目標百貨 (TGT) 2006 Q2 法說會逐字稿

Welcome to the Target Corporation second quarter earnings release conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to Mr. Bob Ulrich, Chairman and Chief Executive Officer.

Please go ahead, sir.

Good morning, welcome to our 2006 second quarter earnings conference call.

On the line with me today are Gregg Steinhafel, President; and Doug Scovanner, Executive Vice President and Chief Financial Officer.

This morning I will briefly outline our perspective on the current economic and consumer environments and describe the impact of these factors on Target.

Then Doug will review our second quarter 2006 financial results and describe our outlook for the second half of the year for the business overall with specific guidance on key individual drivers of our performance.

Next, Gregg will share his perspective on the current competitive environment and provide an update on the key strategic initiatives that continue to fuel Target's strong performance and consistent growth.

And finally, I will wrap up our remarks and we'll open the phone lines for a question and answer session.

As Doug will describe in more detail shortly, we announced excellent financial results this morning for Target's second quarter and first six months of 2006.

In addition, we remain optimistic about our performance for the remainder of 2006 and believe that we are on track to deliver strong full year results.

Certainly, we recognize that the current environment presents a number of real challenges, which may adversely affect consumer spending including; higher energy costs, rising interest rates and a weaker housing market.

And though we are not immune to adverse macroeconomic factors our careful execution and commitment to maintaining the right balance in our "expect more pay less" strategy has produced a remarkably stable and consistent record of top line and bottom line performance over the past decade in a variety of economic conditions.

Our financial results, one layer under the surface, also reveal considerable stability.

For example, our comparable store sales have grown at an average annual rate of 5% over the past decade.

And we have rarely experienced same-store sales gains outside of a range of plus 3% to plus 7% for any sustained period.

Similarly over the past 10 years Target's average earnings per share have grown by a mid-teens percentage and rarely increased outside a range of plus 10% to plus 20% per year.

Overall, we are pleased with your year to date performance and believe we are poised to achieve another year of profitable market share growth in 2006.

We continue to leverage our global sourcing and product design expertise and to delight our guests with the right balance of innovation and value in our merchandise assortment.

We continue to invest in highly productive new Target stores in quality locations throughout the country.

And in keeping with the strategic objectives which underlie our decision to offer credit to Target guests, we continue to enhance guest loyalty, reinforce our brand and generate incremental sales and profits in our retail business through our credit card operation.

We also remain confident in our longer term growth potential.

Without compromising our financial return criteria for underwriting new stores, we are on track to open our 2,000th Target store in the United States and to generate annual sales approaching $100 billion in 2011, just five years from now. we remain firmly committed to our "expect more pay less" strategy and believe it will allow us to remain relevant to our guests for many years to come.

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

Thanks, Bob.

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

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

And Susan Kahn and 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 this morning should be considered in conjunction with the cautionary statements continued in our SEC filings.

This morning, Target Corporation announced our financial results for the second quarter of 2006.

And as Bob indicated, they met our expectations for growth.

Highlights of our results include the following.

We enjoyed a 16% increase in EPS to $0.70 this year versus $0.61 last year on the strength of an 11.3% increase in total revenues.

Again, total revenue growth was driven by the contribution of new stores and also this time, by a 4.6% increase in same-store sales.

This same-store sales performance is particularly noteworthy in light of last year's very strong 6.7% increase.

In our core retail operations, we essentially replicated last year's record high second quarter gross margin rate.

And while we continued to experience a somewhat faster increase in expenses than sales, our overall growth in core retail EBIT was in line with our expectations and much stronger than in the first quarter.

In addition, in our credit card operations we continued to enjoy robust results in line with our recent experience and in line with our enhanced expectations.

Separately, we repurchased 11.3 million shares of our stock in the quarter for $550 million.

We just passed the second anniversary of this program and to date we have reduced our share count by 7.6% gross or by 6.1% net of new shares issued over this period.

Finally, we are well aware that many of you are concerned that our pace of sales growth was slower in July than in May and June.

And always, variability in sales remains the single biggest factor in predicting our short-term growth and profitability.

Yet on balance, we continue to believe we are likely to achieve or exceed our profit objectives for the year.

I'll share more about that in a few minutes.

Given that we're now halfway through 2006, let's spend a if minutes to provide color on up outlook for the third and fourth quarter.

So far this year, we have enjoyed an 11.7% growth in revenue, driven by the contribution from new stores and by a 4.9% increase in same-store sales.

Looking forward, we face another larger than average same-store sales challenge in the third quarter but we will benefit from cycling a lower base of comparable store sales growth in the fourth quarter.

For reference, we enjoyed a 5.9% increase in same-store sales in last year's third quarter, followed by 4.2% increase in the fourth quarter.

So far this year, our overall generation of gross margin continues to be excellent and generally in line with our expectations.

We expect these trends to remain in place in the fall.

Although again, the third quarter will likely be a bit more challenging than the fourth quarter due to the pattern of last year's performance.

Our expenses deserve a bit more analysis.

So far this year expenses have grown at a faster pace than sales, resulting in a 51 basis point increase in expenses as a percent of sales.

Nearly half of this rate deterioration is due to the dynamics of start-up expense.

As we discussed last quarter, some of this year-over-year effect is driven by growth in this year's capital program but the majority of this expense increase, especially in the second quarter, is driven by adverse timing issues, which are now behind us.

Looking forward, we also expect this year's marketing expense to be heavier in the third quarter and lighter in the fourth quarter than last year.

Turning to our credit card operations.

We've continued to grow our receivables in line with sales and we have enjoyed robust results so far this year.

We expect to continue to enjoy similar strategic and financial benefits for the foreseeable future, certainly for the remainder of 2006 and well into 2007.

The only noteworthy underlying issue here is that, as expected, we are already beginning to experience sequential increases in delinquencies, which will lead to sequential increases in write-offs in the back half of this year.

Driven by the OCC mandated increase in minimum payments.

Overall, delinquencies will likely peak in the range of 4.0% to 4.5% of receivables and net annualized write-offs should similarly rise to about 8% of receivables.

Importantly, we believe we are already fully reserved for this projected outcome, so this set of events should not result in any future P&L impact.

For reference we have built the highest allowance for doubtful accounts in our history, both in absolute and relative terms, by expensing faster than write-offs have occurred to appropriately reserve for this identified risk.

Our current allowance is $501 million or 8.3% of gross receivables, up $92 million or 22.5% from this time last year.

And we have already expensed $50 million more this year than we have written off.

In closing, let's tie all of the elements of our third and fourth quarter outlook together.

Today, the median First Call EPS estimate for the full year is $3.11, which would represent a 15% increase from last year's $2.71 actual results.

While we readily acknowledge there is a down side case, in which softer fall season sales growth would drive a lower double digit EPS increase for the year, we believe there is also the potential for surpassing this number.

On balance at this time, $3.11 seems to be a reasonable single-point estimate for the full year in our view.

Contribution of the third and fourth quarters, however, is not in balance in current external estimates.

For all of the reasons I outlined earlier, including the relative strength of last year's performance and known timing differences in expenses this year and assuming we achieve $3.11 for the year; we would expect EPS in the fourth quarter to grow several cents faster than reflected in current external expectations and EPS in the third quarter to grow more slowly than current external expectations.

Now Gregg, will provide a brief summary of current business trends, describe Target's current growth plans, and review some of our recent and upcoming merchandising issues.

Gregg?

Thanks, Doug.

Our second quarter results from our core retail operations were generally in line with our expectations and we are pleased with our performance, particularly in light of last year's outstanding results.

Reflecting typical growth in both guest traffic and average transaction amount, comparable store sales in the quarter rose 4.6% on top of a strong 6.7% increase a year ago.

This sales growth reflected better than average performance in most non-discretionary categories like health and beauty pharmacy as consumables, as well as discretionary categories like apparel, housewares and electronics.

In contrast, sales of prerecorded music and video, and some areas of our home business, such as bedding, rugs and decorative accessories; continued to be somewhat disappointing during the quarter.

We are comfortable with the mix, balance and level of inventories as we head into the third quarter.

As Bob mentioned, we continue to invest in profitable new Target stores.

During the quarter, we opened 26 new general merchandise stores and three new SuperTarget stores, resulting in a net addition to our store base of 26 locations.

At quarter end we operated a total of 1,444 stores in 47 states.

In the next few months we will complete our store-opening program for this year with the addition of 45 new general merchandise stores and 15 new SuperTarget locations.

For more than a decade Target has demonstrated a commitment to our "expect more pay less" brand promise by offering our guests great design, innovation and value.

Over time, we have also established strong infrastructure and built a talented team to sustain our competitive advantage, support continuous innovation and ensure that we remain relevant to our guests.

Even as some of our competitors test new merchandise brands, strive to upgrade their merchandise quality and intensify their focus on inventory management, pricing, and marketing;

We are continuing to deliver on our brand promise by consistently executing our strategy of going our own brands, aggressively pursuing improvement in content and quality, increasing our direct import penetration and improving our supply chain in-stock levels and speed to market.

We continue to drive increased guest frequency by providing greater convenience, reliability and value in consumables and commodities and delivering an exciting shopping experience throughout the store.

Specifically, we continue to differentiate ourselves through our own brands including Market Pantry, Archer Farms and the Target brand.

We are expanding our food offering with up to 34 sides of food in new and remodeled general merchandise stores.

We are right sizing more than 150 stores this year to incorporate our expanded offering of dry grocery and refrigerated and frozen foods.

And we continue to improve our guest shopping experience at SuperTarget by expanding self-service delis, broadening our assortment of organic and natural foods and locally grown produce, and increasing our offering of prepackaged produce to enhance food safety and check-out speed.

In addition to consumables and commodities, we are also giving our guests more reason to shop our stores more often by introducing new products and brands, refining our assortments and reinventing entire categories throughout the store.

For example, in July, we debuted "see-spot-save," and updated approach to our dollar shopping concept, previously called the "one-spot."

Our revitalized presentation includes new signing and features an assortment of better quality products, price at two for $5, in addition to the core $1 items that have been so successful with our guests during the past two years.

During the second quarter, we also completed the final phase of our intimate apparel and hosiery reinvention, which began earlier this year.

Over the past six months, we have introduced numerous improvements in fit, fabric, design and presentation in categories like sleepwear, foundations and hosiery and address the needs of our junior guests, a previously underserved segment.

We recently introduced our third go international flight of fashion with the launch of Paul and Joe by French designer Sophie Albou.

This collection, though not an important driver of sales volume, is an exciting addition to our fall assortment, designed primarily for our junior and contemporary guests.

It consists of a wide variety of styles with fresh colors, vintage-inspired prints and unique detailing for guests who want wearable individual looks for fall.

In September, we are introducing a high-quality, versatile collection of wear to work suiting components in women's apparel.

The Merona assortment will reflect new season lifts, wrinkle resist fabric for maximum comfort and appearance or cater to various body types and personal tastes, and will offer exceptional flexibility as guests mix and match jackets with pants and skirts.

And we are once again offering innovative design and exceptional value in this year's back to school and back to college home furnishings assortment.

For young, newly independent adults, Target's stylish offering of basic necessities, furniture and home decor is designed to transform a dorm room or unfurnished apartment into a comfortable and space efficient oasis for living, studying, and entertaining.

In summary, Target remains committed to maintaining the appropriate balance of differentiation and value in our strategy.

Surprising and delighting our guests with distinctive, exclusive and unexpected offerings.

Providing the right combination of price, quality and design and driving increased shopping frequency through added convenience and reliability.

For more than 10 years, we have successfully executed this approach by anticipating shifts in guest preferences, refining our merchandising and marketing to adapt to various economic challenges, and overcoming competitive threats to produce strong sales and earnings growth.

Though the current marketplace continues to be highly competitive and the macroeconomic environment in the near term appears uncertain, we are confident that Target has the the vision, agility, discipline and capabilities to sustain our competitive advantage over time and translate our strategy and "expect more pay less" brand promise into continued profitable market share growth.

Now, Bob has a few concluding remarks.

In summary, we are pleased with our year to date results and optimistic about our performance for the balance of this year.

We remain confident in our strategy and believe that Target will continue to deliver strong profits and consistent growth well into the future.

That concludes our prepared remarks and now Doug, Gregg and I will be happy to respond to your questions.

[OPERATOR INSTRUCTIONS] Your first question comes from the line of Mark Husson with HSBC.

Yes, I wanted to ask a general question about your planning in the case of type of emergencies or disasters in the light of what we saw this morning?

But in particular, how have you planned to cope with an outbreak of say bird flu, closing down some of your markets out there in Asia?

And have you managed to secure sources of supply?

Well, we're actually spread around the world substantially more than any other people.

We do have a crisis command center and various contingency plans, we're not anticipating anything of that nature.

But should it occur, we think we're reasonable well prepared, as well as anyone could be.

I'm not sure what emergency you were referring to from this morning.

The terrorist threats in London.

Okay.

A follow-on question.

On the food side of the business, you've expanded your food offering, dry grocery, can you just be a bit more specific about how many stores you have expanded it into and where you've got the space from?

What you've cut back on in order to introduce it?

By the end of this year approximately 2/3 of our stores will have the expanded space committed to food.

Approximately half of that 2/3 will be through new and remodeled stores the other half will be achieved through our right sizing program.

In our new and remodeled stores, we have expanded the footprint of the store in the case of new stores.

And in the case of remodeled stores, oftentimes, we have expanded those buildings as well.

And in our right sizing projects we have traditionally in the past downsized those businesses that have been underperforming for a period of years.

And those businesses include areas like home improvement, sporting goods, men's and then a few other categories throughout the stores.

And that's where we have taken the space to support the growth in food and other frequency oriented commodities.

And is the mix in sales is significantly different now -- at year-over-year, we expect gross margins on food to be rather lower and SG&A to be perhaps a bit lower as well.

But is that a significant year-over-year shift in terms of basis points inside the whole mix now, or is it not quite?

This is an issue that we have been executing for many years so in the background over the last 10 years we have averaged 20 or 25 basis point direct impact on gross margin rate due to this mix phenomenom.

The current period is not remarkably outside that range.

Great.

Thanks very much.

Your next question comes from the line of Jeff Klinefelter with Piper Jaffray.

Two quick questions for you one would be on the home category, Gregg.

I know it's been highlighted as an underperforming category for you, now for several periods.

And I was just wondering if there's anything you can share in terms of the your strategy to sort of drive conversion in that area?

Anything going on with pricing or changes to the mix of brands versus basics in order to jump start that on either the domestics or the traditional home side?

And then the other question would be on the earnings.

Doug, I think you mentioned coming out of the fourth quarter last year when that was a slower earnings growth rate that we would continue to see this evolve over time.

That Q4 would likely be -- I don't know -- less profitable or have less profit growth just in terms of the competitive dynamics of the holiday season.

And that Q3 would be stronger.

Has anything changed on that front or is -- are you just wanting people to fine tune slightly how they are looking at the next two quarters?

Jeff, I'll answer your home question.

As you know, parts of our home businesses have been very strong all year and are still performing very, very well.

We have performed well in housewares, which includes storage, small appliance and cookware.

Our bath business has been strong all year.

Our stationary business has been performing quite well.

We have struggled in areas like decorative accessories, bedding.

And the underlying business trends in those categories seem to be strengthening.

We have incorporated numerous transition, content, pricing adjustments throughout the year, and we are seeing the negative aspects of what was -- and how those businesses were performing in the past, strengthen somewhat.

So, we're encouraged that we're on the right path, we're seeing some strengthening.

But they're not -- those businesses are not performing where we would like them to be.

But we feel real good about the changes that we're making and we believe that by the end of this year we'll back on track in all of those categories.

Jeff, in addressing your Q3, Q4 question, one is a long term or secular set of issues, where we have over time meaningfully increased our relative performance in the first three quarters relative to the fourth quarter.

And I think by the time the dust settles from this year, that same overall long-term trend will remain intact.

Separately, though, at this point, midway through the year I think are some specific short-run issues that are relevant to all of us on this call.

Specifically in the third quarter, while there are many other issues that go both ways, I don't want to ignore everything else that's going on; the two biggest issues that we are dealing with in the short run in the third quarter;

We are cycling a substantial favorable Visa Mastercard settlement that we disclosed last year that offset some other expense issues, as you know.

Separately, as I talked about little while ago, we're returning to a more normalized third and fourth quarter split of our advertising and marketing.

Last year we had more power, horse power, more weights in advertising marketing in the fourth quarter than we usually do.

Combined with the relative strength of the sales pace in two those quarters, it means I think we're poised for some operating margin expansion in this year's fourth quarter but that's not the case in this year's third quarter.

Great.

Thank you.

Your next question comes from the line of Charles Grom with J.P. Morgan.

Hi, good morning.

Could you comment on your inventory position, particularly in stock levels?

There's been a lot of chatter here and stocks haven't been good.

I was hoping you could address this issue for us.

Our inventories overall are in excellent shape.

Our in-stock levels, which we watch very, very closely through our own network are also in very good shape as well.

We are maintaining very high levels in the high 90% of in-stock levels in all of our basic, food, consumable, paper, pet categories throughout the store.

So, we're not experiencing any difficulties in supply chain, in replenishment from our vendors.

And I'm not sure what you are seeing out there, it could be an individual store execution issue but overall we're pleased with where our in-stock levels are.

That's helpful.

And then Doug, could you speak to the components of gross profit margin in the quarter specifically, on the markdowns, shrink and mark-up?

Certainly, well first of all in the aggregate, gross margin rate improved 8 basis points from last year's record high second quarter performance.

When I say record high, it was the highest quarter in our history last year.

So, we're not chasing a variance that amounts to much of anything at at all.

At the margin, certainly mark-up was favorable, markdowns were unfavorable.

Neither by a whole lot, by the way.

And shrink and all other factors were less important than those first two.

So basically, all of the elements were reasonably in line with last year's performance as well.

Thank you.

Your next question comes from the line of Dan Binder with Buckingham Research.

Hi, good morning.

Couple of questions, first, on credit, the levels on delinquencies and write-offs that you mentioned in the call, appear to be just a sort of a trend back to where they were prior to some of the changes last year in the bankruptcy laws.

I'm just curious in terms of the pace at which we get there, is that something that we should expect by year end, by mid-next year?

Maybe just a little bit of color on that.

And then that second part of that question is at what point, on that path up towards those numbers, do we start to see the reserves versus the write-offs come down a little bit, since you have been doing so much reserving here early on?

Great series of questions.

Those very precise forward-looking estimates that I made earlier for delinquencies and also for write-offs are stated on annualized basis as we report them quarterly.

And I would expect that in sequence, the third quarter will be considerably higher in both of those metrics that the quarter we just reported.

And by the fourth quarter, you are absolutely right, we will be back in line with our experience from couple of years ago.

As I mentioned earlier and you referenced, we've reserved for this outcome.

It's hard to say exactly how the balance will occur between expenses and write-offs.

Our expense when we get there will be a function of our then current assessment of developing risks and benefits in the portfolio.

But I don't think there will be a meaningful difference between expense and write-off in the third quarter.

It's possible that we would have more write-offs than expense in the fourth quarter.

Although that would not be the case for the full year, I expect to end the year with an appropriate and complete reserve just as we have today.

Okay.

And then just a second set of questions on merchandising.

I think you mentioned electronics were a bit soft.

I have seen what seems to be a fair amount of resell areas.

It's coming along, it looks pretty good.

I was just wondering if you have seen any early results on that?

And then secondly, if you could just comment on what you saw on your HBA resets or as a result of those resets earlier in the year, if that has produced the kind of numbers that you wanted?

Yes the comments I referenced in the call were specifically in the entertainment division, which is essentially our music and prerecorded video businesses.

Those businesses nationally y have been soft, have been declining and our sales are reflective of that national trend.

Our electronics business has been healthy and continues to be healthy all year.

And it relates to the health and beauty reset, the major reset we undertook was a year ago.

We've make planagram adjustments throughout the year.

But those businesses have been performing very, very solidly.

We continue to gain market share in every one of those categories, and we're very pleased with the performance in our health and beauty aids, household chemicals, paper products, beauty businesses.

Great.

Thanks.

Your next question comes from the line of Bob Drbul with Lehman Brothers.

Hi, good morning.

I was wondering if we could talk little bit more just about Target's thoughts around the consumer, and as far as any signs of the paycheck cycle that you are seeing discretionary mix very versus consumables, et cetera?

I was wondering if you could just address a few of those topics for us?

We haven't seen any change in sales patterns around paychecks 1 or the 15.

There is a normalized cycle and blip during those time frames and over the last six months we have not seen any material changes to those -- for those normalized patterns.

Okay.

By far and away the biggest variable when our sales are either on the softer end of that 3% to 7% range that Bob talked about or on the stronger end; is store transaction accounts.

The rest of our business is much more stable month to month, season to season.

And Doug, can you talk a little bit more about in the financial -- or the remodel program that Wal-Mart is having, and if it's having any impact if you have seeing that anywhere in your numbers?

Either Doug or Gregg.

Well you'll have to talk to Wal-Mart about Wal-Mart's remodel program.

I don't have a lot of facts at many my fingertips on that one.

But we do not sense any direct impact in our results from that activity.

Gregg?

It's hard to attribute specifically what impact that remodel activity will have on our store.

And as you know, they are in various stages of remodeling their stores.

Only a certain number have been completed and they are in the middle of transitioning many of those stores right now.

So, I think it will be later in the year before we would feel any impact, if we were to feel any impact.

And we really don't believe that there will be any meaningful impact to us at all.

Okay.

And Doug, one final question for you.

Is -- the 53rd week, does that impact you at all this year and is that in the numbers that you just talked about?

53rd week has some impacts on basis point relationships, but net-net, it is not a meaningful impact at all at the bottom line.

Certainly, it is a lower gross margin rate week and a lower expense rate week, and a lower EBIT margin rate week than the rest of the year.

And so that place through basis point analyses especially stand-alone quarterly basis point analyses.

But the time the dust settles, it's not a meaningful issue to our EPS either in the quarter or the full year.

Thank you very much.

Your next question comes from this line of Virginia Genereux with Merrill Lynch.

Thank you.

Firstly, if I may, Doug, just to clarify your remarks.

And that was helpful on credit.

If you guys have done, sort of -- the credit yield after funding was basically 11% in the April and July quarters.

Did you say, sir that you -- that in the back half that it's going to maintain that 11%?

I don't know that it will fully maintain 11 but certainly I expect the back half of this year to continue our generally robust profit trends from the front half of the year.

Now, that may mean 10 not 11.

I'm not trying to make a precise basis point prediction like that.

But I don't expect any of the core underlying issues that we've talked about to have any adverse effect on our generation profitability.

Last year, after-funding costs, we were a little over 8% in our card portfolio.

So far this year, it has been distinctly an 10% to 11% performance.

I expect this much stronger performance to stay with us.

Okay.

That's very helpful, sir.

And then heading into '07, a couple of folks have asked us about the first part of '07, you -- again, generally sustainable in that 10 and maybe 10-plus rage.

Yes.

Great.

Thank you and then secondly, if I may, Bob, you commented on the longer term trends here and a comp of kind of 3 to 7.

And you guys also talk about traffic versus ticket contribution, and that traffic has really been the only variable.

A couple of folks have asked us, what has been the average unit retail trend over that time?

I know you guys are talking now about ticket contributing more.

But I think you've also said that -- when you say ticket it's really the basket there could be more lower-priced items in the basket.

Can you tell me sort of what has been the average unit retail trend?

Has that moved up over the past decade?

We have seen strength in both number of units in the basket and in the average price of the item in the basket as well.

It has been, on average, fairly balanced.

And during some periods we have experienced greater growth in the unit count per basket.

And at other times we have experienced greater growth in the average price per unit.

But it has been a reflection of both of those elements.

Gregg is absolutely right.

More recently, number of items in the basket has been the bigger driver.

Don't have to go back too far in time for that relationship to be reversed.

Okay.

And then Doug and Gregg are you also having success -- you said more recently it has been more sort of items in the basket, but do you still feel like you still have runway to take up the to take up the unit pricing?

As Gregg you educate consumers on the higher thread count sheets or whatever, are you seeing that?

We believe over the long term we absolutely have opportunities to increase the average price per item.

A very nominal amount when you mix rate out all of the products that are in the basket.

It is a fairly modest amount.

So we can increase our retails or probe up in any part of the store and that will have an impact on that over time.

Because it's in the $5 to $6 range and so it doesn't take a lot to move that nickels, dimes, quarters.

In a lot of categories we have seen a larger unit sales price, when you get into ready-to-wear and accessories and intimates.

That has been somewhat offset by increases in our frequency categories of consumables and grocery.

So the general merchandise, decorative home and apparel, has been going up in price, offset again by the lower value of individual items and the frequency strategy.

So to be clear, none of what we are describing is a function of price increase on identical items.

This is a mix issue.

Thank you.

That's very helpful.

Your next question comes from the line of Christine Augustine with Bear Stearns.

Thank you.

Doug, could you please clarify your comments with regard to the third quarter?

Just more specifically, given the comparisons are tougher, should we expect to see a range of comps that would be a bit lower than the 4 to 6 that you typically look over over a long period of time?

And then my second question is, in the first quarter you did discuss that store payroll costs were a bit pressured by the fact that customers were buying more items in their basket.

And could you just give us some detail on whether or not you saw that in the second quarter?

Thank you.

Yes.

First of all, in terms of our same-store sales outlook in light of our current pace of business and last year's third quarter results, our outlook for the third quarter today is a 3% to 5% same-store sales performance.

Separately, we do -- we have continued to place a great deal of emphasis internally on getting our pace of expense incurrents in line with our pace of gross margin rate generation.

And I feel quite confident that as we look forward, Q4, Q1, Q2, Q3, '07 that issue will be behind us.

In the short-run in the second quarter, yes, we did experience some modest pressure in the expense rate due to slightly faster growth in store payrolls than sales.

Thank you.

Your next question comes from the line of Mark Miller with William Blair.

Hi good morning.

Can you provide a little more detail around the private label penetration currently?

What is the number of SKU's and some perspective on where you're at from a year ago?

Well broadly, we're very committed to the growth of our private brands and private availables.

Whether it's apparel, home goods or food.

I suspect you're specifically referencing where we are today in our private label penetration in food.

And that continues to gain ground.

We are making progress.

We are in the mid-double digits in terms of grocery penetration in our SuperTarget stores and we expect that to increase over time.

All right.

And can you also refresh our memories on the frequency initiative back to early 2003 and from that, what did you learn?

In the event we see a slowdown in consumer spending, which aspects of that might be most appropriate for your business going forward?

Well, our strategy has always been "expect more pay less."

And we are focused on delivering both aspects of that equation.

In times of tougher economic macro environments, we'll focus slightly more on the pay less side of that equation.

And make sure that our content and presentation and marketing emphasis speaks a little bit more directly to price at a time where price becomes slightly more important to the consumer.

But overall, our strategy has always been to focus on both of those elements.

And it's an balanced approach that we take.

And we're just talking about slight shifts in emphasis from where we are today.

And it is something that we are mindful of all the time where that appropriate balance should be on "expect more pay less."

And then a final question, if you would entertain a somewhat subjective exercise.

With your comment on that historical range in comps and historical range on earnings growth, does that -- I assume that imples you think those ranges still hold.

And I'm wondering what might be different now relative to the last decade?

It does seem like there's potentially a somewhat smaller incremental opportunity to increase direct imports.

On the other hand, you have more food and consumables.

So, if we were looking at the downward part of that range 3% comps, do you think you would still be in that double digit EPS growth, thanks?

Generally, I do.

There are certainly are going to be exceptions.

There have been exceptions in our past.

The context of the comment was that across sustained periods of time, our results are rarely outside those ranges.

There's certainly the possibility we would be above or below those ranges moving forward.

But I don't believe that any of the core underlying dynamics that have created that pattern of actual results have changed.

Okay.

Thanks.

Your last comes from the line of Adrianne Shapira with Goldman Sachs.

Thank you.

Now with some distance from July and as Bob mentioned earlier comp's ability is what you've highlighted but traffic clearly seems to be a little bit more volatile.

Now with some distance from July, can you shed some light on how you explain the traffic slowdown?

In hindsight, would you have done it any differently and just any sort of commentary on back to school trends?

Well, we're still very early in the back-to-school time frame but at this particular point in time we're pleased with our back-so-school, both on the hard linesm consumables, paper, pencil, crayon side of the business, as well as our apparel.

So we're expecting back to school, back to college to be approximately where we planned it on.

Looking back in terms of July, we have been cycling strong comps all throughout Q2 of '05 and our 3%plus comp in July on top of what we delivered last year was a very respectable number.

And there isn't anything that we would have done significantly different that what we did this year.

Did you see any of your competition do anything significantly different?

Not really.

July is a transition month in everybody's stores.

People are exiting their spring goods.

There's a lot of clearance activity that sometimes impact comparable store sales.

It's a transition time into back to school.

Everybody launches back to school, back to college aggressively, initiate roll backs, people respond.

The general rhythm and flavor of the competitive environment in July was pretty consistent and predictable to what we've experienced over the past half a dozen years.

Okay.

And then just being in stores recently, it sounds as if home is going through a reset over the next few weeks.

What would you expect the category to look like when the reset is done?

We go through numerous category resets on an ongoing basis.

So, some categories are transitioning out, other category will transition later in the month, some in September.

And what we've been experiencing all year, is as we transition our categories as we strengthen our content and get our good, better, best balance more in line to where it should be; we see underlying strengthening in those businesses as those categories transition.

So, we expect that to continue as we go through the fall season.

Maybe just following on that.

We had heard in our comments in previous calls that we were expecting a little bit more sharper pricing in home.

Would that be an outcome of this reset?

I'm sorry?

Q4.

Actually, in terms of pricing for home, what you are going to see is you are going to see a shift -- a slight shift in mix.

And as appropriate, we will be more selectively aggressive on key items as we focus on key items in our marketing and we focus a little more on conveying classification dominance, instead of some of the lifestyle emphasis that we have had in the past.

That doesn't mean we're going to be super aggressive or disruptive to the market.

We're just going to shift the emphasis from lifestyle merchandising to more classifivation, more key-item focus.

And that shift has already occurred in the second half of the second quarter and will continue in the third and fourth quarter.

Thank you.

You do have more questions.

Your next question comes from the line of Gregory Melich with Morgan Stanley.

Hi.

Thank you.

A couple of questions.

One, Doug, is on the cash flow from operations, it has been down year to date and it was down again the second quarter.

It looks like it's payables versus inventories, is there a timing issue going on with that that, that we should be aware of what's driving it?

Yes, you are correct it is mainly an issue of timing in the flow of our inventories and payables.

I do not expect over time to sustain the relationship that has driven this on a year to date basis.

So for -- what is it specifically?

Or was last year more normal or was this year more normal?

Well, in both cases we're keeping off of year end balance sheets.

And the single biggest driver of this year to date differential is the fact that our year end '05 balance sheet had an abnormally high and abnormally beneficial payables level relative to inventories.

We had negative paid inventory position.

We had sharply higher payables than inventories at year end.

And so, the balance sheet more than anything else is driven by those factors.

There are other factors involved but that's the biggest one.

Okay.

Great.

And then the second one is Bob, you lead off by talking about by 2011 the Company having 2,000 stores and 100 billion of sales.

And I know it's impossible to predict five years of future.

But if you were to guess to get to get to that level, would your EBIT margin or operating margin be the same as it is today or higher or lower?

And would your -- the capital you would need to deploy to get there, would it result in higher or lower asset turns?

First of all we think that our margins have improved significantly over time.

That -- and now we continue to improve margins in some areas with more direct importing.

But that's offset a little bit by the mix of our greater increased focus on commodities and frequency in grocery items.

But we believe it is sustainable at that approximate level.

One issue that I would add to Bob's comment is there's clearly a mix issue involved with SuperTarget versus the rest of the chain.

So part of the answer to your question, Greg, lies in trying to predict with precision the mix of SuperTarget and discount stores, looking out that far.

Importantly to me, even it's very heavily -- hypothetically, even if the equation was much more skewed to lower margin higher turns SuperTarget stores; the EPS path is virtually identical, regardless of that mix issue.

So if we had to guess, the margins would be similar today and so would the asset turns?

I'd say, that it's similar with a plus side on the asset turns.

And similar with a question mark in terms of how many SuperTarget stores will be on the margin side.

But either way you mix it out, it is a distinct double digit EPS growth expectation on average over the next several years.

Great.

Thanks.

Your next question comes from the line of Todd Slater with Lazard Capital Markets.

Thank you very much.

Doug, if we back out the credit numbers, we calculate EBIT growth in the retail side of about somewhere in the high single digit range, we get about 9%.

And while this is better than the third -- better than the first quarter, it indicates that the operating margins in retail may have contracted a bit.

And I'll just wondering how did the retail side of the business come in relative to your plan?

And how do you see growth in that piece in the back half of the year within our general expectations?

Yes, you are absolutely correct.

Using the numbers we disclosed today, the EBIT have -- after one backs out the credit card contribution to EBIT was up about 9% in the quarter on an 11% sales growth.

And it's simply the mathematical result of the my comments.

The gross margin rate is about even and expenses grew faster than sales.

So, projecting that forward for the back half of the year, Q3, what I have said is that we expect epenses to again, grow faster than sales driven in part by last year's credit to expense from the Visa Mastercard settlement and driven in part by the Q3, Q4 advertising and market expense incurrance this year.

So again, I would expect EBIT on this basis, to grow slower than sales in the third quarter.

In the fourth quarter I expect these trends to reverse.

We have several timing issues that we have talked about for the last two calls that turn around in the fourth quarter.

And in addition, I think the possibility exists for some gross margin rate expansion, slight gross margin rate expansion in the fourth quarter.

Also that 53rd week, 14th week in the quarter will meaningfully leverage depreciation in the quarter.

So, for all three of those factors I think there is the distinct possibility for EBIT, excluding our credit card contribution in the fourth quarter, to grow faster than sales.

So just to follow up on that, in the fourth quarter if you exclude the depreciation, are you looking for SG&A to actually -- on the retail side to get leveraged?

Because we have had, I don't know 10 consecutive quarters where you have had a derterioration in the rate, some of it you mentioned was timing, other issues.

So, is that finally going to reverse in the fourth quarter in your opinion?

It is more likely than not to reverse.

If it reverses, I don't want to blow this out of proportion, I don't expect it to create some huge benefit.

But it is more likely than not to be favorable in the fourth quarter.

Okay.

Great.

Thank you.

Your next question comes from the line of Deborah Weinswig with Citigroup.

Good morning, two questions.

There was a question earlier abiyt the dynamics of the kind of change in the third and fourth quarter.

Can you in light of that, Doug, explain the kind of discussion earlier about the marketing expensing, heavier in the third and ligher in the fourth?

Or is there something else to do with that dynamic?

Well, in the third quarter, again there are many factors involved here.

But the two biggest factors are cycling last year's Visa Mastercard settlement, which was recorded and disclosed as a credit to SG&A expense.

And separately, last year's marketing timing was more skewed to expense in the fourth quarter, less skewed to expense in the third quarter than in the average of the many years before it.

This year is more of a return to a normal pattern.

But that means year-over-year, marketing and advertising in the third quarter will grow faster than sales.

Marketing and advertising in the fourth quarter will grow more slowly than sales.

Okay.

And then last question.

I believe that Gregg had talked about increasing the direct import penetration.

Can you remind us where you are now and what the additional opportunities right be?

We are approximately at the 30% level of direct imports and we expect that to grow approximately 1 percentage point per year for the next several years.

Great.

Thank you very much.

There are no further questions at this time.

Are there any closing remarks.

Thank you very much, everyone that concludes Target's second quarter 2006 earnings conference call.

And thank you very much for joining us.

Ladies and gentlemen, this concludes our conference call for today.

You may now disconnect.