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Target Corporation (NYSE:TGT)

Q3 2009 Earnings Call

November 17, 2009 10:30 am ET

Executives

Gregg Steinhafel – President & CEO

Douglas Scovanner – EVP & CFO

Kathryn Tesija – EVP Merchandising

Analysts

Colin McGranahan – Sanford Bernstein

Charles Grom – JPMorgan

Gregory Melich - Morgan Stanley

Jeff Klinefelter – Piper Jaffray

Mark Miller - William Blair

Deborah Weinswig – Citi

Wayne Hood – BMO Capital Markets

Daniel Binder – Jefferies & Co.

Robert Drbul - Barclays Capital

John Zolidis – Buckingham Research

Operator

Welcome to Target Corporation’s third quarter 2009 earnings release conference call. (Operator Instructions) I would now like to turn the conference over to Gregg Steinhafel, Chairman, President, and Chief Executive Officer; please go ahead sir.

Gregg Steinhafel

Good morning and welcome to our 2009 third quarter earnings conference call. On the line with me today are Douglas Scovanner, Executive Vice President and Chief Financial Officer, and Kathryn Tesija, Executive Vice President Merchandising.

This morning I will provide a brief overview of our third quarter performance and the retail environment as we enter the holiday season, and Kathryn will highlight recent merchandising trends and provide a preview of our fourth quarter and holiday initiatives. And finally, Douglas will discuss our financial results and outlook in more detail.

Following Douglas we’ll open the phone line for a question-and-answer session. As a reminder we’re joined on this conference call by investors and others who are listening to our comments today via web cast.

Following this conference call John Hulbert and Douglas will be available throughout today 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 performance in the third quarter which exceeded our expectations and was the result of responsible planning and consistent execution of our strategy by teams across the company, reflecting a somewhat more stable environment and more compelling merchandise offerings, marketing campaigns, and strong store executions, our sales and guest traffic during the quarter increased modestly.

A notable improvement from our first half trend. We were able to translate these sales into higher retail profits due a combination of improved sales in discretionary categories, better margins within categories, and continued strong productivity gains in our stores.

And in our credit card segment, we delivered increased third quarter profitability while many other issuers in the industry continued to experience staggering losses. These results demonstrate the ability of our teams to manage our business profitably while preserving efficient flexibility to invest in opportunities that deliver value for all our guests and our shareholders.

P-Fresh, which offers a much deeper food assortment in our general merchandise stores including perishables, and an expanded offering of dry, dairy, and frozen items is one of these opportunities. We currently operate 108 stores in this format including approximately 30 stores that opened in Philadelphia last month.

Because we firmly believe this concept is a low investment, high [inaudible] way to add convenience for our guests and driver greater trip frequency, we committed to this initial 100-store pilot last year after a highly successful two-store test and when many retailers were retrenching.

By carefully evaluating the number of items in each category this enhanced assortment includes 90% of the food categories and approximately 60% of the SKU’s available in a Super Target store and the concept incorporates unique fixturing and visual elements that clearly convey our commitment to a credible food offering in a general merchandise format.

While it is still relatively early to make a definitive judgment on this format, we continue to be very pleased with our initial results and feel confident enough in its future potential to extend our rollout to an additional 350 stores in 2010. Douglas will talk more about the impact of this decision in a few minutes.

Target’s unique combination of discipline and agility is part of our DNA. Its also the basis for our approach in this year’s fourth quarter. In light of continued economic and consumer spending challenges, and given holiday shopping patterns that are increasingly concentrated in the two days after Thanksgiving and the week leading up to Christmas, we have planned our inventory levels appropriately.

We are also focused on delivering a superior shopping experience with highly engaged team members, fast checkouts, and strong brand standards while maintaining appropriate expense control and productivity growth in our stores and distribution centers.

Our early sales results for November provide additional justification for being cautious in this uncertain environment. While store traffic continues to increase moderately over last year, lower average unit retails are leading to a smaller average transaction, creating pressure on our top line sales.

While these early November results might end up being a retiming of sales until later in the season, the good news is that our conservative planning particularly in seasonal and discretionary categories positions us well in case that doesn’t happen and our third quarter experience demonstrates that we can accommodate the upside if it occurs.

Regardless of the environment we believe our plans for the fourth quarter are appropriately designed to capture profitable market share. As Kathryn will explain in more detail, we are aggressively pursuing in-store and online sales beginning with a one-day only sale on Target.com on Thanksgiving Day, our customary two-day sale in-store immediately following Thanksgiving and compelling Cyber Monday deals.

We have developed a strong marketing plan to support these events and drive traffic throughout December and we will be in stock and priced right on the most wanted items. We also remain keenly focused on reinforcing our pay less message and building on the progress we’ve made this year in changing our guests’ perception of Target pricing.

We’ll continue to focus on prices more boldly in our circular, in our broadcast ads, and with improved signing throughout our stores. And we continue to backup these messages with our commitment to match Wal-Mart’s prices locally on identical items through our low price promise.

Beyond the fourth quarter we’re focused on maintaining a superior experience for our guests in introducing newness and differentiation that will continue to excite our guests and grow our top line sales. In addition to P-Fresh, we’re testing new ideas across all of our businesses, some of which we’ll discuss today and some we’ll be sharing in the coming months.

All of these initiatives are designed to improve our guest shopping experience and drive profitable market share. Now Kathryn will provide more detail on our third quarter merchandising results and our plans for the holiday season.

Kathryn Tesija

Thanks Gregg, our third quarter results demonstrate the relevance of Target’s strategy with our guests and provides evidence that our merchandising, marketing and store experience continues to resonate.

As Gregg mentioned we’re pleased with our third quarter performance. While overall sales are still not growing at our desired pace, we are encouraged by the continued strength of sales in food, healthcare, and beauty and by the improvement we experienced during the quarter in sales of discretionary categories, especially apparel.

Both our discretionary and non-discretionary businesses benefited during the quarter from an increase in guest traffic. In fact the number of store visits per guest increased during the third quarter for the first time in nearly two years.

We believe that this increase in frequency and improvement in our results is attributable to both internal and external factors, including a more stable though still challenging retail climate, our efforts to assure our guests that they do not have to pay more to shop at Target, and our unwavering commitment to deliver the merchandising excitement and exceptional service our guests expect when shopping at Target.

Let me describe some of the ways we continue to reinforce our expect more, pay less brand promise in the current environment. Even though we’ve always delivered exceptional value to our guests, we have not always gotten credit for our outstanding prices. As a result in the past year we’ve taken steps to underscore the value in our merchandise assortment and strengthen our price messaging.

Specifically we have significantly enhanced our in-store signing to communicate price; expanded the number of items included in our competitive shop process, which ensures that we’re priced right on thousands of items across the store; instituted our low price promise to match local competitors’ advertised prices; reinforced our weekly circular to feature more commodities; and frequency driving merchandise to highlight bigger pictures and bolder price points and to showcase attention-grabbing value headlines; launched new more authentic but still brand right broadcast campaigns that reinforce Target’s exceptional prices; allocated more space to non-discretionary categories in new and remodeled stores; and merchandised great values more boldly with fewer bigger items and stronger value message signing including mail aisle end caps, focusing on single price point items.

While we still have opportunity for further improvement we’re very pleased with the progress we are making in changing our guests’ perception to more closely match the reality of our affordable pricing. Expect more has always been a Target hallmark and even in the face of the current economic challenges, we remain committed to delivering newness and innovation throughout the store.

For example, during the third quarter we reinvented the way our jewelry assortment is presented. The area now features merchandise displayed on tables, rather then under glass and all product is priced under $50.00. The compelling assortment, more welcoming and convenient environment, and lower prices are improving the experience for our guests and driving profitable sales.

Electronics is another category where we continue to innovate and pilot new products and services. Programs we are currently testing include a full service cell phone solution which is being tested in about 100 stores; a TV delivery and installation service which is being tested in approximately 180 stores; and an iPod trade-in for Target Gift Cards which is available on Target.com.

While its premature to speculate on the opportunity these test programs offer, we’re encouraged by early results and gaining valuable learning’s from our efforts. The rollout of Up and Up, which represents the rebranding of our core commodity assortment formerly known as Target brand, leverages both halves of our expect more, pay less brand promise.

The new brand encompasses 800 products across 40 categories, offering national brand quality and an average savings of 30%. The brand’s unique design, high quality, and low prices are resonating with guests and we are experiencing increases in both penetration and sales compared to last year.

In 2010 we plan to build on this success adding more than 100 new products to the line. Now I’d like to turn our attention to holiday and the fourth quarter. The official kickoff of holiday is our two-day sale on the Friday and Saturday after Thanksgiving.

Our intent this year is for Target to be the best place to shop for those wanting the best merchandise at the best prices. We’ll open our doors an hour earlier this year at 5:00 am and feature door busters in a broad set of categories.

The shopping experience will be easy for our guests as stores will merchandise and market the door busters and other fantastic deals in can’t-miss ways, such as end caps, bulk locations, and signing. In addition each store will provide guests with a two-day sale map to help them navigate all the great deals.

We expect a strong holiday season in our online business as guests leverage Target.com as a destination to research and plan both their online and in-store shopping. Guests who want to get an early start on some of the most aggressive prices of the season, can shop Target.com’s online only event on Thanksgiving Day.

Or shop an array of offers on Cyber Monday. And to make online shopping even more convenient and more affordable for our guests, Target.com will offer more then 100,000 items that qualify for free shipping throughout the holiday season.

Electronics and toys, including LCD TVs, net books, video games, transformers, [Baccagon], and Disney Princesses, are expected to be among the most wanted gifts. In addition we’ll offer incredible value and differentiation in trim a tree, including many items with lower price points then last year.

To assist our guests with their planning, we mailed our toy catalogue to five million homes and inserted it in 48 million newspapers on November 8, and in coming weeks many of our guests will receive holiday gift catalogues, or other direct mail from Target featuring great gift ideas at exceptional prices.

We also continue to partner with well-known designers to offer guests high-end fashion at an every day affordable price. For example, during the fourth quarter Target is launching a new limited addition handbag collection with acclaimed designer Carlos Falchi, and introducing our next go international line with Rodarte.

And to help our guests get in the holiday spirit, we’re offering a dress collection that features a variety of versatile styles and dressier options designed to appeal to a broad range of guests, all for the incredible price of $39.99.

Finally all our holiday plans and processes are intended to make it easier then ever for guests to find what they want. Our circular and in-store marketing tie more closely together so people can see what they want in our weekly ad and quickly find it in store.

Our compelling and easy to spot signs call out great values and we are employing a truly cross multi channel approach that includes the use of online shoppable videos, programs with partners like Google and Yahoo, where guests can add the Target weekly ad application to their iGoogle, or My Yahoo homepage to be alerted when their favorite items go on sale, and a relaunched iPhone application which was listed as a must-have by Fast Company.

Whether during the fourth quarter or as we look to 2010, we continue to leverage Target’s culture of differentiation, innovation, and collaboration to deliver products our guests want at prices that fit their budgets. These attributes combined with our disciplined execution will allow us to continue to deliver a shopping experience that satisfies our loyal Target guests, attracts new guests, drives incremental sales, and generates profitable sales.

Now Douglas will provide more detail on Target’s third quarter financial results and our financial outlook for the fourth quarter.

Douglas Scovanner

Thanks Kathryn, in my remarks today I plan to discuss the performance drivers for both of our business segments in the third quarter and provide some insight into our expectations going into the fourth quarter and beyond.

As you’ve already heard this morning, we’re pleased with our third quarter performance. Our third quarter diluted EPS of $0.58 represents an increase of more then 18% over last year’s third quarter and is well above the expectation we had going into the quarter.

This performance was driven by much better then expected profitability in our retail segment, combined with solid and improving profitability in our credit card segment. Now let’s take a more detailed look at our performance in the third quarter, beginning with our retail segment.

Comparable store sales declined 1.6% for the quarter. While still negative this performance was somewhat less negative then we expected going into the quarter and much less so then the 6.2% decline we reported in the second quarter.

Among the key drivers of comparable store sales, traffic was up 0.6% in the quarter while average transaction amount declined 2.2% primarily due to a 1.6% decline in units per transaction. Our third quarter gross margin rate expanded 28 basis points, a little less then the 39 basis point expansion we experienced during the first six months of the year, but pleasantly surprising in light of last year’s strong third quarter performance on this metric.

Our performance during the quarter reflected continued improvement in rates across a broad range of merchandise categories, partially offset by an 18 basis point adverse impact of sales mix. This was a much smaller sales mix impact then the 68 basis point headwind we experienced in the first half of the year. In fact, it’s the smallest quarterly mix impact that we’ve experienced in three years.

Third quarter retail segment SG&A expenses grew only 0.5% over last year resulting in favorable expense leverage in light of our 1.4% growth in total retail sales. The most important driver of our favorable SG&A performance continued to be strong year over year productivity growth in our stores, offsetting adverse performance on a few other expense lines including incentive compensation.

Depreciation and amortization expense grew about 15% in the third quarter much more quickly then the first two quarters of the year. This change from the prior trend is the result of recognition of accelerated depreciation on assets that will be replaced as part of our comprehensive 350-store 2010 remodel program that Gregg touched on earlier.

Overall EBIT in our retail segment grew by 2.4% or $19 million in the quarter to $791 million this year while EBITDA grew by 7.1% to over $1.3 billion in the period. Turning next to our credit card segment, this quarter we continued to experience results consistent with the expectations we’ve discussed with you throughout this year.

And again this quarter those trends translated into solid profitability delivered from a somewhat smaller portfolio. Credit card segment profit grew to a very respectable $60 million in the quarter compared with $35 million last year. Period end gross receivables decreased 8.2% or $717 million from a year ago.

Total card revenue as a percent of gross receivables was down only slightly from last year reflecting a meaningful year over year decrease in the prime rate almost completely offset by the yield enhancing terms changes we’ve implemented to compensate for enhanced risk in the current environment.

Net write-offs were $280 million in the quarter, in line with the guidance we’ve provided throughout the year, most recently in the second quarter conference call. Now let’s turn to our expectations for the remainder of the year.

There’s no question that last year’s fourth quarter sales results present an easier comparison then we have faced all year. Working against this more favorable fourth quarter backdrop, are the combined effects of the very weak macro environment and longer-term trends around diminished holiday shopping lists.

On balance while we continue to believe that its possible for us to deliver positive same store sales in the fourth quarter we think its more prudent to plan for a modest negative result in this key metric and we’ve positioned our markdown sensitive inventory commitments with this in mind.

In turn, this approach should deliver a sharp and reliable increase in gross margin rates as we cycle over the corrosive clearance markdowns that we recorded in last year’s fourth quarter. Ultimately the magnitude of our net improvement in gross margin rates, will depend on other factors including our sales mix by category, and the intensity of the pricing environment.

On the SG&A expense line we continue to expect growth in the low single-digits for the overall year. However as we discussed last quarter, the unexpected strength of the last minute shopping in December last year created a staffing environment that was leaner then we had intended.

As we plan for this year’s fourth quarter we expect great store productivity to continue but we do not believe its responsible to deliver the same year over year productivity improvement we’ve seen through the first nine months of the year.

Combined with our current sales outlook this translates into an expectation of a mid single-digit increase in SG&A expense for the fourth quarter. Accelerated depreciation will have a similar dollar impact in the fourth quarter to that we recorded in the third quarter, but its impact on a rate basis will of course be somewhat lower because of the seasonality of our sales.

In the aggregate all of these factors should combine to drive strong increases in both retail segment EBITDA and EBIT in the fourth quarter. In our credit card segment, we’ll continue to manage the portfolio very conservatively in light of the underlying risk environment and in preparation for the legislative and regulatory mandates imposed on the credit card industry, who’s adverse impacts will begin to be measurable in our fourth quarter.

Despite these unwelcomed effects, we expect that our approach will continue to generate modest rates of portfolio profitability in the fourth quarter and into 2010. Seasonal factors will also contribute to somewhat lower profitability in this year’s fourth quarter when compared with the quarter just ended.

But even modest profitability this year would compare very favorably with last year’s loss in this segment. We continue to expect fourth quarter write-offs in the range of $300 million, above third quarter performance yet consistent with our first and second quarter experience and in line with our prior guidance as well.

We also continue to expect that year-end receivables will be about a billion dollars lower then at the same time last year. Before we leave credit cards, I should mention that we’re looking at other possible innovations in our card program to drive future performance. For instance in October we began a test in two markets to understand how our guests would respond to a rather fundamental change to our current rewards program.

In these test markets guests who used their Target card or Target Visa, or Target check card at our stores, received a discount on every purchase rather then accumulating points towards a periodic 10% off certificate that guests earn in the current programs.

Its early in the test, but we’re encouraged with the response that we’ve seen to date. We’ll continue to evaluate the results to determine whether to modify our overall program in the future. Now let’s turn to investment and cash flow.

In the second quarter call I outlined that we will have a lean new store program in 2010 with about 12 total new stores which will likely result in fewer then 10 additional locations net of closings and relocations.

Also as discussed in this call, we’ve committed to remodel about 350 existing stores in 2010 at a total investment of just over a billion dollars. In concept about half of this investment is to add P-Fresh features to these stores and the other half is devoted to other enhanced merchandising concepts and to a general freshening of these stores, consistent with the objectives and magnitude of our remodel program in each of the past several years.

Overall we might reinvest something like $2.5 billion of capital in our business in 2010, up from about $1.8 billion or so this year. Taken in the context of the likely magnitude of cash flow generated from operations this means that we should be in a position sometime in 2010 to engage our Board in a discussion about lifting our temporary suspension of open market share repurchase activity.

If we were able to resume this activity next year we would continue to execute with a keen eye on maintaining our strong credit rating. Finally let me summarize our earnings outlook for the fourth quarter.

As of today, the current median first call estimate for Target’s fourth quarter earnings per share is $1.12. I believe this figure lies within a range of potential outcomes, yet I also believe that many things would have to fall into place to meet or exceed this figure.

For important context, I would observe the related comment that in our view sell side analysts are somewhat more optimistic across most of our industry then we believe is warranted in light of the harsh realities of the current environment.

Now Gregg has a few brief closing remarks.

Gregg Steinhafel

We remain confident in our strategy and our team and continue to make listening to our guests a top priority. We also remain focused on offering affordable products for any budget and driving meaningful innovation across all of our businesses.

We’re confident that Target will continue to deliver on our expect more, pay less brand promise in ways that resonate with our many diverse guest segments for months and years to come. That concludes our prepared remarks, now Douglas, Kathryn, and I will be happy to respond to your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Colin McGranahan – Sanford Bernstein

Colin McGranahan – Sanford Bernstein

First question is really on the discretionary category and if you could maybe parse down a little bit what you’re seeing in terms of units per transaction, through the third quarter and then into November, are people, have they been adding discretionary on the average trip or are they taking more trips with a more discretionary appeal to them.

Gregg Steinhafel

Well in the third quarter they, actually there was a little bit of both of those dynamics. We saw an increase in traffic flows and within that increased traffic we saw a great propensity to buy discretionary items in the basket. In particular we saw our apparel business strengthen in the third quarter vis-a-vie other quarters.

Colin McGranahan – Sanford Bernstein

And how has that behavior changed so far here in November.

Gregg Steinhafel

Well again we’re very early in the month but we have seen slightly softer sales in the first two weeks of the month and a little bit of give back in the discretionary category, but again we’ve got a lot of season ahead of us and we think that this may be as much of a case of retiming of sales then anything.

We’ve got a very strong plan for the fourth quarter in our discretionary categories and we think that we will continue to perform well on the discretionary side of the business.

Douglas Scovanner

As you know we don’t often like to talk about the weather here at Target but I think at this point we should make an exception to that practice. The weather helped us in October and clearly in hindsight accelerated some apparel sales that might have otherwise occurred here in early November.

So, lots of people love to complain about the weather. I would remind everyone that on average the weather by definition is average and we should benefit as often as we suffer.

Colin McGranahan – Sanford Bernstein

And then just a quick follow-up any learning’s you can talk about so far in the Philadelphia P-Fresh rollout and how that has influenced your thinking about the expansion next year.

Gregg Steinhafel

Yes, there have been a lot of learning’s so far and again, its very early so we hesitate to get into much detail as it relates to what’s in the basket and the frequency and things like that. I think its just important to note that we are experiencing in Philadelphia the same kinds of strong performance characteristics that we have observed in our initial pilot stores and other new stores and remodel stores that we implemented throughout the earlier part of this year.

So the same kind of shopping dynamics exist where very, very strong sales in grocery, slight increases in the cross over categories and because its so early, we’re seeing basically flat or up slightly in the discretionary categories.

But as you know we’re going to have an analyst meeting in mid to late January in Philadelphia and we’ll be able to share much more detail as it relates to guest insights and the shopping dynamics at that time.

Operator

Your next question comes from the line of Charles Grom – JPMorgan

Charles Grom – JPMorgan

Just on the accelerated depreciation you said a similar amount in the fourth quarter, should we think about it is that we’ll see a similar amount here in the first quarter and second quarter of next year as well.

Douglas Scovanner

No it will trail off pretty significantly and in round numbers, in the aggregate its about $400,000 of assets per store so we’re talking on the base of stores we’re remodeling next year, about a $140 million plus or minus in assets that will be retired that had book value at the beginning of the quarter, at the beginning of our third quarter.

By the end of this year we will have recorded between $90 and $100 million of that total and that will leave $40 or $50 million in 2010. Obviously if we repeat this program in 2011 then we’ll repeat this cycle of accelerated depreciation give or take in the last half of next year.

Charles Grom – JPMorgan

And then on the P-Fresh, how much of the SKU increase is dry grocery versus perishables.

Gregg Steinhafel

The majority of the SKU increase is in the dry grocery area, I would say its dry, dairy, and frozen contribute the majority of the SKU increase. Clearly we’ve added perishables but the perishable section is still relatively small in comparison to how deep we went in those other categories.

Charles Grom – JPMorgan

And then on credit, you gave us the write-off of over $300 million, could you give us a little bit of color for the bad debt provision line, what you’re thinking.

Douglas Scovanner

Well I said write-offs would approximate $300 million hate to be so picky with words, but I didn’t say over $300, but the provision is something that we won’t be able to determine until we get at the end of the quarter.

A lot of variables go into that calculation every quarter as we assess the risks in the then current portfolio but as a working proposition I would expect that the provision will likely be lower then write-offs in the fourth quarter by a fairly small amount.

Operator

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

Gregory Melich - Morgan Stanley

Can you get a little bit more into the gross margin, its nice to see it continue to grow and we had a nice mix improvement with apparel coming back. How much of that mix improvement that was now only 18 as opposed to down 60 was because of that apparel coming back, or were there other factors that drove that improvement.

Douglas Scovanner

Most of that mix improvement was driven by collapse of the differential between our aggregate same store sales and the apparel same store sales performance. So those were reasonably in line with each other in the quarter in sharp contrast to any of the quarters in the last year and a half.

Home was less negative then it had been, but the big story in Q3 mix was apparel.

Gregory Melich - Morgan Stanley

So from where we are today, if we could keep this sort of difference of comp trend of the categories, do you think this headwind of negative 20 bps is a new ongoing run rate.

Douglas Scovanner

No I think that that would require favorable weather as far as we can see. So again, I don’t like to get too far into weather, but there’s no doubt that our adverse mix impact was less adverse as a result of the acceleration of sales due to favorable weather.

Gregory Melich - Morgan Stanley

And one thing that was interesting was on the ticket that the units seemed to drive more of it then deflation, is there any, was there something behind that especially if discretionary started to pick up, was it items in the basket or how—

Douglas Scovanner

I think that we’re all going to need to adjust our thinking a bit moving forward, after all we’re driving a lot more traffic to the stores with some fundamental and quite intentional changes in our strategy. And some of those trips involve fewer units. Its what we’re trying to do.

Operator

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

Jeff Klinefelter – Piper Jaffray

Maybe just a little bit more specifically on apparel, it’s a pretty big part of the story here in terms of the discretionary recovery, can you talk more about areas in apparel or price points or how you would characterize this recovery in terms of it being part of your strategic initiative, maybe a little bit more detail around home in that same context. And then in terms of the comps that you talked about for the fourth quarter, I guess negative low single-digits, I think describing as being maybe more likely or a more responsible view at this point, any flow by month through the quarter and also any sensitivity you’d be willing to share with us if in fact you did start to see it go more toward a more positive low single.

Kathryn Tesija

So starting out with apparel, I think our strength is predominantly in our core and must haves and I think that would apply to home as well. And while we still have a healthy business on the fashion side, most of our improvements that came in the third quarter really came in the core and the must have side and as mentioned earlier, a lot of that was in the seasonal businesses.

So as the weather turns the guests clearly was updating her wardrobe to accommodate that.

Douglas Scovanner

On the same store sales question, as you know we’ve already provided guidance for November to be essentially flat to last year and Gregg commented that we’re starting out a bit softer then the pace that we would have hoped, but of course a huge portion of November is yet to come because of the concentration of sales around Thanksgiving.

In light of thinking about a quarter that might be a down slightly, down somewhat obviously December cannot be very different from that quarterly outcome if November turns out to be flat give or take. So I don’t expect anything remarkably different about December then what we end up reporting for the entire quarter.

And in terms of sensitivity a point of sales in our fourth quarter of course is a very large number because of seasonality. Certainly something approaching $200 million and the flow through on that could be quite substantial especially if its concentrated in seasonal or higher margin items that otherwise might have been marked down.

Those categories remember are categories in which we already have a real good handle on our unit sales. The question is what will the mix be of regular price, promotional price, and clearance sales. There is some extra expense associated with those sales so I don’t need to make it sound as if all of that would flow through to the bottom line.

But of course as in every fourth quarter our bottom line is very sensitive to what happens in those seasonally important categories.

Jeff Klinefelter – Piper Jaffray

One other thing on your marketing expenses, you talked about building that in the third quarter, your SG&A came in better, or more favorably, have there been any changes in your, the strategic initiatives along the lines of marketing dollars.

Douglas Scovanner

Certainly we have maintained the ability to keep the pace in the fourth quarter in the marketing wars and therefore on a proportional basis or a seasonal basis, we’ll spend a little more in Q4 this year as compared to a little less that we have spent so far this year.

Operator

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

Mark Miller - William Blair

I was hoping you could elaborate on your comments that you have expectations for a highly promotional holiday season, does that represent a change from what I think you’ve described as a rational competitive environment, are you seeing different competitive behavior thus far in the fourth quarter.

Gregg Steinhafel

The way I would describe is we typically expect a highly promotional fourth quarter. The last number of years have been highly promotional and we don’t believe that this year will be any different. We’re not expecting it to be any more promotional then prior years but as you know when you get around Thanksgiving and early in December it gets very price oriented and there’s a lot of door buster activity and limited time only sales.

And we just expect that kind of activity to be there this year like it was last year. We’re hopeful that it will be, that while it might be more promotional in nature from a marketing standpoint we believe that most retailers have done a better job of managing their inventory levels and we think that overall inventory within stores in the pipeline are going to be better synchronized compared to last year so there may not be as much intensity around the clearance side of the business or the marketing to clearance and those kinds of events that had to liquidate all the excess inventory that existed last year.

So they’ll probably be aggressive nature as it relates to be proactive in nature but hopefully there’ll be less activity as it relates to having to get rid of merchandise because retailers over bought. I think most retailers have come into the fourth quarter in a relatively good inventory position.

Mark Miller - William Blair

So my impression the last time we spoke was that you described things I think as rational, you had good markup and I guess my takeaway is it might have even been a little bit, slightly more favorable then normal, can you comment on that and current trends, would you say its average or is it similar to what we had seen during the summer.

Douglas Scovanner

I think you’re putting too fine a micrometer on these comments. The environment has been rational. The environment remains rational. It’s the fourth quarter. We expect a highly promotional fourth quarter. We always expect a highly promotional fourth quarter.

Mark Miller - William Blair

And then looking ahead, Wal-Mart has been talking about the productivity loop coming back, I think its perceived to be more of a forward comment as their expenses come down, but would you offer any comment about how you think that might impact or not impact Target.

Gregg Steinhafel

Well we’ve experienced the same productivity loop. I think both of us have managed our expenses and driven up productivity. Their gross margin rates are up as well so they’re not reinvesting in only low prices. They are to some extent reinvesting in more aggressive pricing, but some of that is dropping to the bottom line.

So as long as that kind of environment maintains itself we should be able to do both, support the productivity loop and hopefully preserve the levels of profitability that we have, or if we see some rebound on the discretionary side of the business or continued rebound, we’ll be able to see some slight margin expansion.

But we’re not counting on it at this time.

Operator

Your next question comes from the line of Deborah Weinswig – Citi

Deborah Weinswig – Citi

What do you think has driven the pickup in traffic in recent months.

Gregg Steinhafel

I think overall consumers are more confident. I think that their confidence level is more about the future then perhaps it is right now, but I think like any adjustment that they go through, they have a tendency to hold back and not go into stores and I think that they’ve adjusted their budgets. They see more stability in the environment, unemployment rates, they’re at high levels but I don’t think anybody is really expecting them to get worse, only better over time.

So I think the consumer is in a better place and more confident. So I think they’re back to more normalized patterns so we’re getting some of those trips back that we have lost when times were more difficult but on the other hand, you’re seeing the consumer being more disciplined and that’s why there is fewer items in the basket or they’re buying private brand instead of the national brands.

So while they’re back to their typical shopping patterns in terms of frequency of visits, they’re more disciplined in their spending habits. They’re coming in with lists and circulars. They’re focused on items that are on sale, they’re coming in with coupons, and rebates and things that can lower the price.

So they’re still very, very cautious in what they’re spending but their basic routines are more normalized is the way I would describe it.

Deborah Weinswig – Citi

You had also gone through a lot of let’s say new initiatives, and there’s also the low price promise, how important to you think those initiatives being fully rolled out and communicated to customers are also having an impact on traffic.

Kathryn Tesija

I think its very important, its reassurance that our pricing is very competitive in the marketplace and that’s how we’re communicating that whether that’s in store with bold signings, or within the circular, having fewer items, that’s larger pictures, bigger price points, easier for her to see and sort through.

I think all of those things contribute to traffic to Target getting on her grocery list or her discretionary list every single week and I think it’s a reassurance that Target can offer the great assortment as well as have great pricing.

Gregg Steinhafel

I would just add that we continue to profitably gain market share by doing everything we need to do well. We’ve got to have the right content, we’ve got to be in stock, we’ve got to communicate these values in inspiring and compelling ways. We’ve got to deliver a superior in-store experience which means highly engaged team members that are available on the floor, that are knowledgeable and then ultimately providing the right kind of low wait times at our registers, whether its in electronics or at the front end.

We’ve got to get people in and out because they appreciate that and we are focused on improving all aspects of that and I think what you’re seeing is Target operating well in all of those dimensions. The pipeline innovation that Kathryn talked about is very, very high. We’re in the process of rolling out P-Fresh but there are a lot of other merchandising initiatives that we have in either a test or pilot phase that we’ll continue to share with you as time goes on, that we think we’re going to continue to make our shopping experience even better then it is today and we believe that the guests will understand it and appreciate it and we’ll gain market share as a result of the innovations that we’re going to be layering in the store over the next couple of years.

Deborah Weinswig – Citi

One of the other initiatives I actually wanted to talk about was in jewelry with the reset there, can you talk about how that came about and if we look out where you are now versus where you were a year ago in jewelry, maybe just some of the early wins and how that came about.

Kathryn Tesija

We set out to make the environment much more guest friendly. As you know in the past we had locked up most of our jewelry under glass and so guests could view it but they needed assistance to be able to get it out of the case and try it on. And so we did a pilot for a period of time and have now expanded that to all stores.

But really bringing all the product out from under that glass, up on the top of those cases and in new stores on tables, so guests can try on the product, touch and feel it, see how it looks. So that’s been a big win in terms of accessibility.

The second piece of that is really changing the assortment, bringing down the price point so everything is under $50.00, which our guests have responded to incredibly well.

Deborah Weinswig – Citi

And then just on P-Fresh, how should, based on the success of the Philly rollout, should we think about those 350 new stores, new stores or the P-Fresh rollouts in 2010 as being in markets like Philly or more as kind of one-offs.

Gregg Steinhafel

We’re going to start with our high priority markets and we’re going to be doing the majority of stores in those markets but we won’t be able to complete all stores within a given market. Over time we will come back to those markets in 2011 and 2012 but sheer volume and capacity and the ability to manage the levels of complexity don’t allow us to get 100% coverage in each of those markets.

But over time we really expect to get through the majority of the chain.

Operator

Your next question comes from the line of Wayne Hood – BMO Capital Markets

Wayne Hood – BMO Capital Markets

Back to the P-Fresh format can you just give us some idea about what your current thinking is that from, what kind of sustained sales lift do you need to cover your cost of capital when you look at a $20 million store that you would convert versus a $40 million store and do you feel comfortable about the smaller volume stores now and being able to roll that back, and get the P-Fresh format back into those smaller stores.

Douglas Scovanner

We’re not yet at that stage. There are a lot of questions that we are in the process of answering that its premature to decide but all else being equal of course, we need a much bigger percentage lift in your smaller store then your larger store if we spend the same amount of capital on which we’re trying to earn a return.

The dollars of the lift in concept need to be the same and that represents a much higher percentage in the smaller store. The other really important open question is whether we’ll enjoy a year two lift in these stores over and above the base line. Separately it’s a bit premature to decide how much of the lift will occur outside the food and cross over related to food categories.

That’s after all what we’re trying to learn here that inform our thinking as we move forward beyond 2010 with this program.

Wayne Hood – BMO Capital Markets

And my second question was can you talk a little bit about your expectations at least preliminarily about 2010 for balance growth in the credit operation or contraction and related to that do you get a sense that the appetite for the size portfolio that you have is more or less better or worse then it would have been say three or four months ago.

Douglas Scovanner

Its not a question of appetite, its far more a question of environment and the environment includes our view of the risks and it also includes the realities of the hugely anti-stimulative credit card tax which will have the direct impact of shrinking our portfolio and shrinking portfolios of virtually everyone else in the industry.

So as we look into 2010 I think you’re very likely to see continued declines in the size of our portfolio, continued declines from an industry standpoint in the portfolios of others as well.

Wayne Hood – BMO Capital Markets

Would you care to put any numbers around that, like high single-digit or is it too early to say.

Douglas Scovanner

Well the pace that we’re on right now, as I mentioned earlier, is to be down year over year about a billion dollars at year-end. That’s a low double-digit percentage year over year and as a working point that currently by definition is our current pace of decline.

In essence charge activity has fallen off at a much faster pace then has payment activity and that is a set of dynamics that are very likely to continue into 2010. Whether it continues at a high single-digit percentage or a low double-digit percentage is an open question, but its highly likely that our portfolio will continue to shrink in gross accounts receivable terms.

Wayne Hood – BMO Capital Markets

And my final question, if you could just discuss with us the sustainability of the gross margin improvements that you’ve made so far as you look broadly across all of those classes and does it continue into 2010 particularly in the back half of 2010 and how you balance the impact of P-Fresh on mix.

Kathryn Tesija

For gross margin you know we have a lot of initiatives to help drive our gross margin and we have grown it in many categories across the board to help offset some of the mix impact that we’ve experienced. So our intent is that we will continue to do that. Some of those initiatives are making sure that we’re growing our own brand portfolio which is more profitable.

Very good inventory control, which has helped us throughout 2009. We’ve done a lot of segmentation both in volume, high and low volume but as well as assortment optimization, which has helped us improve markdown rates in some of those stores.

And lastly really optimizing our SKU count so we’re down about 5% this year in our SKUs which has helped our stores to be more productive as well as reduced markdowns. So we will continue on all of those fronts throughout 2010 to make sure that we’re able to offset the headwinds from the mix.

Operator

Your next question comes from the line of Daniel Binder – Jefferies & Co.

Daniel Binder – Jefferies & Co.

Two questions, first on the bad debt expense, I was just curious what drove the decision to take the bad debt expense in excess of the net write-offs given some of the improvements we’ve been seeing in the credit metrics and then secondly with regard to store expansion next year, at this point is the store openings pretty firm based on your prior guidance or is there still some chance that there could be some upside if [this] continues to improve.

Douglas Scovanner

No, 2010 store opening program is essentially also baked. We’re working on 2011 and 2012. We can’t construct stores fast enough to start thinking about building a store that would open in 2010 right now and actually make it so.

On the bad debt expense question, as you know we take a very careful look at the end of every quarter to determine what our allowance for doubtful accounts should be and that indirectly determines of course bad debt expense for the quarter for the period just ended.

In the most recent analysis I would observe that the slight uptick that we expect in net write-offs in the fourth quarter in sequence when compared to the third quarter is largely attributable to the impact of our May 2009 terms changes. When we changed terms that of course has a net beneficial impact but focusing on this line only, causes a subset of the effected guests to go to write-offs who otherwise would not have gone to write-offs.

So six months of no activity of course yields an aged write-off and so the fourth quarter will represent the peak of aged write-offs directly traceable to the May 2009 terms change.

Operator

Your next question comes from the line of Robert Drbul - Barclays Capital

Robert Drbul - Barclays Capital

Two questions, first on the credit piece of it, with the Master Trust data that was out today, the early stage delinquencies I believe started to have sequentially deteriorated so can you just talk a little bit about how you’ve incorporated that into your prior write-off expectation and the one you talked around $300 million.

Douglas Scovanner

Well again we’re talking about the same issue. We have seen some sequential deterioration since May and virtually all of it is directly attributable to the May 2009 terms change. So all of that is incorporated in our thinking and incorporated not simply in comments I’ve made about bad debt expense and write-offs and balance sheet, but from my standpoint more importantly incorporated in our thinking about our highly likely ability to continue to maintain modest and appropriate levels of profitability moving forward.

We continue to enjoy a very strong performance in 46 states and continue to suffer from lingering nasty losses, in California, Arizona, Nevada and Florida.

Robert Drbul - Barclays Capital

And then on the expectations for the SG&A mid single-digit increase for the fourth quarter, how much of that increase is purely a function of higher staffing levels and can you put any numbers on how your staffing numbers were down last year during the fourth quarter.

Douglas Scovanner

I wouldn’t think of it as higher staffing levels, but rather the way that we have enjoyed the big SG&A benefit so far this year, is by enjoying terrific gains in productivity. So sharp increases in dollar sales per hour worked, per hours worked in our stores.

If you turn the clock back to the fourth quarter of last year, we enjoyed a much bigger year over year performance benefit, a much bigger gain in productivity then we had even wanted to achieve. And so if you think of this as kind of a two year analysis the way that a lot of you analyze same store sales performance, our two year performance in the fourth quarter will look very similar to our two year performance in other quarters, but year over year it means that we won’t enjoy a meaningful productivity gain in Q4 this year.

And in light of the likelihood of negative same store sales performance and in context of increases in wages per hour and increases in benefits per hour, that produces and upside down equation for the quarter only.

Operator

Your final question comes from the line of John Zolidis – Buckingham Research

John Zolidis – Buckingham Research

Just a question on the comp guidance and planning for the fourth quarter, you indicated that you thought it would be, it is possible to achieve positive comps in the fourth quarter and I assume that you believe that even with the context of the slightly softer start to November. So could you just elaborate a little bit on what you think might drive those positive comps and then secondly, I assume that your comment on the streets fourth quarter EPS figure incorporates the current sales trend. That is you’re comfortable with the current street number in the language that you used, even with the current slightly softer trend in November. Is that accurate.

Gregg Steinhafel

The reason we have put a range around the fourth quarter is because we’re up against substantially weaker comps of a year ago so as we’ve watched our business strengthen from second quarter throughout the third quarter we’re now cycling more problematic sales environment of last year.

So with that in mind if there is some resilience to the consumer this year, it could be plus or minus so we’re optimistic that it could be better then what our planning assumptions are, but it might not be that way either.

Early November is a little softer, as Douglas talked about, we think that was more primarily related to warmer weather patterns throughout the United States but so much of this fourth quarter is going to be decided in two days after Thanksgiving and the four weeks prior to Christmas and nobody really knows at this point in time how good its going to be.

So it’s a wide range of estimates and right now we’re expecting somewhere in the neighborhood of flat given everything that we see right now. But if there’s more business to be had, clearly we have the inventory to do mid or low single-digit comp increases in December.

Douglas Scovanner

I think its important to clarify my comments, or to repeat my comments on earnings earlier, I did not say that I was comfortable with $1.12. I didn’t say I was uncomfortable with it either. What I said was that I believe that figure was within a range of potential outcomes and I said that I believe that many things would have to fall in place to achieve it.

Gregg Steinhafel

That concludes Target’s third quarter 2009 earnings conference call. Thank you all for your participation.

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Source: Target Corporation Q3 2009 Earnings Call Transcript

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