目標百貨 (TGT) 2008 Q1 法說會逐字稿

Welcome to Target Corporation's first quarter 2008 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, Tuesday, May 20th, 2008.

I would now like the turn the conference over to Mr.

Gregg Steinhafel, President and Chief Executive Officer.

Please go ahead, sir.

Good morning, and welcome to our 2008 first quarter earnings conference call.

This morning I will share our view of the current economic and competitive environment and describe the implications of this retail marketplace to our strategy.

Then Doug Scovanner, Executive Vice President and Chief Financial Officer, will review our 2008 first quarter financial results in greater depth and describe our outlook for the remainder of the year.

Finally we will open the phone lines for a question-and-answer session.

Beginning next quarter when Kathee Tesija, our new Executive Vice President of Merchandising, joins us on these calls, she will provide updates on key merchandising initiatives as we have in the past.

This morning we announced our financial results for the first quarter 2008 which reflect a difficult overall sales climate that we and others are experiencing.

But we are disappointed in our top line growth, we are pleased with the disciplined and consistent execution of our strategy, our effective management of expenses throughout the company, our continued market share gains, and our ability to achieve earnings per share in line with our expectations.

We are also very pleased with the outcome of the receivables ownership and capital structure review we initiated last September.

Through our significant investment in share repurchase activity and the completion of our innovative agreement with JPMorgan Chase, we believe Target will generate substantial value for our shareholders over time.

In recent months we have engaged in substantial share repurchase, reducing our share count by 8% in the past six months alone.

While we have increased our debt to finance activity, we are confident that shareholders will benefit from this more concentrated share ownership in Target stock as our pace of earnings stock and share price recover.

As gas and food prices continue to rise and housing markets slow, consumers are facing increased financial pressure in reducing their spending, especially in discretionary categories.

Many home furnishings and apparel retailers such as Kohl's, Macy's and JCPenney are experiencing comparable store sales declines in this environment while retailers such as Wal-Mart and Cosco with a significant portion of their assortment devoted to food and commodity items are continuing to generate modest comparable store sales increases.

With our combination of high frequency and fashion merchandise, Target's traffic trends in first quarter was similar to Wal-Marts U.S.

discount stores, while our comparable store sales growth reflected a slower pace due to the 40% of our assortment in more discretionary categories.

As Doug will describe in more detail, we expect this trend to continue in the second quarter as well.

Our expect more, pay less promise continues to guide our strategy.

In this climate, we have heightened our focus on our frequency driving businesses including pharmacy, food and commodities and placed greater emphasis on the pay less side of our brand promise in our weekly circular, in-store signing and through greater use of value pricing on end cap displays.

In addition we remain focused on delivering value by expanding our own brand presence across the store and working with our vendors to offset the rising cost of raw materials.

We are also committed to insuring our assortment reflects the appropriate balance of good, better, best offerings in order to give our guests high quality options at every price point.

In addition to driving traffic and market share growth through must-have assortments, innovative merchandise and exceptional value, we are also intently focused on managing our inventories and being in stock.

At the end of the first quarter despite softer sales, inventories were in very good condition.

As a result, we were able to improve gross margin rates within categories throughout the store even as we continue to experience the adverse mixed impact of faster sales growth in lower margin categories.

As we plan our business for the rest of the year we are working closely with our vendors, pursuing opportunities to segment assortments based on volume and local preferences and carefully managing our inventory to control mark down risk ares and maintain in-stock reliability for our guests.

Our emphasis on controlling the growth of our expenses also remain a top priority.

Second only to the performance we experienced in the fourth quarter of 2007, our first quarter growth in SG&A dollars of 6.2% was the lowest increase in more than 20 consecutive quarters.

While we still experienced a very slight deleveraging in our expense rate in the quarter, due to sales growth of only 5%, this excellent expense control is the result of efforts we initiated in the middle of last year as we recognized that consumer spending was beginning to slow.

We are proud of the progress we have made to date, without compromising any key elements of our brand or service to our guests, and we expect our performance to continue to benefit from this company-wide focus throughout the reminder of 2008.

In addition, we continue to strategically invest in our business to increase efficiencies and optimize results, both in the current environment, and more robust climates in the future.

For example, we continue to improve our product design and development process to enhance quality, increase speed to market and insure we are prepared to react quickly and efficiency.

We continue to develop our distribution network and exert greater control of the perishable food component of our supply chain with the opening of our first target owned semiautomated food distribution center in Lake City, Florida, this fall leading to higher food margins, improved freshness and continued rapid growth of our own food brand.

And we continue to invest in profitable new-store growth.

During the first quarter we opened a total of 26 new stores in 16 states including 18 general merchandise stores and eight Super Target locations.

Net of closes and relocations, these openings bring our total store count at quarter end to 1,613 stores in 47 states.

In July, we will open approximately 43 new stores adding about 35 new locations, net of relocations and closings.

We are confident in the power of our strategy and the passion and experience of our team to lead Target through the consumer spending challenges we are facing in 2008.

Through disciplined execution of our core business operations, we will continue to enjoy profitable market share growth and reward our shareholders for many years to come.

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

Thanks, Gregg.

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

Following our prepared remarks we will conduct a Q&A session, and John Hulbert and I will be 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.

In my comments this morning I plan to cover four topics: first, I will review several financial reporting changes that we have implemented beginning with our first quarter 2008 filings; next, I will review key aspects of our first quarter performance in our newly stabilized retail; then I'll discuss activity under our share repurchase authorization since year end; and finally, I will share an updated outlook for our business in 2008.

First, concurrent with the appointment of Gregg as our Chief Executive Officer, we engaged in a reevaluation of our reported business segments.

As a result of this review, this morning we began reporting results for two business segments: retail and credit cards.

This change reflects the way that Gregg and I and others in our management will evaluate our business results going forward.

This move to two segment reporting, along with the structure of our receivables transaction with JPMorgan Chase, will allow us to provide more clarity into the performance metrics we report on our credit card segment, which I will discuss in more detail later.

In addition we've reclassified distribution and other supply chain costs in our retail segment, moving them from SG&A expenses into cost of sales.

This change was prompted by changes we have made to our supply chain processes and infrastructure, primarily related to the development of our food distribution capabilities.

This change has the analytical impact of creating equal reductions in both our gross margin and expense rates with no change to our retail segment operating margin rate.

To provide context for current reported results we have reclassified prior period results to conform to these reporting changes and we have furnished these reclassified results by quarter for the last three years in the investor relations section of our website.

Now let's move to our first quarter results which were announced this morning.

As Gregg discussed earlier our sales performance fell short of our expectations, but our financial performance met those expectations with earnings per share of $0.74 down $0.01 to last year's first quarter.

In our current environment we continue to see sales and traffic patterns that are significantly lower than we expect to enjoy in the longer term.

Specifically our total sales grew 5.0% in the quarter to $14.3 billion due to the contribution from new stores offset by a 0.7% decline in same-store sales.

Retail segment earnings before interest expense and income taxes or EBIT decreased 2.2% to $959 million this year from $980 million in the first quarter of 2007.

Our first quarter gross margin rate declined nine basis points from last year.

As expected our margin rate was adversely affected by mix as sales of our lower margin consumable and commodity categories out paced sales in our higher margin apparel and home categories.

The magnitude of this mix impact was significant, just under 70 basis points.

Similar to our experience in the third quarter of 2007.

Unlike that quarter, this larger than normal mix impact was largely offset in this quarter by higher margin rates within our assortment.

Our retail segment expense rate increased 24 basis points over last year.

Overall this performance reflects strong control of the dollar growth in expenses offset by the slight deleveraging effect of a relatively weak 5% sales growth in the quarter.

In addition, some year-over-year expense unfavorability was related to the timing of certain items and some related to annualizing the benefit to last year's rate of the $12 million federal excise tax refund.

Finally our depreciation and amortization rate increased 17 basis points, as dollar growth in these noncash expenses grew at a low double digit pace in line with expectations.

This metric generally grows in line with capital investment which we'd have grown over time at a similar low double digit pace.

Now I will move to key results in our credit card segment.

Consistent with our prior guidance, average receivables in the first quarter increased 28% over 2007, benefiting in part from the increase in receivables resulting from last year's product change, in which we offered higher limit Visa cards to a group of our better and best credit quality Target card holders.

Also, as expected period end receivables declined by about $200 million in the quarter from year-end balances, reflecting a typical seasonal pattern in conjunction with modest underlying account growth.

The dollar yield on the portfolio now measured as a spread to one month LIBOR increased modestly in the quarter from $132 million last year to $138 million this year.

As we have discussed in previous conversations, dollar yield on the portfolio is benefiting from the year-over-year increase in receivables substantially offset by the reduction in the rate spread on those receivables, specifically, the yield spread to LIBOR was 6.5 percentage points in the first quarter this year down from 8.1 percentage points in 2007.

Let me pause for a moment to explain these yield metrics, as they differ from our prior use of pretax earnings as our yield measure from the portfolio.

We have moved to a spread to LIBOR framework to analyze both dollar and rate performance since it is the key metric we use to measure performance internally.

As you know, the vast majority of credit card receivables earned variable finance charge revenue tied to the prime rate.

As a result, we fund the majority of these assets with floating rate funding.

In summary, it is only appropriate to judge our credit card EBIT against a floating rate benchmark, and one month LIBOR is the benchmark against which the vast majority of our floating rate funding reprices, including our $3.6 billion transaction closed yesterday with JPMorgan Chase.

This new framework also allows us to analyze the pretax return on credit card receivables funded by Target separately from the yield on receivables from third parties.

Our first quarter reporting shows that the return on receivables funded by Target fell from 16.4% in first quarter of 2007 to 11.5% in the 2008 period, reflecting the decline in our yield spread to LIBOR, as well as the fact Target was funding a larger percent of receivables at the end of the first quarter this year compared to last year.

In had the second quarter and beyond, we expect that our pretax ROIC on Target's residual investment in this portfolio will increase sharply as a direct result of our transaction with JPMorgan Chase.

Finally, as expected, net write offs in the first quarter increased substantially from an annualized 6.0% in the first quarter of 2007 to 7.6% this year.

This year-over-year change is largely explained by two factors, first the unsustainably strong performance in this metric in last year's first quarter, and next, increased write off activity concentrated in four states particularly affected by housing related weakness: Florida, Arizona, Nevada, and California.

Turning back to our consolidated financial statements, net interest expense for the quarter increased by $65 million over last year, reflecting substantially higher debt balances, slightly offset by lower funding costs.

Our higher balances this year is the result of significant investment in both our retail and credit card segments in addition to robust share repurchase activity during last four quarters.

Specifically we have invested more than $9 billion in capital investment, credit card receivables growth and share repurchase over those four quarters.

Our effective tax rate was 37.1% in the quarter down over a percentage point from the first quarter last year due to the resolution during the quarter of specific tax uncertainties.

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.

Generally accepted accounting principles require us to reflect these discreate tax matters in the quarter in which they occur.

For the full year 2008 we now expect our effective tax rate to lie in the range of 37.5% to 38.5%.

Now, let's turn our attention to our recent share repurchase activity.

As you know, in November of 2007, we announced a new $10 billion share repurchase authorization which replaced our prior program.

At the time, we said that under the right combination of business results, liquidity and share price, that we would expect to complete half or more of this new program by the end of 2008.

And we have made significant progress toward that expectation since year end.

In the first quarter, we purchased 30.5 million shares investing approximately $1.6 billion.

This equate to a weighted average price of $51.55 per share.

These amounts include 10 million shares that were repurchased as a result of exercise of the first of three sets of options acquired in derivatives transactions executed in the fourth quarter of 2007.

In addition, since the end of the first quarter, we have retired another 10 million shares as a result of exercising options acquired in the second series of derivative transactions for a total investment of just over $500 million in the past two weeks.

As Gregg mentioned, in the six months since the beginning of this program, we have retired just under 8% of our outstanding shares.

We continue to believe that current share price levels provide a unique opportunity to concentrate ownership which we strongly believe will benefit our shareholders over time as our growth rate and share price recover from current levels.

Let's turn to our outlook for 2008.

90 days ago we discussed that in retail we were expecting sales growth for the year to increase in the 8% to 9% range, reflecting the continued contribution from new stores and an expected comparable store sales increase in the range of 2% to 3%.

At that time, we said that this outlook explicitly assumed that as our sales, that our sales growth would be much better in the second half of the year, as we cycle our softer sales results of the second half of 2007 especially in the fourth quarter.

We continue to believe this is the likely pattern of our sales -- that our sales growth will follow, yet our softer than expected first quarter sales performance has caused us to adopt a more conservative approach to our near-term sales outlook.

In short, our top line growth will likely remain sluggish until we see some stability or improvement in the economic environment.

Consistent with our guidance provided at the end of last quarter we continue to expect a slight to modest operating margin rate decline in our retail segment for the full year 2008 driven by a similar degree of gross margin rate deterioration with an expense rate expected to remain generally in line with 2007.

In the next several quarter will likely continue to experience pressure on our gross margin rate and without the offsetting rate benefit within categories to the same expense that we enjoyed in the first quarter.

The good news is that we continue to expect to offset most of this gross margin rate pressure through effective control of our expenses.

In our credit card segment, we continue to be pleased with how well we are performing in a very harsh credit environment.

We expect 60 day delinquency rates to remain stable throughout 2008, at recent levels in the range of 4%.

And our net write-offs as a percentage of average receivables for the year are likely to lie in the range of 7% to 8%, with the second quarter near the high end of this annual range followed by modest sequential improvement in the fall.

Overall portfolio yields will likely remain at industry-leading levels, although not at the record levels set in 2007.

More specifically, we continue to expect that the dollar spread to LIBOR on the portfolio for the full year will increase as the profitability associated with increases in receivables is only partially offset by a decline in the yield spread.

Our quarterly pattern of profit growth however will not be smooth, with much better year-over-year performance in the third and fourth quarter than in the second quarter.

Our second quarter challenge by the way is due in part to the fact that last year's spread to LIBOR was the best in our had history.

In addition, beginning with the second quarter, the impact of the JPMorgan Chase transaction together the with $1.9 billion of previously securitized receivables, will result in Target providing only about 1/3 of the overall capital invested in our credit card receivables portfolio while still enjoying the benefit of about 2/3 of the profits.

In summary, this means our return on Target's invested capital is expected to be sharply higher in the second quarter and beyond than it was in the first quarter, even at a time when the short term performance of the portfolio is facing obvious headwinds.

Finally, we expect to continue to create significant long-term value by executing share repurchase under the program announced last November.

In particular, I continue to expect that under the right combination of operating results, liquidity and share price, we will execute half or more of the $10 billion program by the end of 2008.

Overall we've tried to provide ample color surrounding the performance outlook of the big segments in the current environment.

In summary, we believe that the current median first call EPS estimates for the full-year 2008 of $3.47 lies within a reasonable range of potential outcomes.

Although our internal outlook for the second quarter is somewhat softer than the current median first call EPS estimate of $0.79.

Now Gregg will provide some final comments.

Gregg?

While the current climate poses challenges to our near term pace of growth, our strategy is sound.

We are keenly focused on superior execution and our team remains committed to delivering the constant flow of innovative and well-designed merchandise at an exceptional value that our guests expect from Target.

As a result, we believe that Target is well positioned to grow profitably in this economic and competitive environment, and we feel confident that Target will continue to deliver substantial value for our shareholders over time.

That concludes our prepared remarks.

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

(OPERATOR INSTRUCTIONS) We will pause for a moment to compile the Q&A roster.

Our first question comes from the line of Deborah Weinswig with Citigroup.

There's no response from her line.

Our next comes from the line of Wayne Hood with BMO Capital.

Yes, I had a credit question and then a store question.

Can you talk a little about the delinquency and default rates in those converted accounts and how that's trending and what percent of those accounts are in Florida and California?

And then Gregg, if you can speak to a little bit about the relationship with the JPMorgan.

There's the financing piece, but can you talk about how you are going to use that to drive revenue, specifically in the electronics department where you don't really have a deferred financing program to compete with the Best Buys and so on?

Do you anticipate a program like that?

And then I had a store question.

I will see if we can cover all of that.

First of all, the accounts that were so-called product changed last year, which are responsible for meaningful portion but not by no means all of our year-over-year accounts receivable growth, are following a very typical pattern relative to the many cohorts that preceding them of product changes adjusted only for the fact that we are in a somewhat harsher credit environment.

So the pattern of delinquencies and write-offs is somewhat higher than the prior two or three or four converted cohorts, but the pattern is virtually identical.

Those converted accounts lie across geography proportionately to the rest of our portfolio.

Which means that both in those accounts and also in the portfolio that existed before those converted accounts more or less 30% of our receivables lie in the four states I mentioned: Florida, California, Nevada and Arizona combined, and therefore, 70% of course lie in the other 46 states.

Our adverse experience in delinquencies and adverse experience in write-offs is very, very heavily concentrated in those four states.

With respect to the JPMorgan Chase relationship, I am looking forward in earnest to rolling up our sleeves together with our credit card team here at Target and the team from Chase card services to find innovative ways that we can both improve the yield in our portfolio and also potentially improve the growth in that portfolio as well.

We just closed the transaction yesterday and I have been kind of busy overnight preparing for some other things.

So we haven't made a lot of progress in the last 18 hours, but I don't intend for much time to pass before we get together and begin that work in earnest.

And my store question is a lot of companies have been curbing their store openings and maybe a secular slow down, at what point in the year do you reconsider your store openings for '09?

You have about 116 or so this year.

But at what point do you think about curbing at that a little bit if at all for the year for next year?

Yes.

We remain committed to opening approximately 90 to 100 net new stores that has been on a gross basis, say 110 to 120 over the last couple of years.

And unless this slowdown in consumer spending is protracted and goes on for some length of time, we remain committed to the growth levels that we have described in the past and we believe that we -- that it is appropriate for us to still grow at that 90 to 100 store mark.

Thank you, Gregg.

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

Hi.

Thanks, good morning.

Doug, can you touch on the other categories a little bit more granular for us, where you saw some strength to help offset the 70 bip increase in pressure?

Certainly.

We had a number of things fall our way this quarter in a favorable sense to our original plans.

First of all I mentioned that in a number of merchandise categories across our assortments we enjoyed the benefits of wider gross margin rate and that went a very long way in this quarter toward offsetting the adverse sales mix pressure on gross margin rate.

Separately, even though our expense rate was up a bit in the quarter, we clearly achieved more than 100% of what se set out to achieve in expense savings.

And finally I would point out that in both the areas of our income taxes and in the effect of the timing of the share repurchase program we benefited EPS as well.

So the collection of those four influences all in the positive direction more than offset in this quarter the adverse sales and related mix impact that we experienced.

Let me just ask the question in a different way then.

Just in which categories did you see a wider GPM rate?

Well, we saw expanded margin rates in more of our hard lines businesses than in home or apparel.

Home and apparel were essentially flat between the two of those, and both our food business and our other hard lines category had slight margin rate expansion.

Okay.

And another one, Gregg, for you, just as you look to the back half, managing inventories, future receipts, can you give us how are you planning inventories for the back half of the year either on a per square foot or per store basis?

Yes, we continue to take a very cautionary approach to our sales and receipt management.

And until we see some underlying change in the environment, and see a strengthening in the business, we are going to be very tough minded as it relates to the receipts that we bring in, so we are going to stay focused on same-store sales in the range of what we have been experiencing in the first quarter until we get into the fourth quarter.

And we expect some up tick in the fourth quarter, but it is still on the conservative side until we get a better feel for what the environment is going to be like.

So, we have got a lot of average inventory in our network we can absorb selling into our inventory without risking being out of stock in any category that is important to our guests.

Let me put a few numbers around that, if I may.

At quarter end, our year-over-year growth in square footage was 9.0%, call it 9%.

Our sales growth in the quarter was 5%.

And our growth in inventories was right in the middle, about 7%.

So we are in great shape moving into the second quarter despite the softness in our sales.

Right.

And then, one more, Gregg -- or Doug for you on the interest expense line, $200 million, can you give us a sense of what we should think for the balance of the year, obviously higher year-over-year, but either an absolute dollar or basis point guidance.

Well, as I mentioned in my remarks the rate is actually modestly favorable, because of course fed funds at 2% today are sharply lower than they were at this point last year.

A lot depends on the actual pace of our share repurchase program.

That would be a good reason to increase interest expense, but I think with a broad brush on it, you can think of maybe $900 million for this year.

And obviously with wider than normal variation around that theme, based on the pace of receivables growth and the pace of share repurchase that are clearly variables in the fall at this point.

Okay.

Thanks very much.

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

Hopefully this works this time.

In terms of, Doug, if we look at 2008 comps versus a year ago, if we look at a two year stack obviously it was negative in the first quarter.

Is there anything that, kind of as we look to the rest of the year, that we should think from a two year stack perspective that things would improve from here?

Well, the first quarter was negative this year, but certainly not negative in a two year stack.

Right.

But the two year stack was a 3.6%, but you are facing a 4.9% in the second quarter and a 3.7% in the third.

If we see the same trend it would potentially indicate negative comps in the second and third quarter.

I think first of all we have already gone on record to tell you that May is likely to lie in the range of minus 1% to plus 1%.

There's nothing particularly unique about June and July combined that on an aggregate basis would lead me to expect something very different from flat plus or minus here in Q2.

As we move into Q3 and Q4 a couple of things are important analytically.

First of all, even though our total sales in Q3, our total comps in Q3 last year were still quite strong, our comps in the higher margin apparel and home categories were not.

So in Q3 even though our reported comps may not be that strong, the underlying financial health of generating gross margin dollars year-over-year is not something I expect to be quite as challenging as Q2.

Q4 by contrast had much softer sales overall.

In other words, the comp trends in home and apparel were about the same in Q4 as Q3, but the big difference was in Q4 our sales growth in the lower margin category cooled off a bit.

And with regards to what you're seeing in May thus far, is that more related to what you are seeing with regards to seasonal businesses or any impact from the fiscal stimulus?

We have not historically in any recent time made any comments mid month and I don't think we should depart today.

We will give you a full color story on the month of May when we report our results in our June.

Looking forward to it.

And then, Gregg, you talked about frequency driving businesses.

Can you elaborate on that comment?

Yes, I mean in this environment, we have been working hard to pay less side of the brand promise.

So it is a selection of merchandise we put on our end caps, making sure we have strong value messaging that our circular messaging and print marketing has a more dominant impact around price and savings and value, in addition to what we typically would do in terms of differentiation and seasonal content.

So we are just very mindful that the consumer is very cash strapped right now and is looking for good values.

They're expecting more sale merchandise and we are responding by insuring that our assortments reflect their desires.

Can you also elaborate a bit in terms of your pharmacy business at the moment, some of the kind of recent initiatives that you have embarked upon and if that is also helping drive traffic to the store?

Our pharmacy business continues to be very healthy.

It has grown at double digit same-store sales for a number of years and this year is no exception.

I mean we continue to match Wal-Mart on price in their $4 generic and their newly expanded $10 generic program for a 90 day supply.

So we are very, very competitive in the business.

We offer terrific service in both the Rx and [OTC] products within our stores, and it has been a good solid growth business for us and we expect that to continue.

Great.

Thank you so much.

You're welcome.

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

Thank you.

Gregg, just following up on your comments on the marketing message on the pay less, just could you help us understand over the near term, with the fiscal stimulus checks heading out, what if any changes or what efforts you are enacting on the marking front to perhaps gain a greater share of those checks?

I think the best way to really look at the marketing message would be what is the point of sale messaging that you see in our store, on our end caps, and secondly what is the message that we are conveying in our weekly circular that's delivered to 50 plus million households.

And if you go through our circular you will see that we have a much stronger headline commitment speaking to value and savings, the way we've organize products, the way we highlighted head lines focused on value, how we have aligned our frequency businesses and created bigger and more dominant statements within that circular and calling greater attention to that -- to that pricing.

And if you compare the circular today versus the circular that we had published six months ago you will see differences in the messaging and you will see a much stronger narrative speaking to the value side of our brand promise.

Okay.

And in light of that, could you just talk about, you had mentioned you believe you're appropriately positioned the good, better and best, can you give us a sense of how customers are shopping, are you seeing a trade down to the good category especially as you highlight the price emphasis?

Well we are seeing some trade down throughout the store and we are also seeing our guests not shop in the more expensive discretionary categories.

So for example in our seasonal business which is seasonal lawn and patio, which is soft in every retailer as well, we are seeing very robust growth in replacement businesses like seating and cushions and some of the accessory categories, but we are not doing well in sets.

So, the mix of those two still is generating -- will generate same-store sales declines, but it is healthy in one part and it is not so healthy in the other side.

In our domestics business, we are seeing terrific growth in our towel business and in our valley of sheet worlds.

So people are coming in and they're buying replacement pillows and sheets but they're not buying the entire ensemble of top of bed and shams and duvets along with their sheets.

So it is more selective purchasing on the consumers part.

Which takes a very careful analysis to interpret trading down.

This is a shift of units more so than a best to good kind of shift.

Understood.

Thanks, Doug.

And then, Gregg, just on the inflationary pressures as we're heading into the back half, give us a sense across categories what you are planning.

And given the current challenging top line environment, how do you expect to deal with those pressures?

Well, we would love to have the inflationary pressures go away.

As you know more of the food and the consumables were the leading edge indicators of what was happening.

And we have been experiencing some inflation in those businesses since the fourth quarter and throughout the first half of this year.

As we move into the year, we are seeing more inflation in those other discretionary categories where we the typically haven't seen them in the past.

So there is some slight inflation in apparel due to raw material costing out of China, transportation expenses and then lack of subsidies.

And other categories such as home products we are seeing greater levels of inflation in the higher single digit and low single digit.

And our response has always been to work with our suppliers so that we don't have to accept them, or we can delay them, or we can accept a smaller portion of them.

But if they do come to us and we have to accept them, which in some cases we do, we are looking to pass those along in the marketplace as a matter of last resort, but we are planning on increasing retails in those businesses where we have to absorb some of these price increases.

Okay.

Great.

And in home about 9% to 11%, and apparel more in the low single digits.

Is that the range?

I would say apparel in the very low single digits, it's a couple of percent, but that's up from a deflationary environment in the past.

And I wouldn't say all of home categories are in the 9% or 10%.

I would say there are some selective categories that have greater pressure than others.

I would say in general, it might be in the 5% to 8% range, the high end being in the 9%, 10%, 11%, in some categories, it is in the 2% or 3%.

Great.

And then just lastly, Doug, just on the 30 million in terms of the exercising of the option it sounds like there's another 10 million to go.

I think on the last call you mentioned you would expect to exercise the options in April through June.

So should we expect the remainer to be completed in the second quarter?

Yes.

As we disclosed in our 10K, there were three series of derivatives with expirations in April, May and June respectively.

So what we have said today is that we have exercised all of the options with respect to the first two series, and the final series that is reflective of the option to purchase 10 million shares precisely, 10 million shares expire various dates in June.

Thank you.

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

Hi.

Yes.

Gregg, I wanted to go back and revisit the margin gains or expansion that you achieved in the first quarter in the nondiscretionary, again just to be clear, you were able to negotiate better margins with hard lines products.

Could you go a little bit further into that?

Was that the result of negotiating different terms with the vendors.

It sounds life imprisonment without like it might not continue at that pace, based on Doug's comments.

Could you put that in context in the source of that and why it wouldn't continue or how it was negotiated?

Let me go through the story in general.

In both soft lines and homes we were thrilled with the margin rate performance in spite of those categories being especially hard hit.

We managed the receipts very well in those categories.

So our clearance mark downs were lower than prior years and we were able to maintain good strong initial mark ups.

Well, we had mark down favorability in our hard lines categories and it was just part of our on going initiatives to be smarter in how we invest our promotional mark downs, manage our mix, manage our clearance mark downs, and pass along some of the price increases that we have received while maintaining the same margin rates, we've had some slight expansion in some of those categories, not all categories, but enough categories to move the needle in the hard lines businesses.

So overall it was a good combination of efforts throughout the store to offset the majority of the mix deterioration with some margin rate expansion.

Okay.

So it was more of an inventory management as opposed to some new negotiation with your vendors.

Well it was clearly inventory management on the home and apparel side.

It was the combination of things I mentioned in -- on the hard lines side.

It is also a continuation of our emphasis to build our own brands both in food and nonfood categories.

And as you know, they hold or carry significantly higher margins than the national brands, and our food brand penetration continues to grow in our hard lines brand penetration is growing as well.

So that helps mitigate some of the margin rate pressure and gives us some expansion capability.

Okay.

And would you expect that environment, in general in balance to continue through the rest of the year, those different offsetting factors on gross margin?

Well, we are hopeful.

I mean we are planning our business cautiously and provided that the competitive environment remains rational and stable like it is today, I mean it is still very competitive, but we have been able to pass through some of these cost increase in the marketplace.

And if that continues throughout the year and we are able to manage our business as we have and invest wisely, it is our every intention to be able to manage the gross margin rate deterioration to traditional levels.

Okay.

One last question.

In terms of pharmacy being a strong business for you comp wise and a traffic driver, as you look at it in term of basket analysis where you have a pharmacy transaction versus where you don't, or the chain average, what are you seeing in terms of the mix of that basket?

Is it favorable in terms of the overall transaction size, the margin mix, what is it driving in your store terms of other sales?

Like our red card baskets, the pharmacy guest at Target is a very important guest to us.

They visit us more frequently than the average guest and their baskets in general are larger than the typical transaction at Target.

It is hard to determine precise cause and effect, but there's a high correlation across a lot of traits.

As Gregg mentioned, a pharmacy guest tends to visit a lot more often, only a subset of those include pharmacy purchases.

Okay.

Thank you.

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

Hi.

Good morning.

A couple of questions.

First, can you talk about the comp trends in the Super Target stores versus the Target stores?

And Doug or Gregg can you elaborate on the trending apparel business, what's working what's not?

And are you changing any square footage allocation in the categories that are struggling a bit in the stores today?

Yes, comp trends in Super Target in general merchandise give or take are very consistent with one another, plus one month, minus another.

But on average for some period of time now they have been within a very close range with one another, and I would love to be able to tell you that there's a lot of exciting trends in apparel right now.

But we would settle for some positive same-store sales growth in any one of our apparel divisions.

Our Converse launch has been successful to date in both genders and in every category.

So we are really pleased with that business.

And then there our selective businesses that are doing slightly better than others, our performance active wear business and intimate apparel have -- is doing exceptionally well this year.

Our footwear business is pretty healthy this year.

And so as the weather is turning and we are starting to see more traditional pattern, we are starting to see some better trends in apparel and footwear than we have seen early in the year.

But overall it is still a business that is discretionary in nature and under some pressure like you are hearing from the other retailers.

Curiously, we continue to gain a lot of market share in those categories despite the current environment, maybe even because of the current environment.

And are you changing in terms of the square footage allocation, are you cutting back on any areas in the store on apparel?

Not in a meaningful way.

Our prototypes evolve and cycle, we constantly make small adjustments to our businesses and our apparel world is fairly consistent over time.

We have made modifications strengthening our presence in ladies and kids and infant, toddlers, and edited down some space in footwear and mens, but there hasn't been any significant changes, and we don't really anticipate any significant changes in the future.

Alright.

Thank you very much.

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

Thanks.

I've got two questions.

First Gregg, I wanted to dig a little deeper on the buy for the third quarter and second half.

It sounds like you guys are being cautious and if what I'm reading that is maybe vying for a one or two comp in the third quarter.

How late given your lead times do you have to decide what you buy for the fourth quarter?

Well, let me take your second question first.

We are basically at that time of year we are finalizing or getting close to finalizing our purchases or sales for the balance of the year.

So our -- as Doug mentioned, we had three quarters last year of pretty descent sales growth in mid 3% plus range in Q1, Q3, a little stronger in Q2, so we are planning those businesses in total give or take around flat with greater strength on the consumable and food side of the business and softer sales in apparel and home.

As we think about fourth quarter, we think there will be some rebound in sales due to the fact that last year was a flat quarter.

So we're not expecting mid-digit comps, but we are hopeful that we should be able to deliver a low single-digit comp during the fourth quarter, and we are planning our purchases to reflect that type of sales environment.

And then within that are we assuming that inflation in that low single digit comp is going to be up a couple of hundred basis points than it would have been in the first or second quarter?

Well, we calculate that on a store wide basis at the end of October every year.

Last year it was slightly deflationary, which was a combination of more deflation in some of our hard lines categories, like electronics and then slight inflation in other categories.

It really remains to be seen where it shakes out because there's both inflationary and deflationary pressures throughout the store.

I would say on average there's slightly more inflationary pressures this year, it is really too hard to tell what that will really mix out by the time we get to the end of October and the balance of the year.

I think you are on the right path though, Gregg.

Clearly, food categories right now need a lot of careful interpret interpretation as to our comps or anybody else's comps.

CPI measured food inflation April this year versus last year is nearly plus 6%, so anybody that's running less than plus 6% in food is either experiencing some trading down in units or a reduction in unit sales.

Apparel by sharp contrast year-over-year was slightly negative as measured by the CPI, April versus same point year ago.

Wouldn't surprise me if that CPI measure of apparel goes slightly to modestly positive by the time we get toward the end of the year.

And of course, we end up having a very strong market share in units and continue to grow market share in the apparel category in this environment.

Okay.

All right.

That's helpful.

A follow-up, Doug, just to make sure I am getting the credit yields right, on the new year you're reporting, in the past you have talked about a 7% yield give or take for this year.

Is that a little bit lower now using LIBOR as the cost?

We could provide a detailed reconciliation to the old method versus the new method off line with anyone who's interested.

But overall, as I look across the rest of the year, more by -- by as much coincidence as coincidence -- let's try that in English.

I think that generally speaking for the year that's not a bad assumption.

I don't think 7.000%, but a range of 7% as opposed to 6% or 8%.

Great.

Thanks.

Your next question comes from the line of [Yuda Werner] with Sanford Bernstein.

Hi.

I wonder if you can please give me some color on SG&A.

I wonder if you can highlight which of the line items were experiencing some deleverage and which ones were benefiting from the strong cost control.

I am going to approach that question in two ways.

Our strong cost controls yielded lower expenses in dollars across all categories than our expectations at the beginning of the quarter.

That's great news.

The bad news of course is that we missed our sales plan by an even larger percentage and so we deleveraged slightly.

Looking forward, I expect to continue to enjoy the benefits of a very broad-based expense control program in dollars, and to a significant enough extent that unless sales get worse, I would expect even better rate performance year-over-year for the balance of the year than we enjoyed in the first quarter.

A lot of individual items and each quarter, timing issues, issues in the base and so forth.

So I don't mean to sound like there's a litany of excuses for a bit of rate deterioration in Q1, but as we sort through those issues looking forward I don't think we are likely to see that kind of rate deterioration for the balance of the year.

And that will go a long way toward offsetting those mix-related pressures in gross margin rate that we have talked about.

Doug, could you please be a little bit more specific on how the labor scheduling is working out in the store?

I don't know what you mean by a little more specific on rate -- labor scheduling.

What aspect of labor scheduling would you like me to focus on?

Just in general on how successful you've been in keeping a labor cost in check at the store level.

Well we have, for quite some time, had an excellent tool for scheduling.

This is not a new issue Q4 last year or Q1 this year.

We have been quite adept over the last two quarters.

Those two quarters in particular have shown remarkable productivity gains in contrast to the kinds of productivity performance that we turned in over the prior several years.

These are basic issues of trying to get our labor in balance as best we can with the pace of sales.

And we have been quite adept at that importantly without sacrificing any guest service standards.

And we are religious, perhaps even fanatic, about measuring guest service standards in each and every store each and every month.

Let me just add to that, Yuda.

We have invested heavily in technology in the past and productivity measures and some of those investments we have made in mobile technology in our stores and in our supply chains are driving these productivity improvements in our stores as well.

So it is a combination of just good discipline and the productivity is that we are getting from, from good investments.

Thank you.

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

Just under the wire.

I have got three quick ones.

Doug, I am surprised that your interest expense would be even as low for the year as you are talking about, considering the January offering and the JPMorgan deal.

Are there any gains on debt repurchase or hedging unwinds that are in there?

And can you also tell us how much of the $17 billion debt balance is effectively floating?

First of all, there's nothing tricky or mysterious one level under the surface.

I would point out that we disclosed as a subsequent event in our 10K and happy to go through this in any level of detail that anyone would care to, that we unwound over $3 billion worth of our interest rate swaps subsequent to year end early in Q1, and we collected $160 million in cash from the various counterparties involved in those transactions.

And that will amortize in the normal course a little over $40 million as a credit against interest expense for the year.

In essence, you should think of that as having fixed some of the variability in a $3 billion portion of our floating rate debt.

Stepping back to answer your second question, generally speaking, over time, we maintain floating rate exposure equal to or slightly greater than our floating rate asset base of card receivables.

At the time moment depending on how you think about that $3 billion worth of debt where we at least temporarily removed the hedges, quite literally our debt today is not responding to floating rates at that same pace as our assets.

But I have an expectation that over time we are likely to put some if not all of those hedges back on.

By the way, the $160 million we collected had we waited until today to unwind those same derivatives we would only collect in the range of $100 million, not $160 million.

So clearly our timing has been quite good in hindsight.

You earned your salary this year, Doug.

And secondly, you were good enough to tell us what percent of the receivables were I think in those four -- what percent of the credit receivables were in the four troubled states.

Can you tell us what percent of the accounts that were converted from red card to Visa sort of last spring were in those four states?

About the same percentage.

We did not discern by geography to offer our guests the opportunity to have us change their products.

So it was in the same 30% range.

That's great.

Thank you.

And then just for you, Gregg, the SG&A -- I think at one point you said most of the SG&A sort of cost initiatives would be sort of realized by the second quarter.

And did you achieve some of those quicker than you thought in the first quarter, or is that still the timing that's enabling you to control this SG&A so well?

Well, as Doug said, the SG -- we expect the SG&A gains to continue throughout the second quarter and the balance of the year.

So this is not accelerating forward into Q1 gaines that we were expecting to achieve in Q2 that we will now not be able to accomplish.

We have a very disciplined approach to SG&A the entire year.

The entire enterprise is doing a marvelous job focusing on expenses and we expect that same kind of performance throughout all of '08.

And even at a slower rate -- I would expect a slower growth rate I would expect based on our comments, because it was a tough compare against the year ago because you had deferred the spending and opened fewer doors.

So you're -- I mean considering that I think your rate of SG&A dollar growth, if it was 6% this quarter and high 5% even adjusted for the excise tax, Doug, that it's going to -- the rate of growth in absolute dollars is going to slow further.

Or the pace of sales will increase from 5.0% overall, given the fact that we now have 9% year-over-year growth in our immature square footage.

Yes.

Thank you all.

Your final question comes from the line of Dan Bender with Jefferies.

Hi, good morning.

Sounds like the category improvements that you saw -- or gross margin in categories that you saw some of it was more inventory management, some was more structural on the trade down on private label, or great percentage of private label.

I am just curious if you can give us an update on what the private label mix is in food and general merchandise today.

Yes, well, in the store in total it is in the 35% to 40% range, somewhere depends on how you define private label and whether you are doing exclusive signature, national brands like we have Eddie Bauer and Converse brand, but I think 35%, 40% is a pretty good range.

We continue to add 200 to 300 basis points per year in food, and I expect this year to be no different than what we have achieved in the past.

So we should be pushing the 20% range by the end of this year.

Was there an especially exaggerated mix in the second quarter that allowed for the better gross margins versus what you are expecting for the full year?

Not at all, actually it was more adverse related due to the softness in both apparel and home.

Okay.

And then, on the -- just for as a point of clarification, did you say that the Super Target stores were trending comp wise similar to the regular --

Yes, I did.

Yes.

Is that surprising?

I guess given the food -- how high food and I suspect heavier traffic as a result, I guess I would have expected that store to be trending maybe a little bit better.

No, I think there is -- first of all a stronger food component in all of our general merchandise store.

And secondly, our Super Targets are in very, very competitive markets.

A greater share of our Super Targets are directly competing against Wal-Mart supercenters than are general merchandise stores.

So we believe that environment -- that food environment is slightly more competitive.

But overall it is very similar between a general merchandise store and a Super Target.

Okay.

And then lastly, on the value message, while it is not clear whether this consumer downturn will last more than another nine months, if it were, and as we progress through the year, it becomes clear there's greater strains, would you imagine that Target could step up to the level of that value message with more perhaps one-time sale events or a greater message on that side?

Our strategy has been and continues to be Expect More, Pay Less.

We are -- we put a greater emphasis on pay less.

I don't really see us ever doing things that would undermine the long-term brand attributes that we've been trying to build over a long period of time.

So we are not about to embark on one day sales, or midweek ROP advertising on hot commodities, or things like that.

We just -- I just -- and we don't as a leadership team believe that's in our best long-term interest.

We are going to continue to focus on what we do best which is delivering superior guest experience, having innovative merchandise freshly brought into our stores, and we are going to focus on the value.

And in this environment we will focus a little more on the value but we are not going to skew down the Expect More Pay Less brand promise to an inappropriate level.

Great.

Thanks.

Okay.

That concludes Target's first quarter 2008 earnings conference call.

Thank you all for your participation.

Thank you for participating in today's conference call.

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