目標百貨 (TGT) 2009 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the Target Corporation's second-quarter 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, August 18, 2009.

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

Gregg Steinhafel, Chairman, President and Chief Executive Officer.

Please go ahead, sir.

Good morning and welcome to our 2009 second-quarter earnings conference call.

On the line with me today are Doug Scovanner, Executive Vice President and Chief Financial Officer and Kathy Tesija, Executive Vice President, Merchandising.

During our call, I will provide a brief overview of our second-quarter performance and view of the current environment and Doug will provide more detail about our financial results and outlook and Kathy will share some insight about our guests and describe some of our key strategic initiatives and merchandise highlights for the fall season.

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

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

Following this conference call, John Hulbert and Doug will be available throughout the remainder of the day to answer any follow-up questions you may have.

Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings.

We are very pleased with Target's second-quarter financial results, which were well above expectations.

Profitability within our retail segment was quite strong due to impressive gross margin rate performance and disciplined expense control across the enterprise.

And our credit card segment generated profits in a quarter when most other card issuers have reported losses.

We continue to manage our business with thoughtful discipline, responsibly controlling both expense and capital investment to match the environment.

At the same time, we are maintaining a steadfast commitment to all our brands and a healthy appetite to invest when we see an opportunity.

We believe that the best way to emerge strong from the worst economic downturn in decades is to stay true to our strategy while preserving appropriate financial flexibility.

While our comparable store sales gap with Wal-Mart narrowed in the quarter by more than two percentage points compared with our first quarter, our top-line performance, particularly in discretionary categories, remained our biggest challenge.

Consumers remain cautious resulting in weak guest traffic and transaction size.

Retail prices, especially in food and commodities, continued to decline resulting in deflationary pressures.

And the economic recovery appeared to temporarily stall as the country cycled the impact of last year's stimulus checks.

While I am not satisfied with our recent sales results, I am pleased with the resiliency of our business model in this environment and how our teams are executing our core strategy.

We firmly believe that Our Expect More.

Pay Less brand promise is as relevant now as it has ever been and as a result, we are aggressively pursuing initiatives in both merchandising and marketing that reinforce our differentiated approach, as well as our strong value commitment.

In a few minutes, Kathy will describe in more detail several of our upcoming design partnerships that will create excitement throughout our assortment and some of the initiatives that will help drive traffic to our stores and convert guest visits into profitable sales, but a few of our strategic efforts bear highlighting first.

One of our most important strategic initiatives is our P-Fresh grocery format, which is now available in more than 40 new and remodeled stores.

We continue to hear from guest that they love the assortment and visual appeal of this innovative concept and sales in these stores continue to meet or exceed our expectations.

Before year-end, we plan to have P-Fresh in over 100 Target stores as we continue to evaluate and refine content adjacencies and visual elements.

We also continue to consolidate and reposition our own brands to drive value for our guests and generate incremental sales and gross margin for Target.

Later this fall, we will complete the phased introduction of our new Up & Up brand, which replaces Target brand as our core commodity own brand.

Guest response to Up & Up has been very positive and is expected to continue to strengthen as guests become more familiar with the brand and more knowledgeable about the exceptional value of these everyday essentials.

Last month, we rolled out our Low Price Promise across the chain, explicitly communicating that Target stores are now matching competitors' advertised prices on identical items in the local market.

The program underscores the value of Target's everyday pricing and gives our guests the assurance that they don't have to compromise even when our competitors have an item on sale.

And earlier this month, we announced our plans to build and manage our own platform for Target.com, reflecting our belief that an integrated multichannel strategy will be key to our future growth.

We expect to launch our new site before holiday season 2011.

I remain confident that Target is well-positioned to grow profitably and deliver superior shareholder value over time.

And I believe that we are effectively managing our business to compete and capture marketshare even in the current economic environment.

Though still early, our back-to-school, back-to-college results are encouraging and our August month-to-date sales have shown modest improvement from recent trends.

Before I turn the call over to Doug, I would like to take a moment to thank so many of you for your support in our proxy contest last May and for your willingness to engage with us on important strategic and governance issues.

We continue to keep your input top of mind as we move forward with our strategy.

Now Doug will provide more detail on Target's second-quarter financial results, which we announced earlier this morning.

Doug?

Thanks, Gregg.

In my remarks today, I plan to discuss key aspects of second-quarter performance in our two business segments and I will provide some insight into our expectations for key metrics and overall earnings for the second half of the year.

As we announced this morning, Target earned $0.79 per diluted share in the second quarter.

In light of our previously reported sales for the period, we are delighted with these results.

Our retail segment continues to show surprising strength in generating gross margin and continues to reflect execution of thoughtful and disciplined expense controls.

Separately, our credit card segment continues to exhibit stability and modest profitability in stark contrast to the credit card results of nearly all other similar competitive card programs in 2009.

Let's begin with a more detailed review of our retail segment for the quarter.

Our pace of sales remains challenging with comparable store sales down 6.2% in the quarter.

Average transaction size contributed more to this result than did our traffic trends; although each of these factors contributed to our sales decline.

In turn, units per transaction had a greater impact on the change in the average dollar value of our transactions than did average selling price per unit.

In light of this top-line performance, we were able to deliver much stronger profitability than we expected.

Our gross margin rate expanded 70 basis points in the quarter and 40 basis points year-to-date as we were able to more than offset the adverse sales mix impact in these periods through a remarkable margin rate expansion in many categories.

In isolation, this mix impact would have been about 45 basis points in the quarter and more than 65 basis points so far this year.

In other words, factors beyond mix added a little more than one full percentage point to our gross margin rate in these periods.

As in any quarter, rate improvements reflect a variety of ongoing efforts that Kathy and her team pursue to drive retail segment profitability.

About half of this quarter's category rate improvement was the result of meaningfully lower transportation costs driven by a combination of lower crude oil costs and transportation industry capacity dynamics.

Separately, we are also beginning to experience cost reductions on a variety of products across a number of merchandise categories.

As we move into the fall, some of these benefits are likely to moderate through sharper pricing and diminished year-over-year changes in energy costs.

On the expense side, our retail segment turned in another outstanding quarter of performance.

SG&A expenses declined slightly in overall dollars in the quarter, a remarkable achievement given the 71 additional stores we had open at the end of the second quarter compared to a year ago.

This performance reflects disciplined execution and continued strong productivity improvements in our stores organization.

Year-over-year, net timing issues were about neutral in the quarter.

Turning next to our credit card segment, our second-quarter and year-to-date results were fully consistent with the expectations we previously laid out.

Our overall profitability and return profile is good in an absolute sense and remarkably strong relative to others in this business.

Quarter-end gross receivables were down approximately $350 million, or 4% from last year, consistent with our expectations.

Total card revenue as a percent of receivables was slightly higher than a year ago despite a significant decline in the prime rate during this period.

The largest factor here is the yield benefit of the terms changes we have implemented in response to the super harsh credit environment.

Net write-offs were $304 million in the second quarter, in line with our expectations laid out six months ago, which we reiterated three months ago.

More importantly, this experience is consistent with the reserve we had in place at the beginning of these periods.

All together, the credit card segment delivered $63 million of pretax segment profit in the quarter.

While this dollar profit was modestly below last year's level, the average of our capital invested in assets of this segment declined at a faster pace, both as a result of the JPMorgan Chase investment and the year-over-year decline in receivables I have already discussed.

The result of these dynamics was a modest increase in our pretax credit card segment ROIC, reflecting an annualized return of 8.8% this year compared to 8.2% last year.

Looking forward to the final two quarters of the year, the single biggest variable in our enterprise remains the pace of sales in our retail business segment.

From a comparison standpoint, last year's third and fourth-quarter comparable store sales numbers create the potential for better year-over-year trends in the next two quarters even without any change in this year's run rate.

This is most notable in the fourth quarter when we will be comparing against a 5.9% comparable store sales decline in 2008.

That said, we continue to be cautious in our outlook and our fourth-quarter inventory commitments are not based on any expected improvement in our sales trends other than the benefit provided by a relatively easier comparison.

And while it remains possible that fourth-quarter comps could return to positive territory, we are not counting on it.

Focusing next on gross margin rate, we believe underlying trends of sales mix and margin rate within categories are likely to continue; although with different likely year-over-year outcomes in the next two quarters.

Specifically, we envision some gross margin rate compression in the third quarter followed by a return to gross margin rate expansion in the fourth quarter.

On the expense side, we continue to expect superb expense controls across the enterprise, but clearly the year-over-year trends in dollars will not be as strong in the second half of the year due to some timing issues and especially because our expenses in the fourth quarter of 2008 were very lean, perhaps even too lean.

All in, we expect to turn in a very strong expense result for the fall and for the full year, this likely will mean a low single-digit increase in expense dollars.

In our credit card segment, we expect year-over-year reductions in gross receivables to continue for the balance of this year and into 2010, perhaps down by $1 billion or so by year-end.

We expect our dollar delinquencies to continue to reflect stability or slight improvement and our write-offs in dollars will be similar in the next two quarters to the past two with some likelihood for a slightly better result in the third quarter.

Overall, we expect to continue to produce appropriate profitability and returns on invested capital in this business segment.

Finally, I want to provide an update on our new store opening plans.

In October, we will add our last wave of 2009 new stores and for the year in total, we continue to expect to open about 75 new stores, adding just under 60 locations net of closings and relocations.

In our last two conference calls, we have indicated that we only had a handful of new store projects approved for 2010, but that we still had some flexibility to approve a small number of additional October 2010 new stores.

We can now provide a more definitive picture of our 2010 program.

As of today, we expect to open a total of about 12 new stores in 2010 and will close or relocate two or three stores resulting in about 10 openings on a net basis.

A few final comments on cash flow and debt before we focus on EPS for the rest of the year.

We continue to expect to generate in excess of $4 billion of cash flow from operations this year and continue to expect to reinvest a little over $2 billion of capital in our retail segment.

This means we are right on track to retire our debt maturities this year with internally generated cash flow.

In fact, we paid off our second and final large 2009 maturity subsequent to quarter-end.

As a result, it remains likely that we would only approach the term debt markets this year if some unique opportunity were to present itself.

Let's pull together all of these forward-looking statements to focus on our outlook for earnings generation.

The current fall season median first call estimate is $1.49, which would lead to a full-year earnings per share of approximately $2.97 in light of today's reported results.

We believe this represents a reasonable single point estimate for the year, but importantly though, if our fall results turned out to be exactly $1.49, I think we would likely exceed the current fourth-quarter median estimate of $1.04 by several cents and fall short of the current third-quarter estimate of $0.45 by a similar amount.

Now Kathy will share some of the key merchandise initiatives we are pursuing in the third quarter and throughout the holiday season.

Kathy?

Thanks, Doug.

As you have already heard this morning, our sales continue to be led by strong trends in our need-based categories, which continue to generate positive comps and gain marketshare.

The overall sales trend remains challenging in the quarter as our comparable store sales softened more than two percentage points compared to the first quarter.

This change was driven in equal parts by slower traffic and lower transaction amounts as our guests remained cautious in their shopping behavior.

Our latest guest research provides insight into the drivers of our sales.

Our best guests continue to curtail their trips to Target as they are cutting back their discretionary trips in order to meet their budget needs.

In addition, weekend trips for our best guests have declined more than weekday trips, making a mindset and behavioral shift as guests now focus their shopping more on need than entertainment, which has the impact of skewing purchases more towards need-based commodity and food items and less towards discretionary wants and apparel and home.

Our research also indicates that guest satisfaction with Target continues to be up among the highest in the industry, that Target's price perception in the marketplace, particularly in our everyday pricing, is improving and that store loyalty from our guests remain high as we continue to gain affluent guests from department stores.

With a greater focus on needs-based shopping trips, it is not surprising that healthcare, food and beauty continue to be among our strongest categories, delivering comparable store sales increases even in the face of overall traffic declines.

In healthcare, we continue to grab share from other channels and are seeing big increases in script volume due to our $4 and $10 generic program.

Our pharmacy rewards program also continues to gain momentum.

Participants in this program visit more often and spend more on each visit.

Beauty sales are benefiting from the introduction of new technology and new brands and affluent aging population and guest migration from department stores.

And even while we are experiencing price deflation on some food items, the grocery category continues to see positive comps overall, benefiting from increased space and emphasis in our general merchandise stores and continued development of new products in our own brand, which now account for more than 20% of our food sales.

In contrast, our more discretionary home and apparel categories continue to be softer than the rest of the store in the second quarter.

Overall, comp sales in these categories declined in the high single digit to low double digit range.

Our strongest results in apparel were in performance activewear and newborn, infant, toddler categories while we saw particular softness in shoes and women's apparel.

And while our apparel sales trends are still not where we want them to be, we are pleased that the gap between the apparel sales and the rest of the store narrowed in the quarter.

In home, we saw relative strength in seasonal categories, including back-to-school items with below-average performance in decorative home and garden, particularly in patio furniture, a category we had planned very conservatively for the year.

In addition to our intense focus on driving top-line growth, we continue to conservatively manage our inventory to help us navigate the challenging sales environment while delivering supply chain efficiency, maintaining appropriate in-stock levels and improving gross margin rates.

We are employing both SKU reduction and segmentation strategies to achieve these results and simultaneously reducing store labor and clearance markdowns.

We exited the second quarter with inventories in very good condition, which has contributed to our favorable markdown rates, margin performance and overall profitability.

As we make plans for the next few quarters, we know that even though our sales and discretionary categories are soft at the moment, they are key to our long-term success because of the value they bring to our guests, our brand and our profitability.

Throughout the fall season, we will continue to demonstrate our commitment to differentiated content and provide compelling reasons for guests to shop at Target with the introduction of several new upcoming designers.

Our August assortment features new design partnerships, including a new jewelry collection by Anna Sheffield that offers unique sterling silver designs, all priced at $49.99 or less for a limited time only, Jay Hersh and her Hollywood Intuition collection and accessories.

Hersh brings her iconic flair to Target as the founder of Intuition Boutique in Los Angeles, a favorite shopping destination for Hollywood's most famous celebrities and fashionistas.

The line will be available at least until spring 2010 and plays on the most popular trends that our guests are seeing in magazines making them attainable and affordable.

Prices for the line range from $3 to $30.

In September, we welcome world-renowned fashion icon Anna Sui for our second designer collaboration collection available in stores and on Target.com for five weeks.

We are thrilled to offer her vibrant pop culture-inspired collection with its vintage influences and sophisticated nuances to our guests at a great value.

And I am excited that Target is the exclusive mass retail partner for Pearl Jam's ninth studio album, Backspacer.

We forged a unique partnership with the band that allows the album also to be sold online and in independent music stores, respecting the band's Fans First philosophy while delivering unique value for Target guests.

The first single debuted at number two on Billboard's rock chart and the album has no signs of slowing down.

Later this year, Target is partnering with acclaimed handbag designer, Carlos Falchi, to launch a limited-edition handbag collection, Carlos Falchi for Target.

The line features the designer's vivid combinations of color, pattern and texture in deep hues and jewel tones on signature silhouettes.

The hobos, satchels, shoulder and messenger bags in shades of plum, teal, brown, black and gray are elegant yet functional with their interior compartments and pockets large enough to fit everyday needs.

The exotic collection features Falchi's iconic techniques and prints with intricate stitching details at amazingly affordable prices ranging from $19.99 to $49.99.

The collection will be available at Target stores and on Target.com beginning early November through the end of December.

Beyond our fashion programs, we are focused on driving excitement and traffic with our third-quarter seasonal program.

Our back-to-school and back-to-college campaigns are off to a good start.

Month-to-date, our August sales are slightly above our expectations and this year's pricing environment appears to have moderated in terms of promotion and intensity.

In these key seasonal programs, we are featuring the products students want most at prices that appeal to our guests' budget.

From school basics, to the latest fashions, to unique designer partnerships.

Like the [Drawer] for Target Home Collection, guests can trust Target to deliver an exceptional affordable shopping experience.

We are driving traffic and sales during this key season through our circulars, direct-mail incentive and back-to-college, a much more aggressive, social and online media mix.

We will continue this seasonal excitement with Halloween where we will capitalize on the fact that Halloween and all the parties will fall on a Saturday this year.

We will show our guests how to throw a great party for less with many party favors and accessories under $3 and our exclusive Skelanimals theme will create a differentiated one-stop entertaining shop and a strong value message.

We are also focusing on initiatives to build on our current success in our frequency businesses.

In our pharmacies, we are growing our top line through a combination of service, compelling loyalty programs and strategic account acquisition.

When combined with the cost savings achieved through more efficient operations and optimized store pharmacy hours, we have generated the necessary resources to more effectively market this key business.

As a result, we are launching an unprecedented integrated marketing campaign to drive even greater awareness for our pharmacy services and convert more Target guests into Target pharmacy guests.

The campaign features our first-ever pharmacy TV spot, extensive online advertising and online videos with pharmacists answering common pharmacy questions.

These efforts will help contribute to storewide sales growth as loyal pharmacy guests are some of our best guests in terms of frequency and basket size.

And as Gregg as already mentioned, we continue to expand our commitment to grocery with the planned expansion of P-Fresh.

P-Fresh will roll out to more than 30 Target stores in the Philadelphia market over the next two months and we intend to incorporate this expanded food offering into a substantial portion of our chain over the next three years, dramatically improving our ability to deliver the convenience of a one-stop shopping experience for our guests.

We continue to leverage our innovative culture, collaborative team, disciplined execution and brand equity to address the challenges of the current environment and best meet the needs of our guests.

We remain committed to delivering an exceptional, affordable, everyday shopping experience to satisfy loyal Target guests, attract new guests, drive trips and generate profitable sales.

Now Gregg has a few concluding remarks.

As you can see, we are aggressively pursuing initiatives to drive results across our business in what continues to be a very challenging retail environment.

We are confident that we have the right strategy and the right team to execute this strategy and we believe our efforts will produce profitable marketshare growth and generate superior shareholder value in the months and years ahead.

That concludes our prepared remarks.

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

(Operator Instructions).

Jeff Klinefelter, Piper Jaffray.

Yes, thank you.

Congratulations on a really well-managed second quarter.

In terms of your guidance for gross margin, Doug, could you just comment a little bit more with respect to your directional guidance on Q3 being down slightly, Q4 being up.

In the context of how you originally or how you originally forecasted Q1 to Q2, meaning before you delivered upside, is the same possibility out there for Q3 or what would be causing the pressure downward as opposed to what happened in Q1 and Q2?

As I mentioned in my remarks, about half of the margin rate, gross margin rate expansion in Q2 that was unrelated to mix was driven by favorable transportation dynamics, largely crude oil year-over-year and secondarily, transportation industry dynamics.

Crude oil averaged about $130 a barrel in the second quarter last year and fell quite significantly in Q3.

So the year-over-year transportation benefit clearly is not likely to be as strong in Q3 this year as it was in Q2 this year.

Separately, our plans have always envisioned a decline in Q3 followed by a rebound in Q4 in gross margin rate year-over-year given the base of performance in last year's Q3 and Q4.

Excluding mix, we had a good strong performance in Q3 last year.

Excluding mix, we had a very weak performance in Q4 last year due to our markdown experience.

So stir all those dynamics together, I think it is more likely than not that we will have gross margin rate declines year-over-year in Q3 and more likely than not, we will have gross margin rate expansion in Q4 year-over-year.

Okay, and then just one for Kathy.

In terms of second-half opportunities and thinking more specifically about electronics and entertainment given the Circuit City liquidation and some other trends in that category, do you see that as an opportunity for Target to take some share?

If so, is it in certain categories?

And then also on apparel pricing or on apparel performance, it sounds like your performance in apparel was a standout in the second quarter.

Were there some changes to pricing that helped you drive additional volume in that category?

So first on your question with electronic and entertainment, we have seen some nice share gains so far this year and I would anticipate that that would continue throughout the year given Circuit City and in addition, just some of the strength in the categories that we do well in.

So TVs are performing exceptionally well, some of the computer peripheral products, some of the portable audio.

So I do expect that we should have some nice share gains in the back half.

In terms of apparel, we have not had much decrease in pricing yet this year.

So some of the cost savings that we have talked about already are really coming a little bit later in the year and those we would be reinvesting in price or in quality to make sure that we remain competitive in the marketplace.

But not much in the second quarter.

Thank you.

Dan Binder, Jefferies & Co.

Hi, good morning.

A couple questions.

The credit portfolio has been coming along nicely; yields are up.

We saw with the filing this morning that the early-stage delinquencies had picked up a little bit, which I think was in part just because the denominator is shrinking, the portfolio is shrinking.

And I am just curious as we look forward, what would you expect the delinquency rates to do as the portfolio shrinks and what are the implications for the reserve?

I don't think that delinquency rates are likely to change materially in the fall with the one exception of course the rates have a seasonal pattern as the denominator grows in the holiday season and dollar delinquencies do not.

I am very comfortable with our current reserve.

I think it appropriately balances between the enthusiasm I might get looking at the fact that our dollar delinquencies are about $100 million lower today than they were in say February, offset by the fact that unemployment rates continue to rise and are likely to continue to rise in the next several months.

Bankruptcies are up considerably year-over-year.

Recoveries of gross write-offs are down.

Payment rates remain stubbornly low and so forth.

And so I think that the reserve that we have established is the right reserve in light of the balance between those opportunities and risks.

Okay, and just a follow-up question.

You outlined your store plan for next year.

I am just curious with the P-Fresh initiative and the remodels you'll be doing, how we should think about CapEx for next year in terms of maintenance CapEx versus new store CapEx?

Well, we haven't put out any specific guidance for 2010 CapEx at this point.

Obviously, in light of our store count discussion, the subcomponent of our CapEx to build new stores will likely be lower next year than this year.

I stress the word likely because, in any given year, we typically lay out a lot of capital to build the following year stores.

And so it remains to be seen how large our 2011 plan would be and how much of a contributing factor that could turn out to be to 2010 new store CapEx.

But we will be taking a comprehensive look at our P-Fresh program over the next couple of months and together with our Board, we will determine the pace of remodeling activity that seems appropriate in light of the results as a starting point.

I think it is a responsible benchmark to think of 2010 CapEx in the aggregate as being the same, maybe a little higher than this year with some meaningful movement among the subcomponents.

Okay, great.

Thanks.

Neil Currie, UBS.

Good morning, thank you for taking my questions.

I have a couple of questions.

First of all, on inventories, I was a little bit surprised to see total inventories up year-over-year and inventory days up; although the inventories per store looked pretty flat.

I was expecting a little bit more of a reduction.

Is there anything behind that?

No, I think from my standpoint, the answer to the question was embedded in one of the facts you cited.

Square footage is up 5.3% year-over-year and inventories are up 2.9%.

I mean we certainly don't directly control the pace of sales in the short run and so inventory to sales certainly are going to deteriorate in any period in which our same-store sales are as weak as they were in Q2.

On balance, inventories are in great shape at this point.

Okay, great.

Just secondly, on the gross margin, you have certainly an impressive performance, but your sales performance, particularly when comparing to some other value retailers like TJMaxx, Ross, Wal-Mart, hasn't been as impressive.

And I am a little puzzled as to, first of all, why you are not getting better sales given that you are a value retailer?

And secondly, why you are not using this strong gross margin growth to either reinvest in further price in improvements or highlight value more aggressively instead of passing it through to the bottom line.

So my two questions are, first of all, what is your impression of why you are not necessarily getting the recognition on value that you deserve?

Is it perception or reality and secondly, will you do something about it and if so, will it be different to what you have done in the past?

Thank you.

Well, this is Gregg.

As I said in my remarks, we are disappointed in our top-line performance.

Clearly we have a great value proposition and we want to remain and have been competitive from a price standpoint.

Where we felt that it was appropriate to reinvest in lower prices, we have done so, but we don't want to go below where the market is.

So some of that savings does go to the bottom line.

We have been working very aggressively trying to find the right and strike the right balance between our Expect More.

Pay Less marketing message.

And it is primarily a perception in the marketplace that our value proposition may not be quite as strong as some of the competitors that you have cited.

But our research says that the rebranding campaign, from the broadcast and the in-store signings are starting to move the needle slightly.

We are starting to get slight basis point improvement in our price perception vis-a-vis of where we were in prior period.

So we believe that we are on the right track, we have made the right adjustments.

We have believed that over time we will continue to narrow that perception gap.

Thank you and good luck with that.

Charles Grom, JPMorgan.

Thanks, good morning, Gregg.

I was just wondering if you could flush out -- I hopped on a couple minutes late.

I was wondering if you could flush out your comments on August getting a little bit better.

Is that traffic ticket, is that discretionary?

Just if you could elaborate there.

Well, the commentary is we are down 6.2% same store sales in the second quarter and so far, early reads on back-to-school are more positive than what we have seen in the past as it relates to that run rate.

A lot of shifting dynamics during the back-to-school season from tax holidays.

State tax holidays were shifted from July into August.

However the Labor Day moved one week later in the accounting calendar, but overall, we are starting to see some slight strengthening in both the traffic and transaction trends.

I caution it is very, very early and we are going to have to see how the back-to-school plays out.

We think we've put together a real strong back-to-school, back-to-college program.

We have been very aggressive on price.

We believe we will gain market share during this time frames, and it is our expectation and really planning to have some improvement in our same-store sales compared to the last quarter.

And to your discretionary question, this trend in our discretionary items is less negative so far this month.

But I would reiterate Gregg's caution, we are two weeks down and 11 to go in the third quarter.

Absolutely.

Thanks for that color.

Then Kathy, on the gross profit line I was wondering if we could go a layer deeper and learn what product categories are delivering the best margin rates and your outlook for the back-half for those same categories?

Well, I don't know that we will talk about specific categories, but I will tell you that across the board we continue to work on offering better gross margin in every division across the board to help offset some of our mix challenges, and we are doing a number of things to be able to do that.

So things like SKU reduction, we are down about 5% this year, which helps us get product out of the back room and save on labor from the stores.

It also helps us reduce markdown expense.

It also helps on the sales side by being able to put more facings out for those things that are selling best.

We have a number of segmentation strategies that we've talked about in the past, things like volume segmentation, really going after high-volume stores but conversely low-volume stores, making sure that we are editing that assortment, getting those inventories out of those stores to avoid some markdowns.

We have some geography segmentation strategies, climate, so a number of different things that are really helping us across the board improve our gross margin.

Let me just add that, to Doug's comment regarding the transportation and fuel, that has helped every one of our businesses.

So we see a natural rate expansion to the transportation costs, whether it is apparel or home or in the hardlines category.

And then as Kathy said, inventories have been exceptionally well-managed throughout the spring season.

So we have managed the markdown rates.

On the other hand, consumers are slightly more promotionally sensitive, so we are seeing sales in our ad product being slightly more aggressive as consumers are using more coupons.

So that is a dynamic that is working against it.

But in total, all of our businesses performed very, very well.

The teams are very focused on acquisition cost and markdowns and managing the business, and it was really across-the-board performance in terms of the rate expansion.

Then last question -- thanks for that color.

Just on P-Fresh, I know it is still pretty early but the two Minneapolis stores I know have done double-digit type comp increases, at least they were a month ago.

Just wondering if you could give a little bit of a sense for the 40 that you have out there right now, what kind of comp lift you are seeing and expectations for potential comp lift out over the next year or so?

Yes, the 40 that we have out there, or 40 plus, about half our new stores, half were remodeled.

So it's hard evaluate the new stores.

I mean the new stores out of the blocks are doing quite well, but because they weren't open prior to this, it is relative to what our expectations were.

The remodels have been a combination of store sizes, volume and geographic locations.

We continue to be pleased with the results on an overall portfolio basis.

Some have been exceptionally strong in the double-digit range like we have experienced in one of our Minneapolis stores.

Others have been in the high single digits; others have been in the mid single digits.

And it is dependent upon when we completed the remodel what the volume of that store was and how big of a grocery expansion that particular store got.

Because the existing store base has garden-variety sizes of food.

In some cases, where we are expanding our footprint 200%, we are seeing a much larger increase in sales lift than in more recently built stores where the increase commitment to food is much less than that.

So it is a little bit of everything.

But overall, the portfolio performance in all 40 of these stores have been very, very solid.

Great, thanks for the color.

Mark Miller, William Blair.

Hi, good morning.

Kathy, I was hoping you could expand on your recent customer research with the perception closing in on what you believe is the reality.

Can you tell us like -- and Gregg, you said it's a few basis points.

But if that gap had been a 10, how much have you closed it?

And just a little bit more of which initiatives you think have been most valuable in that improvement.

Then also with the markets with the low-price promise, do you have specific research there in terms of how much that has helped and is this a meaningful factor as we roll that through the system going forward?

So if I can start with where you ended, Mark.

The low-price promise is actually in all stores, but it did roll out mid-July.

So we don't have specific research just about that campaign, but we have been adding signing through out our store just talking about our pricing and outside of the promise for some time.

So whether that is in softlines adding signs that talk about amazing deals or other things in hardlines, we have been expanding that for some time.

So overall, where we are getting credit from our guests in the guest research is really on everyday prices.

And while I would say it is still early for us to tell at least, we are pleased that it is moving in the right direct and happy that it is coming on our everyday prices.

Because I think that that shows that our guests are starting to gain confidence that, as we are saying we are shopping thousands of items so you don't have to, they are recognizing that yes, our prices are great and giving us credit for that.

There were several other changes we made earlier in the year, particularly in our circular, by reducing the number of SKUs we have in the circular, blowing up the pictures to a larger size and then really hitting those price points harder with harder hitting headlines as well.

So it is not just the Low Price Promise signing that has gone up, but other initiatives have enhanced our price perception as well.

Okay, thanks.

Doug, could you talk about the trend in payables?

It has come down relative to inventories really over the last two years, but the year-to-year decline was a little bit greater.

Is there -- so what are the factors there?

Is there a calculation too that by paying suppliers quicker, you could be getting better terms from them, better pricing and is that a factor in the gross margin experience as well?

No, I think this is a much more fundamental issue.

With negative same-store sales, our inventory turns are slowing down and that has a natural adverse effect on the payables to inventory relationship.

If we could sell our inventories super fast, we would sell them before we paid for them, but that is not the case in an environment where we are running negative same-store sales.

Okay, final question.

If I look at the selling price per unit down 1.2%, that is about a 200 basis point decline from the first quarter.

How much of that do you think is coming from a decline in items, like-for-like items, versus a shift in the mix?

As you know, we only attempt to measure that with any degree of precision once a year.

I personally believe with some anecdotal information, not precise facts at our fingertips, that those trends are more driven by sales mix than by any other factor.

Okay, thank you very much.

Bob Drbul, Barclays Capital.

Hi, good morning.

First question is did the gross margin benefit this quarter from the SKU reduction that you spoke to Kathy, the 5% decline?

We also reduced SKUs last year, so yes, it did.

Okay.

Doug, quick question on the incremental five stores for next year.

You originally talked five, now you are talking 10.

Can you give us a sense on how good the ROI looks that gives you the confidence to build them now versus waiting a little bit later?

You have to appreciate the twinkle in my eye.

It is actually an incremental seven.

The five we talked about before was gross and now we're up to 12 gross.

Certainly, we are being very careful in this environment to approve stores that meet one of two fundamental criteria.

They either are stores in which we have great confidence in achieving very strong returns, which gives us some margin for error if we have misjudged the sales equation.

Or in the alternative, stores that are in impossible to replicate locations, deals, if you will, that we have been working on for many, many years that to turn them down now would be to turn down the only opportunity in individual trade areas for many, many years to come.

Okay.

And just had a couple of questions on the credit business.

Does the -- given the aggressive nature on the average balance reductions, can you talk about how that is impacting your comp today?

Well, when you say the aggressive actions, I mean we are taking actions that are consistent with the actions taken by other leaders of similar portfolios.

And the reason I start there is that the larger impact on our comps is driven by tightening among third-party operators of cards that are used in our store.

There is some seasonality to this metric, but about a third of our sales are on someone's credit card, ours or someone else's, about six points of the total on our card.

So we have 25% to 30% of our sales on the cards of others.

There is a disproportionate amount of our discretionary sales, of course, that are charged on cards and so it is hard to know which way the correlation or causation, I should say, runs as to whether tightening credit is putting pressure on the discretionary sales or if the fact that discretionary sales are low is causing a decrease in the penetration on cards, credit cards in our overall picture.

Net net, I think if you really stretched the assumptions, our own tightening on our own cards is potentially theoretically contributing a half a point or more to our same-store sales decline, but it clearly is not the dominant factor in traffic or ticket.

Okay.

And Doug, can you talk a little bit about approvals and what is happening year-over-year and average approved balance within credit?

I would segregate your question into two different issues.

One is our approval rates are down.

Not necessarily because we are tightening, but rather having to do with the mix of applicants.

Separately, all else being equal, we are tighter on balances as we manage the risks and as we very carefully differentiate state-by-state in our underwriting models using a combination of purchased data, think of credit bureau data, if you will, or FICO data, together with some very carefully assembled proprietary models that are unique to each geography.

And then the other question I have on the credit, when you talked about $1 billion potential to be lower year-over-year, what are you looking for to start pulling back on the reins of the credit contraction?

Is it going to be a write-off rate or a delinquency trend?

I mean how are you thinking about that looking forward?

We have always managed this business with a view to strengthen and deepen our guest relationships, but to only be willing to invest provided we earn an adequate return on invested capital.

So the key to your question is the dynamics of return on invested capital.

I mentioned some of the headwinds earlier.

Certainly another major-league industry headwind is the most recent credit card legislation, which is about as anti-stimulative as anything Congress has touched here in 2009.

It is going to cause us and other industry participants to think about how to restore the damage that will be done later this year and into 2010 to ROICs due to the aspects of that legislation that adversely impact profitability of all card portfolios like this one.

So bottom line, we need to get the confidence that we can earn a proper return on invested capital to want to return to growing this asset category.

Thank you very much, Doug.

Gregory Melich, Morgan Stanley.

Thanks.

I have two questions.

Going back to the traffic, as you've been rolling out P-Fresh and doing that greater advertising to get people back to the stores, what do you think really drove the sequential slowing in traffic?

Do you think the stimulus last year had something to do with that if you look at the deceleration of traffic from first quarter to second quarter?

And then I have a follow-up.

I think that is a responsible hypothesis.

P-Fresh, of course, is not yet large enough across 1719 stores to have a meaningful or even very much of a measurable impact in consolidation at the margin.

Of course, it is positive, but it is not just big enough yet.

I wish we knew with precision exactly what had caused the slowdown in traffic because if we did, we could devise a plan that turned it around in 30 days.

Okay.

And if we go ahead to things in the back half that Kathy listed, those are the key things that are driving traffic.

It is the advertising, as well as getting that message out there and you are seeing some early signs that is working?

Two weeks into 26 in the back half of the year and yes, the trend is better.

But again, that is partially -- it is truthful, but the comment is tongue-in-cheek.

Right.

And then Doug, you also mentioned that in the back half you expected SG&A dollars to start rising again and said it could be single digits.

Do you want to give a little more clarity on that, especially given I know there were some timing issues in terms of ad spend?

Yes, I would stress low single digit increases, but certainly three or four things come to mind in terms of the year-over-year comparisons that are likely to put us into increases in SG&A through the back half of the year.

Marketing timing is clearly one of them.

We expect to spend more as a percent of sales in Q3 and Q4 this year than we did last year.

For the year, our marketing plan is right on, but we have saved some money here in the front half for the expressed purpose of being able to invest it in the back half.

Incentive compensation expense was actually a credit to expenses last year.

We started out with quite strong performance Q1, Q2 and ended up with very poor performance Q3 and Q4 and reversed back into income incentive compensation accruals.

So year-over-year, that clearly is a headwind.

Workers' compensation expense Q3 last year, we disclosed a one-time beneficial adjustment to our reserves.

If such an adjustment were to recur, I wouldn't expect it in the same size.

And finally I mentioned in my own remarks that our store-based productivity was so strong in Q4 last year that we clearly do not expect the same degree of year-over-year performance in Q4 that we are likely to have enjoyed all the way through Q3.

In some respects, I think we got beyond what we were comfortable with in Q4 last year.

So the degree of benefit year-over-year in Q4 will not be the same.

Those are the four items that come to mind.

That's great.

Thanks.

Adrianne Shapira, Goldman Sachs.

Thank you.

Doug, if you could just follow up on the last point in terms of the marketing timing as it relates to the pressure clearly going up in the back half, but perhaps give us a sense greater in the third or greater in the fourth how that balances out.

Well, the third quarter is always a fascinating one as it relates to marketing and advertising as a percent of sales because the sales look a lot like Q1 and Q2 in Q3 and yet, we are beginning to incur a lot of holiday-related spending.

And so Q3 is always a seasonal peak in our advertising and marketing.

And this year, we have elected to exaggerate that trend.

So it is -- net net, it is a couple cents a share.

This is not a huge issue, but it is -- to those who count pennies, it is a meaningful item.

Okay.

Thank you.

And then my second question relates to deflation.

Maybe, Kathy, talk about, if you could quantify the rate of deflation you are seeing in consumables, when you would expect that to perhaps peak and then shifting gears to apparel deflation, perhaps quantify there.

It sounds as if there is an opportunity in the back half.

So on the consumables side, it's hard to say exactly when it is going to peak, but I would say it has been most dramatic in the dairy category with milk pricing this year.

And there has been some across food, but I would say the bulk of it has really been in that particular category.

In apparel, we talked about some of the cost decreases that we anticipate for this fall and how we will reinvest that either in quality or into pricing.

So I think still to be determined exactly how much that will be and can't tell you when that will peak because we haven't finished costing out spring yet.

So don't know if fall will be -- spring will be similar to fall or something different.

But we do want to reinvest that money to be able to remain competitive and make sure that we have compelling offers on the floor.

Okay, great.

And then on the consumables deflation, any quantification there you could share with us?

Not really.

It's like anything.

You have some ups and some downs and overall, it is more anecdotal than anything based on the number of items we track from year to year, but there is more downs right now.

But it is really hard to put a number on it because it is a moving target and some are met with competitive responses and so the gap narrows and others aren't.

So it is pretty hard, but in total, as Kathy said, food commodities and apparel are all collectively showing more deflationary pressure than inflationary pressure.

And while we would love to drop some or all of the bottom line, we know that is not reasonable.

So number one priority is to be competitive in the marketplace.

Number two is to make sure that we are improving the quality and the style and design where we think it is appropriate.

And then three would be to allow some of those additional savings to fall to the bottom line if it is possible.

So we would like all three of those things to happen.

We are just not sure at this point what combination of how those events are going to unfold.

And we probably should wrap things up with one more question so that we can end promptly at 11.30 Eastern.

Doug, if I have one more question, I could just squeeze in maybe a follow-up to Gregg's comments there in terms of the competitive pressure or competitive environment.

We saw obviously impressive margin expansion here.

Wal-Mart as well, strong gross margin showing.

Perhaps give us a sense of how competitive is it out there and also what response you are seeing as you have been now promoting this Low Price Promise in the stores?

What kind of competitive response you would expect?

Thank you.

Well, I would say that overall, the competitive environment is -- it is fairly rational, it is stable.

Back-to-school pricing is actually slightly more rational than last year or less deeply negative than it has been.

So that is a good sign.

And that is the mix of competitors from Wal-Mart, Kohl's, Penney's and Office Superstore, give or take some more, some less, but overall slightly less competitive than what we have experienced in prior years.

The Low Price Promise has only been out there for 30 days, but the experiences that we have had with our two test markets continue in the short term across the chain and that is that there are very relatively few adjustments being made at store level.

So we are not -- I mean we are confident -- we have the confidence that our prices are right and we are seeing that our prices are right because there are very few adjustments being made.

It might be one per store every couple of days.

So it is relatively modest, but we think this will be a terrific credibility builder and marketing umbrella to reinforce that we have got strong value going strong (technical difficulty).

Great.

Best of luck.

Thank you.

That concludes Target's second-quarter 2009 earnings conference call.

Thank you all for your participation.

This concludes today's conference call.

You may now disconnect.