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Target Corporation (NYSE:TGT)

F4Q06 Earnings Call

February 27, 2007 10:00 am ET

Executives

Robert Ulrich - Chairman & CEO

Doug Scovanner - EVP & CFO

Gregg Steinhafel - President

Analysts

Gregory Melich - Morgan Stanley

Jeff Klinefelter - Piper Jaffray

Bob Drbul - Lehman Brothers

Deborah Weinswig - Citigroup

Teresa Donahue - Neuberger Berman

Adrianne Shapira - Goldman Sachs

David Strasser - Banc of America Securities

Justin Post - Merrill Lynch

Mark Rowen - Prudential

Charles Grom – JP Morgan

Dan Binder - Buckingham Research

Dana Telsey - Telsey Advisor Group

Michael Exstein - Credit Suisse

Christine Augustine - Bear Stearns

Presentation

Operator

Welcome to the Target Corporation's fourth quarter and year end 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.

Robert Ulrich

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

This morning I will provide a brief update on our view of the current competitive and consumer environment, and then Doug will review our fourth quarter and full year 2006 financial results and describe our outlook for 2007. 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 fourth quarter and full year 2006. As expected, we enjoyed strong sales growth during the final three months of the year and we were able to translate that top line strength into a meaningful increase in our profitability.

The peak sales period between Thanksgiving and the end of December was intensely competitive, especially in apparel, as we expected it would be. But by remaining focused on our strategy, we delivered a holiday marketing campaign that highlighted Target's distinctive attributes and reinforced our Expect More, Pay Less brand promise. We carefully planned our inventory levels and drove traffic to our stores and Target.com, generating profitable sales growth; we enjoyed double-digit increases in gift card issuance and redemptions; and we continued to delight our guests by offering the right combination of everyday essentials and differentiated designs at compelling value.

Our success in 2006 gives us confidence as we plan our business for 2007. We have a strong, talented organization that is keenly focused on delivering a consistent Target brand shopping experience and remaining relevant to our guests.

We are well underway in the construction of nearly 120 new stores, representing approximately 100 net new locations and we have adequate opportunities for continued profitable growth at this pace in the coming years.

We continue to invest in distribution and technology infrastructure to support our continued growth and maintain our competitive edge. Though we are not trained economists, we believe that both the current economic environment and the current competitive climate are stable and rational. This outlook, combined with our continuous effort to improve every facet of our operation, underlies our optimism that we will continue to generate profitable market share growth and reward our shareholders in 2007 and for many years ahead.

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

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Doug Scovanner

Thanks, Bob. As a reminder, we're joined on this conference call by investors and others who are listening to our comments today live via webcast. We plan to keep today's call to no more than 60 minutes including our Q&A session, and 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 announced our financial results for the fourth quarter and full year 2006, both of which contained an extra week compared with the same period in 2005. For both current year periods, we modestly exceeded our expectations and prior guidance for earnings.

A few highlights of our fourth quarter performance were:

Total revenue growth of 16.3%, driven by an extra week in the quarter and the contribution of new stores;

A 4.8% increase in same-store sales based on a 13-week period in both years; and,

The growth in revenue from our credit card operations.

We leveraged this top-line growth to generate a 22% increase in fourth quarter EPS to $1.29 this year compared to $1.06 in 2005.

In our core retail operations, we modestly expanded our gross margin rate from last year's record high level and experienced a slightly faster increase in expenses than sales with both rate changes attributable to immaterial adjustments to our financial statement presentation in the current year. Overall, we were quite pleased with our 19.5% growth in our core retail EBIT, which was somewhat better than we had expected 90 days ago.

We also continued to enjoy robust results in our credit card operations during the fourth quarter, in line with our expectations and reflecting somewhat slower profit growth than we had experienced in the first nine months of 2006, as we began to cycle strong prior-year profit results.

Average receivables grew 10.5%, and as anticipated, we experienced a sequential increase in write-offs, although our experience remains excellent by historical comparison. Our annualized credit card contribution to earnings before taxes as a percent of average receivables was 10.6%, up from 9.0% a year ago, reflecting the continued strength of our underlying performance.

Overall our fourth quarter performance highlights the consistency of our strategy and the discipline of our execution, and we are very pleased with our results. Additionally, our recent performance gives us optimism and a reasonable benchmark as we plan our business for 2007.

Let's look at the assumptions underlying our 2007 outlook. Comparing 2007 to 2006, on a 52 to 52 week basis, we plan to produce revenue growth in line with our typical low double-digit annual increase, reflecting the contribution from our new store expansion and continued growth in both comparable store sales and net credit card revenues.

This low double-digit underlying growth will translate to a high single-digit percentage sales increase in our reported financial results for two reasons:

First, our fourth quarter 2007 sales growth will be unfavorably impacted by the extra week in the prior year, as we compare the 13-week period in 2007 to the 14-week period in fiscal 2006.

Second, we have a larger than normal group of Phoenix rebuild stores in 2007. That is, mature stores that were closed in January and will be completely rebuilt as new Super Target and other stores scheduled to open in October. This activity will reduce our sales growth somewhat in the first three quarters of this year.

Translating this sales growth to profits in 2007, overall we expect EPS will grow faster than sales, with core retail EBIT in line with sales. Looking at that drivers of this EBIT, our consolidated gross margin and SG&A rates are each expected to be approximately equal to 2006 levels. We remain keenly focused on controlling our core underlying expense drivers and expect the potential benefits to gross margin, such as growth in direct imports, new merchandising strategies, and our ability to leverage our increasing scale, to be offset by the more rapid pace of growth in lower margin categories.

We expect to enjoy continued growth in our credit card contribution to earnings before taxes, reflecting continued growth in average receivables and the strong overall health of our underlying receivables portfolio. We believe delinquencies will remain stable in the range of our recent experience, about 3.5% to 4% of receivables, and we expect our net write-off experience will settle into a rhythm closer to our 2004 and 2005 levels than to the 2006 rate.

On balance, we expect to continue to enjoy both the strategic benefits of our credit card portfolio and the financial benefits of annualized EBT yield in the range of 11% of average receivables.

Now let's briefly review our full year 2006 EPS results in order to create a platform for understanding our EPS outlook for full year 2007. In 2006, we delivered annual EPS of $3.21, representing an increase of 18.5% over the prior year. This exceeded our own internal expectations as well as the median EPS estimate of $3.10 in First Call at the beginning of the year. This overall performance included results in our core retail operation, which met our total year expectations, combined with stellar results in our credit card operations.

For total year 2007 we believe the current median First Call EPS estimate of $3.60, representing about a 12% increase over 2006 results, is within the range of our likely outcome, given our current perspectives. We would be pleased with this performance if achieved and believe there are several reasons why this performance should be viewed as fully satisfactory.

In the first quarter 2006 you will recall that we recorded an adjustment to our depreciation expense that benefited EPS by about $0.02. By its nature this is a benefit that will not recur in 2007 and will therefore adversely affect reported growth in both our first quarter and full year 2007.

Next, our income tax rate for 2006 was 38.0%, representing the low end of the 38.0% to 38.5% range we expected for the year. In 2007, our annual effective tax rate is highly likely to rise from our 2006 rate, perhaps by 30 to 50 basis points or so.

Finally as expected, our 53rd week in 2006 had an immaterial effect on our full year earnings, yet at the margin it had a positive effect on our 2006 EPS results. On balance we remain confident in our underlying strategy and in our continued ability to generate strong double-digit percentage increases in EPS for many years to come.

One final note before closing: beginning with our February 2007 sales reporting, we will include sales from Target.com in our comparable store sales results because we believe this combined measure represents a more useful disclosure in light of our fully integrated multi-channel approach to our business. This change in our prospective comparable sales reporting will have no impact on our total sales or on any element of our profitability.

To provide some analytical perspective, if we had included Target.com sales in our comparable store sales during the past two years, our monthly comparable store sales growth would have consistently benefited by about 30 to 50 basis points. In addition, though the comparable sales guidance provided at the beginning of February did not include Target.com, our sales guidance going forward will reflect our outlook for this sales measure on a unified basis.

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 year of outstanding results in 2006, driven by strong growth in retail sales and strong contributions from our credit card operations. Our full year of comparable store growth of 4.8% reflected increases in both guest traffic and average transaction amount and was fueled by better than average performance in healthcare, food, household commodities, infant/toddler basics and apparel, and electronics.

Throughout the year we continued to focus on great design, innovation and disciplined execution of our strategy, allowing to us surprise and delight our guests and to profitably increase our overall market share. Specifically, we refined our merchandise offering to ensure that we have the right balance of good, better, best throughout our entire assortment. We generated excitement and added newness with the introduction of GO International, featuring collections by Luella Bartley, Target Armone, Sophie Albou and Behnaz Sarafpour.

We continue to drive increased frequency by expanding our food offerings throughout the chain and positioning Target as a destination for everyday essentials, including health and beauty aids, pharmacy and over-the-counter medication, pets, paper products, and household chemicals.

We continued to improve our operational performance and speed through innovation and investment in our infrastructure, supply chain and technology. In particular, we continued to strengthen and expand our global sourcing capability, enabling us to shorten lead times and reduce costs while producing outstanding quality merchandise.

We remain dedicated to delivering a superior guest experience by opening new stores and investing in our existing stores through remodel and right-sizing projects. During the past year, we opened 113 total new stores in 36 states. Net of relocations and store closings, this expansion program included 72 general merchandise stores and 19 Super Target stores, and represented a net increase in square footage of about 8% for the year.

In 2007, we expect to add approximately 120 total and 100 net new stores and open two new distribution centers to support our continued growth. Our first cycle of store openings, scheduled in March, includes ten general merchandise stores and five Super Target locations.

We also remain committed to delivering the right balance of differentiation and value through our Expect More, Pay Less brand promise, and delivering affordable and accessible design through our steadfast focus on innovation and continuous improvement. For example, earlier this month we launched Proenza Schooler, our latest GO International collection. This limited engagement line offers a trend-right assortment with the seasons must have items at affordable prices and will be available at Target through April.

We are extending our concept of limited time offerings to accessories. Based on our success over the holidays, we are updating our Rafe handbag collection for spring and will introduce assortments from new accessories designers throughout the upcoming year. We have improved and expanded our C9 By Champion presentation, adding yoga and dancewear to our women’s assortment and delivering technical innovation and superior quality across all categories of the activewear line. We are launching new fragrance lines and adding more natural products, including Burt’s Bees to complement our bath and body offering. In addition, next month we plan to roll out the Boots cosmetic line chain-wide.

Also this spring we are expanding our assortment of LCD and other flat-panel televisions and dramatically improving our presentation with an enhanced offering of good, better, best brands and larger screen sizes throughout the chain. As we have rebalanced and remerchandised our home assortment during the past year, we have experienced improving performance in these categories and we are encouraged that the changes we have implemented will generate increased sales in the home area throughout 2007.

We also remain focused on providing added convenience and value for our guests by continuing to enhance our food offering and our sales penetration of own brand items. To meet our guests increasing demand, we continue to broaden our assortment, improve our quality, allocate additional space to food in general merchandise stores and open new Super Target locations.

In 2007 we plan to open our first Super Target stores in California, and we'll also begin construction of our first owned perishable food distribution center, or FDC. This FDC located in Lake City, Florida, will serve Target and Super Target stores in southeastern states beginning in late summer 2008.

Finally, we remain dedicated to offering our guests an integrated multi-channel shopping experience by leveraging the synergies between our stores and Target.com. For example, we continue to test new product ideas on Target.com, offer extensions of our in-store assortment and, through our newest online feature, Find It At A Target Store, we are giving our guests greater transparency into each store's merchandise ownership from the convenience of their own home. As we grow, we remain dedicated to delivering online products and services that work seamlessly with our in-store offerings to consistently deliver a Target Brand shopping experience for our guests.

We are proud of our 2006 achievements and we are committed to building on our success throughout 2007. We believe we have the right team and the right strategy to continue delivering a consistent Target brand shopping experience and to remain relevant to our guests, ensuring Target continues to enjoy profitable market share gains for many years.

Now Bob has a few concluding remarks.

Robert Ulrich

In summary, we are pleased with our performance in 2006 and optimistic about our opportunities and potential in 2007. 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

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

Gregory Melich - Morgan Stanley

Doug, could you take us through some more color on the gross margin expansion, mark up and mark down, if inflation had any impact there?

Doug Scovanner

The explanation for the full year is going to sound rather boring, because for the full year gross margin rates was only slightly changed and even the underlying components had very little movement. To be more precise, mark up was within a handful of basis points of last year. Total markdown experience was within a handful of basis points of last year. Obviously we had some mix effects inside gross margin rates, but I cannot recall a year in history where the underlying components were as stable for the full year as they were in 2006.

Gregory Melich - Morgan Stanley

In the fourth quarter?

Doug Scovanner

Little different story in the fourth quarter. As I mentioned in my remarks, the overall favorable rate change in gross margin and the overall unfavorable rate change in SG&A, both of which were very small, were driven in the main by some rather immaterial financial statement presentation issues. While the components moved around a bit more, I'd say in gross margin rate, for example, in the fourth quarter, mark up was unfavorable, and mark downs were favorable to last year. But in essence, neither of those movements was particularly large, and in the aggregate gross margin grew 19 points in the quarter.

Gregory Melich - Morgan Stanley

Gregg, if we look at what food and other things are doing to help drive traffic, I'm thinking, as you go into California and add your Super Targets there, how does that change that equation? Does it change when you're trying to sell food in California?

Gregg Steinhafel

It really doesn't change. We're operating Super Targets in many states right now, and we see California very similar to Super Targets that are operating in Texas or Colorado today, so no real change from our point of view.

Gregory Melich - Morgan Stanley

That mix of first quarter stores of five Super Targets and ten discount stores, I think I remember on the last call you guys mentioned that Super Targets were approaching a third or half of the backlog.

Gregg Steinhafel

I think we said that in square footage, but essentially, the Super Target store count this year will be our largest opening round ever. There's obviously quite a mix in our March, July, and October openers, but we'll be opening 30 to 35 Super Targets this year.

Operator

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

Jeff Klinefelter - Piper Jaffray

Doug, on inflation/deflation you've given us a perspective in the past coming out of fiscal years what role inflation or deflation played in your overall comp trends -- if you could give us an up-to-date perspective on that coming out of this year. Does that lead to any perspective going into this following year in terms of whether comps will be driven more or less by traffic or transactions?

Doug Scovanner

As you know, we measure that with precision once a year as of October 31st. Our experience over the 12 months ended at that point, or comparing that point to 12 months ago, to be more precise, our sales mix reflected about a 1% deflation rate, about 1% deflation. My outlook for '07 is reasonably neutral. There are some inflationary inputs, but we continue to work diligently to control those drivers and zero plus or minus is my outlook for '07 on that figure.

Jeff Klinefelter - Piper Jaffray

In terms of overall mix, Doug, when you look at the lower margin commodities versus the higher margin opportunities in apparel and home and other areas, any change in perspective going into '07 on what the mix might do to overall margins?

Doug Scovanner

No, I think that the mix, as is usually the case for us, is somewhat of a headwind from a gross margin rate standpoint. Very specifically, we enjoy rates of sales growth in the lower margin categories that are typically higher -- in some cases sharply higher -- than the rate of growth in some of our higher margin categories.

Looking back on '06, frankly I'm delighted with our overall gross margin rate performance, given the fact that, as we have discussed many times, earlier in the year some of our home businesses were struggling at the top line. Those are, of course, sharply higher-than-average gross margin rate categories, and we were able to essentially, in consolidation, achieve gross margin rate in line with prior-year levels, despite that mix-related sales issue in our home products. So I'm just absolutely delighted with the aggregate performance.

Jeff Klinefelter - Piper Jaffray

Any comments on Global Bazaar year 3, the effort and what impact that might or might not be having on the overall home business?

Gregg Steinhafel

We just finished Global Bazaar 3, and we're very pleased with the overall performance. As you know, we made some changes to this year's assortment and presentation, focusing more on color, classification, dominance and affordability, and the combination of those factors led to us delivering essentially sales on plan and margin on plan as well. So we're assessing the potential for next year and overall we're very pleased with how we ended the Global Bazaar season.

Operator

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

Bob Drbul - Lehman Brothers

Good morning. When you look at the '07 square footage expectation, can you just talk a little bit about the number of the discount stores that will have expanded food? When do you think you'll start to get the capacity utilization up on these new food distribution centers? How long will start-up costs be until you start to really benefit from the expense savings?

Gregg Steinhafel

All of our stores in '07 will have an expanded food presence whether they are Super Target or a general merchandise store, they will have essentially the largest footprint of food that we have gone to market with. All of our remodels will similarly have that expanded food footprint.

As it relates to our food distribution centers, the first one that opens in 2008, we expect the ramp-up time and the effectiveness of those facilities to be rather short. So we believe that within the first 12 months of operation we will achieve the sufficient scale to deliver the appropriate economic benefits that we're expecting out of this supply chain strategy.

Bob Drbul - Lehman Brothers

Can you talk a little bit about any issues you had in the fourth quarter with out of stocks and where you ended the fourth quarter and your expectations for 2007?

Gregg Steinhafel

We believe that we had strong in-stocks throughout the entire fourth quarter season. Clearly there were some items and categories in video games and some technology that had some shortages, but overall we were pleased with our in-stocks throughout that season. We transitioned very cleanly, very timely, and we're entering '07 in just outstanding shape.

Operator

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

Deborah Weinswig - Citigroup

Good morning. Back in August and September when Wal-Mart was aggressively launching their $4 generics program you stated that you were going to match them. Can you talk about what trends you've seen in pharmacy and maybe the HDA side as well, as a result?

Gregg Steinhafel

Our pharmacy business, our OTC business and related products have been very, very healthy. We continue to see increased script transfers as a result of matching Wal-Mart's $4 generic program. Our gross margin rate is under pressure due to the $4 generics, but overall we are maintaining the margin dollar that the program has generated through increased script transfers and the sales of other related products within those categories. So overall we're just fine with where we're at on $4 generics.

Deborah Weinswig - Citigroup

Very excited to hear about the opening of the perishable food DC You had mentioned it was going to serve both the discount stores and Super Targets. Can you talk a little bit more specifically about what it will be doing with regards to perishable food in the discount stores?

Gregg Steinhafel

Well, currently, as you know, our dry grocery is serviced through our regional distribution center network. The perishable distribution centers will service dairy, frozen, and fresh products both in Super Target stores and the dairy and frozen goods in general merchandise Target stores that have expanded assortments and case counts that are over 38 or 40. Those stores with that expanded assortment will be serviced by these new food distribution centers as they come on line. These are the same stores that are currently being serviced by the Super Value and CNS network.

Deborah Weinswig - Citigroup

With regards to Target.com, it sounds like that's been a great growth opportunity for you. Are you willing at this point in the game to talk about a stated goal in terms of sales? And also, how do you think about the growth opportunities in that business?

Gregg Steinhafel

Well, we're very pleased with our performance in Target.com. We had a sensational year, both on the top line and the bottom line and I think that by describing it in terms of 30 to 50 basis points, you can essentially determine what that size and scope of the business is and what that potential will mean for '07.

Deborah Weinswig - Citigroup

As we think forward we should continue to assume 30 to 50 basis points?

Robert Ulrich

Certainly that's a historic number, and over time that figure, as Target.com continues to grow, will not maintain that basis point effect. But that's a responsible range of expectations for '07.

Deborah Weinswig - Citigroup

Okay, great, thanks so much. I really appreciate it, and congratulations on a great quarter.

Operator

Your next question comes from the line of Teresa Donahue - Neuberger Berman.

Teresa Donahue - Neuberger Berman

Good morning, everyone. I was wondering if you could take a minute to walk through any anticipated impact of a greater number of remodels might have on the first nine months of the year in terms of potential impact on SG&A? I think you've already indicated a sales impact over that time.

Robert Ulrich

Yes. To clarify, we're talking about our so-called Phoenix activity as distinct from our normal remodel activity. The Phoenix activity represents situations where we typically close a store outright in January and rebuild on site a brand new and in most cases much larger building and reopen in our October cycle. There's some variations on that theme but that's the typical situation we're talking about.

The main effect isn't on our margin rates. The main effect is on our sales. On balance, year over year, I mean, we have this activity in many years. We had it in the prior year as well, but the reason I called it out this morning is that year over year, we will have a couple hundred million dollars lower sales, all else being equal. Now those sales come back starting in October of '07 and, of course, we'll be not only expanding our sales as a result of that activity in each of those buildings, but also expanding our profitability.

So it's a temporary phenomenon and it's more of sales and EBIT dollar issue. It is not an EBIT margin rate issue to any substantial degree.

Teresa Donahue - Neuberger Berman

What are the number of Phoenix projects and what were they last year?

Robert Ulrich

We get into some variations on the theme here, but give or take, it's an increment of about five buildings, depending on exactly how you want to count it.

Teresa Donahue - Neuberger Berman

The total number?

Robert Ulrich

Still single-digits, a handful more.

Operator

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

Adrianne Shapira - Goldman Sachs

Heading into the quarter, I believe we had expected pre-opening timing shifts to favorably impact the fourth quarter. Doug, could you perhaps add some color and quantify what that shift was?

Doug Scovanner

Pre-opening expenses in the quarter as a percent of sales, in fact as expected, were a benefit to SG&A expense. Not a huge one, but think of it as 10-plus basis points.

Adrianne Shapira - Goldman Sachs

Okay. So how should we think of the offset there?

Doug Scovanner

I don't know what you mean by the offset.

Adrianne Shapira - Goldman Sachs

Well, in terms of, we didn't see the complete benefit in the SG&A line of the timing, so I'm just wondering what offset some of the benefit related to that?

Doug Scovanner

Recognize that we're down into some very, very small and subtle changes. In the aggregate, SG&A as a percent of sales increased 10 basis points, which, to me, is virtually flat. But I mentioned in my remarks that all of that change actually, about 15 basis points in the quarter of extra SG&A as a percent of sales, was driven by the financial statement issues that I referenced in my remarks.

So, absent that, SG&A was about 5 basis points favorable, and the big driver of that favorability was the 10 -plus basis points of favorable start-up that we're discussing. Again, we're down into some very granular numbers here, talking about single-digit basis points.

Adrianne Shapira - Goldman Sachs

Okay, that's helpful. And then just going forward, can you maybe give us some insight into CapEx. You'd mentioned opening two new DC's this year, so what impact that has on your CapEx plan?

Doug Scovanner

Well, CapEx will likely increase in line with sales this year, and so it will be in excess of $4 billion.

Adrianne Shapira - Goldman Sachs

Lastly we've just seen, obviously, impressive improvement in inventory turns this year at 6.3 up from 6.0 up from '04 levels, 5.8. Tell us what's driving that? Is it obviously the expansion of consumables, and how we should think of that going forward?

Doug Scovanner

Well, it's primarily expansion of consumables and shortening lead times in other parts of the store as well, and just managing our inventories tighter in almost every business category. It's the combination of those factors increased our turns by those handful of basis points.

Gregg Steinhafel

As a reminder, when we begin opening perishable food DCs that will adversely affect this because we'll be carrying more inventories. Today one of the significant financial benefits of being wholesaler supplied is we do not have an investment in those inventories.

Robert Ulrich

There are other factors, of course, that offset this. It's a good investment on our standpoint, given how dense our Super Target store count and how much food product rolls through the rest of chain as well. But on that narrow measure, the improvement in turns will certainly slow down as a result of adding perishable food DCs to the network.

Adrianne Shapira - Goldman Sachs

Gregg, you mentioned the repositioning of the Global Bazaar across good, better and best. You had referenced that in electronics as well. Talk about where else you see that opportunity in perhaps repositioning the assortments and realigning the good, better, and best offering?

Gregg Steinhafel

Well, the primary emphasis in '06 was repositioning our assortments in our home categories, electronics. We had a few issues in our pet department and a handful of others, but the big story really was getting the four home divisions back on track, and we feel very optimistic that we are in a good place as we enter '07.

We are already seeing the strengthening businesses from housewares. Our decorative home business is significantly stronger than it had been in the spring and fall of '06, so we're thrilled about that. We're seeing some categories in domestics strengthen as well. We believe as we move into the balance of '07 that we will have made the appropriate adjustments in those businesses and a handful of other businesses that had just some minor adjustments that we needed to make and did make.

Operator

Your next question comes from the line of David Strasser - Banc of America Securities.

David Strasser - Banc of America Securities

You had talked about California and I just wanted to get a sense of how you view the growth in California for Super Target over the next several years, taking into account some of the issues that Wal-Mart's been plagued with from a zoning standpoint in getting into California in any significant way?

Gregg Steinhafel

Generally speaking we have quite an opportunity, I believe, to grow our Super Target format and to grow our overall presence even beyond Super Target in California. We certainly have some individual markets where it's difficult to find large enough parcels of land that are adequately zoned, but generally speaking, zoning and entitlement issues are not the issue that determines our Super Target growth.

Generally speaking it's the challenge of finding large enough parcels is land in trade areas that have sufficiently dense household counts, with households with income demographics and other attributes that tell us that it would be a great market for a Super Target.

Robert Ulrich

The other thing I'd like to point out is that Wal-Mart is almost totally focused on just the super centers and our mix balance is out somewhere between two-thirds and 70% regular stores. When an opportunity wasn't available for a site large enough for a Super Target we put in a very, very profitable regular store, which also has our expanded food offering to draw additional traffic, but does not happen to have fresh produce and meat.

Operator

Your next question comes from the line of Justin Post - Merrill Lynch.

Justin Post - Merrill Lynch

I have a question on the credit business. I think a few months ago you commented that credit card write-offs had approached 7% to 7.5%, and then today you mentioned it being at 2004/2005 levels, which is more like 8%, I think. I was just wondering can you provide a little more detail on your write-off guidance and any color on timing?

Robert Ulrich

We do expect write-offs to continue to rise and no, I'm not trying to make a comment that as precise as the way you framed your question. We finished the year with an allowance as a percentage of receivables that is a high point for us, and that allowance was specifically calculated, in our case, based on our estimate of what the write-off picture looks like going forward.

In comparing our previous comments to today's comments you should not believe it is not the case that we are making a different numerical judgment. It's simply a different way of describing where we're headed.

Justin Post - Merrill Lynch

Then my second question is just about the EPS contribution from the 53rd week. Could you provide any more color there in terms of roughly how much that was?

Doug Scovanner

Certainly. I would make two separate comments. First of all, if you take a look at the overall contribution to our earnings from our credit card operations for both the quarter and the year, we averaged about $0.01 of EPS a week, and there's nothing different about that 53rd week.

Looking at our core retail operation outside the holiday season, we generated more or less $0.04 or $0.05 per week. That week was sharply lower in its profit contribution from our core retail operations, just because of the specific attributes of the week. But sort through that, you certainly get something in the range of $0.02 or $0.03 of EPS contribution from the 53rd week. That was, of course, incorporated in our plans as the year began and incorporated in everyone's estimates as well.

Operator

Your next question comes from the line of Mark Rowen - Prudential.

Mark Rowen - Prudential

Doug, we've noticed that your delinquencies and charge offs really haven't increased, and given all the reporting on what's going on in the subprime market, do you think that's just contained in home equity and that market and you haven't seen any of it? Or, do you expect in your forecast that your delinquencies and charge offs are going to rise more this year?

Doug Scovanner

Well, all of the attributes of our portfolio, including the minority of our receivables that are classified as subprime, is contained in our forward-looking statements. So at an aggregate level I would tell you that we continue to expect robust overall performance from the portfolio.

Having said that, the fact is that, as I mentioned earlier, our allowance as a percentage of receivables is at an all-time high and that clearly reflects our belief that write-off rates as a percentage of receivables will climb, certainly at a detailed level, a piece of that is at the margin driven by some of the factors you are talking the about. But we are very disciplined in our underwriting, we are very disciplined in our risk management in this portfolio, and I do not expect anything going on in the subprime markets to have any impact to any extent that causes concern in these kinds of calls over the next several quarters.

Mark Rowen - Prudential

Okay. Gregg, you mentioned increasing your share in consumer electronics and certainly resetting the department and increasing selection on flat panels. Given that and given the fact that you're expanding groceries in the general merchandise stores, both of those are lower-margin categories so given that overall you'll have flat margins, what basically offsets those two categories which it looks like you want to gain share in?

Gregg Steinhafel

Sure. As Doug mentioned earlier, really a couple of things. One would be our continued emphasis on direct sourcing and our global sourcing operations, as we expand that approximately 100 basis points a year throughout the organization, that will be an offsetting factor. Our emphasis on private-brand development throughout the store and primarily in our food business continues to strengthen and build momentum, and those are at more attractive margin rates. And then the overall health of the apparel and particularly the home business, as the home business strengthens at substantially above company gross margin rate levels, we would see margin rate offsets to the negative consequences of food, consumables, paper, electronics, and other low-margin categories growing at a faster rate than the company in total. Not dissimilar to what we have been experiencing and offsetting over the last four or five years.

Operator

Your next question comes from the line of Charles Grom – JP Morgan.

Charles Grom - JP Morgan

Can you quantify the costs you will incur for the two new distribution centers you're going to open up this year, both from a CapEx perspective and to the SG&A line?

Doug Scovanner

First of all from a CapEx standpoint, when we open distribution centers it typically represents an investment somewhat above $100 million. Separately, in the aggregate it's just an element of our $4+ billion CapEx program. As I mentioned earlier, CapEx will rise give or take in line with sales this year, and so I don't expect anything meaningful in the aggregate related to start-up costs.

Charles Grom - JP Morgan

Some of the department stores are seeing softness thus far in February, particularly in apparel, citing weather, calendar shifts. I'm just curious to see if you guys have any material change in shopping behavior since the beginning of the year?

Doug Scovanner

Well, we are experiencing the same weather as everyone else, but we mentioned in our sales update mid-month that we are right on track to achieve our sales projections for the month. Of course, as we mentioned earlier today, we're going to incorporate Target.com in those comps at the end of the month, even though it was not in our beginning of the month sales outlook.

Charles Grom - JP Morgan

With GO International in its second year now, can you touch on what you learned in year one and how you plan to tweak the offering over the next 12 months?

Gregg Steinhafel

Well going forward, year two we are going to deliver more newness, more freshness throughout each timeframe of each individual GO International design collection. So, in year one we delivered more of that merchandise, maybe 70% or 75% of it up front, and we had modest amount of refreshment and changes to the assortment in the balance of the 90 days. This year's program, I wouldn't say it is the opposite percentages, but we are delivering far less up front, changing more frequently style, color, and silhouettes throughout that timeframe.

Operator

Your next question comes from the line of Dan Binder - Buckingham Research.

Dan Binder - Buckingham Research

Any thoughts on Q1 in terms of the earnings per share? That's the first question.

Doug Scovanner

Well, we're off to a great start here in the first quarter, as we mentioned with our sales outlook. Certainly the depreciation adjustment that I referenced from the prior year will have an impact on the year-over-year growth, but I'm very comfortable with where we are and where we're headed.

Dan Binder - Buckingham Research

Okay. I guess just looking at the credit card business, as you noted the allowance is at an all-time high relative to write-offs. I'm just curious, in this quarter we saw the provision for bad debt only somewhat higher than net write-offs versus what we saw in prior quarters with build up. As we think about that going forward, should we be thinking about that bad debt provision matching up with the net write-offs more closely in fiscal year '07?

Doug Scovanner

Generally speaking I would think that, if we've done our homework right and if the portfolio behaves the way I would predict that it would, you would expect to see write-offs in line with expenses without a lot of change, therefore, in the allowance.

Now, obviously, every quarter we learn more and we have a refined outlook and make some adjustments to see if they're warranted, but those are really independent calculations. The write-offs are a mechanical result of our accounting policies, and the expense that we record in every quarter is a result of a detailed analysis of the then-current portfolio and its risks. But on balance I would expect that write-offs and expense should be roughly in line with each other in '07.

Dan Binder - Buckingham Research

You noted earlier there was a minority portion of the portfolio that had subprime. I was wondering if you could remind us what that was worth, what percentage that is?

Doug Scovanner

Well, I would refer you back to the archived credit card specific presentation that's on our website. Specifically on your questions, 90% of our overall receivables, give or take, are Visa receivables. About 10% are on our Target card, proprietary credit card good only at Target. Upon initial underwriting we do not underwrite any new subprime Visa accounts. Certainly the portion of our portfolio driven by the Target card has a subprime component and separately, ,as is the case with all portfolios like our Visa portfolio, once underwritten some get credit approved does not. So there is a subprime component to the Visa portfolio, but in the aggregate, given that we don't underwrite any new Visa cards for subprime households, the combination of subprime Visa and subprime Target card is a minority of the portfolio's receivable.

Dan Binder - Buckingham Research

Finally, could you discuss with us what kind of margin benefit there may be from servicing a group of stores with an owned food distribution center versus using a third party? In addition to that, your thoughts on where that growth in self distribution is going over the next three years.

Doug Scovanner

Well, at the margin this is a very meaningful aspect of our business, but in the aggregate these are not large enough changes to alter the overall characteristics of the corporation's financial profile. At the margin, we'll invest several hundred million dollars in distribution capacity, principally the distribution centers. We will have an increment of inventory. We'll also have an increment of payables. So inventory net of payables is not a big factor, but focusing on inventory alone this will add to inventory.

The margin benefit of being self supplied will produce enough incremental profitability to earn a proper return on the invested capital. But a couple hundred million dollars, even if it's $0.5 billion over the next several years, needs to be analyzed in the context of $4 billion to $5 billion in CapEx per year. We'll invest $15 billion to $20 billion of capital in the next four or five years, of which maybe $0.5 billion will be in this arena.

Dan Binder - Buckingham Research

Is there any reason to think that the move towards more self distribution wouldn't accelerate the growth rate of the company?

Doug Scovanner

The move towards self distribution will not change our top line performance. This has nothing to do with the pace of growth of our new stores.

Dan Binder - Buckingham Research

Well, I was thinking more of the bottom line growth.

Doug Scovanner

Well, the bottom line growth will also include the costs of funding that activity. The operating statement contribution, the contribution to EBIT, of course, is positive, but we will, at the margin, incur some combined of interest expense and theoretically a slow down in our share repurchase program to be able to provide the funding. So it's certainly not a free activity at the bottom line.

Operator

Your next question comes from the line of Dana Telsey - Telsey Advisor Group .

Dana Telsey - Telsey Advisor Group

Can you please talk about the impact of minimum wage? Does that have an impact this year in terms of the increase? Lastly, as you look at pricing for 2007, how are you looking at the overall pricing environment and what your stance will be? If it is at all different this year compared to last year on any particular categories? Thank you.

Gregg Steinhafel

We really do not anticipate any impact of significance from minimum wage. In this year and even next year it would be very, very modest. The pricing environment continues to be as it has been. It's aggressive, it's competitive. There are a lot of competitors that we compete with that are aggressive on price and we will continue to match Wal-Mart in local markets on like items, but while aggressive, it's still stable and it's still reasonably rational. So there has not been a real meaningful change in pricing or the dynamics around how aggressive the competitive set is over the last 12 months or so.

Operator

Your next question comes from the line of Michael Exstein - Credit Suisse.

Michael Exstein - Credit Suisse

Just following up on a question on Global Bazaar, your home business was very tough earlier, in '06. Can you just talk about what changes you've made to that business and what you're seeing in that business right now?

Gregg Steinhafel

Well, we've done a lot of things in home, and I don't want to paint the broad-brush that everything in home is treated the same. Our stationary business was strong, continues to be strong, and so we had very minor modifications in that particular business. Our housewares business was consistently strong last year, and that was a combination of home storage, small appliances, and cookware.

Where we really struggled in '06 was our domestics and our decorative home businesses. As we have transitioned category by category, we have worked to improve the good, better, best balance. We have focused on the right space allocation, the right lifestyle merchandising, the right color impact, mix impact, all the merchandising aspects of putting together the right kind of assortment, so that we have an Expect More, Pay Less differentiated, but very compelling assortment.

So we made a number of changes that were different, depending upon if it was furniture or lighting or picture frames or bedding. And we're just encouraged that the combination of those changes, while specific business by business, are gaining traction and as a result of that we expect improved performance in '07.

Michael Exstein - Credit Suisse

What do you think the depreciation and amortization run rate will be for the year?

Doug Scovanner

Depreciation and amortization will approach $1.7 billion for the year. That's essentially right in line with the growth that's consistent with our CapEx, as long as one respects the adjustments that we made in the first quarter of 2006.

Operator

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

Christine Augustine - Bear Stearns

Doug, when you look at your forecast for 2007, what are your expectations for some of the major line items in SG&A, payroll, utilities, benefits? Are you anticipating any relief at all in terms of energy costs? I'm just wondering for the major categories directionally where you think they're headed this year?

Doug Scovanner

As is always the case, we have a huge amount of detail underpinning our overall outlook, and certainly there are some categories that will increase slightly faster than sales. There are some others where we get some benefits by having slower growth in sales. We have been particularly focused on our rate of growth of SG&A, given the experience of the last 12 to 18 months. On balance there really isn't any one category that sticks out, and on balance I believe that SG&A will be well controlled in 2007. Certainly there will be a different story quarter by quarter, but by the time the dust settles on the full year, I do not expect there to be much of an SG&A story in 2007.

Christine Augustine - Bear Stearns

You're not expecting any kind of pressures versus what you saw in '06?

Doug Scovanner

No, and I would tell you I do not expect to see pressures, but I would also add quickly that of the 34 basis points year-over-year adverse SG&A as a percent of sales we experienced in '06, all but about ten basis points is due to the financial statement matters that I talked about earlier and driven by the one-time benefit of the Visa litigation settlement in the prior year and driven by the fact that we no longer enjoy a stream of income from the new owners of Mervyns's to provide their IT services.

So when you bundle all of those kinds of either nonrecurring or rather unique items together, it's two-thirds of the SG&A issue in 2006, with only a remaining ten basis points in the aggregate driven by these pressures. So it wasn't a very big issue in 2006, and I don't expect it to be any issue in 2007.

Christine Augustine - Bear Stearns

In the past, you've talked about mall-based stores, consolidation in the department store industry. If a block of stores became available you would certainly take a look at it. Is that still your strategy?

Doug Scovanner

We remain ready to purchase any site, mall based or otherwise, that is suitable for conversion to a Target store and meets our financial criteria. If blocks of real estate were to come along, we have the financial capacity to be able to acquire that within reason about anything imaginable, but that has not characterized our experience over the last year or so.

Operator

There are no further questions at this time, sir.

Gregg Steinhafel

Thank you all very much for joining us. That concludes Target's fourth quarter and full year 2006 earnings call.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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