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Target Corporation (TGT)

F3Q06 Earnings Call

November 14, 2006 10:00 am ET

Executives

Bob Ulrich - Chairman, CEO

Doug Scovanner - EVP, CFO

Gregg Steinhafel - President

Analysts

Jeff Klinefelter - Piper Jaffray

Charles Grom - JP Morgan

Christine Augustine - Bear, Stearns

Bob Drbul - Lehman Brothers

Mark Rowen - Prudential Equity Group

Greg Melich - Morgan Stanley Dean Witter

Mark Husson - HSBC

Deborah Weinswig - Citigroup

Virginia Genereux - Merrill Lynch

Teresa Donahue - Neuberger Berman

Dan Binder - Buckingham Research Group

Peter Benedict - Wachovia Securities

Adrianne Shapira - Goldman Sachs

Neil Currie - UBS

Presentation

Operator

Welcome to the Target Corporation's third quarter earnings release conference call. (Operator Instructions) I would now like to turn the conference over to Mr. Bob Ulrich, Chairman and Chief Executive Officer. Please go ahead, sir.

Bob Ulrich

Good morning. Welcome to our 2006 third quarter earnings conference call. On the line with me today are Gregg Steinhafel, President; and Doug Scovanner, Executive Vice President and Chief Financial Officer.

This morning, I will provide a brief update on our perspective of the current competitive and consumer environment, and then Doug will review our third quarter 2006 financial results and describe our outlook for the remainder of the year, with specific guidance on key individual drivers of our performance. Next, Gregg will provide an update on the key strategic initiatives that continue to fuel Target's strong performance and consistent growth. Finally, I will wrap up our remarks and we will open the phone lines for a question-and-answer session.

As Doug will describe in more detail shortly, we announced excellent financial results this morning for Target's third quarter and first nine months of 2006, particularly in light of the exceptional strength of last year's performance. In addition, we remain optimistic about our fourth quarter outlook, and believe that we are on-track to deliver strong, full year results.

As always, we expect this year's holiday season to be intensely competitive and as a result, we have planned our business to drive traffic and generate profitable sales. We are sharply focused on having the quality, trend-right gifts that our guests want for this holiday season, at prices that represent great value.

Our holiday marketing campaign reinforces all that is distinctive about Target in a manner and style that is consistent with our brand. Our stores and logistics teams are poised to ensure that Target delivers an outstanding shopping experience for our guests, including consistent in-stock levels, compelling merchandising presentations and fast, fun and friendly service.

We are confident that our year's strategic investment in product design and global sourcing capabilities, our operational discipline, and our commitment to expect more and pay less will deliver a holiday and post-holiday season that delights our guests and generates profitable market share growth for Target in 2006 and beyond.

Now Doug will review our quarterly and year-to-date financial results, which were released earlier this morning.

Doug Scovanner

Thanks, Bob. As a reminder, we are joined on this conference call by investors and others who are listening to our comments today via live webcast. We plan to keep today's call to no more than 60 minutes, including our Q&A session. Susan Kahn and I are available throughout the remainder of the day, to address any follow-up questions you may have. Also, any forward-looking statements that we make this morning should be considered in conjunction with the cautionary statements contained in our SEC filings.

This morning, Target Corporation announced our financial results for the third quarter and first nine months of 2006, and modestly exceeded our expectations for growth, on top of especially robust prior year results. A few highlights of our performance were a 19.2% increase in EPS to $0.59 this year, compared to $0.49 in 2005. This performance is especially noteworthy in light of last year's 37.2% EPS increase over 2004. In the quarter, our total revenue grew 11.2%, driven by the contribution of new stores, combined with a 4.6% increase in same-store sales. This same-store sales performance is again particularly noteworthy in light of last year's very strong 5.9% increase.

In our core retail operations, we slightly expanded our gross margin rate from last year's record-high level. While we continued to experience a somewhat faster increase in expenses than sales, we performed better on an apples-to-apples analytical basis this quarter than we did in either of the first two quarters this year.

As always, we have issues affecting the comparisons which run in both directions, but the single largest of them all, by far, is the nonrecurring reduction in expenses we experienced last year related to the settlement we received from the Visa/MasterCard antitrust lawsuit. Overall, our growth in core retail EBIT was somewhat better than we expected 90 days ago.

In addition, we continued to enjoy robust results in our credit card operations, slightly better than our recent experience and expectations. Average receivables grew 11.3%, in line with our sales; and our credit card contributions to earnings before taxes as a percent of average receivables was 11.5%, up from 7.9% a year ago, reflecting the continued strength of our underlying performance.

A quick note regarding income taxes: our booked effective tax rate was lower in the quarter than you and we would have expected 90 days ago, driven by the sharp increase in our share price.

Overall, our third quarter performance highlights the consistency of our strategy and the discipline of our execution, and we are very pleased with our results. However, in order to understand the context for our fourth quarter and full year outlook, I would like to spend a few minutes discussing our year-to-date trends.

So far this year, we have enjoyed an 11.3% growth in sales, driven by the contribution from new stores and by a 4.8% increase in same-store sales. Looking forward, we expect to achieve a similar increase in comparable store sales in this year's fourth quarter. In addition, keep in mind that Target’s fourth quarter and full year results will have an extra week this year, so our total sales and revenue will reflect even more growth than is typical.

Gross margin rate through the first three quarters of this year is equal to last year's record high performance of 32.5% and in-line with our expectations. In this year's fourth quarter and for the full year, we believe we will continue to enjoy a gross margin rate that is generally in line with our prior year results, sustaining the tremendous gains we have made over the last several years, and especially in 2005.

Our expenses so far this year have grown at a faster pace than sales, resulting in a 50 basis point increase in our year-to-date expense rate. While we are not satisfied with this performance, we know that a portion of this rate increase is due to timing, which will turn around in the fourth quarter. Also, our fourth quarter expense rate will benefit from the additional sales leverage of the extra week, and we remain keenly focused on controlling our core underlying expense drivers. As a result, we expect our expense rate in this year's fourth quarter to be similar to last year's rate.

Turning to our credit card operations, we have continued to grow our receivables in line with sales, and we have enjoyed robust financial results so far this year. We expect to continue to enjoy similar strategic and financial benefits for the foreseeable future, certainly for the remainder of 2006 and well into 2007. The only noteworthy underlying issue here is that as expected, we are experiencing sequential increases in delinquencies, resulting in sequential increases in write-offs, driven by the OCC mandated increase in minimum payments.

Overall in the short run, we believe delinquencies are likely at or near their peak, approximately 4.0% of receivables and annualized net write-offs are now expected to be in a range of 7.0% to 7.5% of receivables. These figures are somewhat favorable to the outlook I shared with you last quarter.

Importantly, we are already fully reserved for this projected outcome, so this set of events should not result in any future P&L impact. Our current allowance is $514 million, or 8.4% of gross receivables; up $97 million, or 23.3% from this time last year, and we have already expensed $63 million more this year than we have written off.

In closing, let's tie all the elements of our financial outlook together. As we head into the holiday season, our momentum remains strong, and our plans envision a mid single-digit increase in comparable store sales for the fourth quarter overall. From today's vantage point, we believe this sales growth will translate into a likely range of profitability consistent with the current median First Call EPS estimate for the fourth quarter of $1.26, which would represent an approximate 19% increase over last year's actual EPS of $1.06.

The natural seasonality of our business, combined with our ongoing share repurchase program, creates the likelihood that the sum of our four quarters in 2006 will not equal our reported EPS for the full year. As a result, we believe the likely total year outcome of achieving this fourth quarter First Call estimate, together with our year-to-date results of $1.92, is $3.17.

We have observed that some of you are concerned over the portion of our year-to-date profit growth driven by the contribution of our credit card operation. In contrast, we expect our sharp growth in fourth quarter profitability to be dominated by our core retail operations due to three primary factors:

First, the prior year profit base before retail EBIT in the first three quarters of 2006 has been much more challenging than the fourth quarter profit base represents.

Next, the natural seasonality of our retail business results in a much smaller relative contribution from our credit card operations in the fourth quarter.

Finally, we will now begin to cycle prior year periods of terrific credit card performance, so our increases will begin to settle into a more normalized pattern.

For these reasons, we expect our full year profit growth to reflect a more balanced contribution from our core retail and credit card operations than is reflected in our year-to-date experience; and we expect that even in light of spectacular credit card performance in 2006, our core retail operations will continue to represent about 85% of our annual earnings.

Now, Gregg will provide a brief summary of current business trends and describe some of our holiday season initiatives.

Gregg Steinhafel

Thanks, Doug. Target delivered another quarter of strong financial performance, driven by growth in comparable store sales of 4.6% on top of a 5.9% increase a year ago. Growth in both traffic and average transaction amount contributed to our sales increase in the third quarter, and categories that enjoyed better than average performance included infant/toddler basics and apparel, men's apparel, toys, healthcare, and food.

We continued to manage our inventories well during the quarter, and are very comfortable with both our merchandise mix and in-stock levels as we head into the holiday season.

Our third quarter store opening cycle was the largest this year, with a total of 59 new stores. After closings and relocations, we opened 36 net new discount stores and 14 new SuperTarget stores, resulting in a quarter end store count of 1,494 stores in 47 states, including 176 SuperTarget locations.

Target's “Expect More, Pay Less” brand products, and commitment to delighting our guests is at the core of these strong results, and our continued profitable growth. We remain sharply focused on offering affordable design, differentiated products, and compelling values to our guests every time they visit our stores.

Several new initiatives during the third quarter included the introduction of contract cell phones by T-Mobile and Verizon Wireless, as well as convenient new extended service plans for other consumer electronics products; the launch of a home collection called Perfect Pieces by acclaimed interior designer Victoria Hagan, which combines both traditional and contemporary elements and assortments of accent furniture, lighting, wall decor, pillows and decorative accessories; the presentation of Paul & Joe from Sophie Albou for our third Flight of Fashion in our GO International program; the continued expansion of our premium-owned food brand, Archer Farms, to a broad array of additional items and categories such as imported frozen pizza and pasta, frozen entrees and vegetables, all natural breads and organic coffee, condiments and snacks, and a designation as a certified organic produce retailer, differentiating Target from many of our national supermarket competitors, including Wal-Mart.

By balancing our steadfast emphasis on design and innovation, with our focus on affordability and value, these initiatives reinforce our brand promise and underscore our commitment to remain relevant to our guests over time.

We expect this year's holiday season to once again be highly promotional and very competitive, but we are confident that Target is well-positioned to deliver an exceptional shopping experience and to capture substantial, profitable market share in the weeks before and after the Christmas holiday. We have a cohesive strategy, which includes leveraging the strength of Target.com to drive traffic to our stores, and believe we will delight our guests by providing all of their holiday entertaining, decorating and gift giving needs.

Shortly, we will enhance our website functionality with a feature called Find It at a Target store, that allows our guests to confirm the availability of their desired item at their local Target store in advance of their shopping trip. This new online capability provides added guest convenience, and is expected to contribute to incremental in-store sales.

In addition, we recently introduced our fourth GO International collection, an assortment by New York designer, Behnaz Sarafpour, which is inspired by New York City night life, and reflects the spirit of the holiday season. We have also partnered with popular New York designer Ramon Felix Potanko to offer an exclusive line of accessories called [Reffi] for Target. Our holiday collection includes stylish handbags, clutch purses, and gloves in both day and night designs.

Once again, this year we will feature our holiday gift program called Target Limited Edition. This luxury collection includes merino wool sweaters, silk neck wear and cashmere scarves for men; and silk velvet evening bags, tasseled clutch purses, and dressed leather gloves for women. Additionally, on the Sunday after Thanksgiving, our weekly circular will feature an assortment of unique merchandise not previously available at Target. The offerings, called Limited Time Only gifts, includes collector items and unique nationally branded goods which are available in limited quantities.

Toys and electronics remain a top priority. We will have the hottest toys at great prices this holiday season, including educational and tech toys, action figures, and board games. In electronics, we will aggressively support the launch of both PlayStation 3 and Nintendo Wii gaming systems, along with a broad assortment of compatible software and accessories. We will also offer an expanded assortment of LCD flat panel TVs and portable electronics, as well as high quality digital cameras.

For decorating, we are offering a large assortment of holiday lights, trees, and bulk packs of gift-wrapped ornaments at compelling prices, as well as Smith & Hawkins wreaths and decor. We are also offering a delicious holiday food gift selection, including our Choxie signature collection, featuring hand decorated truffles.

In conjunction with these merchandising initiatives, our holiday marketing campaign, featuring the work of artist and designer, [Torrent Paunche], brings a winter wonderland feel to our advertising and in-store signage, and further reinforces Target's “Expect More, Pay Less” brand promise. This is our biggest and busiest season of the year, and we plan to transport our guests to a world that is nothing short of magical.

Finally, we remain focused on maintaining our in-stock levels, great values and innovative merchandising after the holidays, with an offering that includes a more compelling global bazaar presentation, and expanded Time to Play assortment in toys, and a host of new video games and entertainment options for younger guests, and those looking for opportunities to redeem their Target holiday gift cards.

We are pleased with our year-to-date performance and very excited about our plans for the holiday season, and in the weeks and months beyond, we are confident that our guests will respond to our innovative merchandising and marketing, our exceptional value, and our consistent execution, and that this favorable response will produce yet another quarter of outstanding financial results in 2006 and help us sustain our competitive advantage as we have moved forward to 2007.

Now Bob has a few concluding remarks.

Bob Ulrich

In summary, we are pleased with our third quarter and year-to-date results, and we are optimistic about our outlook for the fourth quarter. We remain confident in our strategy and believe that Target will continue to deliver strong profits and consistent growth well into the future.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Jeff Klinefelter - Piper Jaffray.

Jeff Klinefelter - Piper Jaffray

Hi, yes. Two questions for you today. One would be on the sourcing front. You have talked in the past, Gregg, about your direct sourcing initiative and your objective over time to increase that by about 100 basis points a year. Could you update us on where you currently are there? Does that remain your goal? Maybe highlight a few opportunities or categories where you think you can pursue that goal most effectively.

On SuperTarget, Doug, in the past you have talked about the return on invested capital in that concept being very similar, when all-in is considered between the Target concept and SuperTarget. Any changes there, and is there a certain scale for SuperTarget that would change the return of that prototype?

Gregg Steinhafel

Yes, first as it relates to global sourcing, we are very committed to our global sourcing strategy and our design development infrastructure. It has been a key initiative for us and continues to yield great results. This year we will direct import approximately 30% of our total purchases and we continue to expect that, over time, we will add approximately 100 basis points per year to our global sourcing initiative and our direct import percentage; so no real change in strategy, Jeff.

Doug Scovanner

On your SuperTarget question, certainly it remains the case that our actual and expected returns on the new stores that we are constructing are of a very similar return profile. It also is true that we have been able to improve our returns on existing SuperTarget stores enough that we now have a larger portion of our new stores that are SuperTargets in the pipeline today than we had, say, 24 or 36 months ago.

Jeff Klinefelter - Piper Jaffray

Doug, is there anything in terms of scale going forward when you reach a certain number that would change, for example, the margins or the contribution from the food side of your store?

Doug Scovanner

There is certainly no threshold, but in a general sense, of course the larger SuperTarget becomes as a base of stores, the more adept we become at food retailing, the better able we are to present freshness and variety to our guests and certainly it has a very beneficial impact on our supply chain capabilities as well.

Jeff Klinefelter - Piper Jaffray

Thank you.

Operator

Your next question is from Charles Grom - JP Morgan.

Charles Grom - JP Morgan

When you look to '07 and beyond, what should we be thinking for the mix between direct and SuperTargets?

Doug Scovanner

The mix between our general merchandise stores?

Charles Grom - JP Morgan

I am sorry, the mix between the discount stores and the SuperTargets? I think historically you said about 25% to 30%, should we think of that for next year?

Doug Scovanner

We haven't announced the exact numbers for next year, but we have generally grown SuperTarget square footage at about double the pace of our discount square footage growth and the blend of those has worked out to approximately 8% per year in the last several years. Those general dynamics remain intact today, and we will be more precise on exactly how they mix out in '07 90 days from now.

Charles Grom - JP Morgan

Then just to go back to the third quarter, can you provide a little bit more granularity on the components of the gross margin improvement and the SG&A rise?

Doug Scovanner

First of all, numerically, the gross margin rate improvement was 14 basis points, and the SG&A rate deterioration was 48 basis points. As usual, there are a couple of accounting issues that, dollar for dollar, cross over that barrier year-over-year. I would tell that analytically, a better way to think about this to me is gross margin rate up very slightly, and expense rate deterioration maybe 35 to 40 basis points. Of the 35 to 40 basis point SG&A rate deterioration on an analytical basis, two-thirds is due to last year's Visa/MasterCard antitrust litigation settlement.

That is what I meant by my comment earlier that on an apples-to-apples basis, we actually had better expense rate performance in the quarter than we had in either of the first two quarters this year. Back to gross margin rate, flat to up very slightly means, of course, by definition we have about an equal number of issues working in both directions. The two biggest issues would be favorable mark-up and on the unfavorable side would be unfavorable markdowns.

Charles Grom - JP Morgan

One last one for Gregg. Can you give us a peek into Global Bazaar in January, what's going to be different with the offering?

Gregg Steinhafel

Yes, this January's Global Bazaar we are very excited about. We are going to focus differently than we have in the past where it's going to be, first of all, we're going to focus on having greater affordability than we have had in the past; we are going to focus on more category and item dominance; more color impact; and a little less about country of origin and artisan uniqueness. So we think that it is going to be slightly more affordable, more appealing and still have a great assortment for our consumer.

Charles Grom - JP Morgan

Good luck. Thanks.

Operator

The next question is from Christine Augustine - Bear Stearns.

Christine Augustine - Bear Stearns

Doug, could you please address the trends that you are seeing in your credit card business? Some of the regional banks have noted some deterioration, and it sounds like you might be seeing something a little different, so if you could please discuss that?

My second question is with regard to the home category, is that where you saw the unfavorable markdowns? How is the progress going there in terms of improving the assortment? Thank you.

Doug Scovanner

Our credit card results remain robust. The one issue that is in the underlying portfolio that is flowing through in terms of sequential trends that are noticeable is the OCC-mandated increase in minimum payments that was effective at the beginning of this calendar year is beginning to have its inevitable and fully predicted effect of causing some sequential increase in delinquencies, and lead into some sequential increases in write-offs.

In both cases, we are keying off of base periods that represent modern era record favorable performance in those two metrics. So those metrics, while migrating in the negative direction, are migrating back toward normalized levels, not migrating to some unforeseen territory. In both cases, we are actually settling out somewhat favorable compared to the forward-looking statements I made 90 days ago.

Stepping back from all of this, the credit card contribution to our overall strategy and contribution, measured in financial terms, remain very strong. One commercial message, this Friday morning we will be webcasting a presentation that Terry Scully, our President of Target Financial Services and I will be delivering in New York, that will dive quite deeply into a lot of the aspects, both financial and strategic of our credit card operations.

Gregg Steinhafel

As it relates to the home business, we are very pleased with the progress that we have made throughout this year. We have been focusing on getting our good, better, best balance more appropriately in line and better segmentation and lifestyle merchandising. We have seen continued strengthening of our home businesses throughout the year. So we are very bullish that we have turned the corner there and we will continue to see positive results in all of our home categories. The light overage in markdowns that we experienced in the third quarter was really not attributable to the specific home categories, but was really markdowns that were broadly spread throughout the company and really not attributed to any one particular division or business.

Christine Augustine - Bear Stearns

Thank you.

Operator

Your next question is from Bob Drbul - Lehman Brothers.

Bob Drbul - Lehman Brothers

Hi, good morning. A couple questions for Gregg. First, can you talk a little bit about your overlap with Wal-Mart in the electronics and toy category? We have seen some of their aggressive pricing moves already, and your ability to really compete with those into the fourth quarter?

Gregg Steinhafel

Fourth quarter is always a very competitive timeframe. This year we expect more of the same and so far this year it has unfolded pretty much as we expected. Wal-Mart takes a generally very aggressive stand in small appliances, toys, and electronics. We respond aggressively so that we are competitively priced on like items in like markets. As far as we are concerned, it's business as usual up until this point. As we get deeper in the holiday season, we expect to experience more price cutting and then we will respond as quickly as we possibly can, to make sure our prices are in line.

Bob Drbul - Lehman Brothers

Just a follow-up question. On the electronics side, can you talk about the allocation levels that you got on the Wii and the PlayStation, and if you are satisfied with that and how successful you expect that to be for you?

Gregg Steinhafel

We expect both gaming platforms to do very, very well this year. As it relates to Sony and PlayStation, we were disappointed in what the final allocations were. We were led to believe we were going to be getting limited but reasonable allocations, and those allocations have come in less than that. So we are more disappointed on the Sony side and the PlayStation side than we are on the Nintendo Wii side, where those allocations and quantities seem reasonably more healthy and appropriate for holiday season.

It still will be in short supply, but we will have significantly more product in Nintendo than we will have on Sony PS3.

Bob Drbul - Lehman Brothers

Okay, great. Thank you very much.

Gregg Steinhafel

You are welcome.

Operator

Your next question is from Mark Rowan - Prudential.

Mark Rowen - Prudential

You mentioned a couple of times that the holiday season will be very competitive. How quickly are you able to react to pricing trends from competitors that come out in the marketplace, given circulars and things that are out there, and are you seeing any impact yet in categories where Wal-Mart has rolled back prices pretty significantly?

Gregg Steinhafel

A couple of things. First of all, we don't respond to competitors' circulars and limited time, limited quantity offerings. That has been a consistent approach on our part, and many competitors don't respond to our weekly prices. We have the capability to respond very quickly. We shop our primary competitor, Wal-Mart, very often. By the time that some of those rollbacks actually appear in their circulars or flyers, we have already witnessed those rollbacks and responded appropriately in our stores.

Oftentimes we anticipate where Wal-Mart will move and in the past they will have rolled something back 30 days ago or 60 days ago and reiterate that position in a circular or a given print vehicle. So we have experienced this competitive landscape over the last couple of years, and really haven't seen any meaningful change to what we have experienced in the past. Wal-Mart will get very aggressive on a couple if items, and we very, very quickly will match them so that we're competitive on that item in that local market.

Mark Rowen - Prudential

You mentioned you are a certified organic retailer now. Do you plan to expand that, particularly in groceries, pretty significantly, and are you finding issues with getting the supply given that there seems to be a problem on the farming side of producing that, and switching over to organic?

Gregg Steinhafel

Yes, we are very committed to delivering healthy foods in our store, whether it's natural products, gluten-free, sugar-free, and organics. Our organics business has continued to grow over time. There is some supply availability issues, and it prevents us from expanding our private-branded Archer Farms organics product at the rate that we would like, but we seem to be getting a decent supply of organic products through the national brands.

Mark Rowen - Prudential

Great, thank you.

Operator

Your next question comes from Greg Melich - Morgan Stanley.

Greg Melich - Morgan Stanley

Could you just give us an update on how you are matching the generic program that Wal-Mart is doing, and what you have seen in your stores, in terms of traffic and what that's done to profitability in pharmacy?

Gregg Steinhafel

When Wal-Mart initiated their test markets in Tampa, we matched them there. We matched them when they rolled through Florida and we have subsequently matched them in 27 states. We are at $4 like they are on the 315 generic drugs and we have experienced script transfers to our stores, so we are getting the benefit, as Wal-Mart is, in terms of script transfers and traffic into our stores.

We believe that while the price reduction on the generics themselves will be at least offset by the increased traffic that we will get through the prescription transfer and the sales of other OTC and products in our stores. So we are expecting at this time for it to be about a net margin neutral change; but again, it's just rolling out, and we will need a little bit more time to really understand the full quantification of the impact of that change.

Greg Melich - Morgan Stanley

When you describe that, you said other over the counter products, but you are not including additional traffic it might do to the rest of the store. Is that fair?

Gregg Steinhafel

We will be looking at including that, but it's difficult to quantify specifically what we are getting from those guests. We can look at and we do see the overall changes in traffic patterns by store, but there are a lot of ins and outs and changing dynamics in each of those marketplaces and it's hard to specifically attribute the change in generic pricing to some of the other changes that we are seeing. But we are seeing positive changes in traffic levels and spending patterns.

Greg Melich - Morgan Stanley

On the SG&A outlook for the fourth quarter, could you quantify what the extra week actually does? How much of the SG&A extra leverage you get just from the extra week?

Doug Scovanner

It's a handful of basis points.

Greg Melich - Morgan Stanley

The items that it would be, would be some of the overhead costs? I imagine labor and everything is still in there for the extra week?

Doug Scovanner

Yes. Expenses that we can precisely measure and accrue for by day have no extra sales leverage, so payroll is a great example. We accrue payroll to the day, and therefore that's not an item here. But some more general overhead expenses are not accrued by the day outside of SG&A. Let's focus on depreciation to make the point vividly. We expense depreciation by month, and therefore we will get a favorable leveraging of depreciation expense due to the extra week. There are other elements inside SG&A of a similar character.

Greg Melich - Morgan Stanley

Great, thanks.

Operator

Your next question is from Mark Husson - HSBC.

Mark Husson - HSBC

The first thing is a number of retailers have talked about the increased cost of opening stores this year, in terms of pre-opening expenses. You opened quite a lot in this quarter. Is there any sort of significant quarter-on-quarter changes, or year-over-year changes we should be talking about?

Doug Scovanner

That's actually a great question. Year-to-date it's one of the two key timing issues that will turn around in our favor in the fourth quarter. Year-to-date pre-opening expenses are a component of our expense rate deterioration, and we spoke earlier in the year about some of the timing issues surrounding pre-opening. For the year it's a non-issue. Year-to-date, it represents deterioration. Therefore it will turn around and be a favorable expense rate item year-over-year in the fourth quarter.

Mark Husson - HSBC

More than a handful of basis points, like 20 basis points or something?

Doug Scovanner

Two hands.

Mark Husson - HSBC

Finally, Wal-Mart has now finished remodeling or just about finished remodeling a bunch of its stores, possibly to look a little bit more like yours. Have you seen any impact on those remodels since they have been relaunched?

Gregg Steinhafel

We really haven't seen any impact on our stores whatsoever. We'll continue to watch it, but as you know, they are just finishing up the final rounds of their remodel program, and we really don't expect it to have any significant impact on our business.

Mark Husson - HSBC

Great. Thanks very much.

Operator

Your next question is from Deborah Weinswig - Citigroup.

Deborah Weinswig - Citigroup

Can you please provide some color on the performance in the women's business in the quarter?

Gregg Steinhafel

Our women's business was good over the quarter. We have had a number of years of explosive growth in women's and we had a good performance, but it was just not as strong as we experienced in the newborn, infant, toddler categories and men's; but it was still decent.

Deborah Weinswig - Citigroup

Last question, with regard to comps, can you discuss traffic versus ticket in the quarter? Within ticket, can you also break it down between units per transaction and AUR?

Gregg Steinhafel

Approximately 1% of the same-store sales was in increased traffic with the balance in ticket, and then within the ticket, it was basically equally split between the increase in the average amount per item, and the average number of items per transaction.

Deborah Weinswig - Citigroup

Great. Thanks so much.

Gregg Steinhafel

It varied by month, but in general, that's the way it shook out for the quarter.

Deborah Weinswig - Citigroup

Okay. Thanks. Very helpful.

Operator

Your next question is from Virginia Genereux - Merrill Lynch.

Virginia Genereux - Merrill Lynch

Doug, maybe for you, to your point on credit, it looks like the difference between book expense and cash write-offs has been $100 million on a trailing four-quarter basis. Why wouldn't yields here continue to increase? As you said, I would have expected bad debt expense to be up a little more in the quarter. So why wouldn't yields continue to increase, given that you are so amply reserved?

Doug Scovanner

Well, yields are at not only a record high level for us, but our yields are about the highest of anyone involved in issuing premium bank cards. I think that I would be absolutely thrilled to sustain yields at these levels, and continue growing our receivables in line with sales, providing the strategic support for our core retail operations. I don't think it's realistic to expect post funding cost yields to climb beyond the current 11% brackets in which they lie. If you look at the year-over-year performance increment, it's truly remarkable. A year ago we were focusing on EBIT as our core metric of performance to measure in our credit card operations.

Our EBIT yield last year in the third quarter was about the same as our earnings before taxes yield this year. Loosely translated, that means that the performance increment has wiped out the economic drag of the $6 billion of funding costs that surround the balance sheet of our credit card operations, a remarkable performance.

Virginia Genereux - Merrill Lynch

I agree. That's another question, but mechanically, what is going to pick up? Is it that write-offs should dramatically increase? Because to your point, write-offs were down $30 million almost year-over-year. Is it the cash write-offs that are really going to start to increase because your past due as a percent of receivables is pushing four? Is that the mechanics?

Doug Scovanner

We are going to get into this issue very deeply in our presentation on Friday morning, but the short answer to your question is yes, we do expect over time modest, not dramatic, increase in write-offs as a percent of average receivables, because even today we remain at a very low level of write-offs as a percent of receivables compared to several years of history. But we believe that write-offs will likely settle into a pace that should allow us to maintain, not enhance our current spectacular yields.

Virginia Genereux - Merrill Lynch

Okay. I won't take any more of that thunder. That will be great on Friday. As I look back over the past year, traffic -- and you guys deserve great credit for the traffic increases that you have driven -- but traffic has not been as big a contributor as it was historically to comps. I feel like traffic has really been up two months in the past year, November and April. As you guys look out, is that the macro at work, or is that a more competitive environment? What's your outlook on your ability to drive the traffic increase? Should we look for more of the comp to be ticket-driven?

Doug Scovanner

Historically, our business model has generated about 5% same-store sales performance on average over a very long period of time. The make up of that 5 points of comp has been about 1 percentage point in average same-store positive traffic trends, with the remainder representing average annual growth in ticket. The statistics Gregg cited for the third quarter just ended are right in line with our long-term history.

Virginia Genereux - Merrill Lynch

September was a big contributor to that. So you, in prior quarters this year, I would say in your July quarter, Doug, that might not have been the case. The ticket was more the driver.

Doug Scovanner

Certainly a statistical series like this one is more volatile by quarter than some others, but again, when our business is operating at premium levels of comp performance, traffic generally might rise into the 2% plus range, but very rarely for any extended period of time have we ever exceeded 2 percentage points of contribution to our comps from guest traffic. When our comps have been most challenging historically, traffic trends have fallen into the zero to minus 1 range, but positive 1 is a very healthy amount of traffic for us measured in any historical basis.

Virginia Genereux - Merrill Lynch

So you don't feel like there's a more competitive environment or whatever out there, that's going to be a little bit of a traffic headwind, it sounds like, Doug?

Doug Scovanner

I think probably the best forward-looking statement I heard out of Wal-Mart this morning was that they intended to earn $0.88 to $0.92 in the fourth quarter, which is a very robust level of profitability. So clearly despite all of the rhetoric surrounding rollbacks, they do not intend to have some kind of fundamental profit delivery problem, and therefore neither will we.

Virginia Genereux - Merrill Lynch

Thank you.

Operator

Your next question is from Teresa Donahue - Neuberger Berman.

Teresa Donahue - Neuberger Berman

Good morning, Doug. Most of my questions have been answered, but I was just wondering as you look at SG&A, is there an update you can give us as to what a comp leverage point might be? I know there's been a lot of noise this year.

Doug Scovanner

I don't think that the fundamental drivers of the answer to that question have changed very much over time, meaning generally speaking with today's inflation in our SG&A inputs, it requires all else being equal, something in the 4% to 5% comp range to neutralize the adverse impacts of those inflationary factors and neutralize SG&A as a percent of sales.

The caveat is that all else is never equal, and this year we do have some drivers that have been larger than the scale that I have just described. I do not expect those to continue into '07 and beyond. We will obviously be much more precise in our '07 outlook a little more than 90 days from now, but I don't think we will be talking in '07, '08, '09 about adverse impacts of SG&A rates.

Teresa Donahue - Neuberger Berman

Thank you.

Operator

Your next question is from Dan Binder - Buckingham Research.

Dan Binder - Buckingham Research Group

Hi, good morning. A couple questions for you, just looking at the credit business a little bit, you mentioned earlier some peak trends that you would expect in the write-offs. If you look at the delinquencies, what would you expect the peak trends to be there?

And then if we look at the allowance for bad debt as a percentage of receivables, what do you expect that would gravitate to over time? Does this mean that you will start to reserve more in line with net write-offs versus well in excess, as you have in prior quarters?

Doug Scovanner

First of all, on your delinquency question, I mentioned earlier that we now expect delinquencies to settle in more or less at the current level, with the peak representing 4% so I think we are probably there for the near term in delinquencies. Again, a lot of the short run action in that delinquency statistic has been driven by the small portion of our guests who revolve and pay the minimum every month.

More broadly, I think it is reasonably likely that our write-offs and our bad debt expense will move more in line with each other. I do not expect continued sequential growth in the reserve, either on a relative or absolute basis, at nearly the same pace that it has grown, that we have caused it to grow in last 12 to 24 months.

Dan Binder - Buckingham Research Group

Your comment regarding retail representing about 85% of the earnings, were you just talking about this year, or do you think that would be representative of what you would hope to do in future years as well?

Doug Scovanner

Well, again, I don't mean 85.0, but about 85% retail, about 15% credit measured at the earnings before taxes or net income line, is where I expect to land this year, and I do not expect those figures to migrate very much over the next couple of years. Certainly they have migrated over the last couple of years after the sales of Mervin's and Marshall Fields from low double-digit credit, up into the 15% range, but that's been more driven by the spectacular increase in the margins in our credit card business, than driven by anything else. It's a horse race, and for that credit figure to grow much more than 15%, it would have to outpace what we believe will continue to be a very robust growth in our retail EBIT over time.

Dan Binder - Buckingham Research Group

Why do you think the write-offs are so much better than we might have expected at the beginning of this year? Is it just the economy? Is it great employment, or have your underwriting standards just been tighter than they had been in the past? Is there room to loosen them a bit?

Doug Scovanner

Probably have everyone leave the phone call if I suggested that we should loosen our underwriting standards as a result of this performance. Again, we will go into a great deal more detail on Friday morning, but generally speaking, I think you ticked off three contributing factors: the economy remains much stronger than one would believe by reading the popular press. Employment statistics are very strong. Our delivery of comp and the contribution of traffic in ticket is in-line with the kinds of successful metrics we have enjoyed over a long period of time, and you are correct in observing that we have sequentially tightened, not loosened credit standards over the last couple of years.

So it is all of those factors and several more, not the least of which in the several more category is the effect of last year's enactment of federal bankruptcy reform, have all contributed favorably to the performance.

Dan Binder - Buckingham Research Group

I guess maybe that leads me to my next question. As a result of the change in power in the House, I guess there's been some suggestions that bankruptcy reform could be revisited at some point. If that were the case, and I realize it's very hypothetical at this point, but if that were the case how would you sort of envision that impacting your credit card business, and the way you execute that?

Bob Ulrich

We will address future legislation when it arrives. I don't even know how to address that one, because I don't know what hypothetical form of legislation you are talking about.

Dan Binder - Buckingham Research Group

Okay. All right, great. Thanks.

Operator

Your next question is from Peter Benedict -Wachovia.

Peter Benedict - Wachovia Securities

I was struck by the inventory management in the quarter. It looks like, if my numbers are right, your inventory was up only about 4% year over year. Doug, can you just talk to us about what's driving that and how we should be thinking about inventory over the next few quarters? Thanks.

Doug Scovanner

Third quarter end represents a fascinating point in time to take a snapshot of our inventory, because there is an enormous amount of receipt activity just before or just after quarter end, related to our seasonal build. This year when that snapshot was taken, some of the receipts fell after quarter end, last year they fell before quarter end. We need to take a look at this one over a little longer period of time. Last year, year-over-year our inventory was up double-digits in percentage, if memory serves, about 14%. And so I think a little longer time period is required to interpret this one.

I would add quickly that given that this is a 53-week year, we are taking a snapshot at the end of January, beginning of February, a week later and that can sometimes have meaningful differences. So that is a very heavy receipt period relative to sales, and in an average 53-week year, that means we will have more inventory on hand relative to sales than at the end of a 52-week year.

Peter Benedict - Wachovia Securities

Fair enough. Thanks so much, Doug.

Operator

The next question is from Adrianne Shapira - Goldman Sachs.

Adrianne Shapira - Goldman Sachs

Thank you. Gregg, a few questions. Can you just talk about what, if any, impact you think department store consolidation is having for you, especially as it seems as if mall traffic is seeing a resurgence?

Gregg Steinhafel

Well, we can't specifically attribute our same-store sales gains to any one particular segment or channel of distribution. We believe over the long term, however, that as we get better at delivering on our Expect More, Pay Less brand promise and we deliver great quality at great value, we will continue to see migration down through the department store channel, mid market channel, to our channel of distribution, and it's just something that we believe will occur as we deliver on our brand promise.

Adrianne Shapira - Goldman Sachs

Are you able to drill down, in terms of stores that were overlapping with former May doors or Federated doors that were closed for any disparity in terms of performance?

Bob Ulrich

We really have not had any negative impact whatsoever from the department stores sector. Another thing you have to remember is there have been some good comps in that sector, but they are not counting the new acquisition and they are not counting the transfer effect of the competing stores often in the same mall that were closed. So I think you are seeing not necessarily an increase in that sector, and certainly nothing that's increasing that is hurting our competitiveness.

Adrianne Shapira - Goldman Sachs

Bob, I meant, I just thought maybe you were seeing some pickup as some of the stores were closing.

Doug Scovanner

Too small to measure.

Adrianne Shapira - Goldman Sachs

Gregg, just moving on to GO International, you have had a few under your belt now, in terms of launches. Maybe give us a sense what's working there, what's worked better than others, and is it helping the entire category, and also, it sounds as if you are launching a new brand into accessories. Is this similar to GO International? Should we expect more of these types of brands in the accessories category as well?

Gregg Steinhafel

Yes, the learnings from GO International are keep it fresh, keep it broad, not deep in any one style, and make sure that even over that 60 or 90-day timeframe, we deliver newness and uniqueness throughout that timeframe. We have evolved to that particular set of tactics and the performance has improved as we have gone throughout last year.

We see the same type of opportunity in other categories throughout the store, the Reffi collection is a great way for us to take the GO concept and apply that to another category within the store. It's been very, very well received from our guests, and we anticipate doing more of that over 2007.

Adrianne Shapira - Goldman Sachs

So apparel and accessories, more GO International. Any other categories beyond those two?

Gregg Steinhafel

Well, right now we are prepared to talk about ongoing initiatives in accessories, and we are working on other things right now, but it's premature to share anything at this time.

Adrianne Shapira - Goldman Sachs

Great, thank you.

Operator

Your final question is from Neil Currie - UBS.

Neil Currie - UBS

Would you give an update on your food sales in your regular Target stores, and an update on how many stores have been remodeled to the P 2004, or the updated version of P 2004?

Gregg Steinhafel

Sales continue to outpace the company growth rate, and we continued to gain knowledge and credibility in that business, in both SuperTargets and in our general merchandise stores.

I can give you the approximate rundown. Today, about 75% of our 1,494 store network has some form of either right-sizing, of P 2004, or an expanded food assortment in a general merchandise store, or is a SuperTarget. So in rough numbers, we have approximately 176 SuperTargets. Approximately 190 stores that have an expanded grocery, which would be approximately 25 sides or more, or have more than 40 refrigerated or frozen cases within that store; and we have about 700 or so stores that were either right-sized or were part of our P 2004 format.

So the combination of those three formats are about 1,090 stores out of the network.

Neil Currie - UBS

The new products you mentioned earlier that you are going to be introducing before the holiday period in the food side or the Archer Farms side, will they go in all stores, or will they be skewed more towards the SuperTargets?

Gregg Steinhafel

The Choxie collection will be in all stores.

Neil Currie - UBS

Thank you. Just a final question if I may on the same topic. Given some of the tighter planning or zoning constraints around big boxes in metro markets, would you ever consider testing a smaller format, which was maybe more focused around food and fast fashion?

Bob Ulrich

We have been very successful with our larger formats, and if one goes back into history, we occasionally tested some smaller formats and our guests, generally having a positive demographic in terms of education and profession, normally being a little bit higher in discretionary income, is also a little more demanding, and wants a broader assortment and better service, and that's why our whole “Expect More, Pay Less” philosophy fits so well, but we find we have to give them a full assortment in order to compete effectively.

Neil Currie - UBS

Thank you.

Operator

Thank you. At this time, I would like to turn the conference back over to Mr. Ulrich for any closing remarks.

Bob Ulrich

That concludes Target’s third quarter 2006 earnings conference call. Thank you all for your participation.

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