目標百貨 (TGT) 2007 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Target Corporation second quarter 2007 earnings release conference call.

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

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

(OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded, August 21, 2007.

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 2007 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 provide a brief update on our view of the current retail environment, then Doug will review our second quarter 2007 financial results and describe our outlook for the fall season and full year.

Next, Gregg will provide an update on key strategic initiatives that continue to fuel Target's performance and growth.

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

This morning we announced our financial results for the second quarter of 2007 and we are pleased with our performance.

We continued to gain market share, growing our total sales by over 9%.

We further expanded profit margin, as EBIT grew 11.8%.

Through slower growth of net interest expense and meaningful share repurchase, we leveraged this EBIT increase to fuel growth in earnings per share of 14.0%, and we continue to strategically invest in our business, opening 42 new stores and one new regional distribution facility.

Through the first six months, our comparable store sales reflect this year's economic environment and a somewhat more cautious consumer, with year-to-date comparable store sales up 4.6%, aided by sales at Target.com, compared with last year's 4.9% days excluding online sales.

Our outlook for the remaining two quarters of 2007 and for the year overall envisions that Target will continue to generate a mid-single digit increase in comparable store sales, as our guests continue to find more reasons to shop at Target more often and to spend more on each visit.

In addition, we expect both our new stores and our credit card operations to remain meaningful contributors to our overall earnings.

Reflecting our significant investments in sourcing, private development, and supply chain, which reduce merchandise lead times, ensure a constant flow of great design and exceptional prices and enable us to react quickly to short run variability in our pace of sales, we believe that Target is well positioned to continue to gain profitable market share growth for a long time to come.

Now Doug will review our results for the second quarter, 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.

Following our prepared remarks, we will conduct a Q&A session and Susan Kahn and I are available throughout the remainder of the day to answer 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 contained in our SEC filings.

This morning Target announced our financial results for the second quarter of 2007, which met our expectations for growth in both our core retail and our credit card operations.

Let's review some of the highlights of the quarter in more detail.

Total revenues grew 9.5% to $14.6 billion, fueled by the contribution from new stores, a 4.9% increase in comparable store sales and the growth in revenue from our credit card operations.

In our core retail operations, we expanded gross margin rate by 39 basis points, primarily due to improvement in markdowns while our expense rate increased by 44 basis points.

As a reminder, our year-over-year gross margin rate is currently benefiting from the affects of a couple of small financial reporting refinements that have a parallel, inverse effect on our expense rate.

This means that analytically, the magnitude of our gross margin rate favorability and expense rate increase on our retail EBIT margin would each have been about half of their reported amounts without these reporting refinements.

Our credit card operations also continued to deliver strong profit performance.

Average receivables grew 13% from a year ago and we produced a 34% increase in credit card contribution to earnings before taxes.

On an annualized basis, our credit card contribution to EBT as a percent of average receivables was 9.7% this year, up from 8.2% a year ago.

This larger than normal yield increase was driven in part by the beneficial impact on late fee income of conforming the terms on all of our portfolios to the typical industry practice of tiering the late fee amount based on balances and a 25-day grace period.

Overall, our earnings grew at a solid double digit pace.

Earnings before interest and taxes or EBIT rose 11.8% to nearly $1.3 billion compared with just over $1.1 billion in the second quarter of 2006.

Net earnings increased 12.7% to $686 million compared with $609 million last year and diluted earnings per share grew 14.0% to $0.80 from $0.70 a year ago.

Net interest expense in the second quarter increased $14 million from $140 million a year ago to $154 million this year, primarily due to higher average funded balances, including the debt to fund our receivables growth.

Our effective income tax rate for the quarter was 38.4% compared with 38.8% in last year's second quarter.

We expect that there will continue to be variability between our individual quarterly and full-year effective tax rates as tax uncertainties arise and are revolved.

GAAP requires us to reflect these discreet tax matters in the quarter in which they occur.

For the full year, we continue to expect our effective tax rate to rise modestly from our 2006 rate of 38.0%.

During the second quarter, our Board of Directors increased the authorization of our share repurchase program from $5 billion to $8 billion and we continue to repurchase shares of Target common stock.

Specifically, we invested $476 million to buy approximately 7.5 million shares of our common stock at a weighted average price of $63.23 per share.

Year-to-date, through the first six months of 2007, we've repurchased just over $1 billion of our common stock, acquiring 16.7 million shares at an average price of $61.34 per share.

For the program to date, we have now repurchased 87.8 million shares of common stock, representing a little over 10% of our current shares outstanding at an average price of $50.99 per share for a total investment of approximately $4.5 billion.

As a result, weighted average diluted shares outstanding in the quarter were lower than the corresponding figure last year by nearly 10 million shares or about 1%.

We believe that we will complete our total share repurchase authorization by the end of 2010 or sooner.

Now let me turn to the balance sheet.

Net accounts receivable at the end of the second quarter were $6.4 billion, 15.5% above our receivables levels at this time last year.

Over the same period, we have increased our allowance for doubtful accounts by $8 million to $509 million in total, representing 7.4% of our quarter end gross receivables.

Our balance sheet inventory position grew 5.9% from a year ago, over 3 percentage points lower than our 9.3% sales increase.

Property and equipment net of accumulated depreciation increased $2.8 billion from a year ago, reflecting our ongoing investment in new stores and the distribution and systems infrastructure to support our continued growth, as well as our commitment to maintain our brand integrity by reinvesting in our existing stores.

A portion of our year-over-year increased investment is related to timing of 2007 and future capital projects.

For the full year, we expect capital spending to be in the range of 4.5 billion to $4.7 billion.

Now let me provide some additional guidance for the balance of 2007 and put this in perspective by keying off of our experience through the first half of 2007.

I'll begin with our core retail operations.

During the first six months of 2007, our comparable store sales increased 4.6% and total sales increased over 9%.

For the remainder of the year, we expect our trend of mid-single digit comparable sales increases to continue, adjusted for calendar shifts.

However, we expect sharply lower total sales growth in the fourth quarter due to the affect of the extra week in that period last year.

We continue to expect our growth in earnings per share to be stronger in the first half of the year than in the second half of the year.

This has been our plan since we first laid it out for you and it remains our plan today.

Even more precisely, as previously disclosed, we continue to expect our full year retail EBIT margin rate to remain essentially flat to 2006.

In other words, in light of our modest year-to-date EBIT margin expansion, we continue to expect some modest contraction in our EBIT margins in the fall season.

On the credit card side, we expect to continue to enjoy our current strong, underlying performance throughout the remainder of 2007 with receivables continuing to grow in-line with or faster than sales and with delinquency rates and net write-off rates highly likely to remain within the range contemplated by our current balance sheet reserve.

As a result, we expect to continue to enjoy both the strategic and financial benefits of our credit card portfolio.

Combining expected retail and credit card performance, we continue to believe that $3.60 remains within the range of likely outcomes for 2007 full-year EPS.

In my opinion, as of today, the prospects of earning slightly more than $3.60 are roughly equal to the prospects of earning slightly less.

Consistent with this outlook, we expect our EPS growth rate for each of the next two quarters to be in the single digits rather than in the double digits.

This performance would, of course, position us well to earn $4 or more in EPS in 2008.

As Bob explained, we remain confident in our underlying strategy and in our continued ability to generate outstanding financial performance in a variety of market conditions.

We're confident that our proven combination of growth, innovation, and disciplined execution will continue to reward our shareholders on average with double digit percentage increases in EPS for many more years to come.

Now Gregg will provide a brief summary of current business trends and describe several of our current merchandising initiatives.

Thanks, Doug.

As Bob and Doug indicated, we are pleased with our performance in the first half of 2007, particularly in light of the somewhat more difficult economic environment facing our guests.

As we look to the remainder of the year, we are planning our business more conservatively to reflect this climate as well as the calendar impact of last year's 53rd accounting week.

While we have incorporated this discipline into our plan we also are focused on creating and exploiting opportunities to grow sales and gain market share profitably regardless of the external environment and our plans enable the flexibility to react when those opportunities arise.

Looking back at the second quarter, our comparable store sales rose 4.9%, reflecting typical growth in both guest traffic and average transaction amount.

Our sales results included better than average performance in women's apparel, electronics, and nondiscretionary categories like health and beauty, pharmacy, and consumables while sales in categories such as footwear, music and movies, intimate apparel, and lawn and patio were weaker than average.

During the second quarter we continued to expand our store base, opening a total of 42 new stores, including 32 general merchandise stores and 10 Super Target locations.

Net of closings and relocations, these openings bring our total store count at quarter end to 1,537 stores in 47 states, including our first ever three-level sales floor location in Glendale, California.

In October, we will complete our store opening program for 2007 with the addition of 43 new general merchandise stores and 18 new Super Target locations.

Considering the economic challenges currently facing all of retail, the strength of our second quarter financial performance reinforces our confidence in our strategy and our Expect More, Pay Less brand promise to our guests.

We have established a strong bond with guests by satisfying their wants and needs and delivering exceptional value through our unique guest-focused store experience.

By delivering both reliability and newness throughout the year, we give our guests more reason to shop at Target more often and to buy more on each visit.

During the second quarter, for example, we debuted Patrick Robinson and his Greek inspired fashions in Go International and in July introduced unique styles and looks in a collection called Libertine by Cindy Greene and Johnson Hartig.

In May we also significantly enhanced our offering in electronics by improving our balance of good, better, best, and introducing a new 44 foot presentation of televisions.

About three-fourths of this space is devoted to flat panel and specifically LCD technology.

We extended our limited engagement strategy to women's accessories, adding a collection of handbags, clutches, and wallets, which showcase metallic skins and oversized jewels from award winning handbag designer Devi Kroell.

And the second quarter marked the beginning of Target's new online photo partnership with Shutterfly and Kodak Gallery.

Across categories during the quarter, we maintained strong instocks while controlling receipts and inventory.

As a result, we realized significant markdown rate improvement versus last year and ended the quarter with inventory levels in very good condition.

To sustain our competitive advantage and continue to delight our guests, we are launching several new initiatives in this year's third quarter as well.

For example, we have refined our back to college program by improving our assortments, packaging, in-store signing and marketing, as well as enhancing our supply chain to optimize shipment quantities and timing for specific markets.

Beginning this month, Target will feature a fresh, fun, feminine jewelery collection by L.A.

designer, Dominique Cohen.

Also this month we're introducing a bath and body line from the U.K., Soap and Glory, developed by Marcia Kilgore.

In September, Go International will feature English designer Alice Temperley, known for her ultrafeminine styles.

We're continuing to refine the balance of good, better, and best items in our home categories and are pleased with the strength of recent sales trends in this part of the store.

We are expanding our assortment of healthy alternatives in our food categories and will be featuring those products more prominently in our circular and end caps.

And in electronics, we continue to extend our Sony assortment and LCD HDTVs and we expect to continue our strong sales trend in video game hardware and software, particularly in light of recent hardware price reductions.

In addition to merchandising initiatives that create excitement and drive traffic to our stores, we continue to find new opportunities for Target.com to deepen our guest relationships and drive both online and instore sales.

For example, we continue to extend the instore assortments online by offering additional sizes, colors, and styles on target.com.

We continue to use technology, such as find it in a Target store, and our gift finder tool to help our guests save time while driving store visits.

This fall we will add more convenience with Target lifts, which allow guests to create individualized shopping lists for both everyday trips and special occasions.

In addition, our gift registries continue to serve as a primary gift-giving resource for major occasions.

Close to half of all of our wedding and baby registries originate online.

Finally, Target.com helps guests save time by previewing the weekly circular, ordering their in-store prescription refills and uploading their photos for pickup, all on the site prior to their store visit.

These examples demonstrate that Target.com continues to grow as part of an integrated strategy to simplifying shopping for our guests and drive both instore and online sales.

The success of this approach has been measurable.

Both sales and traffic to the site continue to grow at a double digit pace and Target.com is among the top three most visited retail sites on the Internet, ahead of Wal-Mart.com.

In addition, our research shows that Target.com drives incremental store visits and in-store sales.

In our stores, to ensure that we are prepared to react quickly and efficiently in a variety of sales environments, we remain focused on finding additional opportunities to leverage our sourcing, technology, and supply chain infrastructure.

For example, we continue to improve our product design and development process to enhance quality and fit and reduce merchandise lead times.

We continue to develop our distribution network by adding regional and import capacity support to support our growth, adding one import warehouse and one regional distribution center to our network in 2007.

And we are pursuing opportunities to reduce inventory while improving in-stock levels, improving transit times and eliminating costs throughout our supply chain, both domestically and internationally.

We know that our disciplined execution and culture of continuous improvement and innovation constitute a winning combination that cannot easily be copied by other retailers.

By focusing on the store experience and anticipating wants and needs at an exceptional value, we are confident that Target will continue to remain relevant with our guests and we will continue to deliver great results in 2007 and beyond.

Now Bob has a few concluding remarks.

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

We believe that Target remains on track to delight our guests and deliver another year of solid growth and strong performance in 2007.

That concludes our prepared remarks.

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

(OPERATOR INSTRUCTIONS) Your first question comes from the line of Deborah Weinswig with Citigroup.

Good morning.

Gregg, you had talked about planning the business more conservatively, and also the economic challenges facing retail.

Could you provide additional color around what you are specifically seeing with your customer as it relates to those comments?

We feel that entering the third and fourth quarter, we should be slightly more conservative than our planning assumptions at the early of the year.

We're not talking about huge shifts, we're just talking about making minor adjustments to make sure that we make strong instocks in all of our consumable and nondiscretionary categories, but we're a little bit more mindful and we manage our inventory a little bit more carefully in our apparel and seasonal (inaudible) and that's really just a slight adjustment to what we typically would do.

Deborah, I would also point out that so far this year, our same-store sales performance as reported is about 3/10 of a point lower than where we found ourselves at this point last year.

But, of course, as you know, this year's figure include the beneficial effect of Target.com.

So our comps year-to-date on an apples-to-apples basis are slower than last year by nearly a full percentage point.

And we are not anticipating that that will soften, we're basically saying we're at a slightly more modest pace than we were last year and we see that continuing into the fall season.

Okay.

Doug, you also saw -- and I understand there's the accounting adjustments, but pretty impressive improvement in gross margins and I understand there's an improvement in markdowns.

Can you kind of provide additional color around that and also if there was anything else in the gross margin line we should focus on?

Yes, I'll provide a little bit of color there.

Both the quarter and year-to-date have about the same basis point improvement in gross margin rate and in both cases, about half is due to those accounting refinements, but give or take 20 basis points is genuine underlying favorability driven in the main by improvements in markdowns.

We continue to experience adverse sales mix affects on gross margin rate, and that of course will continue into the fall season.

I would not expect that the degree of markdown improvement that we've enjoyed in the first half would continue.

Frankly, that's been our plan all along, to enjoy better markdown performance in the front half of the year than the back half of the year.

Combine that with the fact that over the last couple of years our third quarter gross margin rate improvement has well outpaced any other quarter, pull all of that together, clearly I would personally be concerned about our ability to replicate last year's gross margin rate in the third quarter.

Fourth quarter is more about that extra week, but third quarter I have a bit more concern about hurdling last year's record high third quarter gross margin rate.

Okay.

Last question, you spoke at the analyst meeting the addition of instock teams in March to your stores.

Can you talk about what the experience has been and what you've seen as a result in the store?

Yes, the instock teams that we initiated early in the year are performing very, very well.

Our instocks consistently are at or slightly higher levels than last year, and these teams are more focused on ensuring that any out is researched and dealt with on a more frequent basis than what we had been experiencing in the past and so rather than having our team leaders or department managers managing the outs and the research process, we have a very dedicated, small team in each store who's only responsibility is making sure that they get around the store on a very regular basis so that we can respond more quickly than how we've responded in the past.

So far, we're very pleased with the performance of these teams.

Great.

Thanks so much and best of luck.

Your next question comes from the line of Mark Husson with HSBC.

Good morning.

A couple of questions on the trade-off between cost price and selling price here.

The first one is on food price inflation.

What are you seeing, have you been able to pass it through?

The second thing is, currencies have been all over the place.

I know you saw normally in dollars, but somebody somewhere has to pay for that stuff in local currencies.

Are you seeing any change there?

I will handle the food inflation and Doug will handle the currency issue.

As you know, there's been substantial food inflation throughout the first half of this year.

We saw more of that inflation in the first quarter than we have in the second quarter.

I wouldn't say that it has stopped altogether, but it is at a decreasing pace than what we experienced at the first quarter.

The marketplace has been receptive in terms of passing through those cost increases along to the consumer in the forms of higher retail.

So that experience has been consistent throughout the fist half of this year.

In terms of your question regarding the inflationary pressures in imported product, you're correct in observing that there are some inflationary pressures.

In our case, I think it is much more of a direct impact of the dollar cost inflation in some raw materials than it is driven by the dollar exchange rate with specific foreign currencies.

To be clear, anything related to oil or energy directly or indirectly in dollar terms, of course, is experiencing some inflationary pressures.

So far, this has not amounted to a meaningful increase in the inflation of our imported product, but it is something we carefully watch.

And just one quick follow-up on imports, you've become a little bit more conservative as you were saying on the way that you've planned out the second half.

Does the increased penetration of direct sourcing make that more difficult to manage the lead times, or have you been able to finesse that?

No.

The direct import percentage penetration that we have really doesn't really impact our ability to manage our business one way or another in the second half of the year.

Okay, that's good.

Thank you.

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

Two questions.

One for Gregg and then Doug.

Gregg, could you give us a little more color in terms of the markdown improvement year over year and what it was on apparel versus home, and particularly if you're seeing -- how those two categories are playing against each other?

Well, as Doug said, we managed our inventories exceptionally well throughout the entire first half of the year and we experienced markdown savings in both apparel and home with slightly greater savings in the home businesses.

Our home businesses continue to gain momentum and strength and we are in a position where we're chasing more inventory than we are trying to get out from under categories that aren't selling.

We're in a very, very good position there and we saved a fair amount of markdowns in the second quarter in the sense that we really don't expect that to continue into the third quarter because of our record high levels of gross margin performance and markdown savings of last year.

Great.

Doug, could you -- just given the current situations and the credit markets, could you just discuss how the securitization of the receivables is going and your view of the commercial paper market?

Well, we do have a portion of our receivables funded via securitization transactions.

That is not an ongoing process, so there isn't any liquidity related issue in our AAA rated securitization securities, receivables-backed securities.

Separately though, in the commercial paper markets, oh, what a wonderful time to have A1, P1, F1 commercial paper ratings from Moody, Standard & Poor's, and Fitch.

Because as you're well aware, lower-rated paper is very difficult to place at any price and when placed, typically overnight at sharply higher rates.

So this is a wonderful time for us to capture these strategic and financial benefits of those short-term commercial paper ratings.

Have you done any CP in the last week?

In the last week, we have benefited from -- over the last couple of weeks, we have benefited from $1.5 billion of fresh, new money incoming due to a combination of two financings, and therefore we have not needed to access the commercial paper markets, but the commercial paper markets are clearly open and available for issuers such as ourselves with very strong credit ratings.

Great.

Thanks a lot.

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

Thank you.

Good morning.

I have two questions.

The first is, what plans do you have for this fall as you begin cycling the rollout of the $4 generics program in the pharmacy area?

Then secondly, have you observed any sort of trade down in the basket or any sort of, I guess, skewing of what people are purchasing to more of the basic and consumables away from discretionary items?

Thank you.

We don't really have any significant or major plans to do anything different other than what we're currently doing in our health care business, which is continue to offer $4 generics, continue to offer great service, and to build our franchise and market share in our recs and over the counter.

As it relates to basket and competition and size and trading down, we really haven't experienced any meaningful change in our basket composition or our average retail per unit.

So it's fairly consistent to what we've been experiencing all year.

We do continue to enjoy sharply higher rates of sales growth in lower margin, typically commodity and consumable products than in our higher margin businesses, but I think it would be a mistake to interpret that as trading down.

It's the natural way we have gathered market share for many, many years.

Thank you.

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

Yes.

Gregg, a question for you on the category performance.

One, have you noticed any particular emphasis or pressure on back-to-school categories as a result of more competitive pricing from Wal-Mart and others?

Also, on home, we've been hearing from a number of retailers over the last couple of weeks that the home category is improving and in some cases even surprising retailers given everything that's going on in the housing sector.

Does that continue to be a positive trending category for you or an improving category and how do you see that playing out?

I would characterize our back-to-school business as essentially getting off to a slightly slower than expected start in the month of July.

I'm not sure if there was a -- it was a combination of things that were happening, weather was exceptionally dry and warm at that time, there are more schools that are going back later and later and that may have contributed as well as some shifts in some of the tax-free events in states like Texas and Florida.

As we are moving deeper into the season, we are seeing our business perform at or better than planned, so we are capturing -- recapturing some of that shortfall that we experienced in the month of July and as we reiterated on our call the other day, we are expecting August to be in the range of 4 to 6%.

As it relates to our home business, we've seen strengthening of that business all year so far.

Part of it is due to the fact that we've struggled in that category over the last couple of years and we initiated a lot of assortment changes and we've transitioned and as we have done that we've seen our business improve and we've got a much stronger good, better, best selection and we've just made a lot of changes that have been driving that business forward.

So we've been experiencing positive momentum all spring and that continues throughout the month so far.

Okay.

Doug,just one other question for you regarding guidance.

Your comment about at least $4 of earnings next year off of a $3.60 would reflect very low double digit earnings growth or EPS growth.

Any color, further color you could share.

Is that a base level expectation with the current model?

And what would it take for you to accelerate back up to closer to a mid-teens performance?

Well, my exact comment was that the performance of $3.60, give or take this year, would position us well to earn $4 or more in 2008.

I think it's a little premature to be giving precise 2008 guidance.

We'll be happy to do that once we have completed the 2007 holiday season.

Okay.

Thank you.

Your next question comes from the line of Charles Grom with JPMorgan.

Thanks.

Good morning.

Just to follow-up on Christine's comment earlier, Wal-Mart said last week that their consumers trading down to more private brands from national brands.

Just wondering, Gregg, if you're seeing a similar trend there?

We're not seeing a similar trend, although I will tell you that our private brand performance in both health and beauty and food continue to outpace the category growth, but that is not a change in performance.

That experience has been consistent for the last couple of years.

So we're really not seeing -- we're really not seeing that same pressure that Wal-Mart is.

Nor do our guests view that as trading down.

This is a very important comment that I know I'm repeating, but it's worth repeating.

Fair enough.

Then Doug, one for you.

If SG&A expenses were up 44 basis points and half of that was to reclass back to GPM, could you speak to the factors that led to that increase in the quarter?

Well, there were a number of factors, nothing really dominates the picture.

I think that I would point you to the fact that combining the first and second quarters gets rid of a lot of the noise and the timing issues.

We're unfavorable 6 basis points year-to-date and more than 100% of that is those accounting refinements.

I feel very good about where we are on an expense basis year-to-date.

I feel very good about where we will land for the full year as well.

Our previous guidance that we expect generally the same gross margin rate and expense rate for the year remains intact.

Okay.

Last one, just on the credit card, when did the late fee tiering go into place and is the 6.5% run rate as a percentage of receivables a good barometer for the next couple of quarters and going forward in general?

During the quarter, we conformed the terms on all of our cards.

Previously, the majority of our cards had tiered late fees, but we were not conformed on those tiers and we were not conformed in terms of the timing of assessment of the late fees.

So generally speaking, it's our proprietary card portfolio who's terms were pulled in-line with both the tiering and timing of late fee income that we had previously put in place in our Visa card portfolio.

I did not understand your question about the 6.5% reference.

Just looking at the, I think it was $109 million as a percentage of the average receivables, just the way we model it, it was up 120 basis points sequentially and pretty higher than any run rate we've seen in the past.

Just wondering if that's a good run rate to use.

Now I understand your question.

Yes, a small portion of the late fee income that we recorded in the quarter represented an acceleration, a little more than 90 days' worth, if you will, but I think that the lion's share of that increase will be with us for many, many, many quarters to come.

Great.

Thanks very much.

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

Thank you.

So Doug, I'm sorry, just following on that, you said that late fees will stay at this sort of higher level going forward?

Is that what we should assume?

Which in turn helps your entire financial charge revenue?

Yes.

Okay.

Thank you.

So it isn't -- Doug, it isn't four quarters of that?

I guess that will sort of anniversary, but it will stay out there going forward?

For a while we would expect year-over-year increases to be larger than normal and beyond that, we would continue to enjoy the benefits of this higher level of late fee income as a percent of average receivables for years to come.

Okay, thank you.

Let me -- when you say you have a 25-day grace period and you guys, when you disclose delinquencies that are 30 plus days past due, how are you treating the grace period in that?

Does somebody have -- is it really 55 days past due because somebody has got 55 days, they have a 25-day grace period?

Yes.

Generally, you're on the right track.

Okay, okay.

So a little more.

Let me -- how about the -- how about the allowance for doubtful accounts now at 7.4%.

Your cash write-offs are running -- the 7.4 is sort of where you were in '04 and '05, but the cash write-offs are running so much lower today.

Is it fair to assume that your reserve levels could also come down?

It's certainly possible.

At every quarter end, we take a very careful look at lots and lots of risk-related attributes of our portfolio on a very granular basis and develop the reserve that we think is appropriate in light of the expected future write-offs of the then-current period end receivables.

We've been doing that for many years.

So certainly it's possible that if our experience is favorable moving forward, you could see that in that event, you should expect to see that our allowance as a percentage of gross receivables would fall over time it.

It certainly isn't something that's preordained by the current attributes of the portfolio.

And is there, Doug, anything that you're seeing out there that concerns you in terms of the consumer, on the consumer credit front?

I notice your receivables jumped up, they increased a little bit, just the rate of receivables growth went up to 14%.

Some credit analysts out there are saying that's a precursor to potentially some deterioration.

People are putting more on their cards.

Do you see anything out there that's concerning to you?

I know you gave us a little more disclosure this quarter with the 90-plus days, that's nice.

Well, obviously, if we felt that that that deterioration was reasonably possible or reasonably likely, we would have reflected it in increased bad debt expense and an increased allowance on the balance sheet, so the mere fact that we report our numbers in this fashion should be a clear indicator that we have a high degree of confidence in the continued health and prosperity of our credit card operations.

And to your point, you've -- the best indicator of your pace of cash write-offs are really these past due accounts?

It's a useful shorthand.

I would stop way short of calling it the best indicator.

Okay.

We can continue offline.

Thank you.

That was very helpful.

My second question -- my second focus was for you, Gregg.

You made some remarks that basically suggest you guys are better positioned, maybe, than a year ago if you do have a slowdown in sales.

I just want to get you to summarize that again.

If I go back to April of '06, you -- retail margins were down pretty big.

I feel like that was sort of a surprise to you all's plan.

Sales, as you remarked, have been a little slower this year, but the retail margin--?

Excuse me, I think that Gregg was just saying that our inventories are not up as much as sales are and we're a little leaner and we're very clean and we're very well positioned to respond.

We're not anticipating any further slowdown, but if you would like some more specifics, maybe you could call in a little bit later with more detail.

Thank you.

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

Thank you.

Doug, just following up on the SG&A point, I understand the 42 stores you opened in the quarter.

If you strip out some of that preopening expense, could you give us a sense of expense leverage in the quarter?

Even excluding preopening expenses, expenses deleveraged in the quarter.

We had payroll and benefits running up faster than sales.

Marketing expenses as a percent of sales went in the other direction.

A lot of pluses and minuses, but this is not something that on a quarterly basis we intercede to try to directly manage.

We are very focused on how these numbers flow together over time and over time, both year-to-date and expected full year, very comfortable with our expense position.

Great, thanks.

Then, Gregg, could you talk about -- you talked at the analyst meeting, conversion to the collaborative approach in an effort to collapse lead times, increase flexibility, perhaps update us on that conversion and give us a sense, is that what's helping perhaps reduce some commitments heading into the back half?

That's an ongoing long-term process in terms of reducing lead times, adjusting our calendars, working more collaboratively with fewer, larger vendors.

So this isn't something over a two or three-month time frame we make a significant am of progress on, but over a longer-term time frame over a couple of years, we expect to continue to do more business with fewer resources providing greater levels of clarity and transparency with one another so that we can collapse lead times and run our business more efficiently.

Okay.

Then just on the home, the repositioning on the good, better, and best obviously sounds like it's working.

Could you give us an update, those efforts to perhaps reposition the intimates?

We have cycled the intimate strategy of '06 and we believe the worst is behind us and as we enter into the third quarter, we're going to start to see the intimate apparels business start to gain momentum and generate positive same-store sales growth.

So we've done a lot of repositioning, we have transitioned through probably 80% of the assortment challenges that were facing us and we believe that as we head into the fourth quarter, in particular, we'll be 100% of where we want to be in terms of assortment and good, better, best balance and price point and things like that.

Thank you.

Your next question comes from the line of Peter Benedict with Wachovia.

Thanks, guys.

Two questions.

First, Doug, can you confirm this financial reclassification, the accounting change, that goes on for one more quarter, I think the third quarter and then it doesn't affect the fourth quarter, is that right?

Generally, yes.

There's a trivial affect in the fourth quarter, but the significant affect that we've experienced for the past several quarters will continue with us through Q3 and generally be gone in Q4.

Are you seeing any changes in new store construction costs out there?

Would just be interested in your comments on that.

Generally speaking, there are some inflationary trends in construction costs.

Having said that, we continue to develop a very high quality pipeline of new stores, one store at a time, that have preserved our going-in or expected economics over time.

Given our current business model, those pressures are easily afforded in preserving metrics like ROIC and EVA over time.

Okay, great.

Thanks so much.

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

Hi.

Good morning.

A couple of quick questions.

On the traffic versus ticket, have you seen any dramatic changes in traffic throughout the last several months and can you give us the breakdown, the exact number, during the second quarter?

We haven't seen dramatic changes and our comp store sales increase was split about evenly in terms of mature traffic increases and basket size increases.

Okay.

On the Super Target comp versus the general merchandise store comp, can you maybe break that down for us as well, the trends that you're seeing?

They're running very, very similar to one another.

In any given quarter or season, you'll get it working both ways, but on average they're very close to one another.

Okay.

On the gross margin side, are there any categories that pricing is really significantly impacting your margin performance competitively from what Wal-Mart is seeing?

Are they pressuring you in any specific areas?

Well, we saw a slightly more aggressive positioning in term of pricing at the beginning of back-to-school, but that was more related to the office superstores rather than Wal-Mart.

Wal-Mart was, in our belief, was fairly consistent with their approach to last year.

Where we've seen Wal-Mart become more aggressive in some of the top tier, branded health and beauty aids and consumables, like laundry and paper goods.

That's where they have taken a particularly aggressive position over the last 90 days.

Great.

Thank you very much.

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

Hi.

Good morning.

I was hoping, Doug, you could provide a little more perspective on the acceleration in the receivables?

How much of the growth is coming from increase in accounts relative to balance per account and how does that trend look versus prior periods?

Then, just the longer-term perspective on how much growth you see in the receivables, if you could talk about receivable spending, how much of it is at Target or what's the penetration look like?

Thanks.

A lot of those relationships are very consistent.

If I would single out one feature that has caused, more recently has caused our receivables growth to slightly outpace sales, it's the growth if spending on the Target Visa card outside our store is outpacing the growth inside the store.

And that in large part is responsible for that slight percentage favorability of receivables growth relative to sales growth in our stores.

Generally, though, we're still in the same arena we've been in in the past.

Generally about 30% of the charge activity on Target Visa cards is inside our stores and about 70% outside the stores.

It would take a continuation of these trends for a long, long period of time to move the needle, say, to even 25, 75.

Over the long-term, I do expect, and we work very hard toward the objective of being able to grow our receivables in-line with or faster than sales while continuing to focus intently on the portfolio quality.

In light of the core loyalty programs on this card, that outside spend is not irrelevant to us.

It ends up helping our guests along the way toward earning reward certificates redeemable only in our store, and last year we redeemed about a -- we redeemed certificates collectively driving $1 billion of retail sales in our stores.

A huge portion of that $1 billion represented incremental sales.

So this isn't simply a nuisance that comes along for the ride.

We love it when our guests choose to use this card more often, because they're doing it for a specific purpose.

Okay.

Can you talk about the overall representation of food and consumables in the business today versus where we were last time it got rough for the consumer, say 5 to 7 years ago, in ballpark terms?

Thanks.

We continue to focus on food as a priority and as we've talked in the past, each iteration of our prototype and remodels, we have expanded the footprint in the store and our commitment to the business in general and if you go back five or seven years ago, we have had on average in a new store, approximately 16 or 18 sides of food in a new store or remodeled store, it would be in the neighborhood of 34 sides of food.

So we've nearly doubled our commitment to food over a five to seven-year time frame.

As we define the categories, consumables and commodities in the aggregate represented 32% of our sales in 2006.

If you turn the clock back five to seven years with an equivalent definition, would have been in the lower middle 20s.

Part of that is driven by the higher rates of growth in those categories.

Part of that is driven by the increased penetration of Super Target stores in our mix over that period.

Okay.

Thank you very much.

Your next question comes from the line of [Jack Fallis] with Midwood Research.

I would like to ask you about your payroll control.

It seems as though you need over 4% comps to even try to reduce it.

Do you have any plans in case sales get weaker going forward to try to control payroll?

Well, we control our payroll and manage our store business in a variety of economic climates and we are very capable of flexing down modestly or flexing up modestly depending upon what the sales environment is all about.

When we are operating at anything north of 4% same-store sales, we're leveraging our payroll and leveraging our expense rate and where we're performing at that level, we are seeing leverage on the expense side of the equation.

So 4% is the break point to go above 4%, you get positive payroll ratios; is that right?

Well, I wouldn't tell you that there's a hard and fast rule as it relates to 4%.

That's give or take.

I mean, it could be in the 3.5 to 4% range, but as we grow our same-store sales at 4% or greater, 3.5% or greater, we see expense leverage in our stores and in our headquarters and our other expense centers.

Okay.

Because I was under the impression that that was not incurring in most of '06 and most of '07?

I think we're trying to put too fine a point in this.

Gregg is focused on payroll in the stores in the main and headquarters expense centers, we have a lot of other expense activity beyond these areas.

I would generalize to say that for quite some time it has required something in the range of 4 to 5% to be expense neutral and if we're meaningfully below that, we have deleveraging and if we're meaningfully above it, you should expect to see favorable leveraging.

Of course, our same-store sales performance in the period you're citing has not been above that 4 to 5% range.

Okay, thank you.

Okay, we'll take one more question.

Your final question comes from the line of Chris Brown with Banc of America.

Hi.

Thank you.

Just a quick question on financing given the turmoil in the debt markets.

As you look at the next six months, given the buybacks and given some inventory ramp for the holidays, how do you see financing your business?

Do you expect to come to the unsecured bond markets, et cetera?

We remain well positioned at this moment to be able to fund ourselves for our seasonal working capital peak here in 2007.

As I stated earlier in the call, our short-term ratings, in particular, provide us with the foundation to enjoy ample liquidity to continue to aggressively reinvest in our business, to repurchase the shares that we think are appropriate to repurchase, and to continue executing our strategy over the long-term.

There certainly has been quite a sea change in the fixed income markets, but we continue to have ample opportunities to access those markets to provide the liquidity to implement our strategy.

I guess just a quick follow-up would be, as you look at what some of the other large companies like yourselves have done, adding moderate leverage to their capital structure and balance sheet, do you guys have targets, per se, from a ratings or a ratio perspective?

We don't have any hard and fast targets.

We, as you can tell from my comments, value our strong investment grade credit ratings quite highly, but that's not meant to focus intently on any one particular ratio or on the precise long-term ratings that we have today.

Thanks for your time.

Okay, that concludes Target's second quarter 2007 earnings conference call and thank you all for your participation.

Ladies and gentlemen, this concludes today's conference call.

You may now disconnect.