目標百貨 (TGT) 2005 Q1 法說會逐字稿

Hello, and welcome to the Target Corporation's first quarter 2005 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. [OPERATOR INSTRUCTIONS] As a reminder this conference is being recorded Thursday, May 12, 2005.

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

Sir, you may begin.

Thank you.

Good morning and welcome to our 2005 first quarter earnings conference call.

On the line with me today are Jerry Storch, Vice Chairman, Doug Scovanner, our Executive Vice President and Chief Financial Officer, Gregg Steinhafel, President, and Bart Butzer, Executive Vice President of Stores.

This morning Doug will review our first quarter 2005 financial results and describe our outlook for the second quarter and full year.

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

Gary will update you on the growth and performance of our credit operations and target.com, as well as developments in our supply chain.

Then I will wrap up our remarks and we will open the phone lines for questions.

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.

We plan to keep today's call to no more than 60 minutes including our Q-and-A session.

Susan Kahn and I are available throughout the remainder of the day to address any follow-up questions you have.

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

This morning Target Corporation announced results for the first quarter of 2005.

For the period net earnings from continuing operations grew 26.4% to $494 million compared with $392 million last year.

On this same basis, diluted earnings per share rose to $0.55 from $0.43, an increase of 30.3%.

Total revenues in the quarter grew 12.7% to $11.5 billion, reflecting similar rates of growth in both merchandise sales and net credit revenues.

Comparable store sales rose 6.2% in the quarter on top of a strong 7.3% increase a year ago.

Gross margin rate expanded by 67 basis points over the first quarter of 2004 as both mark-up and inventory shortage improved.

And SG&A rate was unfavorable to the prior year by 41 basis points, about half of which is due to differences in timing of expense and strategies that drive incremental gross margin rate.

Depreciation and amortization expense grew $48 million or 16.4% compared to the same period a year ago.

Total net interest expense decreased $32 million in the quarter from $143 million a year ago to $111 million this year.

This decrease was attributable to substantially lower average funded balances reflecting the application of proceeds from our Mervyn's and Marshall Field's transactions and a lower loss on debt repurchase; partially offset by higher average portfolio interest rates.

More on our outlook for interest expense in a few minutes.

Our effective income tax rate for the quarter was 37.9%, 10 basis points higher than our rate in the first quarter of 2004.

Under our $3 billion authorization provided by our Board of Directors in June of last year we continued to repurchase shares of Target common stock during the first quarter of 2005.

Specifically, we invested $453 million to buy approximately 9.2 million shares of our common stock at a weighted average price of $49.37 per share.

Cumulatively we have now repurchased 37.7 million shares of common stock at an average price of $45.89 per share for a total investment of approximately $1.7 billion.

As a result, weighted average diluted shares outstanding in the quarter reflected a reduction of 28 million shares or about 3% from the corresponding figure last year.

We continue to believe that we will complete our current share repurchase authorization within two to three years of the program's inception.

Now let me turn to the balance sheet.

At quarter end the remaining proceeds from our 2004 dispositions of Mervyn's and Marshall Field's of approximately $600 million were invested in short-term securities shown on the cash and cash equivalents line.

Net accounts receivable at the end of first quarter were $4.9 billion, 11.9% above our receivables levels at this time last year.

Over the same period we have increased our allowance for doubtful accounts, at a slightly faster pace, to $394 million or 7.5% of gross receivables at quarter end.

Our balance sheet inventory position grew 21% from a year ago, reflecting the natural increase required to support additional square footage, same-store sales growth, and our strategic focus on increasing direct imports.

In addition, as we have previously discussed, the year-over-year increase reflects the refinement of our measurement of the point in our supply chain at which effective ownership occurs.

This refinement in methodology which explains about 9 percentage points of the year-over-year growth results in a parallel and ongoing increase in our inventory and accounts payable.

We will begin to annualize the most significant element of this change in methodology in the second quarter.

So year-over-year inventory growth is expected to normalize as we move through the remainder of the year.

On balance, our inventory is in very good condition.

Now let's put our year-to-date results in perspective and use them to provide some guidance for the balance of the year.

Financially, this year is off to a great start.

We exceeded our internal expectations in the first quarter in sales, gross margin rate and in profitability of our credit card operations.

On balance, these factors allowed us to modestly exceed our EPS expectations.

In the second quarter we expect to generate same-store sales increases in the range of 4% to 6% above last year's performance.

Assuming that further gross margin rate expansion is substantially offset by related increases in operating expenses, we should be able to generate increases in earnings before interest and taxes, or EBIT, in line with our total revenue growth.

Separately, we expect our interest expense in the second quarter to approximate the $111 million we incurred in the first quarter.

Collectively these assumptions stand behind our belief that the current median EPS expectation and First Call of $0.53 represents the midpoint of a reasonable range of likely outcomes.

In this year's third and fourth quarters, we expect similar dynamics to unfold in same-store sales as well as gross margin and expense rates although a few issues merit a bit more attention.

One of these issues relates to our recent conversion of the majority of our credit card receivables to a prime based floating rate.

And to the parallel steps we have taken to denominate a like amount of our debt to reprice on a nearly identical timetable.

In summary, future increases in short-term interest rates would create increases in our contribution to EBIT from our credit card operations and in our interest expense; without meaningful impact on our profitability.

Another issue that continues to shape our financial results is that many of the drivers of our gross margin rate expansion also produce some increase in operating expense.

The most visible of these has been the significant growth we have engineered in our direct imports program over the past several years.

I expect that other unrelated efforts underway will continue to have similar effects in our P&L over time.

For the full year, we expect these programs to result in our SG&A rate being approximately 20 basis points higher than last year.

With the second and third quarters looking a lot like our first quarter, followed by a sharp improvement in the fourth quarter.

Finally, one specific quantitative comment about the fall season ahead of us.

While we think the combined EPS outlook of $1.50 for our third and fourth quarters, as reflected in First Call, seems reasonable at this time; the third quarter median estimate of $0.43, if achieved would reflect a somewhat more robust operating performance than the current $1.07 fourth quarter estimate.

In summary, if we produce the $1.50 in EPS, as expected in the fall season, it is possible that we would deliver something less than $0.43 in the third quarter and something more than $1.07 in the fourth quarter.

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 very pleased with our performance.

Comparable store sales increased 6.2% during the quarter above our expectations of 4% to 5% and compared to a 7.3% increase a year ago.

This same-store sales growth is attributable to a very strong growth in guest traffic and an even stronger increase in average transaction amount.

And reflected better than average performance in intimate apparel, lady's apparel, entertainment, other nondiscretionary categories like consumables and pharmacies.

During the first quarter we continued to expand our store base.

Opening a total of 26 new stores, 22 stores net of closings and relocations, and bringing our total store count at quarter end 1,330 stores in 47 states.

Our store opening program in the second quarter is expected to include a total of 23 new stores, or 21 net of closings and relocations.

Our first quarter financial performance confirms the appeal of our expect more-pay less brand promise.

In order to consistently deliver the freshness and excitement our guests expect, we continually update our assortments throughout the year and infuse the right combination of innovation, design and value in our merchandise.

In some categories, like sporting goods and shoes, we make minor improvements.

And in others, such as pets and home, we undertake significant more reinvention.

In pets, we have broadened our assortment and included more merchandise that recognizes the pet's elevated status within the family. we now offer Isaac Mizrahi pet couture, more styles of Woolrich pet beds, exclusive toys by American Kennel Club and [Shawn Conway] birdhouses.

In addition, we continue to increase the penetration of our own brands, Boots & Barkley and Pet Essentials.

Year to date sales of pet supplies and accessories are growing much faster than the chain overall.

We believe our updated and expanded offering provides a considerable opportunity for additional growth.

In home, we have repositioned our assortment to include five different lifestyle preferences: casual, classic, contemporary, global and modern.

And expanded our spectrum of price points and quality to offer our guests enhanced decorating options.

For example this spring we introduced a new bed and bath collection by Fieldcrest, broadened our assortment of own brands such as Target Home and expanded our design partnerships with Rachel Ashwell and Isaac Mizrahi.

In addition, we published our first home catalog and distributed more than 13 million copies to reinforce our new positioning.

The catalog is also available on our target.com Website and continues to get an average of 50,000 hits each week.

This fall we will introduce an exclusive line of home merchandise called Vintage Modern from Thomas O'Brien, a popular well known home designer.

This is one of the largest new merchandise launches we have ever undertaken.

And we are very excited about the quality, styling, value, and breadth of the line.

It consists of more than 500 items throughout our home assortment including; furniture, decorative accessories, dinnerware, bedding, bath and stationary and has tremendous appeal to both men and women.

Thomas O'Brien, like our other designer brands, represents our best quality offering and reflects our commitment to be a destination in home decor.

Our commitment to delight our guests extends beyond's Target's core merchandising and innovative design to increase convenience and superior value.

For example, in late April we launched Clear Rx, our new pharmacy bottle design and system that makes it easier for our guests to take their medications properly.

The feedback we have received from our guests, the media and others, even the Surgeon General has been extremely positive.

This month we are rolling out our new photo finishing program which combines Target's great guest service with state-of-the-art digital processing equipment and a new partnership with Yahoo.

As a result, our guests will joy improved capability to store, share, and print digital photos.

We are also undertaking a significant transition in the adjacencies and presentations of cosmetics, health and beauty, household, personal, and baby categories.

The transition was in inspired by the success we have experienced in our P-2004 prototype stores.

We believe that changes will drive increased guest frequency and sales by making shopping in these areas much easier and more intuitive.

And at Super Target we are increasingly delivering exceptional quality and value throughout our own brands.

We continue to expand our offering of Archer farms and Market Pantry.

This spring we introduced a new line of steakhouse quality Angus beef called Sutton & Dodge, which includes a full assortment of fillets, steaks, roasts, rubs and sauces.

We also recently launched a Website dedicated to Super Target that features weekly store specials, coupons, recipes, simple meal solutions to provide added convenience for our busy guests.

At Target continuous improvement and superior execution are critical to our ability to grow profitably and sustain our competitive advantage.

Whether we are managing our supply chain, designing and sourcing merchandise, developing IT systems or managing a Target store, we strive for excellence in every aspect of our business.

While we have a strong track record, we continue to seek opportunities for incremental improvement because we believe that in order to build upon our current success we must continually raise the bar.

Doug indicated we remain optimistic about the remainder of 2005 and believe our strategy of innovation and discipline will continue to fuel Target's momentum and growth for many years.

Now Jerry Storch will give you an update on our credit card operation, our supply chain efforts, and target.com.

Jerry?

Thanks, Gregg.

As evidenced by the strength of our first quarter performance;

Target's relentless focus on innovation and efficiency is delivering positive results for our Company.

And these results reinforce our commitment to drive change, embrace growth and rise to new challenges to sustain our competitive advantage.

In the first quarter, our credit card operations generated a pretax contribution of $142 million, an increase of 28% from 2004.

Our average receivables rose 11% from the same period a year ago and our net write-off and delinquency rates improved significantly reflecting the excellent credit quality of our portfolio.

We remain very pleased, both with the current performance of our credit card operations and with our outlook.

In addition to the benefits of our continued profitable growth, we believe that the recent bankruptcy legislation will have a favorable impact on our results longer term.

Though we may experience a somewhat higher rate of bankruptcy filings for the next few months, consistent with other credit card issuers, in advance of the legislation's effective date we are comfortable that we are adequately reserved and that this rate will normalize thereafter.

In addition, as Doug mentioned, we have now converted the majority of our Target credit card accounts to a prime-based floating rate, which results in parallel growth in credit card EBIT and interest expense as interest rates fluctuate.

In the current rising interest rate environment we expect our contribution to EBIT from our credit card operations and interest expense associated with funding our receivables will continue to increase.

We are also excited about the initiatives we are pursuing in our supply chain and about their implications for increased speed, accuracy, and efficiency within our retail business.

Currently our network includes three import warehouses and 22 regional distribution centers or RDC's.

To support our continued growth, we plan to increase network capacity this year by about 5%.

Opening a new RDC in Amsterdam, New York, next month and expanding two of our import warehouses by the fourth quarter.

We are also continuing to enjoy the benefits from our ongoing supply chain initiatives described to you in past conference calls including more sophisticated technology and systems, increased automation, and the continued application of our segmentation strategies.

As a consequence, in-stock's remain at historically high levels for top-selling items, ad items, and for the store as a whole.

Looking forward we are committed to the application of world-class technology to our supply chain.

We continue to test RFID at the case and pallet level and believe that over time this technology will transform our approach to inventory management.

We believe that these and other initiatives will help Target sustain our competitive advantage and will contribute to Target's continued growth and profitability.

And speaking of growth, target.com continues to be one of the fastest growing major Websites in the world.

Last year our online sales doubled and year to date our sales are growing at an even faster pace.

We continue to enhance our online merchandise selection, expanding our assortment from 10,000 SKU's, in February 2004 to approximately 90,000 SKU's today.

By year end we expect to offer about 145,000 SKU's.

More than double the selection of a typical Target store.

Strategically, we remain focused on strengthening Target's brand and on driving profitable sales.

We have broadened our online assortment to include extended size ranges, color variations and style alternatives.

And we are increasingly testing merchandise on target.com before integrating it into our store assortments.

As Gregg mentioned, this spring we have partnered with Yahoo to offer a digital photo service on target.com.

This summer we will add in-store pickup for our digital photo service guests.

And Target will be the exclusive pickup destination for millions of guests who use the Yahoo photo service.

And our gift registry celebrates its 10th anniversary this month.

Providing in-store and online convenience for thousands of guests each week.

In addition, we continue to leverage our marketing onto the Internet significantly extending our reach through the use of online content.

And we are aggressively pursuing operational improvements to reduce costs and deliver increased profitability.

Our commitment to innovation and continuous improvement, which underlies the significant improvements in our supply chain and at target.com has also propelled Target to embrace Six Sigma.

A disciplined data driven methodology for measuring performance and improving processes.

To date, we have utilized its approach for several hundred projects.

Driving incremental sales, generating cost savings, increasing productivity and improving guest satisfaction as a result.

A few of the recent projects include; increasing ad in-stocks, driving incremental sales and improved guest satisfaction while significantly reducing rain check volume.

Increasing the flow of large bulky ad items directly to our stores, enabling us to speed product to our shelves, improve distribution processes and free up premium storage space.

And improving the forecast accuracy for call volume at the Target financial services call center.

Allowing us to continue to meet guest service requirements while staffing more efficiently.

As evidenced by the initiatives I've described above we continue to work diligently to achieve world-class status in our credit card operations, on the Internet, in our supply chain, through Six Sigma and in every other area of the Company.

We believe that a focus on continuous improvement throughout our organization is imperative.

And that our efforts will contribute to continued profitable growth at Target 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.

Target remains on track to delight our guests, accommodate -- [Inaudible] for another year of strong growth and outstanding performance.

That concludes our prepared remarks.

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

Thank you. [OPERATOR INSTRUCTIONS] And our first question comes from Deborah Weinswig of Citigroup Smith Barney.

Doug, you talked about in terms of on the SG&A, that unfavorable in CapEx was due to timing difference and also strategies that drive incremental gross margins.

In the past you've talked about needing a 4% to 5% comp to leverage.

Is that still for modeling purposes the correct number or is it even lower these days?

Generally speaking ignoring the issues that you just talked about we need a 4% to 5% comp to neutralize expenses as a percent of sales.

What we're saying is: that on a reported basis that comp would be much higher because we are incurring expenses that are designed to drive gross margin.

And in addition in something like interim quarters, first, second, third quarter, there's obviously a leveraging issue in our lower quarter - - lower sales quarters relative to the fourth quarter benefit.

Okay.

And maybe just elaborating on some of those expenses you say the bulk of that has to do with global sourcing or maybe just elaborating a bit?

I could give you lots and lots of examples.

I'll give a few.

And if you'd like a lot longer list feel free to follow up with Susan and myself.

A couple of examples in the quarter: As you know, we and everyone else in retailing were required to adopt 02-16 a couple years ago.

And that accounting standard significantly tightened up requirements for vendor income to be recorded as an offset to advertising expenses.

We are increasing this kind of activity, and a lot of the income that we collect for our vendors doesn't meet the specific identifiable and incremental criteria to record as an offset to advertising expenses.

So it flows through our statements in the form of higher advertising expense and higher gross margin rate.

Another example in the quarter, as you know, we early adopted the provisions of FAS 123 as revised regarding stock-based compensation.

We now essential expense all compensation related to stock options and related performance shares.

Late in the quarter there was some new interpretive guidance put out by the SEC that caused us to accelerate the timing of recognition of some stock-based compensation.

So there's a lot that goes on in any quarter, let alone any year, through operating expenses.

And those are a couple of examples in the current quarter.

I do want to clarify your comment - - your question and my answer about expense leverage.

Those are annualized figures and any quarter is going to have a lot of variation around that annual theme.

Great.

Jerry you talked about credit card.

If we look kind of year-over-year there's a significant improvement in terms of third-party merchant fees.

Can you talk about that and also maybe just about your increasing communication with your proprietary cardholders?

We are - - what's the question about the merchant fees?

I'm sorry, I'm not aware of that one.

You've seen - - in the release today that kind of if we look at the third-party merchant fees they went from 20 to 27. 20 '04 to 27 this year.

It's about a 35% increase from the third-party.

Well, merchant fees continue to increase.

Let me try to answer that generally.

Merchant fees continue to increase as there have been both rate increase charged by Visa, MasterCard, and others.

And also increasing penetration particularly of debit cards in the mix.

On the other hand, with the growth of our Target Card - - Target Visa Card portfolio we earn income on those interchange fees including the increase and they're largely offsetting of each other.

So the 27 versus the 20 consists in part of increased dollar volume of usage of the Target Visa Card outside our stores and is driven further by rate increases that we benefit from.

As Visa interchange fees increase, we're on the receiving end of that in our credit card operations.

Net, we don't really advocate increases in interchange fees, however, even though we've buffered ourselves somewhat from that with Target Visa.

Okay.

And then just the last question Jerry.

In terms of your increased communication with your proprietary cardholders; can you talk about your initiatives there and just kind of where we are?

Well, communications continues to - - with cardholders continues to be the number one reason why they choose to have one of our cards.

And we have an extensive program there on our Target Visa and always have on our Red Card.

We've made efforts more recently to make sure that were taking the Red Card level up so that it was more consistent with what we're doing on the Visa.

And we think our guests are quite pleased with both.

Great.

Thanks so much.

Thank you.

Our next question comes from Annie Tazlov of Sanford Bernstein.

Doug, continuing with the SG&A what I wanted to clarify was; on last quarter's conference call in the Q&A you said that above planned comps could drive a flat to down SG&A rate.

And obviously you came in above plan but you deleveraged a lot.

So are these items that you were just listing, are a lot of these just new quarterly events that could change our thinking?

And then separately, in terms of credit, the spread on bad debt expense and net write-offs contracted quite a bit from Q4.

And I recognize the delinquency in write-off trends are improving.

But I would have thought that given bankruptcy filings are expected to increase given the new law.

And that you are experiencing strong growth in receivables that those two factors would have kept that spread closer to what you had in the fourth quarter.

Can you help us understand why it narrowed and how we should be modeling it going forward?

Thanks.

Let me go back to the operating expense question first of all.

Comments that I made last quarter which you're correctly characterizing apply to annualized periods.

As we incur extra expenses pursuing many of these strategies it causes a deleveraging Q1, Q2, Q3, fully offset by substantial favorable leveraging in Q4.

One of the reasons I expect adverse operating expense rate performance in the next two quarters is directly traceable to this phenomenon.

The benefit comes across our P&L in the form of even gross margin rate on sharply higher sales in the fourth quarter than the other quarters.

Yet the occurance of expense is smoothly recorded through the year.

So if we were to incur higher than expected sales for the year I would expect to be able to neutralize or leverage sales.

We have enough individual issues that we can see headed our way in operating expenses that that's not likely to occur this year.

Hence my comment about expecting about a 20 basis point recorded, reported deterioration in expenses as a percent of sales for the full year.

Driven in the main by strategies that drive extra gross margin dollars.

And for the year most of the timing issues, of course, wash out.

Back to credit cards, all indicators of health in our credit card business are in terrific shape with the sole exception of what we think the short run issue might be in terms of a little blip in bankruptcy related write-offs as individuals rush to file before the new legislation takes place this fall.

Really, if it weren't for that risk and for the potential of additional write-offs due to increases in our required minimum payments, driven by a lot of regulatory discussions that are happening throughout the credit card industry, you'd probably have seen us, absent those two factors, you'd probably see us with a lower allowance at quarter end than what we have.

Okay.

So the 60 basis point spread is more realistic going forward?

I don't think that it's appropriate to think of that spread because there are absolutely different dynamics driving each of the two pieces.

All right.

I'll check back with you after the call.

Thank you.

Our next question comes from Adrianne Shapira from Goldman Sachs.

Thank you.

Gregg, given the tremendous success of Global Bazaar and obviously the resulting very strong margin, can you give us a sense is there any opportunity to do perhaps nothing of this size but something similarly strong margin opportunity in the back half?

Certainly we're not going to be doing another Global Bazaar in the second half of the year.

But what Global Bazaar taught us, is that our guests respond to great quality, great value.

And some of our higher selling price points sold exceptionally well.

So we are taking that knowledge in all of our business reinventions and seasonal updates, whether it's our back to school, back to college strategy, Halloween or holiday programs we will continue to infuse newness, high quality, luxury items at great values as well.

So is it fair to say that in the seasonal offerings we'll see a growing global sourcing component to all of these offerings?

You will see a growing global sourcing component.

And you'll see us continually push the envelope in terms of our best quality and luxury quality offerings within each of those businesses.

And you had highlighted pets and home as clearly two categories of opportunities.

Home continues to be an area of emphasis.

Are there other parts of the stores that we should see similar types of reinventions coming?

Well, as we've discussed, we have had numerous reinventions this spring and those will continue throughout the year.

We've talked about pharmacy, photo finishing, the health and beauty aids, adding both Coke and Pepsi products in the store, California Closet.

We reinvented our intimate apparel area, the Thomas O'Brien launch this fall will be another big launch.

And our seasonal initiative like Halloween, back to school, back to college will be very innovative, very theatrical and will drive sales and market share as well.

Then just last question on square footage, anything perhaps you could share with us given what is clearly an increasingly consolidating department store sector?

Any sort of opportunities you see on mall in terms of additional square footage opportunities?

Well, it's very but obviously with the consolidations going on there are opportunities for people to merge stores.

Some things will come on the market, we have indicated our interest to a number of people.

And I would expect we would get some locations but nothing is currently happening.

Thank you.

Thank you.

Our next question comes from Jeff Klinefelter of Piper Jaffray.

Yes, couple questions, Gregg.

One on Super Target.

First of all, any updates on the performance of food versus general merchandise as we enter 2005 relative to 2004 trends?

And specifically are you getting any better recognition of your favorable pricing in food, which I know there was a little disconnect in terms of how competitive your prices are versus perception?

And then any updates on kind of what the comp trend is for a Super Target store in the first few years of operation versus a regular Target store?

As you know food is a key component of our overall strategy whether it's in a general merchandise store or a Super Target.

It is important part of our frequency strategy and food in Super Target is performing well.

I mean, we're pleased with the results.

And it continues to drive the kind of frequency that we need to make that strategy successful in terms of the - -.

in terms of the first couple of years of performance in same-store sales terms our super Target Stores enjoy the same very sharp increases in same-store sales that we also enjoy throughout the rest of the chain.

Okay.

Gregg, also, in the patio product in particular, I know that was category you had focused on, and changed your assortments heading into the spring season, testing.

And I think you mentioned last fall favorably going more toward a better-best strategy.

Can you give us any updates on how that's going this spring in terms of the reception of those higher price points?

And then lastly, for Doug, just a quick update on inflation-deflation kind of outlook for the year versus last year?

Our patio business got off to a very, very strong start.

We saw great response to the better and best items.

Our best selling gazebo is our most expensive gazebo on the sales floor.

We really hadn't seen any price resistance at all through that.

And they've really embraced our strategy.

We have seen, however, geographic differences as the weather patterns have been very mixed this year.

Our business has been very strong on the west coast of recently.

And our business has been very strong in the south.

But it has - - it started strong in the north and the east, and we've had some periods of some very cool and wet weather.

And recently it's been fairly soft in those parts of the country.

Our outlook on inflation and deflation in our retail sales is virtually identical to the outlook we had 90 days ago.

Specifically, we're reasonably neutral in our outlook and that's a quite different comment from the experience of the last couple of years characterized by pretty sharp levels of deflation.

Thank you.

Thank you.

Our next question comes from Gregory Melich of Morgan Stanley.

Two questions.

One and this would be for Bob or Gregg and then one for Doug, What do you think, if you had to rank it is really driving the traffic increase?

We see so many retailers having trouble driving their traffic.

And Bob, I remember last year at the analysts' meeting you said that your customers don't really know, not enough of them know how low your prices are in consumables.

Do you think that people now are finally getting that and that's what's driving it?

I'll let Gregg answer because he put together our frequency initiative but obviously consumables are an important part.

It's a combination of all the things that we've been working hard for a long time to implement in our stores.

Clearly it's great execution of the composite of our expect more pay less strategy and low prices and frequency is a core component of that.

Having the right content, tactfully presented is a key ingredient of that success as well.

As the marketing program that is resonating so well with our guests.

Our supply chain efforts that have improved our in-stocks have contributed to the overall loyalty and subsequent increases in guest traffic.

And then in - - and lastly just the execution at store level, the speed of service, friendliness, the can I help you approach that we're taking in our stores all contributes to the long-term success in the stores.

And slowly but surely we continue to get traffic increases on a mature store basis.

So it really is a combination of all those elements working together that drives the strategy forward and drives guest - - mature guest counts into the building.

And as Gregg mentioned earlier, we are increasing our assortment of food in many, many stores and that is also helping drive traffic, whether it's dry grocery or whether frozen or whether it's refrigerated products.

And then, Doug, as a follow-up to the inflation/deflation do, could you update us on what would happen or what would be the opportunities or risk if the Chinese were to revalue their currency or there was some sort of brewing protectionism that's going on out there?

How would you guys respond?

Well, first of all, from a standpoint of the countries that we source from we have offices in 40 countries around the world.

And that's spread throughout Asia, China is naturally a very important part but we're certainly not exclusively there.

We're in India, we're in Pakistan, we're in Vietnam, we're in a variety of places.

So, if there some inflation there it's possible some programs would move.

Overall, we feel our sourcing is in very good shape.

As far as the deflation aspect, Doug might want to comment.

I think keying off of Bob's comments, it isn't likely in our view to have a very meaningful impact on our overall equation.

Certainly not a meaningful impact in our competitive position given the fact that whatever occurs is something that will have a relatively even effect across many competitors.

I think that there's far, far, far more hype in the press regarding this issue than is warranted.

Thanks.

Thank you.

Our next question comes from Teresa Donahue of Neuberger Berman.

My questions has been answered.

We'll move on to Mark Husson of HSBC.

Could we focus on pharmacy business here right now.

You're in over 1,000 stores now.

Is the improved gross margin we're seeing on generics across other participants in the industry; is that meaningful to you at this stage?

And then secondly, as Medicare changes next year, are there any specific challenges to your guidance in terms of having a high number of uncovered seniors as customers currently?

The changes pharmacy and gross margin rates really is insignificant in the total gross margin rate at the Company level.

And our gross margins in pharmacy have been fairly stable for the last couple of years.

Obviously, you know, Medicare implications will have an impact on all of us and we will continue to monitor what's going to happen with that, and we will respond accordingly.

Just another big picture question.

In the press again today there was some speculation about a link-up with Tesco and the nature was rather vague.

But you have linked up with people in the past.

Is there any appetite that you have for looking overseas in some kind of partnership?

Well, we know that we can currently double the number of stores in the continental U.S. and then with comparable store sales growth that would lead us to be able to triple in size in this country.

And it's very sexy to be overseas, however, there's a very strong return for our strategy here and so I think overseas is still a ways off.

We do have offices in 40 countries around the world and source overseas.

We also benchmark marvelous retailers like Tesco and trade information with them on a regular basis.

And so that is the only form of collaboration we are looking for in the future.

Thank you.

Our next question comes from Dan Binder of Buckingham Research.

Good morning.

Couple of questions.

First, with regard to the credit business, Annie had cited some changes in the bankruptcy law, which we're all familiar with.

Is is there any change that would actually benefit you on your ability to collect?

That's the first question.

Second question, with regard to any expansion on the mall, should opportunities arise, would you sort of view that as being incremental to your 8% ongoing square footage growth rate goals?

And thirdly, on the stock-based compensation issue you had cited, and we are all familiar with the more stringent rules there.

Is that going to result in greater stock option expense this year than you originally expected?

On the bankruptcy question, we very much believe legislation will be positive for us over the long term.

It's just in the first few months until the law becomes actually the law.

It's been signed but it's not the law for a few more months, people are rushing to file for bankruptcy to get it under the window.

As soon as that is over with we expect it to be a very trend for us.

As far as mall expansion, if as a result of industry consolidation a number of stores become available at attractive rates for our investment, there could be a short-term spike upward in the number of stores that we would have.

On your timing question regarding stock-based compensation, yes the acceleration added 10 basis points in the quarter to our operating expenses.

That is a timing issue that will turn around during the four-year vesting life of our recent option grants.

But will not turn around this year for the year it will add two or three basis points of SG&A as a percent of sales.

Great.

Thank you.

Thank you.

Our next question comes from Robert Drbul of Lehman Brothers.

Couple of questions please.

The first one is; can you talk a little about the pricing environment on the consumable level, if you're seeing any pressures there from a competitive basis?

Second question would be, can you just give us an update in terms of the performance of the amount of business that you're driving through the circular?

And have you seen any sort of deviations from what you had been seeing in the past?

Yes, the pricing environment has maintained fairly decent stability over the last couple of years.

We haven't seen huge shifts either way.

Wal-Mart continues to be aggressive with their roll-back strategy and we respond accordingly.

But as we have experienced some price increases in some categories like food and other areas where there's steal or in base we've been able to pass on some of those cost increases in the form of higher retails.

And higher retails have generally stuck in the marketplace.

So, there's overall I would say general rationality in the pricing environment today.

As it relates to our circular sales as a percent of total sales, that has been fairly stable over the last couple of years.

We haven't had any significant changes whatsoever.

It fluctuates a couple of percentage points here and there but overall it's pretty stable and we're not looking to make significant changes with that.

Great.

Gregg can you just provide an update on the experience you're having with the One Spot initiative and what we should be looking for as we look at the rest of the year for that?

Well, the one spot continues to do well particularly after we reset.

We change the assortment out every six to eight weeks, we see a huge spike in business, and it's generally incremental to our overall strategy.

We'll cycle it this September, which is when we rolled out One Spot to the entire chain.

But it's got a fun assortment of quality gift oriented impulse merchandise, kind of treasure hunty, and our guests just love it.

They've responded very positively to it.

Thank you.

Thank you.

Our next question comes from Christine Augustine of Bear Stearns.

Thank you.

Could you let us know by the end of this year what percentage of your store base will be in the P-2004 format?

And then Gregg, you talked about some resets in the health and beauty aids area.

Is that something that's happened across the store base or is that you're rolling out over a certain period of time?

Christine I would ask that you follow up with Susan or me because we'll need to do a calculation for you to answer your P-2004 question.

But in the ballpark it's going to be in the range of 25% to 30%.

The health and beauty aid transition I was referring in to my remarks is a reallocation of space that expands and contracts certain businesses within that area and really realigns adjacencies for a more improved shopping experience.

We'll commence this activity in early June.

And it will be over approximately a two and a half to three week time frame.

So this is yet to come.

You'll experience it in the next four or five weeks.

Thank you.

Thank you.

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

Thanks.

This is sort of a broader question.

The message that you're sending certainly about the near term and the year as a whole is certainly an up-beat one, guiding for comps of 4% to 6% in the second quarter which is consistent with your longer term guidance.

And we're getting a different message from your biggest competitor.

So my question is why are you not as concerned about the macro environment as Wal-Mart?

Is and maybe if you could just give me some thoughts on the macro environment as it relates to your business, that would be helpful.

Well, certainly if you go back a period of time, a couple of years ago, when the economy was not as strong, Wal-Mart sales, frankly, were a little bit better than ours on a comp store basis.

And we felt they were driven more by commodities and foods which are not as much discretionary purchase.

With the economy being a little bit better and our business is focused more on discretionary items;

I think it's reasonably natural to see our sales pick up and do a little bit better overall this environment.

We think the economy is softening a bit but we still think it's very healthy and we anticipate at this point in time reasonable increases going forward.

But I'm sure there are many people in the audience who have far greater knowledge of economics than I do.

If you think about your April same-store sales growth it wasn't a huge miss but it was a miss for you.

And you haven't - - you hadn't recorded a miss in awhile and you had comp trends in the 8% to 9% range in the February-March period.

I mean would you - - I know Easter complicates things, the shift of Easter, and some other issues the weather and so forth.

But in thinking about the comp trend into the second quarter, it sounds like you're looking for sort of a more normalized rate of same-store sales growth in the second quarter, which would be somewhere in the mid single digits.

Let's go back and review what actually happened in March and April regardless of our outlook at the time.

Our actual March adjusted for the calendar shift were about 5.7%.

Our actual results in April were about 4.1%.

Again, those figures simply adjust our reported numbers for the measured effect of the calendar shift. 5.7, 4.1.

That differential is reasonably typical of month to month kind of differentials we experience throughout any year.

As we look forward into May-June-July we had a very strong performance last May and weaker performance from a same-store sales standpoint in June.

Therefore we think 3% to 5% increase is likely in the cards here for May.

And we expect a stronger increase in June and for the quarter given the importance of June to the quarter, 4% to 6% for the quarter. 3 to 5 for May in our view is just perfectly consistent with the recent history adjusted for those calendar shifts.

That's great.

Helpful.

Thank you.

Our next question comes from Mark Miller of William Blair.

Hi.

Good morning.

Target's had a growing number of partnerships with designers and I'm sure when you go into discussions with designers prospectively you talk about the performance of these exclusive lines.

Could you give us some color looking back on what type of growth you've seen in your exclusive lines?

If you could compare them generally against national brands across the store?

First of all, almost all of our apparel is internally developed and sourced, and we don't have that many national brands.

Sure, there's some basic underwear and things like that.

In general, our experience with designers has been much more positive than just having a normal line that we have had for sometime, whether it be a Cherokee or Exhilaration or Merona.

Isaac Mizrahi for instance has been incredibly influential.

On the other hand, our mainline brand names still continue to do well.

And the designers add sort of a buzz level and excitement and they stimulate guests and they're doing very well.

But I wouldn't imply that that's the bulk of our volume at this point in time.

Separately with the comp trend that you're seeing, what's the component of traffic versus mix?

Our traffic most recently has been in the positive 2 to 3 range, which is very, very strong compared to our history and the rest, of course, is hit.

So Doug, has the upside been in the traffic versus expectations or how much is on mix?

I guess I'm interested in your comment, Gregg's comment, about the higher price points for the gazebos.

Wouldn't that be, all else being the same, positive to labor if your higher price point items are doing better?

All else being equal of course.

But all else if far from equal in our stores right because there's a lot of extra activity that we're driving in our stores as a result of a lot of these merchandising initiatives that we've discussed and those activities create the need for extra labor.

But is the upside on comps been in mix or traffic or both?

I'd say a bit more than half of the upside from my expectations has been driven by traffic.

Great.

Thanks.

Thank you.

And our next question comes from Marc Cohen of Forest Capital Management.

In previous calls you've said that you have number of mall-based stores in your current portfolio and that you like those stores very much.

In recent months there's been a lot of speculation which was highlighted in Women's Wear Daily that you were close to reaching a deal with Sears Holding to buy enough stores to meet or exceed your square footage expansion plan in one fell swoop.

Could you please comment on this?

With respect to that publication I don't take my M&A guidance from Women's Wear Daily.

We operate about 100 mall-based stores now.

Definitions get to be important here.

That's not 100 multilevel stores in classic A and B suburban mall locations.

And we like those stores just as much as we like our off-mall stores.

We use the same financial criteria to measure expected results and actual results.

And we are a lot more driven by trying to find adequate real estate in trade areas that are chock full of the kinds of households that love shopping at our stores regardless of whether that real estate is on the mall or off.

Just, you mentioned M&A there.

When you guys were back in late kind of mid to late last year, were you thinking about making a competing bid for the entire company of Sears to get all those stores?

I don't think it's appropriate for us to ever comment on idle speculation regarding our M&A activities or lack thereof.

Our next question, Ben Stoler of HS Cap.

Hi this is Avi Kernan, Ben is actually off the desk.

I have a couple of apparel focus questions.

I'm trying to get a sense of how the apparel part of the business is performing.

And are we happy with our brands of Cherokee and Mossimo?

We are happy with our brands of Cherokee and Mossimo.

Our apparel business so far year to date has been good overall.

We've been performing slightly better than the Company in ladies and we've been performing slightly less than the Company rate in our kids business for year to date performance so far and men's has been pretty close to Company average.

And going forward are we going to see an increase or a decrease in the square footage allocation to apparel?

I wouldn't expect any significant change in the footage we devote to apparel going forward.

And just help me understand, if we like the brands, does it make more sense just in terms of margins to bring them in-house and kind of eliminate the speed that we have to pay out for a process we basically do ourselves?

Are you speculating on outside stock relationships?

We - - always look at the brands and some of them we own and some of them we have licenses on.

And we continue to look at that on an ongoing basis but we certainly have no major moves in mind at this point.

But that's something that we would consider?

All our national brands, all of our own brands, all of our designer relationships have life cycles to them.

We will - - we evaluate our current mix appropriately on an ongoing basis and we make strategic changes or tactical changes when appropriate.

FYI, Mossimo is for sale has peaked our interest.

Thank you very much for that information.

Thanks very much.

Good quarter.

Thank you.

We're down to the point where I think in order to finish on time we'll take one more question.

Actually, sir, I'm showing no further questions at this time.

That is very good.

That concludes our first quarter 2005 earnings conference call.

Thank you all very much for your participation.

This concludes today's conference.

We thank you for your participation.

Have a good day.