目標百貨 (TGT) 2005 Q2 法說會逐字稿

Hello and welcome to the Target Corporation's second quarter second quarter 2005 earnings release conference call. [OPERATOR INSTRUCTIONS] As a reminder, this conference is being recorded, Thursday, August 11, 2005.

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

Sir, you may begin.

Good morning.

Welcome to our 2005 second quarter earnings conference call.

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

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

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

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

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

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

Thanks, Bob.

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

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

But Susan Kahn and I are available throughout the remainder of the day to address any follow-up questions you may 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 announced outstanding financial results for the second quarter of 2005.

We had earnings from continuing operations, grew nearly 50% to $540 million, compared with $360 million last year.

And on this same basis, diluted earnings per share rose almost 55%, to $0.61 from $0.39 a year ago.

Even adjusting for last year's $74 million or $0.05 per share loss from the early retirement of debt, Target delivered superior performance and earnings growth in the current year.

Well ahead of our $0.53 EPS expectation when the quarter began.

This strength in performance is primarily attributable to two related factors.

Better-than-expected same store sales growth of 6.7%, compared to a plan of 4 to% 6%.

And exceptional gross margin rate expansion, totaling 110 basis points and reflecting substantial improvement in mark-up.

In addition, mark-downs and inventory shortage performance were also favorable in the quarter.

Our credit card operations also continued to contribute meaningfully to our overall profitability.

In the second quarter, the contribution to EBIT, or earnings before interest and taxes, from our credit cards was $153 million.

Reflecting an increase of $33 million or 27.5% compared to the same period a year ago.

Average receivables grew about 13%.

Net write-off and delinquency rates improved significantly in the quarter, reflecting the excellent credit quality of our portfolio.

Our expenses in the quarter increased at a faster pace than our sales.

This resulted in a 44 basis point increase in our expenses as a percentage of sales, which is primarily attributable to two issues.

First, our profits and our stock price increased significantly in the quarter.

These facts in turn drove increases in stock-based compensation, and incentive pay, which represents somewhat over half of the expense rate increase.

And on a net basis, the remainder of the increase was driven by strategic actions and accounting issues, which directly benefit gross margin rates.

I use the word net because in any quarter, there is a list of generally offsetting changes and this quarter was no exception.

Depreciation and amortization expense grew $47 million, or 15.7%, compared to last year's second quarter.

A combination of our exceptional sales performance during the quarter, our significant gross margin rate expansion, and the contribution from our credit card operations produced second quarter EBIT of $979 million.

An increase of more than 24% from $786 million in the second quarter of 2004.

EBIT as a percent of total revenues expanded by more than 70 basis points, to 8.2%.

Net interest expense decreased $97 million in the quarter, from $207 million a year ago, to $110 million this year. $74 million of this decrease was attributable to last year's loss on debt repurchase.

The remaining decline of $23 million was driven by lower average funded balances, partially offset by higher average portfolio interest rates.

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

Under the $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 second quarter of 2005.

Specifically, we invested $80 million to buy approximately 1.7 million shares of our common stock at a weighted average price of $47.42 per share.

Cumulatively, we have now repurchased 39.3 million shares of common stock at an average price of $45.95 per share, for a total investment of $1.81 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 expect to complete our current share repurchase authorization within two to three years of the program's June 2004 inception.

Net accounts receivable at the end of the quarter were $5.0 billion. 14.8% 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 $409 million, or 7.5% of gross receivables at quarter end.

Our balance sheet inventory position grew 14.5% from a year ago.

Nearly 4 percentage points of this increase results from last year's inventory accounting requirement - - refinements, which we have previously discussed.

On an apples-to-apples basis, inventory increased somewhat slower than sales.

By the end of the third quarter, we will have fully annualized last year's refinements and our balance sheet inventory comparisons will be directly comparable.

Overall, our current inventory content and level 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.

As a reminder, our year to date results include significant year-over-year financial statement benefits of application of last year's $4 billion-plus of after-tax transaction proceeds.

From this point forward, we will be cycling prior year periods, which already reflect this benefit.

And this year's second quarter, once again, our sales, gross margin rate, and the profitability of our credit card operations exceeded our internal expectations.

And in combination, these factors allowed us to exceed our EPS expectations.

For the first six months, our actual results are $0.11 above the First Call EPS consensus for this period when the year began.

We have enjoyed robust growth in sales and profits so far this year, and today, we believe we are well positioned to deliver the combined third and fourth quarter EPS expectations of $1.50 currently shown in First Call.

This performance would represent a 19% growth in EPS, reflecting yet more profit margin expansion on top of last year's strong results.

But let's be clear.

Our long-term strategy envisions maintaining, not expanding our operating margins, and generating an increase of 4% to 6% in same store sales.

This is our recipe for delivering reliable average annual mid-teens percentage growth in EPS over time.

And we will be delighted to achieve this outcome.

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

Gregg?

Thanks, Doug.

Target delivered strong financial results during the second quarter.

Reflecting a keen focus on our guests and sound execution of our overall strategy including; innovative and compelling merchandising, such as our launch of Clear RX, and our reinvention in home and pets.

Distinctive marketing that resonates with our guests, exceptional value delivered through a combination of outstanding quality and pricing.

Superior in store execution and instock levels, and great guest service.

Total revenues in the second quarter increased 13.6%, to $12 billion, due to a 6.7% increase in comparable store sales and the contribution from new store growth.

This same store sales growth was driven by increases in both average transaction amount, and guest traffic, reflecting strength in food and consumables, as well as our seasonal and apparel businesses.

Again, we managed our inventories well during the quarter, and are very comfortable with both the quality and level of inventories as we head into the second half of the year.

During the second quarter, we continued to expand our store base, opening 23 total or 21 net new discount stores.

At quarter end, we operated 1,351 stores in 47 states, including 147 - - 141 SuperTarget locations.

Our store opening plans for the remainder of this year include the addition of 60 new stores in October.

Net the relocation and closings this opening cycle, our largest ever, includes 32 new discount stores and 17 SuperTargets.

Our guests enjoy Target's innovative and affordably designed products and they increasingly look to us to identify new trends, test new products, and deliver the unexpected.

As we move into the fall season, we are continuing to add excitement and build on our year to date momentum.

For example, in apparel we are expanding wear to work assortment to include suit separates for men and women.

Featuring fabrics, construction and finished details on specialty demands like specialty brands like Banana Republic and Ann Taylor but at half the price.

As part of the home reinvention, we are launching a superior quality home collection with our new designer, Thomas O'Brien, that includes hundreds of items.

We are also introducing Redell(ph) wine glasses and adding 600 thread count sheets to the Field Crest line.

To offer our guests greater value we are adding our new own brand as well called Modern Home.

To enhance and simplify our guests' shopping experience in electronics and entertainment we are adding new adjacent fees and signing expanding the space devoted to video games by about 50%.

Offering the late nest gaming including X-Box 360 and other new releases.

Also we are repositioning and expanding our TV offerings with new and larger screens in high definition, LCD, DLT and plasma format.

And earlier today, we announced a new design partnership with Smith and Hawkins for an exclusive line of garden-inspired items that are expected to be in our garden centers in late 2005 and in stores nationwide in March, 2006.

The collection will feature key items including patio furniture, fire pits, opera decor, wreaths and planters for the patio, front porch and entryways.

Finally, we are featuring great value and innovative design in the back to school and back to college assortment including an exclusive Ipod backpack an expanded lighting and furniture offering.

Unique merchandising is supported by a compelling marketing program that includes a series of short Internet film episodes with cutting edge music and film partners.

A Website with downloadable audio files and ring tones.

And a 52-page catalog and coupon booklet, special back to college events in major college markets.

Based on early results, which are in line with our expectations, our back to school, back to college guests are pleased with both our merchandise offering, and marketing approach.

Throughout our stores we remain focused on delivering our Target brand experience and on driving increased guest frequency.

Because consumables and commodities are integral to this effort, we are more than doubling our food offering in our new and remodeled general merchandise stores.

In addition, in selected discount store, where a full remodel is not currently rescheduled we are adding refrigerated coolers alongside with dry grocery items to right size the consumables assortment.

By the end of this year, we expect nearly half of our stores to reflect these updates.

At SuperTarget an increasing number of guests are buying both groceries and general merchandise items when they shop.

Responding to the innovation, quality, and value of our offering, and favorably impacting our gross margin performance.

Additionally, our instock levels on food items across the chain continue to be at record high levels, as we grow in size and scale.

And increase the efficiency of our supply chain through greater self distribution of nonperishable items, continued partnership, on perishable distribution with Supervalue, McClain and others.

We now, self distribute nearly 50% of all food SKU's available at SuperTarget and about 40% of the food items we carry in our traditional discount stores.

To stay relevant to our guests, we continue to innovate and refine our capabilities with internal design, product development, and global sourcing.

And continue to seek opportunities for additional efficiencies, full and cost reductions throughout our operations.

Our commitment to delight our guests and deliver on our expect more, pay less brand premise remains as firm as ever.

We are confident in both our strategy, and in the agility and experience of our organization to achieve continued success.

Now, Jerry Storch will give you an update on our credit card business, target.come and our supply chain initiative.

Jerry?

Thanks Greg.

Target's commitment to continuous improvement, innovation and great design throughout our organization is a critical element in our ability to sustain our competitive advantage and achieve world class performance.

Whether in our credit card operations at target.com, in our supply chain, or in many other areas of the Company, we remain focused on innovating and driving results.

As we grow our business, we are increasing our efficiency, flexibility, and reliability, to strengthen our relationships with our guests and capture market share profitably.

As Doug mentioned, we are very pleased with the performance of our credit card operations, which continued to enjoy meaningful growth in the second quarter.

This business has consistently met or surpassed objectives, and we are delighted with our continued momentum.

However, we are not standing still.

We continue to innovate through advanced analytics and process improvements to sustain our excellent results.

And to maintain strong relationships with our existing guests, and attract new guests to target, we are enhancing the loyalty programs on both our Target Visa and Target Card, collectively referred to as our Red cards.

For example, in July, we extended the Target rewards program, a key loyalty driver for the Target Visa to the Target Card, enabling all of our Red card holders to earn savings certificates through card usage.

And for a seven-week period during the back to school season, Target is doubling the contribution we make to eligible K-(ph) 12 schools through our take charge of education program, to 2% of our guests instore and online, Red card purchases.

We also build loyalty with our guests through our gift card program.

For the past several year, gift card issuance and redemptions have been growing at a strong double digit pace, reflecting our cards' innovative designs and functionality.

Our reloadable gift cards including the two-part gift card, that allows parents to replenish their college students gift card remotely, continue to be well received by our guests.

This element of convenience is one more way we fulfill the expect more component of our brand promise, and achieve improved financial results.

Target.com is another key element in our strategy to connect with our guests and reinforce our brand and our efforts are generating positive results.

Year to date, traffic is up by more than 50%.

Placing target.com in the upper echelon of retail Websites.

And sales have more than doubled from a year ago.

To sustain this appeal with our guests and propel our growth we remain focused on delivering exceptional value, unique an exciting merchandise, and superior service.

Several recent and ongoing initiatives include; we are expanding our assortment for approximately 90,000 SKU's today to about 200,000 items at year end.

By broadening our selection in furniture, home decor, gift, toys and apparel and adding new categories such as hardware, fine jewelry and tabletop.

We are developing merchandise assortments that compliment and extend the offerings available to our instore guests.

Examples include a greater assortment of colors and sizes in key fashion items, furniture and accessories that complete a set.

An expanded array of seasonal products; such as our back to college offering this fall with 7500 SKU's of college logo and teen merchandise from the top 125 schools.

After testing at target.com we are leveraging online sales results and our sourcing speed to incorporate highly desirable merchandise quickly into our instore assortments chainwide.

And we continue to add personalized marketing and expand online functionality to enable our guests create a shopping list, check their schools take charge of education total, or find out if their prescriptions or photos are ready for pickup.

We believe these initiatives at target.com allow us to deliver our guests' preferred online shopping experience, more often and more consistently.

To provide a platform that fuels more guest visits to our stores as well.

Our supply chain is another area of strategic importance and significant investment.

We remain focused on developing the appropriate word class infrastructure and technology to support our continued growth and deliver consistent record high instock levels for our guests.

For example, we continue to expand and improve our two-tiered distribution network, which currently consists of three import warehouses and 23 regional distribution centers.

We continue to increase the number of programs participating in transition tracking, which is creating a dramatic improvement in our store workload and merchandise presentation.

As a result of the Six Sigma initiative, we've implemented changes, which have produced meaningful improvements in our instock levels for advertised items.

And reduced rain checks by approximately 30%.

And we've recently extended our segmentation program to include our top grocery items.

And though early in the program we are encouraged by the results.

In conclusion, we believe that a Companywide focus on continuous improvement is imperative to sustain our competitive advantage, and we are working diligently to achieve and sustain world class performance.

While we are pleased with our progress to date we continue to seek opportunities for even greater efficiency, speed, and innovation in our operations.

And we are confident that our efforts will contribute to continued profitable growth at Target for many years to come.

Now Bob has a few final comments.

As you've just heard in detail, we are pleased with our overall results in the second quarter.

Through our continued strategic investments and unwavering focus on delighting our guests, we believe that Target remains on-track to deliver another year of outstanding performance in 2005 and profitable growth for many years to come.

That concludes our prepared remarks.

Now, 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 Smith Barney.

Good morning, and congratulations on a great quarter.

Gregg, you spoke about what is happening on the food offering side is.

This any different in terms of strategy than when you originally rolled out the P2004?

And also you can talk about any change in frequency of visit, either at the discount stores or SuperTarget.

There is no change whatsoever from we have been doing in our right-sizing strategy for the last three years or when we introduced our P2004 format.

So, it's a consistent program that we have undertaken.

In terms of frequency, we continue that realize that food is driving frequency.

And our frequency is increasing in both our general merchandise and SuperTarget stores and we're very pleased with that.

Okay.

And then Jerry, talked about kind of using the Website as a way to kind of do a better job of kind of testing some of your products.

Can you talk about how you're using it for any of the merchandise you're using in the back half of year the and maybe kind of help us understand how you might use that going forward as well?

It is an ongoing process.

We test products on the Web.

For example, if we have ten colors or something we want to try for the stores, we might put all of them on the Web and only bring four forward in the stores.

So, it's a continuous process throughout the year.

Great.

Thanks so much.

Thank you.

Our next question is from Jeff Klinefelter of Piper Jaffray.

Yes, two quick questions for you.

First of all Doug could you talk a little bit more about your gross margin expansion and SG&A spend?

It sounds like you've been investing SG&A to drive the gross margin expansion.

Can you talk a little bit about when we cycle that stepped-up level of spending?

Is that spending on your direct sourcing infrastructure to enable that mark-up?

And maybe is the mark-up coming across a lot of different product categories?

Or is this mix shift with very strong apparel driving a lot of that gross margin expansion?

And then I have a quick follow-up for Gregg.

First of all on the your SG&A question, some of the SG&A that I've referenced that drives gross margin rate is related to those strategic actions.

Some of it quite candidly is simply a direct accounting result, not something that is standing behind an overall strategy.

Let me give you an example in the latter category.

We have stepped up our co-op advertising this year and we are receiving consideration from our vendors to cover a portion of that.

But the consideration doesn't always meet the strict technical accounting criteria to be accounted for as an offset to advertising.

And the alternative of course is an offset to cost of sales.

Quarter over quarter, this year versus last year, 11 basis points of the SG&A rate deterioration represents co-op advertising that we received reimbursements for, but in our financial statements it shows up as advertising expense offset by lower cost of sales, which is higher mark-up.

On your mix question, sources of mark-up and so forth, the mark-up increases are across the board, and in the quarter, while we had lots of ins and outs on a net basis, mix was relatively neutral to gross margin rates.

Okay.

Great.

And Gregg, you have some fantastic brand launches and category extensions going on in the store and I know that there has been a trend toward capitalizing a little bit more on the better-best part of your good, better-best strategy.

I think one thing investors think a lot about is on a go forward basis; how do you balance that delicately, particularly if we continue to find that the lower end consumer is challenged by gas prices, et cetera?

Maybe give an update on this year versus last year trendwise.

Are you putting more of your inventory in that better-best or how are you protecting and balancing that lower end and the pay less part of your equation?

Well, we're very committed to both expect more and the pay less side of our brand promise.

We're very dedicated to making sure that we're competitively priced with all our comparable items with Walmart, all like items.

We go through a rigorous process to make sure that we have appropriate levels of opening price point and good products throughout every category, throughout the stores.

Throughout the store.

But we also recognize that our best guests and more affluent guests really enjoy the high quality and the stylish merchandise that we are able to deliver.

And so when we segment our merchandise, we are able to redirect some of the merchandise that we have in the better to the best and some of best to the luxury categories.

And these are minor shifts.

And we look for selective opportunities where we can push up the quality and push up the styling of merchandise.

And as you know, it has been at home, it has been in apparel and a few other categories with the store.

And those categories have been very, very well received by our guests, they're doing quite well.

But in no way shape or form are we abandoning the value price offerings that we have, or our commitment to the price sensitive consumers.

Great.

Thank you.

Thank you.

Our next question is from Adrianne Shapira of Goldman Sachs.

Thank you.

Doug just had a question following up on the expenses.

Of you stripped out the accounting changes could you give aus sense of what - - would we have seen leverage on expenses X the accounting shift?

To be clear those aren't accounting changes.

That is simply application of the same accounting year-over-year where this business activity gives rise to higher gross margin rate and higher expense rate.

But excluding all of that category of issues, the key explanatory factor year-over-year in the quarter would be a substantial increase in incentive compensation and stock-based compensation, both stock options and performance shares, all as a percent of sales.

That represented a bit more than half of the 44 basis point year-over-year increase, due to the combination of exceptionally strong profit performance and a share price that increased 27% during the quarter.

Okay.

Understood.

I'm just trying to understand it, X that understanding the share price obviously very strong.

I don't want to get into a X everything that went wrong, it was a great quarter.

But certainly if we get rid of stock-based compensation, incentive compensation and the accounting issues I talked about, we're down to essentially neutral expenses as a percent of sales.

Okay.

Fair enough.

Then just had a question about the expansion, given the fact that now we've heard from Federated, how many stores are being divested.

Could you give us a sense what the appetite could be for mall-based stores, incremental to your current square footage growth plans?

What you would be willing and able to do?

What we currently have 100 mall-based stores, and we look at locations, whether it be mall-based or free-standing, primarily on the basis of the demographics of the area and are there enough Target guests in that area.

And we do equally well in either location, everything else being equal.

Okay.

But could you give us a sense, current 8% square footage growth what that could grow to?

Given the fact that are you doing well on mall-based stores?

Certainly we have the financial capacity to ramp that up.

If you look back in our history, shortly after our acquisition of the 35 premium sites that we acquired out of the Montgomery Ward bankruptcy, for two years running, would agree in the 11% and 12% range.

So there is an example of how to answer your question.

I think it is a little premature to speculate what the outcome as it relates to us might be, out of Federated's interest in selling some stores.

Okay.

Great.

And just my last question for Gregg.

A few quarters ago you had talked about stepped up private label across the food business and Archer Farms.

Could you just give us an update how those lines are trending especially now that you are going back in, adding refrigeration to a the lof the discount stores?

Well we remain very committed to our private brand strategy.

And both Archer Farms and Market Pantry continue to do well.

The total share of private brand food as a percent of total continues to grow.

We finished the year around 10%.

We're in the low teens right now.

And we expect over time that that number will continue to grow as our own brands become more and more popular.

And we're very pleased with them.

They're performing well.

As we expand food into our general merchandise stores, it gives us an opportunity to expand our private brand into these stores as well.

And currently we have some space constraints that really prohibits us from the private brand expansion in the stores that don't have coolers or the space for dry groceries.

So as we expand, you will see more and more Market Pantry and Archer Farms in our general merchandise stores.

Terrific.

Thank you.

Thank you.

Our next question comes from Emme Kozloff of Sanford Bernstein.

Hi.

Doug can you tell us what the 100 plus basis points of gross expansion in the quarter correlated, to what I say ume was several basis points of the SG&A increase due to direct sourcing?

And last quarter you said that SG&A should increase about 20 basis points for the year.

Does that still hold given the incentive comp?

And then again I'm just trying to understand how much gross margin improvement for the year do you specific specifically to be driven from direct imports?

We don't have a way to calculate the portion of our mark-up benefit driven by direct sourcing, but certainly, our year-over-year increment of direct sourcing is a meaningful contributor to the mark-up.

And mark-up was certainly in the range of 2/3 of the gross margin rate improvement during the quarter.

On your incentive compensation question, you tell me how strong results will be in the back half of the year and I will be able to calculate for you what happens to incentive compensation.

This is one of those classic cases where the stronger results are, the higher expense as a percent of sales will record.

If we hypothetically had a very weak back half of the year, we would enjoy a year-over-year benefit to expense of reduced compensation expense.

That's obviously not in our current thinking.

But that equation is very, very sensitive to increments of performance, especially so when the performance is well above our internal plans that are designed to deliver generally speaking mid teens EPS growth.

So the 20 basis points that you were guiding to for the year on SG&A since you've backed the back half guidance - - consensus, does that - - is that range still reasonable?

Yes, but I'm going to be very cautious in saying yes to 20 as opposed to 25 or 30 or 35.

That equation is extremely sensitive to performance.

And separately, in something as short as the quarter, $5or $6 million is 5 basis points.

We're down into a category of year-over-year expense changes where there is a very large list that would be 5 basis points or higher contributors plus or minus to expense rate.

Okay, on credit, also possibly has been very strong with net write-offs continuing to decline yet we've been seeing increases in bankruptcy filings overall in advance of the reform.

Have you experienced higher bankruptcies that once we see reform goes into effect we would see even stronger underlying trends?

Like the entire industry we have seem higher bankruptcy filings within this period but within our expectations.

And within our expectations of frankly Visa as a whole and other issuers at this time.

What we are seeing is underlying performance that is very, very strong in terms of the nonbankruptcy write-off that is driving the results that you see.

The one note of caution that I think is an industrywide issue is that the OCC of course has mandated increases in minimum payments, minimum required payments.

That affects us.

That affects all of the card issuers as well.

That issue at this point will have an unknowable effect on write-offs in the short run and long run.

And then finally Gregg, in terms of the home business, from the monthly comp recordings it seems that the category has been a laggard and given the attention you have given to upgrading design and the instore presentation and marketing it seems surprising.

Can you give us some color on that?

I wouldn't call it a laggard.

I would say that it has been slightly underperforming the Company in total.

And there have been pockets of strength within our home businesses and there have been pockets of weakness.

And for example in home textiles, our bedding business has been very strong and our bath business has been a little weaker.

And in total our home textiles business is okay.

The same that exists in home decor and stationary as well.

We have portions of home decor, like small appliances and furniture, that are doing quite well.

And our decorative home business is soft right now.

So it's really a mixed bag out there.

And overall it is just slightly underperforming the Company.

But we're making progress and we're seeing that from the first quarter to the second quarter, the business got a little stronger.

Thanks.

Thank you.

Our next question is from Robert Drbul of Lehman Brothers.

Good morning.

Nice quarter.

The question I have is; could you share any insights with us on what you have seen so far with the back to school trends and where things are performing better or worse than expected?

Well, we're still somewhat early into the back to school season, and so far, we're meeting our expectations.

On the apparel side of it, we have had warmer than average weather throughout the country.

So we have seen stronger sales in categories like t-shirts and hats, and shorts and more of our wear now products.

The basic back to school supplies, like lunch boxes and backpacks and pencils and Crayola and things like that are right on plan.

So right now, it is performing as we expected, and the only softness we've seen would be in more of the heavier fall-related type products.

Like denim for example is a little softer, and fashion denim is good but basic denim is a little softer.

But that balance of the categories are pretty decent right now.

Great.

Thank you.

Thank you.

Our next question comes from Todd Slater of Lazard Capital Markets.

Thank you.

My question is related to your internal plan for flat EBIT rate going forward.

You've got the implementation of the inventory management system.

You've got increasing direct sourcing.

You've got improved efficiencies, across the supply chain, and in merchandising, all which contribute to higher IME's in gross margins, I'm assuming and have been.

Does the flat EBIT margin plan assume less contribution in the gross margin and growth from these areas going forward?

Or does it assume the higher SG&A as an offset?

And I'm wondering if you could just sort of flush that out for aus little bit more?

Thank you.

Well, obviously, looking back in time, we have enjoyed on a net basis quite substantial growth in EBIT margins.

Our business plan, our strategy moving forward is designed to generate generally speaking, mid-teens average annual EPS growth without the benefit of further EBIT margin expansion.

Might it occur?

Of course.

But I can give you a large list of issues that work against those generally favorable items that you described.

The whole question is, which of those lists will end up being the larger impact or will they generally offset each other as our business plans envision.

So are we sort of in the latter innings then of some of the catalysts that I mentioned?

No I don't think we're in the latter innings of the catalysts at all but I think that list of issues ignores a whole host of issues that we're also in the early stages of that have an adverse impact.

And so it is a matter of the relative contribution pro and con of each.

Let's be clear.

The continued increase in our rate of sales in lower margin categories at a much faster pace than our storewide averages is likely to continue pulling down gross margin rate by 20 basis points or so per year, as far as the eye can see.

So we need the first 20 basis points as benefit from that list just to tread water.

Okay.

That's fair.

And then just one other thing.

I'm just wondering if you would care to share any analysis you've observed in relationship between record high gas prices and sales trends, if that has had any kind of a break on the business?

So far, our rate of same store sales appears positively correlated with gas prices.

But obviously, I think that is a coincidence, not cause and effect.

Seriously, we have had very, very strong sales run here in the last several months, when gas prices have hit an all-time high.

So there is clearly at least in the short run, a very, very loose correlation or certainly no explainable causation between gas prices and our sales.

In the long run, of course sharply higher gas prices than today's levels would affect the economy.

And we certainly are affected by the macro economy in our pace of sales.

Thank you very much.

Thank you.

Our next question is from Christine Augustine of Bear Stearns.

Thank you.

Could you describe how One Spot performs - - has performed, and if you're making any changes to that initiative?

And then could you tell us for the full year, what is your expectation now with regard to either deflation or inflation?

Maybe if you could just describe it for the whole Company or if you would be willing to talk about it by sort of major families of business.

Thank you.

I will address the One Spot.

The One Spot continues to be - - to do very, very well.

It's generally all incremental business and it is a fun treasure hunt type of experience that we change out and reintroduce new products about every six to seven weeks.

We have 3 to 400 SKU's in that part of the store and it continues to do very, very well and it has been well received by our guests.

We will cycle the full chain implementation of One Spot in early September.

And right now we're - - we've had it chainwide for about 11 months.

So it continues to do well and we're pleased with it.

On the inflation/deflation question, a real quick reminder what we are measuring and we measure it with with precision once a year is the inflation or deflation in our retail prices with a careful attempt to level set year-over-year quality differences, that we exclude from that inflation/deflation.

Over the last ten years we averaged about 1% per year deflation.

Over the last couple of years, far more significant retail price deflation, 3% or 4%.

Our expectation late year, when we actually get a good read year-over-year on that figure, remains somewhere in the neutral category.

Some categories mildly inflationary, and some continue to be mildly deflationary.

Generally speaking, plus or my minus a point or two, neutrality is our expectation.

Doug, do you think - - is there anything within the composition of the same store sales that ticket versus traffic that would maybe suggest to that you your customer is doing more one-stop shopping with target.

And because they're going there anyway for the consumables, so they're buying of other things that they might have otherwise would have bought elsewhere?

No, I think that if there is any evidence at all is the strength of our traffic, our transaction count statistics tell us they're coming more often and purchasing a reasonably typical basket while in our stores.

Certainly, One Spot, with its very high unit volume and very low retail prices affects the contribution to average ticket from units and average price per unit.

But excepting One Spot, it is a very difficult kind of pattern in our transaction size.

And transaction count is much healthier today than it was two, three, four years ago.

Thank you.

Thank you.

Our next question comes from Mark Miller of William Blair.

Hi, good morning.

You can elaborate a little bit more on how much of the comp growth is coming from traffic versus average ticket?

And then you talked a little bit about the composition of ticket.

But how much of that increase is coming from items per transaction?

And dollars per item?

And then as you probe higher price points I'm curious about what areas you see some of the greatest opportunity within the store that enhance the quality of the merchandise mix?

First, on the transaction count or traffic question, generally speaking, we have enjoyed year-over-year increases in the range of 2% to 3% recently.

And that is certainly at or above the level of year-over-year transaction count increases that I would personally view as operating at full health.

Historically 1% to 2% traffic increases would have delighted us.

And we are currently enjoying better year-over-year performance than that.

On your question regarding transaction size, and the contribution of units and price per unit, One Spot, as I mentioned earlier, clearly has an effect on this.

So we're cycling periods last year where we had very little One Spot compared to this year's unit volume.

So without any adjustments to our data, you would see that units per transaction is a much bigger contributor than any change in the price per unit.

If you wash One Spot out of the analysis, the analysis turns around the other way.

Average selling price per unit, X One Spot, is actually the much larger contributor to the year-over-year increase than transaction size.

And then the other part of the question is, as you - - I think in the past, you said you haven't had a lot of resistance as you've introduced items selectively with higher quality.

And Gregg talked about how some of the items, more opportunities in the better, best luxury.

So I guess I'm curious about the areas of the store the categories right now where you see some of the best opportunities?

We will continue to push price points and quality levels up in apparel, footwear and accessories areas.

We are by no means done there.

So you are going to continue to see us look for opportunities in that area.

Clearly, there is opportunities in electronics, with digital technology, and as we transition from analog to digital televisions and plasma an DLT technology, that pushes the price points up in those categories as well.

Plus, there is other categories like decorative home from our Global Bazaar experience, we've recognized that the guest is looking for higher quality items in our stores.

So whether it be accessories or framed art or mirrors or rugs, we see an opportunity to increase the quality in categories like that.

As well as in our stationary area where we can do a better grade of paper, and things like that.

So, we're really looking selectively in all of our business categories for that next layer of excitement and value and quality.

And some areas are going to have a little more than others.

And I would also like to pick up on what Greg said earlier in his presentation, the prices on these goods are roughly half of what people would pay for them in department stores, and specialty stores, so it is a great, great value for our guests.

For example, when we do the Smith and Hawkin launch, we will be doing all of the sourcing on Smith and Hawkin.

So you will see the great styling and the great quality but you will see at great Target prices.

That seems like a terrific addition to the store.

Doug, I wanted to follow up on the comment you made about mix.

You said it was on the whole roughly neutral to gross margins.

To be clear, would that be then about 20 basis points better than what you would have thought coming into the quarter since you indicated that over time, that's roughly the detriment to mix?

Certainly, 20 basis points better than our expectation on average over time.

But that statistic is a series that runs from 20, 30 basis points favorable to 100 unfavorable quarter to quarter to quarter.

There isn't a discernible pattern.

It just averages 20 basis points or so annualized unfavorable over time.

Okay.

And then my last question is Jerry, if you could just elaborate a little bit on what you're doing with Six Sigma?

And your significant improvement in the - - I guess in stocks of your advertised items?

I mean that was always one of the I guess customer complaints that was out there.

But that seems like a pretty significant rate of improvement.

So what actually have you done if you could just give ail little more color on that?

Six Sigma as you know is a business improvement program.

We have a Companywide initiative there and it is showing results in multiple areas throughout the Company.

In advertising, it is one of the items, one of the areas that we targeted, for review there.

And we're doing a lot more measurement, and monitoring of the inventories there, both before and after the ad.

And incorporating that learning so that we get better and better over time.

And you're seeing the results.

Okay.

Thank you.

Thank you.

Our next question is from Mark Husson of HSBC.

Yes, good morning.

Could you just over what period of time do you think the Yuan and other Asian currency increases versus a dollar finally gets fed through to your cost of goods?

And it is fair to say that increases in overall Asia importing and direct importing in particular will be enough to offset that?

We haven't really seen much change at the current time.

I would also like to point out we have over 2,000 team members around the world.

We have offices in between 40 and 50 countries.

And we move from country to country as prices or as their desire for quality changes.

So we feel we're in very, very good shape to be extremely competitive and at least near term, we do not see any significant price increase right now.

Yes, and another question is, because some of the safeguards that replaced the quotas have been sort of reimposed in a fairly random pattern across America, have you had any shipments stopped at docks and sent back, have you seen any disruptions in that sense?

No we really haven't.

We laid out a very elaborate contingency plan early in the year and we anticipated that there would be some disruption.

And we had plans in place to minimize those.

And so we've been able to have really minimal impact on our business as it relates to quotas being called, and things like that.

That's great.

And just on AMC and just in general term, obviously it is like having a little Lee and Fung(ph) buried inside your business and can you say how busy it has been? and what sort of volume is ut handling year-over-year?

And obviously you're still doing stuff for third parties.

Can you just talk about that experience too?

I can assure you they are very busy.

Not only our direct import business continues to grow but the share of business that we are doing through AMC continues to grow as well.

And so it is a very strategically important part of our business.

And we have been adding resources and infrastructure to make sure that we can deliver great quality at low cost, and stylish merchandise and have better control of our brands.

So we are very pleased with AMC and they're working very hard and they're doing a great job.

The aggregate size of Target sourcing service AMC, in my view is substantially larger than "a little Lee and Fung".

Well, let's talk about Lee and Fung is up about 18%, 19% is that the kind of increase you're seeing in terms of your business or more than that?

Well, it is actually more than that.

Okay.

And then the sourcing for third party, are you doing more of that or are you trying to back out of that?

We are doing less of that as we do more things inhouse and design and development and direct imports and that's been one of the factors that we talked about before is that is influencing our higher gross margin rate.

Great.

Thank you very much.

Thank you.

Our next question is from Gregory Melich of Morgan Stanley.

Thanks, a question for Gregg and then Doug as well.

Gregg, on the Smith and Hawkin deal, you said you're going to be doing sourcing for them.

Have you sourced for them - - [ Inaudible ]

Sorry, one moment [Technical difficulties ] please stand by while we correct this technical difficulty.

Mr. Ulrich?

Yes.

Sir, you can go ahead.

Greg, getting back to your question on the sourcing for Smith and Hawkin, we are going to be doing the sourcing for the merchandise that Target will be carrying only.

We are not going to be doing sourcing per se for Smith and Hawkin.

We're just talking about the merchandise that we're going to be carrying.

Okay.

And so that - - the product that you have will be different than the product that they're running in their stores?

It will be different.

Okay.

And then second, is on the CapEx front, so that was up quite a bit in the - - I guess up almost 30% year to date.

What is driving that?

Is it just the real estate getting more expensive or the cooler doors sort of adding structurally to costs?

Or is it just timing?

First of all, last year, we invested a bit over 3 billion in CapEx.

And we said at the beginning of the year that we expected to invest between 3.3 and 3.5 billion this year.

Largely as a direct result of our growth year-over-year, that's not a timing issue.

What you see so far this year is that the year-over-year increment is about what we expect for the full year.

So I think the year-over-year increment of CapEx will slow down third quarter and fourth quarter in all likelihood.

It is driven by the usual suspects.

We are investing a lot more capital, building new stores because we are building more of them.

And with respect to distribution centers there is a bit of a timing issue.

Year-over-year, we have invested more capital this year than last in DC's, that capital is largely in support of 2006 distribution centers.

Great.

Thanks.

Thank you.

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

Good morning, gentlemen.

Two quick questions.

One is what was the actual share count at the end of the quarter?

Since there was so much activity with obviously incentive comp.

And two, going forward, the whole industry seems to have a problem with SG&A.

I mean in your case it is a good problem, I guess.

But is there any light the end of the tunnel in terms of being able to see leverage?

First of all, on your shares outstanding question, in the attachments to our press release at the bottom of the balance sheet, we reflect 884.7 million shares outstanding at the end of the second quarter this year, compared to 903.3 million outstanding at the same point last year.

On your SG&A question, since more than half of the driver of our SG&A expense, as you point out is good news, I would be thrilled if incentive compensation and stock-based compensation as a percent of sales went to the moon in the second half of the year, we could easily end up with 30, 40, 50 basis point year-over-year increase in SG&A expense that would correspond to a $70 share price and an EPS of $3 a share.

And obviously those extremes are not what we expect to happen.

But the lion's share of the driver of our year-over-year SG&A expense in the quarter was absolutely good news and not something of any sense of pressure.

Excluding the accounting issue and the incentive compensation and the stock-based compensation equation; we were pretty close to neutral SG&A as a percent of sales.

But is it possible to actually lever SG&A?

I'm not sure we would want to, because that would reflect a slow down in the year over-year benefits that are directly transferring into even larger gross margin rate increases.

On most measures of unit productivity, we are showing improvement in some cases considerable.

A lot of what you see there is the items Doug mentioned plus investment that helps drive our sales and gross margin rate.

And it's right-side up investment.

If the gross margin rate contribution from these activities were to diminish, we would diminish the activities and then you would see the kind of classic SG&A rate leveraging that you would expect to see at a 6.7 comp.

Thank you.

Thank you.

Our next question comes from Dan Bender of Buckingham Research.

Hi, good morning.

A couple of questions.

First, on - - you mentioned a lot of the remodel and resizing activity that you've been doing.

Could you give us an idea of what it looked like specifically last year by remodel and resize and how that looks this year?

And then the second part of that question is, have you been able to identify, I'm guessing you can, how much of that activity has been driving your comps versus, your stores that haven't been touched?

I think that in terms of the exact count of remodels and store counts that are in this category, I would suggest to follow up with Susan Connor, myself to walk through because this is a fairly complex set of numbers with a lot of different categories.

Generally speaking, we're delighted with our performance in guest traffic, and certainly some piece of that is likely attributable to the kinds of changes we've executed in the prototype.

I guess I would emphasize that more than almost any other retailer I know of, we have a commitment to maintaining the freshness of our building.

So we remodel buildings more often and more thoroughly than most of our competitors.

And we have for a long time.

That is not anything now.

By the end of this year including new stores that we have opened in this format across the last couple of years and stores that we have significantly remodeled along these themes, give or take half of our store base will reflect most of the elements of these changes.

Okay.

I guess what I was trying to identify is just in terms of the level of activity that you did last year, how that compares to the level of activity this year?

If it is part of what what is driving comps, I think it is probably important to understand, you know, relative to where were you a year ago, how that is shaking up this year?

No, I don't think that is significant contributor to this year's same store sales performance.

Okay.

I guess that's what I was trying to get at.

I appreciate it.

In the short run of stores that are torn up undertaking a major remodel, typically have a year-over-year sales decline.

Okay.

Great.

Thanks.

Great shape by year end but some of those stores that are under remodel right now are contributing or holding back same store sales performance.

In addition, there is a group that are remodeled this year that were undergoing that phase last year that are up sharply.

Okay.

Great.

That's very helpful, thank you.

Thank you.

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

Thanks.

Doug, I think you said that the implementation of One Spot had - - was having a slightly negative effect on your average ticket.

Is that the case?

I said that the - - at the margin, One Spot of course, with its lower retail, decreases price per unit for average unit sold.

So my question is really on just on One Spot, I'm wondering if you might give us a few more details just to get some sense of the size of that business?

And maybe just again outline how many square feet is dedicated to One Spot, how many SKU's are in One Spot?

And maybe how many - - what the penetration might look like for your typical basket?

Well, first of all, the square footage varies by store.

And you kind of go from one store and you get sort of an idea.

But it does have a pretty good velocity.

But we don't get into individual categories and strategies in terms of breaking out and releasing those figures.

It is significant to say that yes it is pleasing our guests.

And obviously it is a reasonable significance in our sales since it is taking the average unit price down and is contributing to our overall comp store increase.

Operator I'm showing 10:30 Central Time at this point and we will field one more question and then Susan and I will be handle any remaining questions for anyone later in the day by telephone.

Thank you, sir.

Our final question comes from Steve Serl of Conning Asset.

Yes, the pace of share repurchases really seems to have slowed in this quarter.

Would we be incorrect in assuming that's the little financial flexibility in case of some stores do become available for purchase in the market or - -?

Yes, that would be incorrect.

When the share price increases sharply, we slow down and when the share price decreases, we speed up.

And net-net, we clearly expect to finish the $3 billion authorization in the two to three-year time frame from the June 2004 inception of the program.

And I think chances are highly likely that we will continue repurchasing shares here in the third quarter.

Thanks.

And that concludes Target's second quarter 2005 earnings conference call.

Thank you very much for your participation.

This concludes today's conference.

We thank you for your participation.

And have a good day.