Target F1Q07 (Qtr End 4/29/07) Earnings Call Transcript

May.23.07 | About: Target Corporation (TGT)
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Target Corporation (NYSE:TGT)

F1Q07 Earnings Call

May 23, 2007 10:30 am ET

Executives

Bob Ulrich - Chairman, CEO

Doug Scovanner - CFO

Gregg Steinhafel - President

Analysts

Charles Grom – JP Morgan

Bob Drbul - Lehman Brothers

Jeff Klinefelter - Piper Jaffray

Todd Slater - Lazard Capital Markets

Dan Binder - Buckingham Research

Christine Augustine - Bear Stearns

Greg Melich - Morgan Stanley

Virginia Genereux - Merrill Lynch

Dana Telsey - Telsey Advisory Group

Neil Currie - UBS

Peter Benedict - Wachovia

Presentation

Operator

Welcome to the Target Corporation's first quarter 2007 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 2007 first 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 view of the current retail environment, and then Doug will review our first quarter 2007 financial results and describe our outlook for the second quarter and describe our outlook for the second quarter and full year. Next, Greg will provide an update on key strategic initiatives that continue to fuel Target's performance and growth. Finally, I will wrap up our remarks and we'll open the phone lines for a question-and-answer session.

This morning, we announced excellent financial results for the first quarter of 2007 and we are pleased with our performance. Overall, we continued to increase our market share, growing our total shares at 9%; a much more rapid pace than the growth rate of the overall U.S. market for similar or identical merchandise.

Despite sales weakness which was concentrated in the first two weeks in April, our guests continue to find more reasons shop at Target more often and spend more on each visit during the quarter and a solid increase in average transaction amount. Our outlook for the remaining three quarters of 2007 and for the year overall envisions that Target will continue to generate a mid single-digit increase in comparable store sales. In addition, we expect both our new stores and our credit card operations to continue to contribute to our profitable growth.

At the current time, we do not see any near term economic indications that give us an undue amount of concern, though we are certainly prepared to manage our business in a more difficult economic or competitive climate. We are confident that our merchandise initiatives will continue to represent the right combination of value, innovation and unique design and that our marketing efforts will continue to strength the emotional bond we have with our guests and that our stores will continue to deliver superior in-stock reliability, convenience, and guest service. As a result, we remain optimistic about both our plans and performance for 2007.

Now Doug will review our results for the first quarter 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 might 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 first quarter 2007, which modestly exceeded our expectations for growth in both our core retail and our credit card operations. Let's review some of the highlights for the quarter in more detail. Total revenues grew 9.2% to $14.0 billion fueled by the contribution from new stores, a 4.3% increase in comparable store sales and the growth in revenue from our credit card operations.

In our core retail operations, we expanded gross margin rate by 39 basis points, primarily due to improvement in markdowns and we reduced our expense rate by 34 basis points. As a result, we enjoyed somewhat stronger growth in our retail EBIT in the quarter than we had anticipated.

As a reminder, our year-over-year gross margin rate is currently benefiting from the effects of a couple of small financial reporting refinements that have a parallel inverse effect on our expense rate. This means that analytically, our EBIT margin rate expansion in the quarter was driven largely by favorable expense leverage, some of which we'll turn around later this year. Additionally, our SG&A expenses were reduced by $12 million -- or the equivalent of nearly $0.01 of EPS -- as a result of our recording our share of the telephone excise tax refund.

Our credit card operations also continued to deliver strong profit performance. Average receivables grew 11.0% from a year ago, which resulted in a low double-digit increase in credit card revenues. In addition, we leveraged slower growth in our credit card expenses to produce a 21% increase in credit card contribution to EBT. On an annualized basis, our credit card contribution to EBT as a percent of average receivables was 8.7% this year, up from 8.0% from a year ago. As a reminder, we've redefined credit card contribution to EBT to exclude intra-company merchant fees, and include the effect of new accounts and loyalty rewards discounts as expenses of our card programs.

Depreciation and amortization expense increased $58 million or 17.2% compared to the same period a year ago, as a result of normal growth and the impact of last year's adjustment, which benefited first quarter 2006 results by $28 million. Overall, earnings before interest and taxes, or EBIT, rose 18.0% to $1.2 billion compared with just over $1 billion in the first quarter of last year.

Net earnings in the quarter grew 17.6% to $651 million compared with $554 million last year. On this same basis, diluted earnings per share rose to $0.75 from $0.63, an increase of 19.6%.

Net interest expense increased $5 million in the quarter from $131 million a year ago to $136 million this year. This increase was entirely attributable to higher average funded balances including the debt to fund our receivables growth.

Our effective income tax rate for the quarter was 38.8% compared with 37.5% in last year's first quarter. We expect that there will continue to be variability between our individual quarterly and full year effective tax rates as tax uncertainties arise and are resolved. GAAP requires us to reflect these discrete tax matters in the quarter in which they occur. For the full year, we continue to expect our effective tax rate to rise modestly from our 2006 rate of 38.0%.

Under the $5 billion authorization provided by our Board of Directors, we continue to repurchase shares of Target common stock during the first quarter of 2007. Specifically, we invested $549 million to buy approximately 9.2 million shares of our common stock at a weighted average price of $59.79 per share. Cumulatively, we have now repurchased 80.2 million of common stock at an average price of $49.84 per share for a total investment of approximately $4 billion.

As a result, weighted average diluted shares outstanding in the quarter were lower by nearly 15 million shares or about 2% than the corresponding figure last year. We continue to believe that we will complete our total share repurchase authorization by the end of 2008, if not sooner.

Now let me turn to the balance sheet. As you know, we've adopted FAS 158 regarding accounting for pension and post-retirement healthcare benefits and also FIN 48 regarding accounting for income tax uncertainties. Neither of these had a material effect on our financial statements or on our outlook for profit or cash flow, but together they have caused several of our balance sheet accounts to change from last year's presentation. Additional detail on these adoptions will be available in our first quarter 10-Q which we expect to file next week.

Net accounts receivable at the end of the first quarter were $6.0 billion, 11.9% above our receivables levels at this time last year. Over the same period, we've increased our allowance for doubtful accounts by $28 million to $504 million, representing 7.7% of our quarter end gross receivables.

Our balance sheet inventory position grew 5.9% from a year ago about 3 percentage points lower than our 9.0% sales increase. Property and equipment net of accumulated depreciation increased $2.6 billion from a year ago, reflecting our ongoing investment in new stores and the distribution and systems infrastructure to support our continued growth, as well as our commitment to maintain our brand integrity by re-investing in our existing stores.

A portion of this increased investment during the first quarter is related to the timing of 2007 and future capital projects. For the full year, we now expect capital spending to be in the range of $4.5 billion to $4.7 billion, which is about $300 million higher than we had previously forecast.

Now let me provide some additional guidance for the balance of 2007 and put this in perspective by teeing off of our first quarter experience. I'll begin with our credit card operations. We expect to continue to enjoy strong underlying performance throughout the remainder of 2007 with receivables continuing to grow in line with sales and with delinquency rates and net write-off rates highly likely to remain within the range of our current balance sheet reserve.

As a result, we expect to continue to enjoy both the strategic and financial benefits of our credit card portfolio. These products not only enable us to enjoy stronger relationships with our retail guests but also allow us to continue to enjoy superior and predictable financial results as well.

In our core retail operations, as Bob mentioned, we remain comfortable with our sales outlook for the balance of the year and we believe our EBIT margins for the year will approximate last year's levels as we translate our sales to profits. We expect to further leverage the growth in our full year EBIT at the EPS line through the benefit of continued share repurchase.

Overall, First Call median estimates for Target continue to reflect EPS of $3.60 for the full year. Just as we discussed 90 days ago, we continue to believe this estimate is within the range of likely outcomes. The opportunities and risks we see for the remainder of the year remain very similar to those we described 90 days ago. As I mentioned earlier, we expect some of our first quarter expense favorability to turn around even as soon as beginning in the second quarter.

In short, we remain confident in our underlying strategy, and in our continued ability to generate strong double digit percentage increases in EPS in 2007 and again in 2008 and for many years to come.

Now Gregg will provide a brief summary of current business trends and describe several of our current merchandising initiatives.

Gregg Steinhafel

Thanks, Doug. Target is off to a strong start in 2007. We are pleased with our first quarter performance and excited about our plans for the remainder of the year. We believe we will continue to delight our guests by offering a continuous flow of fresh, new, high quality well designed merchandise at exceptional prices.

In the first quarter, our comparable store sales rose 4.3%, reflecting fairly typical growth in both guest traffic and average transaction amount. Our sales results included better than average performance in newborn infant/toddler, electronics, and nondiscretionary categories like health and beauty, pharmacy and consumables; while sales and categories such as music and movies, intimate apparel and many of our seasonal weather-sensitive categories were weaker than average.

During the first quarter, we continued to expand our store base opening a total of 15 new stores, including ten discount stores and five Super Target locations bringing our total store count at quarter end to 1,500 stores in 47 states. Our store-opening program in the second quarter is expected to be considerably larger, including a total of 42 new sites comprised of 32 discount stores and ten Super Target locations.

The strength of our first quarter financial performance reinforces the relevance of our strategy and the merit of our Expect More, Pay Less brand promise to our guests. By consistently delivering great design, innovation, and value in our merchandise assortment and a superior experience in our stores, we give our guests more reasons to shop at Target more often and to buy more on each visit.

During the quarter, for example, we featured Proenza Schouler as our newest Go International designer, creating a sense of excitement and urgency with our limited time assortment of exclusive merchandise and exceptional value. We expanded our offering of natural products in bath and body adding new cosmetics and skin care brand such as Boots and Bert's Bees. We continue to drive frequency with our expanded assortment of food and our commitment to convenience and commodity categories such as mom and baby and healthcare. And, we further leveraged our differentiation through the collaborative efforts of marketing and merchandising in our Valentine's and Easter seasonal presentations.

To sustain our competitive advantage and continue to delight our guests, we are launching several new initiatives in this year's second quarter as well. For example, earlier this month, we debuted Patrick Robinson and his Greek-inspired fashions in Go International. In July, we will be introducing unique styles and looks in a collection called Libertine, by Cindy Greene and Johnson Hartig.

In May, we also significantly enhanced our offering in electronics by improving our balance of good, better, best and introducing a new 44 foot presentation of television. About three-quarters of this space is devoted to flat panel and specifically LCD technology.

We are extending our limited engagement strategy to women's accessories adding a collection of handbags, clutches and wallets which will showcase metallic skins and oversized jewels from award winning handbag designer Devi Kroell. Finally, this quarter marks the beginning of Target's new online photo partnerships with Shutterfly and Kodak Gallery.

Throughout our stores we also remain firmly committed to driving increased guest frequency and providing greater convenience, reliability and value in our consumables and commodities offerings. Specifically, we continue to differentiate ourselves through increased penetration of our own brands including recent product introductions in Market Pantry, Archer Farms, Choxie, Sutton & Dodge and the Wine Cube.

We continue to expand our food offering and general merchandise stores with up to 34 sides of food in our new and remodeled stores. We are rolling out to more than 400 stores throughout the chain an expanded assortment of authentic Hispanic food and we continue to improve our guest shopping experience at Super Target with our expansion of self service delis, broader assortments of organic and natural foods and locally grown produce and greater availability of prepackaged produce to enhance both food safety and check-out speed.

To support these merchandising initiatives and ensure that we deliver the right product to the right stores quickly and at the lowest possible cost, we remain focused on opportunities to leverage our sourcing, technology and supply chain sophistication and capture incremental efficiency. For example, we continue to improve our product design and development process to enhance quality and fit and reduce merchandise lead time. We remain committed to strengthening our vendor partnerships to ensure that we continue to deliver a continuous flow of great merchandise at great prices. We continue to expand our distribution network by adding regional and import capacity to support our growth and we are pursuing opportunities to reduce inventory while improving in-stock levels, improving transit times, and eliminating costs throughout our supply chain both domestically and internationally.

As Target continues to grow and innovate and competition within the retail environment intensifies, we are increasingly committed to continuous improvement and superior execution throughout our organization. By remaining unwavering in our focus on delighting our guests and firmly committed to balancing innovation with discipline, we believe we will achieve our goal of being best for our guests, our team members, our shareholders, and our communities.

Now, Bob has a few concluding remarks.

Bob Ulrich

As you've just heard in detail, we are pleased with our overall results in the first quarter and confident in our core strategy. We believe that Target remains on track to delight our guests and deliver another year of strong growth and outstanding performance in 2007. 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 the line of Charles Grom - JP Morgan.

Charles Grom - JP Morgan

Back in April, you guys were one of the first in retail to tip your hat that the consumer was pulling back. Can you walk us through the month, I think you said the first two weeks were soft and into the first three weeks of May; what trends you're seeing at the consumer level to give some perspective on why you think the consumer did, in fact, pull back those two weeks?

Bob Ulrich

Well, in the early April time frame and just prior to Easter, we thought it was primarily due to the weather being unseasonably cold -- as a matter of fact, regard setting cold throughout the United States. Since that time, the consumer has bounced back and our business, overall, is fairly healthy, although our mix is slightly more skewed to our nondiscretionary categories than to some of the seasonal related categories like apparel and summer goods. But overall it was just that two or three-week timeframe that we really saw the softening up.

Charles Grom - JP Morgan

Doug, could you review for us again which SG&A expense and gross profit margin items in Q1 that you're calling timing? Can you quantify those for us and I guess looking ahead over the next few quarters what the cadence of those factors are going to actually hurt margins in the next few periods?

Doug Scovanner

The timing issues are much more focused on expenses than elements of gross margin rate. I'll call out a few, although, I would be careful to describe that our expense favorability was rather broad based. A couple of examples would certainly include marketing expenses which were much more favorable in the quarter than I would expect would be our experience either in the second quarter or the full year just simply because of the timing of how the calendar lies this year.

Separately, as Gregg laid out in detail, we had a considerably smaller number of new store openings in Q1 this year than Q1 last year and we expect a considerably larger number of new store openings in Q2 this year than Q2 last year. As a result, start-up expense related to our new stores was favorable year-over-year in the first quarter and will be unfavorable year-over-year in the second quarter. Those are a couple of examples.

Charles Grom - JP Morgan

Last question on the credit side, bad debt. If you look at bad debt as a percentage of average receivables, it was down about 100 basis points sequentially. What should we think about on this line item going forward over the next few periods?

Doug Scovanner

Well in the short run, we're clearly seeing some trends that were somewhat more favorable than we would have predicted coming into the quarter. Looking out over the next several quarters, we are clearly positioned from a reserve standpoint to withstand a modest increase in write-off rates and that either will or won't occur. If it occurs, we're properly and fully amply reserved. If it doesn't occur, then you'll continue to see a pattern as you saw in our first quarter numbers of appropriately reflecting that favorability as it occurs and as it develops.

Operator

Your next question comes from Bob Drbul -Lehman Brothers.

Bob Drbul - Lehman Brothers

Gregg, can you talk a little about the profitability performance of the Global Bizarre and how it performed versus your expectations and what you learned this year and what you might apply for next year?

Gregg Steinhafel

We were very pleased with the performance of Global Bazaar this year and we focused primarily on three things: greater affordability, stronger color impact and greater classification dominance. The combination of those efforts yielded to stronger sales and profitability results compared to the prior year.

We will continue to enhance that for '08 and focus on those very same things and probably increase our level of promotional activity just slightly over last year, that was one area of opportunity we did cite after the fact. Overall, we're very pleased with our performance.

Bob Drbul - Lehman Brothers

Given the disappointment in the first two weeks of April, the inventory number looks pretty clean. Are there any pockets of inventory that you are concerned with as you go into May and the rest of this year?

Gregg Steinhafel

Overall, our inventory levels are in excellent shape. We would like to see a little bit stronger results out of our seasonal categories and out of our apparel group, but even having said that, overall those inventory levels are in pretty good shape as well. That is primarily as a result of our ability to shorten up lead times and keep liquidity within our business and being able to do that, we were able to get out of some of our second quarter commitments. So overall, we're fairly confident that we're going to have a decent sell-through in second quarter.

Operator

Your next question comes from Jeff Klinefelter - Piper Jaffray.

Jeff Klinefelter - Piper Jaffray

Can you give us some perspective of your current run rate for in-stock and how it compares to last year in total and then the key item focus within your assortments and how that group is performing? I am really just trying to get to how much better can it get and how much can that contribute to your efficient inventory management and markdown reductions?

Gregg Steinhafel

Overall we're pleased with our in stock levels, they are approximately at last year's levels or slightly above last year's levels and we're really continuing to focus on our top 2,500 items, our private branded products, add-in stock, our in-stocks during our transitions and really focusing on how we can continue to reduce our lead times and take unproductive inventory out of the network.

So those are really the initiatives we're focused on. We really don't see a lot of upside in improving the in-stocks in some of our more basic categories because they are pretty significantly high right now. But in our seasonal areas and in our high volume and unique stores, we believe there are opportunities to reduce some of the inventories we have in the back room.

Jeff Klinefelter - Piper Jaffray

Okay. This is a follow-up, Gregg, in terms of your utilization of your import DCs over the last couple of years in those seasonal areas. What kind of magnitude of in stock performance have you seen there?

As a follow-up on your mid single-digit comp guidance for the balance of the year, what are your expectations for the lower margin commodities versus the higher margin in home and soft lines areas within that mix of that comp? Really looking at, if there is going to be upside to gross margin, is it going to come from an outperformance some of those higher margin categories?

Gregg Steinhafel

I'll take your second question first. That's exactly correct. If there is going to be upside, we need to see stronger performance out of both our apparel and our home-related businesses. Our margin rates are strong across the board and where we have softness, it's almost exclusively due to the mix-related impact of our consumables and food business growing at a faster rate than apparel and home.

As relates to the import warehouses, we're really pleased with how they perform and our ability to aggregate upstream apparel and seasonal merchandise and the primary benefit is to wait and see how the season develops and to more closely pinpoint the second and third and fourth installments of our inventory.

So we continue to invest in those facilities and they're producing excellent results.

Operator

Your next question comes from Todd Slater with Lazard Capital Markets.

Todd Slater - Lazard Capital Markets

Doug, if the write-off rates continue to remain lower as you've mentioned, what would be your expectation on the credit margin for the rest of the year?

Doug Scovanner

Well, I think you've dictated the answer by the way you phrased the question. If our write-off rate remains lower then of course our profitability as a percent of receivables would increase. The write-off rate that we're currently experiencing, as you know, includes a layer of write-offs that were very easy to predict in both magnitude and timing associated with our adoption of new standards of increased standards of minimum payments.

We talked a lot about that last year. We clearly reserved for the losses associated with that in advance as appropriate, and we're now experiencing some of those write-offs. It's one of the key reasons why write-offs in the quarter exceeded our expense in the quarter. But obviously, if our experience turned out to be favorable on that metric moving forward, it would have a beneficial impact on credit card contribution to earnings before taxes as a percentage of earnings receivables.

Todd Slater - Lazard Capital Markets

Could that also be where there's some potential upside to your numbers?

Doug Scovanner

I'd underscore the word potential, but that potential certainly exists.

Todd Slater - Lazard Capital Markets

Could you also talk about the trend in funding costs year over year, where we cycle those rate increases and things like that?

Doug Scovanner

Year over year at this point we're still experiencing an increase in floating rate funding costs and as the year moves on, I would personally expect that to moderate. Admittedly, I'm using a bit of a crystal ball there to try to guess what the Fed actions might be for the balance of the year.

From a mix standpoint, though, our overall portfolio actually has a rate benefit year-over-year because we have a higher mix of lower cost floating rate debt today than we had a year ago as a result of funding the increase in floating rate assets in our credit card portfolio.

Operator

Your next question comes from Dan Binder - Buckingham Research.

Dan Binder - Buckingham Research

First, just on the credit business again. Given that the delinquencies have been coming down the last couple of quarters, is there any reason that the reserve couldn't also come down? If you can give us an idea longer term what kind of rate you would target as a percentage of the receivables?

Doug Scovanner

Well, delinquencies of course as we just disclosed them, 3.2% at the end of the quarter and 3.0% a year ago; delinquencies have been relatively stable in the last several quarters, certainly looking one layer below stability, we see a bit of favorability. That's a great leading indicator but it's certainly not the only metric by any stretch of the imagination that's relevant in assessing what our reserve position should be.

Net-net as I mentioned earlier, we're reserved in anticipation of some modest adversity in write-offs as a percentage of total receivables compared to current experience. Again, that either will or won't occur. If it does occur, then you'll see stability in our P&L. If we're favorable to that outlook, then you would see some modest expansion in our profit margin measured any way you want to measure it.

Dan Binder - Buckingham Research

Longer term, should we be thinking about the allowance as a percentage of receivables in sort of that 7.5% to 8% range? Is that reasonable?

Doug Scovanner

Well, of course, that's a statistic that has seasonality to it so even if things were absolutely on auto pilot, that metric will go up and down with the quarters as we take on seasonal receivables that at the margin are less risky, less prone to future write-offs than receivables during the year. It's why our allowance as a percentage of receivables is typically higher at the end of the first quarter than it is at the end of the year.

But generally speaking, I would expect the allowance as a percent of receivables properly seasonally adjusted to be stable to potentially declining if this more optimistic scenario develops.

Dan Binder - Buckingham Research

On your guidance from 5% to 7% comp store sales gain, is it reasonable to assume that there's about a point benefit from the Memorial Day shift since you are typically guiding 4% to 6% or do you think it's more than that?

Doug Scovanner

It's certainly a full point, yes. We have not yet disclosed our June specific sales outlook but clearly our June same-store sales outlook will be meaningfully lower than the 5% to 7% outlook for the month of May.

Dan Binder - Buckingham Research

Then the last item, just in terms of store growth by quarter, you mentioned that Q2 will be a little bit heavier. Can you give us maybe just a rough idea of what the store opening should look like by quarter?

Doug Scovanner

Very specifically in the quarter just ended, we opened 15 new stores this year compared to 25 last year. In the second quarter, we expect to open 42 stores this year compared to 29 stores last year. So year over year, in terms of start-up expense, quite favorable in the first quarter, quite unfavorable in the second quarter. Those numbers are all gross. Our net store openings would be net of closings and relocations. Gross is the way that our CapEx is derived and of course the way that our expense for new store openings is derived.

Dan Binder - Buckingham Research

In the back half of the year is it reasonable to assume that similar to last year Q3 is heavy also on store openings and then Q4 a bit lighter?

Doug Scovanner

Well, we open stores three times a year -- March, July and October – and so we don't open new stores in Q4. It's a Q3 issue. Q3 is give or take in the same range as last year. This is really a Q1, Q2 story in terms of the year-over-year changes.

Operator

Your next question comes from Christine Augustine - Bear Stearns.

Christine Augustine - Bear Stearns

Thank you. Could you please discuss where you're seeing any inflation, if you are, at retail and then also on the cost side the big items like payroll or medical costs?

Just so I can understand better the gross margin improvement in the first quarter, you had lower markdowns. Could you discuss what impact, if any, you're still seeing from the $4 generics and how that might be affecting the gross margin? Thank you.

Gregg Steinhafel

The inflation as it relates to the general merchandise business is primarily concentrated in the food categories right now and to a lesser extent some of the resin-based products or commodity products like paper, but we've seen some fairly aggressive increases in food, whether it's citrus products or related to corn and wheat-based products, that is having a pretty meaningful effect.

Doug Scovanner

I would follow-up, add the comment that if you look at the first quarter analytically adjusted for those financial reporting issues that I've talked about before, gross margin net-net analytically up maybe 15 or 20 basis points, more than 100% of that driven by markdown favorability due to excellent inventory controls coming into and throughout the quarter. Partially offset by mix and other adverse mark up factors.

Gregg Steinhafel

$4 generic impact really has a negligible effect on total company performance but within that business unit itself obviously is putting strain on the margin rate within our RX and pharmacy business group, but we are getting substantially more new guests and new prescriptions both on the generic side and on the branded side. Because we have the capacity within our stores to handle those increases in script volume, we're not incurring any levels of payroll expense within our stores. So we're getting the benefit of increased traffic at a lower margin rate, but we're getting the offset of that is new prescriptions and greater sales of OTC and other products throughout the store.

Christine Augustine - Bear Stearns

Just on the cost side, Doug, I'm just wondering about some of big line items. Are you seeing any variation versus how you'd planned?

Doug Scovanner

On balance nothing significant relative to our plans. We remain in a situation where there are, of course, a lot of inflationary inputs into our expense base, and it remains critical to delivering our P&L for us to be able to engineer improvements in productivity in our stores, in our distribution centers, and elsewhere to be able to control expenses as a percent of sales. But nothing significant compared with our expectations when we came into the year.

Operator

Your next question comes from Greg Melich -Morgan Stanley.

Greg Melich - Morgan Stanley

Two questions. First, Doug, what's the change in CapEx versus what you had planned at $300 million? What's it actually going into? Then Gregg, could you talk a little about sourcing and particularly how these things rumbling in Congress in terms of protections in China could influence how you think about sourcing into next year?

Doug Scovanner

On the CapEx side, this is nearly exclusively a new store story. Some of it has to do with timing. But importantly some of those timing issues are '07 versus future spending, very specifically in the first quarter.

For example, we acquired some fairly expensive pieces of land that will be developed to be new stores opening in '08 and '09 as part of our ongoing store program and collectively, we think those timing issues will drive an additional $300 million net for the year. As an aside, we also acquired in the quarter's CapEx in an unplanned sense, if you will, a piece of land underneath an existing store a very high volume, very high profit store that was sitting on leased land where the lease would expire long, long before the value of that store could be fully realized. By acquiring the land underneath the store, we have now ensured our ability to continue to run that high volume, high profit store for many decades to come.

Gregg Steinhafel

As it relates to your question on China, no one really knows what's going to happen as it relates to China, but whatever does happen it will affect all of us basically the same. We don't believe our exposure is any greater than any other retailer. We have been committed to a very balanced import and international sourcing network for some time with key offices and manufacturing centers in other parts of the world. We will adjust accordingly if there is some legislation or some change that would impede our ability to continue to do business the way we're currently doing it in China.

Greg Melich - Morgan Stanley

Doug, if I could follow-up on just the CapEx, how much of your stores now do you actually own the land underneath? Is it still 80% plus? Is that going up?

Doug Scovanner

I wouldn't say that it's going up and we lay out the detail in the 10-K, but it's in the range that you're describing. A lot of our new store development in heavily populated areas is development that takes place with owners who want to be leasors and not sellers. So we end up having some fairly expensive leases. That 80% ballpark is a good rule of thumb moving forward. That land that we purchased under a store that we currently owned was a terrific thing for to us to be able to accomplish this quarter. We won't see the benefits for many, many years to come but it will allow us to continue operating that store which is located in a densely populated area of Southern California for many, many decades to come.

Operator

Your next question comes from Virginia Genereux -Merrill Lynch.

Virginia Genereux - Merrill Lynch

I see the Archer Farms ads on television. Are you advertising the food more and if so, could that be impacting some of the sales mix shift you referred to?

Gregg Steinhafel

I wouldn't say that the Archer Farms campaign would in and of itself drive the incremental food sales to the extent that we are seeing overall food sales. That is our branding campaign and an image campaign and a positioning campaign to really establish Archer Farms as a signature national brand, an important component of our long-term strategy to build our own brands. Typically, our broadcast campaigns are not going to drive short-term sales in any given category. It's more long-term brand building image conscious and awareness kinds of equity we're trying to create through our broadcast campaigns.

Doug Scovanner

Beyond that, if it does drive guests to the store to buy Archer Farms, all the more delightful, but it’s a rare basket analysis that contains Archer Farms products and nothing else.

Virginia Genereux - Merrill Lynch

I guess I'm asking, is more of the ad budget going to food?

Gregg Steinhafel

As our presence in food increases, I mean, we are evolving and we are giving more space in our circular. We are committing somewhat more of our broadcast to the food business. It is not in a disproportionate sense by any stretch of the imagination, it's just part of our evolving campaign to focus on key priorities and segments that we believe are important to us and mix shift. Sometimes it's going to be on food. Next season we'll shift the emphasis. It'll be on home. Then we'll rotate that on apparel. It just happens to be this time of year we're focused on food.

Doug Scovanner

But I think it's important to clarify, we don't lead sales mix changes with advertising emphasis. We follow along the way what our sales mix is trending toward and obviously in the case of Archer Farms, a very, very well respected brand, very high quality, our guests love it, and of course we find it logical to advertise it.

Bob Ulrich

Also as Gregg has mentioned in the past, we're working hard to develop more frequent visits by our guests and food is an important part of that strategy, plus we have right sized our stores and plus our new stores and remodels have a larger concentration of food as grocery becomes more important, not just at Super Target but across the chain, so this is an anticipated mix change.

Virginia Genereux - Merrill Lynch

Doug, the interest expense was up $5 million year-over-year and the net debt was up almost 19%. You always come in a little lower than I forecast interest expense. Was there anything in the quarter and I don't know if your mention of the telephone excise tax refund where that might have fallen?

Doug Scovanner

Specifically telephone excise tax refund was a credit to SG&A expenses. It's one of the reasons that our SG&A was so favorable during the quarter. But specific to interest expense, a couple of comments. First of all, I would expect the year-over-year increase in interest expense to be larger moving forward than it was in the first quarter fundamentally due to weighted average debt balances.

One of the drivers of that of course was a significant amount of share repurchase activity in the first quarter. Separately, as a direct result of the CapEx activity, our year-over-year reduction of gross interest expense before arriving at the reported figure due to capitalized interest was meaningfully higher in this year. Be happy to go offline with you and talk about individual elements if you'd like to build a more robust interest expense model.

Virginia Genereux - Merrill Lynch

Then on the credit card business, you're saying yield depends on where cash write-offs go. But if you know what the bankruptcy legislation and the minimum payments dynamic were, Doug, in terms you said there's a layer of higher cash write-offs related to those, then two things. Isn't then delinquencies the leading indicator of cash write-offs and if they're coming down, write-offs have to come down? Or if they're stabilizing, write-offs will come down?

Doug Scovanner

Delinquency rates are a very useful leading indicator of future write-offs, but by no means are the only factor that we need to look at to determine the magnitude and the timing of future write-offs. Net-net I remain very optimistic about the prospects of our credit card operations to continue growing assets, receivables, at a double-digit annualized percentage and to continue to generate industry-leading levels of profitability.

Virginia Genereux - Merrill Lynch

In terms of the flow of EPS over the year, you said the Street's at 3.60, that's 12% growth. EPS grew almost 20% this quarter. It sounds like most of the expense unfavorability relative to the first quarter hits in Q2, Doug, is that right? I'm asking this because at the end of February, we were at $0.74 or whatever. We took it down based on some of your commentary then. Is it July where you'll see most of this expense unfavorability?

Doug Scovanner

Well, a couple of comments to try to address this issue as closely as I can. We're certainly going to stop short of providing specific, quantified EPS guidance by quarter. But as we look forward, as I mentioned earlier, 3.60 a share, the current median First Call estimate remains inside the range of what we think are the right kinds of likely outcomes for the full year. That obviously means in light of the growth in first quarter earnings that we don't expect earnings to grow, EPS to grow at the same rate for the balance of the year that it grew in the first quarter.

As I look at the pattern in First Call of Q2, Q3, Q4, that pattern doesn't look awkward or uncomfortable from my standpoint. It looks responsible. But obviously, a mechanical addition of current Q2, Q3, Q4 estimates together with what we earned for Q1 would add up to more than the 3.60 that we've been discussing.

More of the expense items will turn around for among those that will turn around, more will turn around Q2, Q3 than in Q4 but I would certainly observe that we enjoyed a very strong EPS performance in the back half of last year and those represent taller hurdles and that's one of the reasons why I think it's perfectly responsible for sharper, stronger earnings growth in the front half of this year than the back half.

Additionally, we have talked quite a bit before, and you and I have personally talked about the effect of the 53rd week last year. That specifically added some EPS last year that won't be repeated this year.

Operator

Your next question comes from Dana Telsey - Telsey Advisory Group.

Dana Telsey - Telsey Advisory Group

Good morning, everyone. Can you please talk a little bit about private label penetration and food and in other areas, where you see that going, what the opportunity is, what you're seeing on the $4 generics program? Also, anything and any progress on the consumer electronics area and your response to that? Thank you.

Gregg Steinhafel

Our private label penetration in food, we ended 2006 at approximately a 15% penetration rate and we expect to add between 200 and 300 basis points per year for the next two or three years.

As it relates to the $4 generic, I mentioned we're seeing excellent growth in the scripts, it's putting pressure in our margin rates. Overall, we're very pleased with how that mixes out in the end with new generic and branded scripts coming our way. Slight pressure on the margins but greater mix and traffic flow went into our stores.

The consumer electronics business reset at the end of April. We had a strong first quarter in consumer electronics. The business is healthy. As we head into the second quarter, we're seeing good growth in video games, in portable electronics and in obviously flat panel televisions and a handful of other categories and overall we expect it to be a decent year.

Operator

Your next question comes from Neil Currie - UBS.

Neil Currie - UBS

I just wanted to ask the same question a different way from previous questions. Just to categorize your thoughts on the first quarter, maybe adjusting for some of those different timings of SG&A expenses, would you say that the first quarter came in line with what you expected at the start of the quarter or maybe better than where you expected or maybe even in line, despite a weak or early April? Is there any color you can give on that?

Doug Scovanner

Yes. I mentioned earlier in my prepared remarks that in both our core retail operations and in our credit card operations our results were modestly higher than our expectations coming into the quarter.

Neil Currie - UBS

So I presume therefore if we had a better April, maybe even better then?

Doug Scovanner

Certainly. Other than the things that went wrong, it was spectacular.

Neil Currie - UBS

The different timing of the cost that you talked about?

Doug Scovanner

I think that's called EBS, earnings before bad stuff.

Operator

You're final question comes from Peter Benedict -Wachovia.

Peter Benedict - Wachovia

It sounds like obviously business picked up since that early April but am I understanding correctly that seasonal is still on the softer side of your expectations? If so is there a regional explanation there? What can you tell us about that? Thanks.

Gregg Steinhafel

Your assessment is generally correct. We're seeing our seasonal business -- apparel, lawn, and patio, sporting goods, and related categories -- performing slightly under our expectation, but better than they did during that two-week timeframe in April and the end of March, but not quite as robust as they have been in the first two months of the year. Overall, it's respectable but not as healthy as we would like it to be right now.

Peter Benedict - Wachovia

Thanks, Gregg. One more follow-up just on that, you guys aren't planning any big price points, but is there anything that you can look below the layer and see an aversion to the higher price point parts of the store? Is that evident, or any trading down, anything like that?

Gregg Steinhafel

We're currently not seeing any of the trading down. As a matter of fact, we're pleased with the initial reads out of our new electronics set and the average transaction amount in that area is up slightly over last year. So we're seeing really no resistance from at least the technology side of our business. I really can't speak to the apparel or the home side right now but I'm not aware of any change in what our average transaction amount is in those areas.

Bob Ulrich

Operator does that conclude the people waiting for questions?

Operator

Yes, sir. There are no further questions.

Bob Ulrich

Okay. Then that concludes Target's first quarter 2007 earnings conference call. Thank you all for your participation.

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