目標百貨 (TGT) 2004 Q3 法說會逐字稿

Hello and welcome to Target Corporation's third quarter earnings release conference call.

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

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

At that time, if you have a question, you will need to press star 1 on your telephone.

As a reminder, this conference is being recorded, Thursday, November 11th, 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, and welcome to our 2004 third quarter earnings conference call.

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

Gregg Steinhafel, President;

Doug Scovanner Executive Vice President and Chief Financial Officer; and Bart Butzer, Executive Vice President, Stores.

This morning Doug will review our results for the third quarter of 2004 and describe our outlook for the remainder of the year.

Then Gregg will provide an update on Target's recent business and current initiatives.

Jerry will update you on the growth and performance of our credit card operations and Target.com as well as developments in our supply chain.

Then I will wrap up our remarks and we will open up 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 are joined on this conference call by investors and others who are listening to our comments today live via webcast.

As usual, today's call will be limited to 60 minutes including our Q&A session.

For any of you who may still have questions after the call, please follow up with Susan Kahn or me directly.

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.

3 months ago we outlined our plan to deliver strong growth in third quarter results from continuing operations, and this morning we announced actual results which reflect this strength.

For the period, net income was $537 million or 60 cents per share and included earnings from continuing operations of $330 million or 37 cents per share, and this reflects a 23% increase over last year.

Earnings from discontinued operations of $4 million, reflecting results of Mervyn's for the month of August, and a gain of $203 million or 23 cents per share related to the sale of Mervyn's.

Our earnings from continuing operations were reduced by a pretax adjustment of $18 million, or about a penny per share, related to accounting for certain store leases.

This adjustment resulted from a detailed review of our releases which began in conjunction with our Mervyn's and Field's transactions.

Let me discuss results from our continuing operations in a bit more detail.

Revenue in the quarter grew 11% to $10.9 billion, reflecting an 11.2% increase in merchandise sales and a 5.5% increase in net credit revenues.

Gross margin rate improved 62 basis points from the third quarter of 2003, primarily due to improved markup.

SG&A rate was unfavorable to the prior year by 30 basis points.

A little more than half of which was due to the lease accrual adjustment.

Depreciation and amortization expense grew $47 million or 16.9% from a year ago.

Primarily due to our ongoing capital investment related to new store and supply chain growth.

Interest expense declined $18 million in the quarter to $113 million from $131 million a year ago.

This decrease was attributable to lower average funded balances, partially offset by a higher average portfolio interest rate.

Each of these factors was heavily influenced by application of proceeds from our recent transactions.

For the third quarter, our effective income tax rate was 37.8%, compared with 37.3% in the same period of 2003.

Our annual effective tax rate was 37.8% in both years.

Now, let me turn to the balance sheet.

Once again, our third quarter balance sheet presentation segregates assets and liabilities for our discontinued operations from our presentation of continuing operations.

The prior-year presentation of assets and liabilities for discontinued operations include both Mervyn's and Marshall Field's, while our balance sheet as of October 30th this year reflects both the receipt of cash proceeds and the disposition of assets and liabilities related to the Mervyn's and Marshall Field's transactions.

At quarter end the remaining proceeds of approximately $1.1 billion were invested in short-term securities, shown on the cash and cash equivalents line.

Net accounts receivable at the end of the third quarter reflect balances for the Target Card and the Target Visa.

Net of the allowance of $363 million on these receivables, balances at quarter end were approximately $4.6 billion, in line with our expectations and modestly above our receivables levels at this time last year.

Our balance sheet inventory position grew 26% from a year ago, reflecting both the natural increase required to support additional square footage, same-store sales growth and our strategic focus on increasing direct imports, and as we discussed last quarter, the refinement of our measurement of the point in our supply chain at which effective ownership occurs.

This refinement in methodology, which explains a bit more than half of our year-over-year increase at quarter end results in a parallel and ongoing increase in our inventory and in our accounts payable.

Our balance sheet for the next few quarters will continue to reflect these effects.

On balance, our inventory is in typical excellent condition, as we enter the holiday season.

We continue to repurchase shares of Target common stock during the third quarter under the $3 billion authorization provided by our Board of Directors in June.

Specifically, we invested $503 million to buy approximately 11.4 million shares of our common stock at a weighted average price of $44.16 per share.

Cumulatively, we have now repurchased 22.4 million shares of common stock for a total investment of $975 million.

And we continue to believe that we will complete this repurchase program within 2 to 3 years of the program's inception.

Finally, let me turn to our outlook for the remainder of the year.

As you know, at the beginning of 2004, we communicated an expectation that envisioned stronger financial results in the first 9 months of the year, followed by more modest growth in the fourth quarter, as our base of performance becomes more challenging.

Through 9 months we have generated 19.3% growth in EPS from continuing operations, driven by an 11.9% increase in total sales combined with gross margin rate expansion.

Our outlook for this year's fourth quarter envisions a low double-digit percentage growth in total sales, driven in part by an expected increase in same-store sales in the range of 3 to 5%.

We expect to achieve a similar low double-digit percentage increase in EBIT, or earnings from continuing operations, before interest and taxes, as we cycle against the significant gross margin rate expansion we achieved last year.

Finally, we expect EPS from continuing operations in this year's fourth quarter to grow at a faster pace than EBIT as we benefit from reduced debt levels and reduced share count related to the application of transaction proceeds.

Today the median first call estimate of EPS from continuing operations for this year's fourth quarter is 94 cents, which reflects an increase of about 18% from last year's 80 cents.

On balance, I believe this represents a reasonable single point expectation of our performance.

Separately, for those of you who maintain detailed financial models of Target's performance, it is important for you to be aware that our 4 quarters of EPS in 2004, will not add to our full-year EPS.

This is due to our share repurchase, and our seasonality of earnings among other factors.

One final forward-looking comment.

As most of you know, we measure the impact of inflation or deflation on our retail sales only once a year and we're currently undertaking this effort.

Although we will not complete our analysis for several more weeks, we remain confident that our actual annual retail price deflation for 2004 will be considerably less than the 3 to 4% deflation rate we have experienced in each of the past 2 years.

On a related note, we expect no LIFO charge or credit in this year's fourth quarter, or for the foreseeable future.

Now, Gregg will review Target's results and current business trends and highlight several key initiatives at Target this fall.

Gregg.

Thanks, Doug.

Target delivered strong results in the third quarter and we are very pleased with our performance.

Sales of our back to school and back to college offerings were in line with our expectations.

We completed the rollout of our One Spot concept to all stores, and we continued to delight our guests with new and differentiated merchandise, as well as exceptional value.

Growth in both traffic and average transaction amounts contributed equally to our sales increase in the third quarter and categories that delivered stronger than average same-store sales performance included pharmacy, commodities and consumables, apparel and accessories, and footwear.

Target also continued to expand our store base during the quarter.

To bring our convenience, excitement and value to more guests, Target opened a total of 46 new stores during the quarter.

Each of these new locations, including 31 net-new discount stores, 10 new Super Target stores reflect the key elements of our P-2004 prototype design.

We remain pleased with the results from our earlier P-2004 store openings, and are confident that this latest group will meet or exceed our expectations.

At quarter end, we operated 1,313 stores in 47 states, including 136 Super Target locations.

As we move into the 2004 holiday season, Target's commitment to our "Expect More, Pay Less" brand promise remains as strong as ever.

We continue to differentiate our assortment through the offering of trend-right merchandise, exclusive brands, design partnerships and the use of lifestyle merchandising and seasonal events to create in-store excitement.

At the same time, our commitment to value provides our guests with style, timeliness and quality, at best-in-class prices and a complete assortment of consumables and commodities priced at parody with Wal-Mart.

Maintaining an appropriate balance in this equation is what helps Target sustain its competitive advantage and deliver superior financial performance.

The theme of this year's holiday campaign at Target is "Get Ready."

It will focus both on gift giving and holiday traditions and will provide our guests with great reasons to make Target their preferred shopping destination for the holidays.

Specifically, our holiday offering will include a broad assortment of high quality, low-priced holiday decor products, ranging from holiday dinnerware and table top, small electrics and gifts, ornaments, tree skirts and gift wrap.

Exclusive items created by some of our favorite designers, such as hand knit sweaters from Mizrahi, a paisley jacket from Mossimo, a colorful makeup set from Sonia Kashuk, and an expanded line of holiday dinnerware from Christopher Radko and a dominant assortment of the season's most wanted toys, electronics and entertainment products, such as digital cameras, DVDs, video game software, Apple iPod, Leapster educational products and board games.

Food is always an important component of holiday celebrations and festive gatherings, and Super Target is increasingly focused on delivering freshness and solutions for all of our guest's entertaining and meal preparation needs throughout the year.

For this holiday, Super Target will offer both exceptional convenience and value.

For example, guests can purchase a complete six-serving dinner of turkey or ham with all the trimmings for only $39.99 and a 12 inch lattice top apple pie for only $6.99.

Exclusive offerings this holiday season at Super Target include a Frango cheesecake from Cheesecake Factory, best selling gift items from Swiss Colony, Betty Crocker and Ghardelli chocolate cookie kits, a collectible 6-pack of 8-ounce bottles of Coca-Cola, and an assortment of sweets and treats, such as chocolate fondue for 2, a heart-shaped candy cane wreath and various marshmallow ornaments designed by our partners at Swell.

To reinforce our unique brand promise of differentiation and value at Super Target, "Eat Well, Pay Less" has become the cornerstone of our communication with guests.

Additionally, we have developed bold new in-store signing and made it more consistent throughout the store.

And we have strengthened our value message on our produce tables and bake good end caps with more 2-for value offerings and single price point messages.

We also continue to build awareness of the quality and exceptional value of our own brands.

In the past year we have introduced attractive new packaging for both market pantry and Archer Farms and substantially increased our assortment of these brands, more than doubling our offering of market pantry offerings and growing our Archer Farm selections by more than 50%.

The performance of these own brand products continues to meet or exceed our expectations.

At Super Target we continue to identify opportunities for continuous improvement, just as we do at our discount stores, and both formats remain important contributors to our future growth.

Our commitment to deliver great products at great prices remains a priority as we move into 2005.

In January we will roll out to all stores for a period of approximately 6 weeks a big and bold new concept called, "Global Bazaar."

Our presentation will occupy the seasonal space in our stores, and we'll showcase an all new collection of decorative accessories and furniture from Asia, Latin America, Africa, India and Europe.

To differentiate Target's assortment from those at other retailers, every item we offer is authentic and sourced directly from the region it represents.

Some items such as the decorative gourds from Africa are handcrafted by local residents of small villages.

Guests will be delighted by the eclectic offering and affordable pricing of these global products.

Also in early 2005 we plan to meaningly enhance our bed and bath assortment with the introduction of the Field Crest brand.

We will delight our guests by offering them both a classic line and a luxury collection with incredible items like 400 thread count Egyptian cotton sheets and silk quilts.

Exclusive to Target, this well-respected high-quality brand allows us to offer our guests traditional styling and genuine luxury at extremely attractive prices.

Now, let me turn to our outlook for the fourth quarter.

Inventories are in excellent condition as we head into the holiday season, reflecting our strong sales and disciplined receipt management.

As we have indicated previously, the strength of last year's fourth quarter results presents a difficult hurdle for us this year.

Specifically, a year ago Target delivered a 6.1% increase in comparable store sales and a strong improvement in profitability.

This year, our expectations reflect a bit more modest growth.

Comparable store sales in the fourth quarter are planned to increase in the range of 3 to 5%, profit is expected to grow essentially in line with total revenues.

We believe that Target is well positioned to deliver solid fourth quarter performance and we are confident that Target will enjoy healthy growth as we move forward through 2005.

Now, Jerry Storch will give you an update on Target.com, several guest relationship initiatives, our credit card business and our supply chain efforts.

Jerry?

Thanks, Gregg.

Gregg has just shared with you many of the exciting merchandising initiatives we have underway in our stores, and we're equally excited about the initiatives we are pursuing at Target.com that allow us to further strengthen our relationships with our guests and leverage our resources to drive incremental sales and profits.

Target.com continues to be one of the fastest growing sites on the Internet, generating sales and traffic volumes ranging from 70 to 100% higher than our results a year ago.

And we remain confident that this channel is providing value for our guests and our shareholders.

This holiday season, Target.com will showcase approximately 70,000 items, including the best brands and designer products from Target, and an expanded selection of web-exclusive merchandise, that will provide our guests with greater breadth of assortment, as well as increased size and style choices.

This offering will include toys, such as large outdoor toys and play furniture, electronics, such as DVD players, audio, MP3 players, digital cameras and TVs, furniture, and baby items.

As we move forward, Target.com continues to satisfy our guests and leverage resources to generate profitable growth.

For example, the greater breadth and depth of Target.com's assortment allows to us identify emerging trends quickly on our website, and then partner with our merchandise organization to update our in-store assortments giving our guests more reasons to shop at Target.

Target.com's smaller scale allows to us work with new vendors and evaluate their production and delivery capabilities with limited risk before expanding our relationship with them.

And Target.com's merchandising flexibility allows us leverage the global product design, developments and sourcing efforts of Target's merchandise organization to offer products our guests want, that we are unable to sell in our stores.

We are pleased with the tremendous growth we are experiencing at Target.com and we are confident that our guests will continue to be delighted by Target.com's merchandise selection, value, speed and convenience.

We are particularly excited about this holiday season and believe we are poised for continued growth throughout 2005 and beyond.

Gift cards are another important element of our holiday strategy and another way for Target to simultaneously please our guests and generate positive financial results.

Gift cards satisfy a wide range of gift giving occasions and reinforce Target's brand image to their innovative and differentiated designs.

Target is among the largest issuer of gift cards in the world, both in terms of dollars and units.

Importantly, Target's average gift card transaction is 25 to 50% greater than a typical non-gift card transaction.

A significant portion of the guests who redeem a Target gift card spend more than the value of the card.

The fourth quarter represents a substantial percentage of Target's annual gift card issuance and redemption, and consistent with our year-to-date growth we expect to increase our issuance of Target branded gift cards during this year's fourth quarter by about 1/3 versus last year.

As evidenced by this outlook, Target gift cards remain an important and growing payment form and marketing vehicle, and contributor to our overall results.

Our credit card operations also continue to contribute to our overall profitability while reinforcing our strategic objective of strengthening our guest relationships.

Pretax profit from our credit card operations grew 13% in the quarter to $120 million on growth and average receivables of approximately 4%.

As a result, our annualized net portfolio yield grew to 10% from 9.2% a year ago.

The quality of our portfolio continued to improve during the quarter, resulting in significantly lower net writeoffs and improved delinquency rates.

Net writeoffs in the quarter were $99 million or 8.2% of average receivables compared with $115 million or 9.9% of average receivables in 2003.

Delinquencies, which provide a strong leading indicator of future writeoffs were 3.8% in this year's third quarter compared with 4.4% for the same period a year ago.

From a strategic perspective, we continue to integrate our credit card programs in our retail business to drive greater sales and increase guest loyalty.

We are keenly focused on enhancing our credit card marketing and branding efforts to create more credit card awareness, and more compelling reasons for our guests to use their Target credit cards for payment.

We are optimistic that the new initiatives we are pursuing will increase our penetration and generate favorable financial performance.

Finally, our supply chain continues to be an area of major emphasis and substantial strategic investments and we continue to make progress on a variety of initiatives.

Specifically, we remain focused on supporting Target's new store growth through expanded distribution capacity, increasing our productivity and in-stock performance, and improving our store's service levels and we are excelling on each of these dimensions.

In prior quarters we have described in detail many of the efforts we are pursuing that include collaborative planning, forecasting and replenishment, item segmentation, transition trapping and timing, increased direct imports, speed sourcing and RFIDs among others.

And we continue to look for new applications of technology, and new approaches to reach our fundamentals that will further strengthen our competitive position.

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 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 third quarter.

With the completion of both the Marshall Field's and Mervyn's transactions, the strategic direction of Target is clear and our long-term outlook is bright.

We continue to delight our guests with differentiated merchandise and exceptional value.

We continue to invest in technology and leverage our resources across pyramids and departments throughout our organization to enhance our performance.

We continue to identify ample opportunities for profitable growth in the United States, and capture incremental market share gains, and we remain confident that we are on track to deliver another year of outstanding performance in 2004 and to deliver superior value to our shareholders over time.

That concludes our prepared remarks.

Now Doug, Gregg, Jerry, Bart and I will be happy to respond to your questions.

Thank you.

Once again if you would like to ask a question, please press star 1 on your telephone touch pad.

And our first question comes from Emme Kozloff of Sanford Bernstein.

Hi, Doug.

In terms of the lease charge, can you clarify exactly what this is and can you tell us if you've ever recorded a similar charge like this in the past?

And in terms of SG&A, of the remaining 15 basis points of deleverage, how much of that was due to the effect of direct imports?

And I just have a follow-up question on credit.

Certainly.

Let me first address the lease question.

As a result of analysis performed at the end of the quarter, we found that we were under accrued in our leasing area and we addressed this issue immediately by adjusting the accrual.

Essentially, I think it's important to note that this had built up very slowly over a long period of time.

Maybe a few hundred thousand dollars per quarter or less than a tenth of a penny in net income effect and probably over a longer than 10-year period.

Certainly it's not reflective of anything that I think goes beyond this quarter.

It's an isolated issue, a non-recurring issue.

Certainly, I personally regret that it occurred, but I don't believe it has any future implications.

On your SG&A question, in basis point terms we were up 30 basis points, 18 of the 30 was this issue.

The remaining 12 basis points is due to net offsetting issues that went in either direction and no one of the other remaining issues was remarkable in any sense, positive or negative.

Okay.

And then on credit, in the last few quarters your bad debt expense as a percentage of average receivables has been only slightly ahead of your actual net writeoff experience, but this quarter it looks like the gap widened to about a full percentage point.

So I'm wondering if you could tell us what's underlying this change and how we could modeling bad debt expense in the writeoff going forward.

I think I recall your last guidance about a year ago was for both bad debt and net writeoff to be in the 8.5 to 9% of receivables range, but obviously this included the department store card portfolios.

So what should we be looking for now?

In the current quarter, "the" issue that causes that relationship to be different from what it was in Q1 and Q2 is that we grew receivables.

Receivables were up several hundred million dollars in the current quarter sequentially, and it's appropriate, of course, to reflect a portion of those receivables as uncollectible as we generate them.

So the answer to your modeling question is, to the extent that we are successful in continuing to increase our receivables balance, you should expect to see expense in excess of writeoffs.

Separate issue, our underlying trends in the credit card portfolio are very strong, as Jerry indicated.

Delinquencies, writeoffs, about any measure of -- that represents a leading indicator of future writeoffs are currently favorable.

Obviously, if that kind of trend were to continue, then we would reflect this.

So you would see it reflected not only in our actual future writeoffs, but also in our thinking and our modeling and our calculations that drive the expense figure as well.

Great.

Thanks.

Thank you.

And our next question comes from Daniel Barry of Merrill Lynch.

Good morning.

Congratulations on a strong quarter.

Gregg, question in supercenters.

You discussed the food area a bit.

Can you tell us first if the supercenters are still getting the same return as the regular Target?

And maybe give us -- roughly guess what the comps were in food for the quarter and if the food comps were stronger in the third quarter than the second?

We -- you're correct, we still are generating the same kind of returns that we have in the past, and the Super Target comps have pretty much mirrored the general merchandise comps all year so far.

There has been very little variability between the chain's average.

We might be up about a half a tick one month and below half a tick, but on average, it's been very, very close and consistent.

Very good.

Thanks.

Thank you.

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

Good morning.

Can you please provide any additional color on the higher IMUs that drove gross margin improvement?

Sure.

We are very pleased with our -- with the IMU improvement in the third quarter, and it's really driven by, you know, a number of factors.

First our mix was quite favorable in the third quarter.

Secondly, we enjoyed somewhat of a slightly more favorable pricing environment than what we had expected in the third quarter.

And lastly, as you know, we have been aggressively pursuing growth in direct imports and as a result of that in our sourcing strategy, we were able to lower our acquisition costs.

It was a combination of those elements that drove the strong IMU in the third quarter.

And then quick question for Jerry on the gift card.

Jerry, I just want to make sure that I got it correctly, that you had said that it would be 1/3 growth in terms of gift card issuance, and how should we think about that in terms of percentage of sales during the holiday season on the gift cards?

And, obviously, with a significant number of redemptions being done after Christmas, are you doing anything to merchandise the stores into no, not really.

No, not really and I don't think we quote statistics on exactly when they are redeemed, but we have seen this business to continue to grow and compound at a meaningfully high double-digit growth rate for several years now and we're excited about it.

We think it drives trips to the stores, it drives frequency and it's great for our guests to be out there giving these gifts to people who then come to our stores to redeem them.

Great.

Thanks so much.

Thank you.

Our next question comes from Jeff Klinefelter of Piper Jaffray.

First of all, Gregg, one question for you.

In terms of the outlook for Q4, overall, understanding and appreciating it's about a 3 to 5% comp outlook, in terms of specific categories, looking back at your performance last year, noted that electronics and home decor both stood out as sort of underperforming categories during several weeks of the holiday season.

And then we also have a lot of dynamics in toys now with store closures and a de-emphasis at Toys "R" Us.

Are there opportunities in those key holiday categories for you this year?

And kind of how are you approaching that from a merchandising standpoint?

And one quick follow up for Doug.

Sure.

As always we are going to take a very aggressive stand to our fourth quarter business, and there's a number of businesses that we go after in a very meaningful way, whether it's our home business, small appliances, toys, electronics, entertainment, we really expect to have share gains in all of those categories and we'll probably get some greater gains in those categories that may have been a little softer than in the -- than in prior years.

We expect to make market share gains in toys, as you specifically mentioned; although, toys, as a category this entire year has been somewhat sluggish.

I mean it's been okay, not great, and we'll wait and see how it performs in the fourth quarter, but the third quarter and early reads in the fourth quarter, it has been following the same pattern that it has throughout the first 3 quarters of this year.

Great, thank you.

And then, Doug, just a quick follow-up.

Your import BCs that you have put in place have been benefiting gross margins and I believe some sort of vendor pricing negotiations on the private label side of your business has been helping as well.

Can you give us a quick -- a little bit of color on kind of what kind of an impact that had to gross margins last year, and what sort of an impact you anticipate it having this year for year-end?

That's certainly a calculation that involves some judgment and estimation along the way, as I have said before, I think the SG&A side of this, which is where the expense of those distribution centers is recorded, is putting, say, 10 basis points plus, in some periods as much as 10 basis points of pressure on our SG&A rates.

On the gross margin side, we clearly are benefiting to a greater extent.

Not just from a rate expansion, but also from an improvement due to that activity, in the mix of our sales that are at full price, versus the clearance price.

Okay.

Thank you.

Thank you.

Our next question comes from Mark Miller of William Blair.

Hi.

Good morning.

Doug, on the very last point you made there, I would be interested in the magnitude of the level of sales full price this year versus last year.

In our overall business it's not meaningfully different, because these centers were certainly very much in line last year as well.

It simply allows to us to mete our product out closer to the moment of need and get a better regional flow of our products that take into account current year regional demand due to weather and other factors to a much better extent than we were able to in the past.

And then can you also elaborate on the markdowns year-to-year?

Markdowns in the third quarter year-over-year were somewhat adverse, but the big issue in gross margin rate, as we talked about earlier is markup, but directionally markdowns were adverse to an extent year-over-year.

Okay.

And then on the SG&A, my understanding is that the figures we're looking at are truly comparable.

In other words, they are not including basically fees that you are getting from the buyers of Mervyn's and Marshall Field's.

If that's the case, I'm curious what are the factors that would've caused the SG&A growth rate to slow a little bit versus prior quarters?

And if you could just talk about, you know, where you are at in terms of the spending within AMC and other trends and healthcare and worker's comp, to the extent they're relevant.

Thanks.

First, let me clarify your assumption regarding Mervyn's and Marshall Field's.

Included in our SG&A expense is the expense we're incurring to provide transition services, IT transition services and other transition services to the buyers of both of those businesses, and netted against that expense is the reimbursements that we are receiving from those businesses.

So there is activity inside our SG&A, both expense and offsets to expense associated with that activity.

Net, it is not a huge issue, but it is in there.

Separately, the current quarter increased 12 basis points other than the lease matter is a lower year-over-year increase than what we have experienced in some other quarters.

If you recall in some other quarters, one of our key explanations was timing differences, looking at some of those key drivers, workers' compensation this year is a much bigger year-over-year issue for us, than year-over-year healthcare expenses.

Next year I expect that relationship to reverse.

In 2005, I think healthcare expenses net running through our P&L will be a bigger challenge for us than workers' compensation year-over-year.

Thanks.

Final question is your outlook for November, is a 2 to 4 comp and then you have a 3 to 5 for the quarter.

Is that due to the growth of gift cards such that you would be in the 2 to 4 range again in December, but then well over that in December -- in January rather with the gift cards or is there anything else there?

No, absolutely not.

The issue that's driving that difference, again it's our outlook 2 to 4 in November, 3 to 5 for the quarter, is driven by the fact that November last year was more than a 7 comp.

And so once again, we pay very careful attention to the performance in prior years, as we set the precise seasonality of our plans for any period.

Separately, gift cards couldn't be big enough mathematically to drive January higher, if December were as low as 2 to 4, it would be mathematically impossible for the quarter to be 3 to 5 if both November and December were 2 to 4.

So it's a way of circling back and saying that even though we haven't yet talked about December with precision, from this math, chances are pretty strong that we will be in the range of 3 to 5 for December to hit our quarterly plans.

Thanks, Doug.

Thank you.

Our next question comes from Gregory Melich of Morgan Stanley.

Hi, thanks.

A couple of questions related to CapEx and then free cash flow on the balance sheet.

CapEx, it looks like it's running at 4 to 5% this year, with square footage up 8%.

I'm wondering how long you can keep that up or at some point, do those 2 numbers have to run at a similar rate or even faster on the CapEx side?

And then second, I guess related is assuming they eventually equate, with the $4 billion plus of cash coming in from Mervyn's and Marshall Field's, but $3 billion spent on a buyback, should we assume that the other billion is going somewhere else or what should we think about as the appropriate capital structure going forward?

First, on your CapEx comment, there's some very important timing issues and we do invest a lot of capital in activities that aren't directly related to square footage growth, such as the hundreds of millions we spend per year on store remodeling, and the hundreds of millions we spend per year investing in IT technology.

Nonetheless, I think over the longer term our CapEx is likely to rise on balance in line with sales, not square footage growth as a result of those other factors.

So your comments, your question regarding application of transaction proceeds, yes we do have somewhat over $4 billion of net transaction proceeds net of income taxes that is, and we did announce as you know a $3 billion share repurchase program.

Those aren't quite as directly tied, as your question implied.

In other words, that program was sized -- the share repurchase program was sized to take into account not only our anticipated transaction proceeds, but also our capital capacity that our ongoing operations are expected to generate over the next couple of years.

By the time the dust settles, the balancing item is our indebtedness, and as of this moment, our debt is billions and billions lower than it was at this point last year.

And you're comfortable with that?

You don't feel you are underleveraged?

Certainly, I don't know that I would use the word "underleveraged" but there's no doubt about the fact that we have substantial, incremental capital capacity today compared to where we were a year ago, and ultimately, that capital capacity will be utilized through some combination of returns to shareholders, think share repurchase and investment in strategically and financially sound business propositions.

Think new store growth for Target.

Thanks, Doug.

Thank you.

Our next question comes from Aram Rubinson of Banc of America.

Hey, good morning, guys.

I had a question for Jerry and then an overriding question as well.

I was hoping on the dot-com business you could give us a sense of the mix of business, the merchandise mix of business, how that differs than what you experienced in the stores?

And also what the economics and economic levers and how those compare?

And then I had one follow up.

On the dot-com, we sell, you know, a lot of electronics, a lot of home goods, a lot of toys, hard-line type businesses also we expanded into apparel.

We don't sell, that's big in the stores, would be health and beauty care type of products, other consumables, food, goods like that, so there is a different mix there.

And the -- you know the basic economics of the business are driven by the size of the average order and the gross margin rate, just like -- just like any other business.

In addition, even though it's not part of our sales equation, we issue a substantial amount of gift cards via web-based transactions.

Thanks.

And then the follow up's on real estate generally.

There's clearly been a lot of activity in the real estate markets and, of course, you guys were part of that, but it seems to be at least the appearance of activity elsewhere in the retail space.

I'm curious if you have any thoughts and can comment on what might be an imbalance in supply and demand in the real estate markets if there's lots of property on the market from some struggling retailers out there, if there's any implications for your business?

We're not seeing any major differences in the real estate markets around the country.

It's pretty much business as usual.

These things periodically happen.

But we're seeing enough opportunities to continue to expand and grow, but we're not seeing swings wildly either upward or downward in pricing.

And how would you think about, whether it's Sears or Toys "R" Us and K-Marts and all of those others, if you would like down into the future what might expect from that.

Certainly can't speculate on their futures, but as always we're looking for real estate opportunities, as happened with awards, but we're still also looking at fresh opportunities and I think it's going to be business as usual.

And does it ever present an opportunity for you guys to unleash value or is that not in your thinking?

Unleash value in the sense of selling real estate?

Monetizing it in some way.

No, we have executed all the real estate transactions this year that we have in mind.

If anything, we'll certainly be poised and ready from a capital capacity and any other aspect if an attractive block of real estate were to come available through whatever means, that made sense to develop new Target stores, we would pursue that opportunity aggressively.

Thank you.

Thank you.

Our next question comes from George Strachan of Goldman Sachs.

Thank you.

Now that you have rolled out One Spot, Gregg, could you comment on how the dollar price point is working so far as a traffic driver and what you are seeing in terms of sales productivity in that space.

Well, we're thrilled so far with the rollout.

We rolled to all stores in September, and we have just reset for the holidays about a week ago, and the sales for the third quarter were slightly greater than what we expected so we're very pleased.

We are -- also believe that having everything priced at $1 was the appropriate way to go to market.

It's a very simple concept.

Our guests understand it.

They like it, they like the merchandise mix, the treasure hunt experience, and at this point in time, we are -- you know, we're very pleased and we're going to continue to support this program with about 6, 7 changes a year.

So you will see this continually get refreshed about every 6 to 8 weeks.

Okay.

Thanks.

And, Doug, as you mentioned, D&A appears to have jumped a little bit in the quarter, it was up 22 million in Q2, up 56 million in Q3, and that was actually the biggest variance from our Q3 expectation, not the accrual catchup.

Could you elaborate a little bit on why D&A popped a little bit in the quarter and what you should we expect on that line going forward?

First of all to clarify, depreciation and amortization in the current quarter was up 47 million, not 56, but you're correct in observing that that is sequentially a larger increase than what we had experienced before.

Some of that is due to pure timing.

We opened a record number of Target stores in the current quarter compared to any quarter in our history.

So that's part of what's driving it.

Some of it has to do with some nuances or anomalies related to the transactions that cause a year-over-year relatively small flip flop between SG&A and depreciation expense.

For example, there are some very small IT systems that we're utilizing to support the transitions short run that have caused an acceleration in the depreciation on those capitalized systems that after a brief period of time will go away.

[Inaudible] like the Q3 D&A or would you expect it to fall off again?

George, I apologize.

We were talking over each other.

Could you repeat the question?

Yeah, just modeling going forward, have we kind of reached a new level of where this should stabilize at this point, would you say?

Generally, yes, there will be anomalies in the future but, generally yes.

Thanks very much.

Thank you.

Our next question is from Robert Drbul of Lehman Brothers.

Hi.

Good morning. 2 questions for Gregg, please.

The first one is, can you talk a little bit about the penetration levels of your consumables, you know, around how the comp trends have been in that business.

And the second one would be, can you elaborate a little bit on the apparel initiatives that you've had this year and some of the experiences that you've had with some of the private label launches and some of the national launches that you've rolled out?

Sure.

The penetration of consumables -- our consumable and commodity business has been very healthy all year.

Very consistent to what it has been throughout the last number of years.

It essentially continues to slightly outpace our total comp store sales increases.

So it's been healthy, it continues to be healthy, as you know, as we remodel existing stores and add new stores, the share of space devoted to those categories is larger than had been in prior formats.

So we expect that sales trend to continue along those patterns.

As it relates to the apparel initiatives, we're very pleased with our apparel business year-to-date, it is been a good apparel year.

Our third quarter was very positive.

We are getting good traction from new initiatives like C9, our Mizrahi business is very strong, our casual business within our own brands, whether it's Merona or Cherokee has been very solid as well.

So we have seen good sales trends in our kids business and ladies' and we're especially pleased with the turn around we have experienced this year with men's.

As you know that's been a sluggish category for us over the last couple of years and we seem to be on track this year.

Great.

Thank you.

Thank you.

Our next question comes from Christine Augustine of Bear Stearns.

Thank you.

Could you provide us with an update on the P-2004 prototypes.

I believe on an earlier call this year you said they were running 20% ahead of plan.

I'm wondering if that trend has continued?

What types of -- what type of a comp boost do you see from a store that's remodeled into the P-2004 format?

Does it vary at all from, you know, from prior-year remodels when you did not have the format?

And then finally, how many multi-level stores are you currently operating?

Thank you.

Going back to the comments you made about the percentage of increase, that actually related to our first cycle in March, and that has moderated but it's still above our expectations, and for the total year our sales are running above expectations in all new stores.

Now in terms remodel, it depends as to whether or not we expand as well.

Normally we get a lift when we expand, but the primary goal of our remodeling is to keep our assets fresh over time.

Make sure that the guest experiences the Target brand character.

And of our 1,100 plus discount stores, that excludes our Super Target stores at quarter end, about 30 are multi-level stores.

Okay.

Thank you.

And for Jerry, is there any update that you can provide us with on the smart schematics system?

I think the system you are talking about is the one that we use in the stores in order to help us lay out the planograms.

We're pleased with the system.

It's one of a numerous number of initiatives we use to accomplish the effects of making our work in the stores easier.

And is that rolled out to all stores now or still just in a small percentage?

No, it's rolled out.

Thank you.

Thank you.

Our next question comes from Teresa Donahue of Neuberger Berman.

Hi, everyone.

My questions have been answered.

Thanks.

Thank you.

Our next question comes from Patrick McKeever of SunTrust Robinson Humphrey.

Okay, thanks.

On the P-2004 prototypes, how many stores have you remodeled with P-2004 features at this juncture in time?

Approximately 70, 7-0.

Okay.

And a second question, the ports situation out in California that's getting some play in the media, is that an issue or is that just a non-issue for you in terms of delivery of your imports for holiday?

It's not an issue for us.

Okay.

And then just a quick third one, a broad question.

There's been some speculation about overseas acquisitions or international acquisitions.

Could you just comment just broadly on your thoughts in that area?

Well, there's no question that Target will be an international presence at some point in time, but in the near-term future, we have no plans and we continue to have the opportunity to at least double in size in the U.S. and so our goal, currently, is expanding in the U.S. without any outside intentions.

Okay.

Thanks very much.

Thank you.

Our next question comes from Michael Exstein of CS First Boston.

2 questions, one is when you decide to take a mall location, what governs it?

Is it lack of availability of Greenfield [ph] sites that you could do on your own or is there something about the malls that you feel comfortable about?

Just talk about that.

And secondly, I noticed in Gregg's conversation about emphasis -- merchandise emphasis in the fourth quarter to a lot more electronics areas.

Are you sort of focusing more attention in that area because it's been relatively underpenetrated in your mix historically?

First of all, mall versus Greenfields.

We continue to look at any available opportunity.

We'd like to be covered in as many neighborhoods as we possibly can.

Really it is a situation of what is available, and we are very comfortable with both.

As Doug said earlier, we now have approximately 30 plus multi-level stores.

We have learned how to operate them and we're equally comfortable.

In terms of electronics --.

Yeah, I mean electronics is very important to our mix in total.

It will not get a disproportionate emphasis over prior years, we just see some strong trends this year in the business and a lot excitement that are going to generate some nice comp-store gains, as you know, digital products are very strong.

The prices of LC TVs are coming down.

We are into LCD TVs.

The video game business looks to be pretty strong this year.

MP3 player, audio products.

We are just excited about the prospects for the fourth quarter, it doesn't mean that they are not equally excited about some of the other businesses that we have as well.

Thank you.

Our next question comes from Dan Binder of Buckingham Research.

Hi, good morning.

A couple of questions.

First, on credit.

Now that we have -- we're dealing with just Target, I'm wondering if you could kind of what your outlook is over a long period of time, the -- with regard to net yield and writeoff as a percentage of receivables -- or excuse me, gross yield and net writeoffs as a percentage of receivables.

That's my first question.

Our net yield, again this is the yield on the portfolio, return on invested capital in the portfolio before funding costs and interest expense.

Through 9 months, that figure is 9.8%.

And I think that is generally reflective of our expectation moving forward within a relevant band plus or minus.

High single-digit yield on a portfolio dominated by high credit quality visa cards is an ample yield, a greater than market average yield by about any measure.

And the delinquency and writeoff trends, again we haven't clarified within a tight range what our expectations are, but obviously we're in a mode of improvement at this point.

And so our prior statements, obviously need to be adjusted not only for the disposition of Mervyn's and Field's, but also for the fact that the portfolio is now much more heavily visa portfolio in an improving credit quality environment, we feel quite good about our prospects for this business moving forward.

Okay.

And then on the remodels, what -- have you disclosed at this point what the cost is for the average remodel and then what the comp lift is that you need to cover the cost of capital?

I realize that you are running ahead of that at this point, just trying to look for more detail on that.

Well, when we talk about remodels, our terminology is meaningfully different from what many other retailers mean.

We spend several million dollars a copy to essentially thoroughly renovate the inside of remodeled stores to look, shop and feel as if they are new Target stores of the then current vintage.

That's an expensive proposition, but one that we think is very important to the perpetuation of our brands to the points of distinction that make our guests delighted to shop at Target.

As a result of that, we incorporate the expense of remodels in our initial new store underwriting, and take into account the long-term return of invested capital characteristics associated with it.

We do not engage in remodels mid-life in a store, in order to generate a then current proper return on invested capital.

Okay.

And then the last question was with regard to traffic and ticket.

I think last quarter ticket was probably like 2/3 of the comp, this quarter, roughly equal with traffic.

What should we be thinking about in terms of the profile of the comp going forward?

Is it something that will be more driven by ticket, as you get better cross sell in the stores, as you drive consumable traffic or is it going to change for some reason?

In the current quarter, about half of our same store sales performance was driven by an increase in average ticket and the other half by an increase in transaction count.

Those relationships ebb and flow.

The more stable of the 2 is traffic.

Traffic is a lot more sticky statistic, this month's traffic is a great leading indicator of next month's traffic.

Average ticket's a little more volatile.

I tend to think of that in percentage point terms of contribution to comp instead of decomposing the comp into the portion driven by each of those.

Okay.

Do you imagine a deflation is going to play at all into this?

What's your outlook on that front?

The inflation, deflation always has an effect on this and our current outlook is neutral to slight rates of deflation, which is a quite different outlook from what we had 12, 18, 24 months ago.

Okay.

Thank you.

Mm-hmm.

Thank you.

And our next question comes from Todd Slater of Lazard Asset Management.

Thanks very much.

You guys mentioned that your mix was -- or at least, Doug, that your mix was favorable, but that your markdowns were somewhat higher than last year.

You know, interesting on the recent CNBC Wal-Mart piece, Wal-Mart management actually credited you guys with doing a better job from their point of view, at least, on matching prices or staying sharp on price points.

I'm wondering how much of the markdown increase you saw in the quarter was driven by matching, you know, prices versus, you know, markdowns on apparel or other areas that don't overlap but maybe that weren't hitting their sales targets and needed to be liquidated.

It was a little bit of both.

We do match Wal-Mart on all identical items and that activity and practice continued into the third quarter.

From our vantage point, Wal-Mart was aggressive, but no -- there was no significance in -- no significant difference in the level of competitive from other quarters.

Part of the markdowns that we had in the third quarter, was due to some slight underselling in the second quarter and those markdowns happen to fall into the third quarter.

And that's where the clearance markdowns that we did occur, were over our planned levels came from.

The rates of sales in the third quarter were very positive, however, and third quarter business and weather trends have been just great.

Could you just touch on the categories where there was the highest level of markdowns from the second quarter carryover?

It was just a little bit of a lot of things.

I mean, we had summer seasonal products that we undersold, whether it was toys and sporting goods, you know, pool goods and eye goggles and things like that.

There were some lawn and garden products that we didn't sell through as cleanly as we expected, and then obviously in our apparel and footwear categories we had a little bit of men's, a little bit of ladies, a little bit of footwear.

It wasn't anything significantly at all.

It was just the culmination of the softness in sales that we experienced in late May and June led to a little bit of carry over into the third quarter.

To maintain our schedule, we'll have time for one more question.

Actually, sir, that was our final question.

So I can turn the conference back over to you.

That sounds just terrific.

Thanks all of you for your participation.

That concludes Target Corporation's third quarter 2004 earnings conference call, and I hope you all have a wonderful holiday season and remember to shop at Target.

This concludes today's conference.

We thank you for your participation.