that we refined the -- think of this at the point in time in our supply chain where we hand off inventory between our global sourcing unit and our individual segments, and therefore part of the growth in Marshall Field's inventories in the quarter is simply a shift between accounting for those inventories earlier in the pipeline, previously as "Other inventory," and today as Marshall Field's inventory.

That's one issue, certainly, on balance.

There are other issues, but overall, we're very, very comfortable with our current inventory position at Marshall Field's relative to sales.

Linda, would you like to comment on the base of sales in April?

Yes, our sales overall in April were very strong in our apparel areas.

Pretty strong in the men's area and cosmetics, and then weaker in the home division.

As we report external revenues, and that was that 6/10 reported number, internally we have -- we had sales at 2.8% level.

So, when we factor in the mix of our partner businesses, which, as you know as a core part of our strategy, for State Street and Top 15, we report those revenues only based on the level of income we get, not the sales that we're generating internally so there was a shift there because of the partner businesses, and then also a shift in how we accounted for our quarterly results in furniture.

I'm sure Susan Kahn can give you more details on this because it's somewhat complicated.

But the entire quarter's adjustment [inaudible] April, and that had an effect of about 1.5% --

I think essentially the trends at Marshall Field's, if you break them out by business, were similar to what we saw with the high-end businesses with other reported numbers.

High-end business is doing well, and, you know, apparel doing very well.

Thank you, and your next question comes from George Strong from Goldman Sachs.

Thank you very much.

Gregg, you talked about the success of the -- the P 2004 and we've admired the stores we visited quite a few of them, and we found that in some cases you were hard-pressed to keep up with in-stock, really so much demand for merchandise that it wasn't on the shelves in some places.

Could you talk about how you're trying to calibrate the whole supply chain to meet the requirements of these new stores in some cases?

Yes, I think if you visit our stores now, George, you'll see we're caught up and our in-stock position is rock solid.

What we experienced is -- is substantial sales increases over what we expected, especially very early on.

So, over the first 30 days, 30, 45 days, we experienced some inconsistent in-stocks and supply chain issues around grocery and some of our other -- some of our other categories and we have since been able to make those kind of adjustments and we're in great shape.

I'd also just quickly comment that we've found over a period of time that it is much easier for us to adjust upward rather than overstocking the stores.

And so -- so we tend go in there, we have a fairly accurate projection, but these stores in total were probably 20% in excess of our projection, and now we're back at stock.

Especially when it comes to food and date-coded product.

We don't want to front load too much because there's -- I mean we want to make sure that our merchandise is as fresh as it possibly can be.

Obviously you're working with a supplier on the food side.

Are there any problems specific to that category in trying to -- again, to calibrate the supply?

No, we're not really experiencing any supply issues with them other than the short-term surge that we experienced in these new stores.

Great, thank you.

Thank you.

And your next question comes from Daniel Barry from Merrill Lynch.

Good morning.

Wal-Mart this morning indicated that their food inflation was up a little over last year, but they expected to see the general merchandise inflation higher by year-end.

You indicated, if I heard you correctly, that deflation would be less.

A little difference there, but can you explain maybe why there might be a difference?

I'm not not going to try to reconcile our figures and Wal-Mart's, but let me tell you what I know about ours.

Last year across the store, we experienced a rate of deflation in our retail sales approaching 4%.

This year, that's not at all likely to repeat.

It is premature to tell whether the actual outcome will be a much more modest rate of deflation, or something that's essentially neutral to slight inflation.

But in either event, the outcome certainly would not be nearly as deflationary as last year.

I think that's what Gregg meant by his comment.

And what would it assume -- we'd assume that your comps would track that change?

Certainly.

That's an explicit component of our same-store sales performance.

Thank you.

Thank you.

And your next question comes from Jeff Klinefelter from Piper Jaffray.

Yes, congratulations on a great start to the year.

Two quick questions for Gregg.

One, could you give us an update on the dollar concept that you have, that you've been testing in stores toward the front of your store, I think a 4 foot by 8 foot section rollout plan.

How it's trending, how that fits into your frequency strategy?

And then secondly, on apparel costs, there's much ado about the phase-out of quotas beginning of Jan '05.

And I think a lot of people assume that kind of lower cost producers or discounters are going to benefit the most in terms of quota representing a larger percent of lower cost goods.

Could you talk about how that factors into your strategy for apparel?

Thank you.

Sure, we are testing the Dollar Store concept in 125 stores, and we have different sizes and configurations at varying square footage from about 60 to 80 square feet.

So far we're pleased with the performance of the test.

We have cycled through a couple of different merchandise categories and overall we're -- we're pleased with the sales, we're pleased with the profits and it is -- it's basically an incremental add-on to the overall basket for that store.

So, we haven't made any determination in terms of a national rollout yet, but we are encouraged by what we've seen so far and if the performance continues to -- to do well, we will -- we will get back to you at the appropriate time in terms of what our future plans are there.

In terms of what's happening with quotas and in China and in -- in '05 in particular, China is our largest trading partner and with the elimination of quotas, we will continue to maintain a very strong position in China and should there not be a revaluation -- and there are a lot of moving parts here where there's pluses and minuses, but if quota does go away and there is not any other offset, you could expect to see modest deflation in the cost of apparel goods out of China in the neighborhood of somewhere around 10%.

That's what we're figuring at this point in time.

Having said that, we're very committed to a balanced sourcing strategy throughout the world and while China will -- will remain a priority partner, we're also committed to make sure that we develop strong relationships and partnerships like we currently have in the sub Indian continent and in Pakistan and central America and other parts of the world.

We're still going to balance the -- the -- have a balanced portfolio of sourcing internationally and China will continue to be very strong for us.

Okay.

Gregg, is the strategy to pass that 10% along to the consumer?

Or some combination of the two?

Well, we'll look at that on a case-by-case basis.

In some cases it might be passed through.

In other cases it may be that we're just going to upgrade the product and build more quality and features and trim and upgrade the fabrics, in which case we wouldn't be passing that on at all.

So we make the determination program by program.

Thank you.

Thank you.

And your next question comes from Bob Drbul of Lehman Brothers.

Hi, Doug, I have a question for you.

In terms of the cash flow, can you talk about your priorities -- you know, you're throwing off a lot of cash and paid down a little bit of debt.

I'd like to hear, sort of the priorities around dividend, share repurchase or debt repayment for the rest of the year?

I'm going to take a little longer view than the rest of the year in answering your question.

Our principal focus over time is to make sure that we have ample liquidity to fund our core strategy, to be able to reinvest aggressively in growing our business and to simultaneously maintain strong investment-grade credit ratings, leading to easy and inexpensive access to the capital markets.

At times in our history, when we've had excess capital capacity over and above all of those needs, we have turned to share repurchase.

We slowed that down, as you know, as we entered a period of much more aggressive capital reinvestment and as we entered the period of growing our Visa receivables.

Together with our Board as we look forward in the rest of the year, we'll sort through this equation and figure out what makes the most sense in terms of application of cash.

Okay.

Thank you.

Thank you.

And your next question comes from Mark Miller from William Blair.

Hi, good morning.

I was intrigued by some recent, I guess qualification of your opportunity to increase direct imports from 15% of the mix to roughly double in the next couple of years.

And I think previously you talked about a 50 to 100% increase.

I'm wondering if you're seeing more opportunity than you saw before?

And is this going to represent an acceleration from the current pace?

Well, by the way, we look at it, 15 to 30 as a doubling.

So, I don't think there's been any intent here to change our message in terms of the ample opportunity to considerably increase direct imports as a percentage of our mix.

So, if we've left that impression, it was inadvertent.

You've got about 2,000 people in AMC right now.

How much of the infrastructure investment is already in place?

And how much ability do you have to basically scale that and leverage that investment?

Well, most of that investment is in place and the team members are in place and we have been scaling that up on a fairly aggressive pace and we are in very good position with offices in 50 countries right now.

We're very well established in China and as we grow in size, we should -- we should have no difficulties in wrapping up our -- the business that we do through AMC.

Great, and then the debt repurchase you talked about is impacting the interest expense.

How much was that on the quarter?

Thanks.

In the quarter, the effect on interest expense of debt repurchase was to add about $15 million to what interest expense otherwise would have been this year.

There was a modest amount in last year's first quarter, rounded to about $1 million.

Okay, great, thanks.

Thank you.

And your next question comes from Ed Rush from Banc of America.

Oh, hey, it's Aram Rubinson from B of A.

A couple of things on the operating model.

I'm just trying to understand if and how inflationary pressures at all influenced the operating model.

Number 2, on the new stores, I know they're a different mix inside to a degree.

Is there a different operating model that you're kind of learning with those stores?

Or is it pretty much steady as she goes?

And I just want to clarify that you said that the new stores are opening 20% ahead of plan, is that right?

Yes, right.

As a group they've been doing that.

And we're early, we're only talking two months.

The operating model, though, is essentially very, very similar.

We're not seeing enough difference to have a different model.

Nothing's really changed in terms of the relationship between inflation and our operating model, certainly there have been and continue to be substantial inflationary pressures in many elements of our SG&A equation.

And we've talked about the retail price issue, obviously as we've enjoyed the benefits of cost of sales deflation over the last couple of years.

Some of that has flowed to the bottom line in the form of higher gross margin rate and some has been funneled back to the guest in the form of lower pricing and/or higher quality of the merchandise.

And just lastly on the new stores, the improvement clearly is coming in frequency.

Are you seeing the desired effect in some of the adjacencies as well, so your items per transaction, things like that, is it kind of a -- all strategies seem to be working there?

We're very comfortable and very pleased with the performance of our new stores.

I do not want to leave the impression that we have somehow redefined some new paradigm.

The stores are performing well.

Quite often our stores do outperform our expectations as they open.

I think it's premature to pass judgment of any more fundamental kind about what we're up to.

Thank you very much.

Thank you.

And your next question comes from Teresa Donahue from Neuberger Berman.

Good morning, everyone.

I had a follow up to Aram's question on the impact of inflation on the income statement I apologize if I missed something, but to the -- is it fair to say that deflation was a slight positive on a net basis?

And if so, what does that imply about inflation?

You know, I think from an economic standpoint, inflation impacts so many different things it's almost impossible to answer that question.

The main thing is that it impacts our competitors, as well.

And so in the competitive marketplace, I'm not sure how much difference it really makes.

The old song in retailing, though, is that mild inflation is actually good for the business because it inflates the top line, while many of the expenses, such as the depreciation charge and the fixed expenses on stores, are, in fact, fixed.

Okay, thank you.

Thank you.

And your next question comes from Dan Binder from Buckingham Research.

Good morning.

A couple of questions.

First on the -- on the credit side, credit looked great.

Just a question on the bad debt provision going forward.

Would you expect that to more or less track in line with the net write-off?

It looked a little bit lower this quarter.

Or is there an opportunity to take that allowance down?

And then the second question sort of stems from Aram's question about the adjacency sales on these new stores.

I was wondering if you can just you speak to the chain as a whole in terms of the cross-sell that you're seeing now that you're driving better traffic with food and consumables versus let's say maybe a year ago?

I'll address the credit card question.

In this quarter, you're correct, our expense was slightly lower than our net write-off experience.

As much as anything else, that had to do, in the current quarter, with coming off of the seasonal peak of receivables to a lower absolute level of receivables in the current quarter.

I think what will happen to the relationship between those two numbers in the future has everything to do with the pace of growth in our receivables and the question of whether or not our delinquency and write-off experience will stabilize at current favorable levels or continue to see sequential improvement, in which case, obviously, we would need to reflect lower bad debt expense.

Okay, thanks.

Thank you.

And your next question comes from Patrick McKeever from SunTrust Robinson Humphrey.

Thank you very much.

Just a broad question, and I apologize for asking such a broad question, but looking at gas prices today and where they're expected to go, at least by the government agencies that keep track of gas prices, how have you budgeted in gas prices as -- as they are expected to -- the increase in gas prices, that sort of thing, going forward here?

Or maybe just could you comment how it's affecting your business now, and how it might affect your business going forward?

There are two ways, one as it relates to our cost of doing business.

And of course it is an increase in factor costs, but we've also negotiated excellent decreases elsewhere in our costs.

So I don't think that's going to be a big net factor in our cost of doing business.

As for how it impacts the guest, I know there's been a lot of speculation about that.

And increasing gas prices are kind of a tax, however, there have been decreases in many other costs.

The guest is seeing deflation in many other parts of the economy, including decreases in taxes.

And so whether or not that's going to affect sales as a whole is totally speculative, and we are not seeing a slowdown yet.

But on the cost side, you're saying more or less kind of a wash to some extent?

So far we're comfortable we can handle it because we have decreases elsewhere in our cost structure.

Okay, and then question number 2 is on our RFID.

I think during your last conference call you didn't have any specific things you had discussed publicly with the Street about your plans for -- for implementing RFID, but there've been a few things in the press here and there about Target in the back half of the year, asking vendors to support RFID technology and that sort of thing.

Can you just give us an update on RFID?

ell, we think RFID will eventually be a very important development in our supply chain and be as revolutionary as barcode technology was.

It's not ready for primetime yet, however, we are working as fast as anyone in the industry on developing the technology.

Any specific plans for the latter part of the year in terms of asking vendors to comply with the standard?

Only what we've announced already and we're working with all the relevant parties, making sure there is, in fact, one standard.

Okay, thank you very much.

Thank you.

And your next question comes from Gregg Mellic [ph] from Morgan Stanley.

Thanks, just two questions.

One on the Cap Ex side, I noticed it was just down a little bit year-over-year.

Is that just a timing thing?

Or are you finding that the stores are actually getting little cheaper to put up?

Or you're using up a land bank?

Or what was driving that?

My belief is that that's more likely than not going to turn out to be a timing issue.

We still believe we will invest in the range of 3.2 to $3.4 billion this year in our business, which would represent an increase, not a decrease, from last year's actuals.

It's a little hard to predict that figure with precision because often as we source new land, sometimes it's leased and sometimes it's purchased.

And when it's leased, under leases that aren't capital leases, economically it feels like a capital investment, but it doesn't show up in our Cap Ex line.

And your intention is to try and actually reduce the amount of leases where you can?

Or is that...

It's been an unwaivering objective of ours over many, many years to purchase as opposed to lease when we have the option to go either way.

In many developments, we don't have that option.

The choice is either to lease or not to participate.

And obviously, we choose to participate when the economics are strong.

Gotcha.

And then the second, and not to beat the energy prices a little too much, but could you just give a little more numbers on how it would have impacted say, freight costs versus utility costs in terms of both gross margin and SG&A, to help us flush that out a little bit?

Are there any particular numbers or basis points you could give?

Well, I can tell you that we have said in the past that our aggregate utility costs are in the range of a half a point of sales, so you can use that as a -- a rough guide to -- to adjust what percentage changes in energy costs might do to SG&A expense.

To this point, fuel prices have not been a significant explanatory factor in our cost of sales.

Frankly, a lot of those supply chain costs are in SG&A and not cost of sales anyway, but in the aggregate, to this point it has not been meaningful.

Certainly if energy costs stay where they are, it could become more meaningful, but I doubt that it will be an overwhelming explanatory factor in the next several quarters.

Great, thanks.

Thank you.

And your next question comes from Wayne Hood from Prudential.

Gregg, you mentioned in your commentary that you'd moved a promotion that affected the marketing expense in the first quarter.

Can you give us some sense of the magnitude in that impact?

And would the expense rate have been leveraged if you had not moved that expense line?

Yes, the timing of our incurrence recognition of marketing expense was in rough terms 10 or 20 basis points of expense at Target in the quarter, and it represented in essence the change in SG&A expense.

So, excluding that timing issue, SG&A expense at Target was reasonably neutral as a percentage of sales.

Okay, also, Doug, you -- following the possible transaction, I guess, with Mervyn's and Marshall Field's, are you prepared yet to maybe give us some idea of how much cost that Target is going to have to absorb now that those two divisions are away?

Are we going to have to wait until the transaction actually closes, or possible transaction?

I'm afraid we will need to wait for some more passage of time for us to clarify what that might look like.

There are a lot of variables and we think we're on top of them, but it's premature to attempt to clarify what those variables would look like.

Frankly, it's premature at this point to talk about transactions.

If we had transactions to talk about, we would have put out a release specific to that notion.

Yeah, okay.

And it sounded like in your commentary you made the point, or at least I heard it, anyway, you said sale is an ongoing business.

And are we to read in that you don't really want somebody to look at these companies that are going to just liquidate the chain or buy it and then sell off pieces, that you do really want somebody that's going to run it as an ongoing business?

You listened carefully.

The phrase that I used was that this review would include an evaluation of the possible sale of one or both of these divisions as ongoing businesses.

That is a word-for-word lift from our comments in March, and, yes, those words are intended to convey the notion that at this point in time, we are not pursuing a liquidation of either of those two operations.

Okay.

And then for Gerry, and I'll get off here, I just -- each -- what my question is each 100 basis points of direct business of sourcing that you do versus indirect business, what impact does that have on gross margin rate?

Is it 10 or 20 basis points for each hundred basis points?

Or is there some color you can put around that?

As in many of these questions, including those relating to factor of costs, like all costs, whatever, keep in mind it's a competitive world.

And so, you know, as long as -- as long as our competitors do similar things, then much of this gets competed away.

So we can't be precise on how much goes to gross margin, how much goes to price decreases, how much then goes to sales increases because we lowered our prices.

Okay, thanks, Gerry.

Thank you.

And your next question comes from Bill Dreher from Deutsche Bank.

Hey, guys.

Great job, way to lead the sector.

I've got a few questions here.

First off on the guidance, Doug, you mentioned a 47 cents is reasonable.

Then, Gregg, you mentioned a couple of things regarding the comps and then the total sales, you also mentioned something about the pretax, could you give us a bit more color on that?

Next, my other question was regarding the additional traffic at the P 2004.

Is it more a matter of additional traffic being driven by the food, or is it rub-off sales, or is it a matter of the approved adjacencies and the sort of more exciting presentation, which is causing additional traffic?

And finally, can you give us some color on the difference between -- and maybe the opportunity between the Smart Markdown program that you guys use internally and what you're seeing in Profit Logic and if you were to roll it out to the Target stores overall, would we be seeing another incremental sales and margin opportunity?

I'll start with attempting to put some color on your segment profit question.

The 47 cent figure, of course, is the current First Call median and mean for the second quarter.

And I said earlier that I thought that that was a reasonable estimate at this point in time.

We're cycling periods from the last year in which our aggregate combined three-business segment profit growth was very weak.

It was up only 2% in the first quarter of last year, and we just cycled that with a positive 19% performance in the first quarter of this year.

The second quarter last year, it was only up 1%.

So, we expect another quarter of very strong, double-digit growth in segment profits.

As we evolve through the back half of this year, we'll cycle the fourth quarter of last year in which our segment profits grew 17%, and that is all that stands behind my commentary about our expectation of much, much sharper increases in profitability first half of the year versus second.

On your trapping question, Gerry's trapping discussion is a chain-wide issue affecting all stores in the chain and how we manage our supply chain.

It is not unique to P 2004 stores.

I'm sorry, I meant the traffic on the P 2004 being higher, what could be driving the traffic?

Traffic, that's a different word.

Sorry about that.

I'm sorry.

You're going to have to be more specific about your traffic issue.

The point is you're -- it sounds like you're seeing additional traffic at the P 2004.

There is additional food there, as well as sort of improved adjacencies on the general merchandise side, as well as maybe a better presentation -- more exciting presentation.

Are you seeing the additional traffic being driven by the food?

Or is there a nice rub-off from general merchandise sales...

We're probably spending too much time on 2004 at this point in time.

We've only got a couple of months of history.

We're very pleased and all of these stores in the group have the same basic configuration and mix.

So, there's really no test group to evaluate a guess.

As we go on and do more remodeling, we will be able to track those changes versus what they were performing on a prior basis or against stores that were not remodeled.

Again, suffice it to say, we're very pleased initially, the guests certainly like it, the results are good, but too preliminary to put too much weight at this time.

On your question regarding Profit Logic and Smart Markdowns, we've had a propriety system that we've used to manage markdowns at Target in particular for many, many years and have been extraordinarily happy with its performance.

Whether or not the advent of Profit Logic would represent an improvement is a question that we will address in the future.

Thank you very much.

Thank you.

And your next question comes from Shari Ebert from JP Morgan.

Good morning, everybody.

I just wanted to follow up on Wayne's question about the SG&A leverage at Target Stores in the quarter, and I guess the timing shift accounted for the deleverage, but I was wondering why there wouldn't be any leverage of expenses on a 7.3% comp, and if you could revisit what comp you need to get leverage on your expenses at Target Stores?

Tracking something over such a short period of time as SG&A leverage in a quarter is, to me, quite directly analogous to trying to understand share price changes over a week.

It has a lot of issues in it that have nothing to do with bigger picture.

There are a lot of timing issues in every business in every quarter.

Generally speaking, I think these days we need something on an annualized basis in the range of a four-comp give or take, might be as low as 3, could be as much as 5, at Target, in order to leverage our expenses.

That's an all else being equal comment.

One of the things that is not equal across time is that many of the business practices we're engaged in have as their outcome, higher gross margin rates, partially offset by higher expense rates.

And so quarter after quarter when we talk about gross margin rate expansion at Target, some of it is due to these business practices that embed higher SG&A rates quarter after quarter, and that would not be a all else being equal kind of item in my 3 to 5 comp for leveraging on an annualized basis.

Can you give an example of what one of those would be?

We are employing a substantial number of people in hardlines design in order to support future shifts of certain hardlines products from indirect imports to direct imports, and the design capabilities that we have here in Minneapolis represent SG&A expense and they will manifest themselves in increases in gross margin rate, item by item as we shift some of those items into direct imports in the future.

And our warehouse strategy is another great example.

Okay.

That's very helpful.

And then just wanted to ask you about any help you could provide just on the corporate expense line in terms of modeling that?

I know you had brought some -- I think you had brought some expenses forward in the beginning of the year in the last two years, is that what is happening again here?

How should we be thinking about that?

There certainly was a modest contribution in the quarter to our corporate and other expense line from some of that same benefits activity that we've described and disclosed across the last two years.

But generally speaking, core background, net expense on that line is not something that I expect to be highly volatile in the very short run.

Okay.

So --

Last year's actuals, give or take, gives you a pretty good barometer for -- for our expectations on that line item.

Okay.

Thank you.

Thank you.

And your next question comes from Christine Augustine from Bear Stearns.

Thank you.

Gregg, to what do you attribute the improvement in the apparel area and what are your expectations for the rest of this year in that specific category?

And then secondly, could you please discuss your philosophy and your strategy with regard to the Target brand merchandise that's in the stores now?

I've mainly see it in consumables and health and beauty aids.

Thank you.

Yeah, in terms of our apparel business, I think it's really attributable to two things.

One is the apparel business has not been that strong over the past couple of years and I think we are getting -- we're getting back some of the sales that -- that perhaps we could have gotten or should have gotten in prior years and the other half of it is due to the fact that we are just better and stronger at internally designing and develop merchandise, our -- our content is right on.

Our colors, our fabrics and silhouettes and sizing and all those elements that we work so hard to put together that create exciting content for our guests is really registering this spring.

We expect to have good apparel sales through the balance of the year, whether or not there is as strong as they have been for the first quarter remains to be seen, but we're planning the -- the business to be -- to be reasonably good throughout the balance of '04.

In terms of Target brand that is -- I mean we have a company-wide commitment to own brands and it manifests itself with the Target brand in basic consumables area.

So, that is the brand we use in health and beauty aids and household chemicals and paper goods and things like that.

No different than what we do with Market Pantry in food and other private brands throughout the stores.

We're very committed to it.

The Target brand products are doing quite well.

They have -- they're comprised of outstanding quality at superb prices that are lower than the national brands.

So, we're increasing our market share and penetration in Target brand like we are with our Market Pantry and Archer Farms products.

I think as we approach the 60-minute mark, it probably makes sense for us to field one more question here on the open phone lines.

And obviously, as always, Susan Kahn and I will be available after this call for follow-up.

One more call, please.

Thank you.

And your next question comes from Michael Exstein from Credit Suisse First Boston.

Good morning, everyone.

Very quickly, then, one is what was the impact on your gross margins, you said most gross margin improvement came from reduced markdowns, but what was the impact from more and more direct sourcing?

And secondly, for Gerry, has he discussed with any of the potential credit vendors, if you were to outsource, whether you could sustain the same sort of promotional programs and customer relationships that they do in-house today?

Thanks.

With respect to your gross margin question, on a net basis, corporate consolidated gross margin, 100% of the explanation is markdowns.

Certainly there is a benefit from improved markup embedded in Target's gross margin rate that was offset in consolidation by several unrelated factors.

So, numerically, net, markdowns are the story in the first quarter in terms of the year-over-year change.

As for the outsourcing of credit operations, I'm not sure what you're referring to, we don't have any intention of outsourcing any credit operations related to, you know, Target.

Do you want to clarify that question, Michael?

Yeah, I just thought if you talked about the reason for continuing the credit businesses, the continuity of the customer and what makes you believe that you couldn't do that if you outsourced credit?

Oh, if we were to do it, could we do it?

Is that what you're saying?

Yes.

Well, we run an excellent credit operation and have very high return in the business, and we think that's the best way to run it.

We're not looking to outsource it.

There are privacy regulations, though, that make some of the work that you might want to do in this area of guest relationship management problematic, if you did outsource.

Thank you.

Okay, well thank you all for your participation.

That concludes Target Corporation's first quarter 2004 earnings conference call and we look forward to seeing many of you in two weeks at our meeting in Chicago.

This concludes today's teleconference.

Have a great day.

You may disconnect at this time.