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Target Corporation (NYSE:TGT)

F2Q07 Earnings Call

August 21, 2007 10:30 am ET

Executives

Robert Ulrich - Chairman, CEO

Douglas Scovanner - CFO

Gregg Steinhafel - President

Analysts

Deborah Weinswig - Citigroup

Mark Husson - HSBC

Gregory Melich - Morgan Stanley

Christine Augustine - Bear Stearns

Jeff Klinefelter - Piper Jaffray

Charles Grom - JP Morgan

Virginia Genereux - Merrill Lynch

Adrianne Shapira - Goldman Sachs

Peter Benedict – Wachovia

Bob Drbul - Lehman Brothers

Mark Miller - William Blair

Jack Balif - Midwood Research

Chris Brown - Banc of America

Presentation

Operator

Welcome to the Target Corporation’s second 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.

Robert Ulrich

Good morning. Welcome to our 2007 second quarter earnings conference call. On the line with me today are Gregg Steinhafel, our 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 second quarter 2007 financial results and describe our outlook for the fall season 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 our financial results for the second quarter of 2007 and we are pleased with our performance. We continued to gain market share, growing our total sales by over 9%. We further expanded profit margin as EBIT grew 11.8%. Through slower growth of net interest expense and meaningful share repurchase, we leveraged this EBIT increase to fuel growth in earnings per share of 14.0% and we continue to strategically invest in our business opening 42 new stores and one new regional distribution facility.

Through the first six months, our comparable store sales reflect this year’s economic environment and a somewhat more cautious consumer, with year-to-date comparable store sales up 4.6% aided by sales at Target.com, compared with last year’s 4.9% base, excluding online sales. Our outlook for the remaining two quarters of 2007 and for the year overall envisions that Target will continue to generate a mid single-digit increase in comparable store sales as a our guests continue to find more reasons to shop at Target more often and to spend more on each visit. In addition, we expect both our new stores and our credit card operations to remain meaningful contributors to our overall earnings.

Reflecting our significant investments in sourcing, product development and supply chain which reduce merchandise lead times to ensure a constant flow of great design at exceptional prices and enable us to react quickly to short run variability in our pace of sales, we believe that Target is well positioned to continue to gain profitable market share growth for a long-time to come. Now Doug will review our results for the second quarter, which were released earlier this morning.

Douglas 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. Following our prepared remarks we will conduct a Q&A session; and Susan Kahn and I are available throughout the remainder of the day to answer 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 second quarter of 2007, which met our expectations for growth in both our core retail and our credit card operations. Let’s review some of the highlights of the quarter in more detail. Total revenues grew 9.5% to $14.6 billion, fueled by the contribution from new stores, a 4.9% 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, while our expense rate increased by 44 basis points. 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, the magnitude of our gross margin rate favorability and expense rate increase on our retail EBIT margin would each have been about half of their reported amounts without these reporting refinements.

Our credit card operations also continued to deliver strong profit performance. Average receivables grew 13% from a year ago, and we produced a 34% increase in credit card contribution to earnings before taxes. On an annualized basis, our credit card contribution to EBT as a percent of average receivables was 9.7% this year, up from 8.2% a year ago. This larger than normal yield increase was driven in part by the beneficial impact on late fee income of conforming the terms on all of our portfolios to the typical industry practice of tiering the late fee amount based on balances and a 25-day grace period.

Overall, our earnings grew at a solid double-digit pace. Earnings before interest and taxes or EBIT rose 11.8% to nearly $1.3 billion compared with just over $1.1 billion in the second quarter of 2006. Net earnings increased 12.7% to $686 million compared with $609 million last year. And diluted earnings per share grew 14.0% to $0.80 from $0.70 a year-ago.

Net interest expense in the second quarter increased $14 million from $140 million a year-ago to $154 million this year, primarily due to higher average funded balances including the debt to fund our receivables growth. Our effective income tax rate for the quarter was 38.4% compared with 38.8% in last year’s second 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%.

During the second quarter, our board of directors increased the authorization of our share repurchase program from $5 billion to $8 billion and we continue to repurchase shares of Target common stock. Specifically, we invested $476 million to buy approximately 7.5 million shares of our common stock at a weighted average price of $63.23 per share. Year-to-date through the first six months of 2007, we have repurchased just over $1 billion of our common stock, acquiring 16.7 million shares at an average price of $61.34 per share. For the program to-date we’ve now repurchased 87.8 million shares of common stock representing a little over 10% of our current shares outstanding at an average price of $50.99 per share for a total investment of approximately $4.5 billion. As a result, weighted average diluted shares outstanding in the quarter were lower than the corresponding figure last year by nearly 10 million shares or about 1%. We believe that we will complete our total share repurchase authorization by the end of 2010 or sooner.

Now, let me turn to the balance sheet. Net accounts receivable at the end of the second quarter were $6.4 billion, 15.5% above our receivables levels at this time last year. Over the same period, we have increased our allowance for doubtful accounts by $8 million to $509 million in total, representing 7.4% of our quarter-end gross receivables.

Our balance sheet inventory position grew 5.9% from a year ago; over 3 percentage points lower than our 9.3% sales increase. Property and equipment, net of accumulated depreciation, increased $2.8 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 reinvesting in our existing stores. A portion of our year-over-year increased investment is related to timing of 2007 and future capital projects. For the full year, we expect capital spending to be in the range of 4.5 to $4.7 billion.

Now let me provide some additional guidance for the balance of 2007, and put this in perspective by teeing off of our experience through the first half of 2007. I will begin with our core retail operations. During the first six months of 2007, our comparable store sales increased 4.6% and total sales increased over 9%. For the remainder of the year, we expect our trend of mid-single-digit comparable sales increases to continue adjusted for calendar shifts. However, we expect sharply lower total sales growth in the fourth quarter due to the effect of the extra week in that period last year. We continue to expect our growth in earnings per share to be stronger in the first half of the year than in the second half of the year. This has been our plan since we first laid it out for you and it remains our plan today.

Even more precisely, as previously disclosed, we continue to expect our full year retail EBIT margin rate to remain essentially flat to 2006. In other words, in light of our modest year-to-date EBIT margin expansion, we continue to expect some modest contraction in our EBIT margins in the fall season.

On the credit card side, we expect to continue to enjoy our current strong underlying performance throughout the remainder of 2007 with receivables continuing to grow inline with or faster than sales and with delinquency rates and net write-off rates highly likely to remain within the range contemplated by 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.

Combining expected retail and credit card performance, we continued to believe that $3.60 remains within the range of likely outcomes for 2007 full year EPS. In my opinion as of today, the prospects of earnings slightly more than $3.60 are roughly equal to the prospects of earning slightly less. Consistent with this outlook, we expect our EPS growth rate for each of the next two quarters to be in the single-digits rather than in the double-digits. This performance would of course position us well to earn $4 four more in EPS in 2008.

As Bob explained, we remain confident in our underlying strategy and in our continued ability to generate outstanding financial performance in a variety of market conditions. We are confident that our proven combination of growth, innovation and disciplined execution will continue to reward our shareholders on average with double-digit percentage increases in EPS for many more 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. As Bob and Doug indicated, we are pleased with our performance in the first half of 2007 particularly in light of the somewhat more difficult economic environment facing our guests. As we look to the remainder of the year, we are planning our business more conservatively to reflect this climate, as well as the calendar impact of last year’s 53rd accounting week.

While we have incorporated this discipline into our plans here, we also are focused on creating and exploiting opportunities to grow sales and gain market share profitably, regardless of the external environment. Our plans enable the flexibility to react when those opportunities arise. Looking back at the second quarter, our comparable store sales rose 4.9%, reflecting typical growth in both guest traffic and average transaction amount.

Our sales result included better-than-average performance in women’s apparel, electronics, and non-discretionary categories like health and beauty, pharmacy and consumables, while sales in categories such as footwear, music and movies, intimate apparel, and lawn and patio were weaker than average.

During the second quarter, we continued to expand our store base opening a total of 42 new stores, including 32 general merchandise stores, and 10 SuperTarget locations. Net of closings and relocations, these openings bring our total store count at quarter-end to 1,537 stores in 47 states, including our first ever three level sales floor location in Glendale, California. In October, we will complete our store-opening program for 2007 with the addition of 43 new general merchandise stores, and 18 new SuperTarget locations.

Considering the economic challenges currently facing all of retail, the strength of our second quarter financial performance reinforces our confidence in our strategy and our Expect More, Pay Less brand promised to our guests. We have established a strong bond with guest by satisfying their wants in needs and delivering exceptional value through our unique, guest-focused store experience. By delivering both reliability and newness throughout the year, we give our guests more reason to shop at Target more often and to buy more on each visit.

During the second quarter, for example, we debuted Patrick Robinson and his Greek-inspired fashions in GO International, and in July introduced unique styles and looks in a collection called Libertine by Cindy Green 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 televisions. About three fourth of this space is devoted to flat panel and specifically LCD technology. We extended our limited engagement strategy to women’s accessories, adding a collection of handbags, clutches, and wallets, which showcase metallic skins and oversized jewels from award-winning handbag designer Devi Kroell. The second quarter marks the beginning of Target’s new online photo partnerships with Shutterfly and KODAK Gallery.

Across categories during the quarter, we maintained strong impacts while controlling receipts and inventory. As a result, we’ve realized significant markdown rate improvement versus last year and net in the quarter with inventory levels in very good condition. To sustain our competitive advantage and continue to delight our guests, we are launching several new initiatives in this year’s third quarter as well.

For example, we have refined our back-to-college program by improving our assortment, packaging, in-store signing and marketing, as well as enhancing our supply chain to optimize shipment quantities and timing for specific markets. Beginning this month, Target will feature a fresh, fun feminine jewelry collection by LA designer Dominique Cohen. Also this month, we are introducing a bath and bodyline from the U.K. Soap and Glory developed by Bliss Spa founder Marcia Kilgore.

In September, GO International will feature English designer Alice Temperley known globally for her ultra-feminine styles. We are continuing to refine the balance of good, better and best items in our home categories, and are pleased with the strength of recent sales trends in this part of the store. We are expanding our assortment of healthy alternatives in our food categories, and we will be featuring those products more prominently and our circular and end caps. And in electronics, we continue to extend our Sony assortment in LCD HDTV, and we expect to continue our strong sales trend in video game hardware and software, particularly in light of recent hardware price reductions.

In addition to merchandising initiatives that create excitement and drive traffic to our stores, we continue to find new opportunities for Target.com to deepen our guests’ relationships and drive both, online and in-store sales. For example, we continue to extend the in-store assortments online by offering additional sizes, colors and styles on Target.com. We continue to use technology such as, find it in a Target store and our gift finder tool to help our guests save time while driving store visits. This fall we will add more convenience with Target lists, which allow guests to create individualized shopping list for both everyday trips and special occasions. In addition, our gift registries continue to serve as a primary gift giving resource for major occasions. Close to half of all of our wedding and baby registries originate online. Finally, Target.com helps guests save time by previewing the weekly circular ordering their in-store prescription refills and uploading their photos for pickup, all on the site prior to their store visits.

These examples demonstrate the Target.com continues to grow as a part of an integrated strategy to simplifying shopping for our guests and drive both in-store and online sales. The success of this approach has the measurable. Both sales and traffic of the site continued to grow at a double-digit pace and Target.com is among the top three more specific retail sites on the Internet ahead of Walmart.com. In addition, our research shows the Target.com drives incremental store visits in in-store sales.

In our stores, to ensure that we are prepared to react quickly and efficiently in a variety of sales environments, we remain focused on finding additional opportunities to leverage outsourcing, technology, and supply chain infrastructure. For example, we continue to improve our product design and development process to enhance quality and fit and reduce merchandise lead times. We continue to develop our distribution network by adding regional and import capacity to support our growth, adding one import warehouse and one regional distribution center to our network in 2007. 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.

We know that our disciplined execution and culture of continuous improvement and innovation constitute a winning combination that cannot easily be copied by other retailers. By focusing on the store experience and anticipating wants and needs at an exceptional value, we are confident that Target will continue to remain relevant with our guests, and we will continue to deliver great results in 2007 and beyond.

Now Bob has a few concluding remarks.

Robert Ulrich

As you’ve just heard in detail, we are pleased with our overall results in the second quarter and confident in our core strategy. We believe that Target remains on track to delight our guests and deliver another year of solid growth and strong performance in 2007. That concludes our prepared remarks. Now Doug, Gregg and I will be happy to respond your questions.

Question-and-Answer

Operator

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

Deborah Weinswig - Citigroup

Gregg, you talked about planning the business more conservatively and also the economic challenges facing retail. Could you provide additional color on what you are specifically seeing with your customer as it relates to those comments?

Gregg Steinhafel

We just feel that entering the third and fourth quarter we should be slightly more conservative than our planning assumptions earlier in the year and we’re not talking about huge shifts, we’re just talking about making minor adjustments to make sure that we maintain strong in-stocks in all of our consumable and non-discretionary categories, but we’re a little bit more mindful and we manage our inventories a little more carefully in our apparel and our seasonal sensitive period and that’s really just a little slight adjustment to what we typically we do.

Douglas Scovanner

I would also point out that so far this year our same-store sales performance as reported is about three-tenths of a point lower than where we found ourselves at this point last year, but of course as you know this years figures include the beneficial effect of Target.com. So, our comps year-to-date on an apples-to-apples basis are slower than last year by nearly a full percentage point. We’re not anticipating that will soften we’re basically saying we’re at a slightly more modest pace than we were last year and we see that continuing into that fall season.

Deborah Weinswig - Citigroup

Doug you also saw -- and I understand there is the accounting adjustment -- pretty impressive improvement in gross margins; I understand there is an improvement markdown. Can you provide us some on color on that and also if there is anything else in the gross margin line we should focus on?

Douglas Scovanner

Both the quarter and year-to-date have about the same basis point improvement in gross margin rate and in both cases about half is due to those accounting refinements, but give or take 20 basis points is a genuine underlying favorability driven in the main by improvements in markdowns. We continue to experience adverse sales mix effects on gross margin rate and that of course will continue in to fall season. I would not expect that the degree of markdown improvement that we’ve enjoyed in the first half would continue; frankly that’s been our plan all along to enjoy better markdown performance in the front half of the year than the back half of the year. Combine that with the fact that over the last couple of years, our third quarter gross margin rate improvement has well outpaced any other quarter pull all of that together and clearly, I would personally be concerned about our ability to replicate last year’s gross margin rate in the third quarter. The fourth quarter is more about that extra week but third quarter I have a bit more concern about hurdling last year’s record high third quarter gross margin rate.

Deborah Weinswig - Citigroup

You spoke at the analyst meeting about the addition of in-stock team, I think in most of your stores. Can you talk about what the experience has been and what you’ve seen as a result in the store?

Gregg Steinhafel

The in-stock team that we initiated early in the year are performing very, very well. Our in-stocks consistently are at or slightly higher levels than last year and these teams are more focused on ensuring that any out is researched and dealt with on a more frequent basis than what we had experienced in the past. So rather than having our team leaders or department managers managing the house and the research process, we have a very dedicated small team in each store whose only responsibility is making sure that they get around the store on a very regular basis so that we can respond more quickly than how we have responded in the past, and so far we are very pleased with the performance of the teams.

Operator

Your next question comes from the line of Mark Husson - HSBC.

Mark Husson - HSBC

A couple of questions on the trade-off between cost price and selling price. The first one is on food price inflation. What have you seen, and have you been able to pass it through?

The second thing is currency has been all over the place, I know, you sell normally in dollars, but somebody somewhere has to pay for that stuff in local currencies. Are you seeing any change there?

Gregg Steinhafel

I will handle the food inflation and Doug will handle the currency issue as you know, there has been substantial food inflation throughout the first half of this year. We saw more of that inflation in the first quarter than we have in the second quarter, so I wouldn’t say that it has stopped altogether but it is at a decreasing pace then what we experienced in the first quarter. The marketplace has been receptive in terms of passing through those cost increases along to the consumer in the forms of higher retail so that experience has been consistent throughout the first half of this year.

Douglas Scovanner

In terms of your question regarding the inflationary pressures in imported product, you are correct in observing that there are some inflationary pressures; in our case I think it is much more of a direct impact of the dollar cost inflation in some raw materials than it is driven by the dollar exchange rate with specific foreign currencies to be clear on anything related to oil or energy directly or indirectly in dollar terms of course is experiencing some inflationary pressures. So far this has not amounted to a meaningful increase in the inflation of our imported product but it is something we carefully watch.

Mark Husson - HSBC

You have become a little bit more conservative as you were saying on the way that you have planned out the second half. Does it sort of increase penetration of direct sourcing, make that more difficult to manage the lead times or have you been able to finesse that?

Douglas Scovanner

The direct import percentage penetration that we have doesn’t really impact our ability to manage our business one way or another in the second half for the year.

Operator

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

Gregory Melich - Morgan Stanley

Gregg, could you give us little more color in terms of the markdown improvement year-over-year and what it was in apparel versus home, and particularly if you’re seeing how those two categories are playing against each other?

Gregg Steinhafel

Well, as Doug said, we managed our inventories exceptionally well throughout the entire first half of the year and we experienced markdown savings in both apparel and home with slightly greater savings in the home businesses. Our home businesses continued to gain momentum and strength, and we are in a position where we’re chasing more inventories than we are trying to get out from under categories that aren’t selling. So we are in a very, very good position there and we’ve saved a fair amount of markdowns in the second quarter, and then as Doug said, we really don’t expect that to continuing in the third quarter because of our record high levels of our gross margin performance and markdown savings of last year.

Gregory Melich - Morgan Stanley

Doug, just given the current situations in the credit markets, can you just discuss how the securitization of the receivables are going and your view of the commercial paper market?

Douglas Scovanner

Well, we do have a portion of our receivables funded via securitization transactions; that is not an ongoing process so there isn’t any liquidity-related issue in our AAA rated receivables backed securities. Separately though on the commercial paper markets, what a wonderful time to have A1, P1, F1, commercial paper ratings from Moody, Standard & Poor’s and Fitch. Because as you all aware, lower rated paper is very difficult to place at any price and when placed typically overnight at sharply higher rates. So, this is a wonderful time for us to capture the strategic and financial benefits of those short-term commercial paper ratings.

Gregory Melich - Morgan Stanley

Have you done any CP in the last week?

Doug Scovanner

Over the last couple of weeks, we have benefited from a $1.5 billion of fresh new money incoming due to a combination of two financings and therefore we have not needed to accesses the commercial paper markets, but the commercial paper markets are clearly open and available for issuers such as ourselves with a very strong credit rating.

Operator

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

Christine Augustine - Bear Stearns

What plans do you have for the fall as you begin cycling the rollout of the $4 generics program in the pharmacy area?

Secondly, have you observed any sort of trade down in the basket or any sort of skewing of what people are purchasing to more of the basic and consumables away from discretionary items? Thank you.

Gregg Steinhafel

We don’t really have any significant or major plans to do anything different other than what we are currently doing in our healthcare business, which has continued to offer $4 generics, and continued to offer great service and to build our franchise and market share in Rx and over the counter.

As it relate to basket composition and size and training down, we really haven’t experienced any meaningful change in our basket composition or our average retail per unit. So, it’s fairly consistent to what we’ve been experiencing in whole year.

Robert Ulrich

We do continue to enjoy sharply higher rates of sales growth in lower margin, typically commodity and consumable products, than in our higher margin businesses, but I think it would be a mistake to interpret that as trading down; it’s the natural way we have gathered market share for many, many years.

Operator

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

Jeff Klinefelter - Piper Jaffray

Gregg, a question for you on the category performance. Have you noticed any particular emphasis or pressure on back-to-school categories as a result of more competitive pricing from Wal-Mart and others?

Then also on home, we’ve been hearing from a number of retailers over the last couple of weeks and the home category is improving and in some cases even surprising retailers given everything is going on in the housing sector. Does it that continue to be a positive trending category for you, an improving category, and how do you see that playing out?

Gregg Steinhafel

I would characterize our back-to-school business as essentially getting off to a slightly slower than expected start in the month of July and I am not sure if there was combination of things that were happening whether was exceptionally dry and warm out that time. There are more schools that are going back later and later and that may have contributed as well as some shifts and some of the tax-free events in states like Texas and Florida. As we are moving deeper into the season, we are seeing our business perform at or better than plan, so we are recapturing some of that shortfall that we experienced in the month of July and as we reiterated on our call the other day, we are expecting August to be in the range of 4% to 6%.

As, it relates to our home business, we have seen strengthening of that business all the year so far, and part of it is due to the fact that we have struggled in that category over the last couple of years and we’ve initiated lot of assortment changes and we transitioned and as we have done that, we have seen our business improve and we have got a much stronger good, better best selection and we just made a lot of changes that have been driving that business forward. So, we have been experiencing positive momentum all spring and that continues throughout the month so far.

Jeff Klinefelter - Piper Jaffray

Doug, just one other question for you regarding our guidance. Your comment about at least $4 of earnings next year off of a $3.60 would reflect a very low double-digit earnings growth or EPS growth. Any further color you could share? Is that sort of base level expectation with the current model and what would it take for you to accelerate back up to closer to a mid-teens performance?

Douglas Scovanner

Well my exact comments were that the performance of $3.60 give or take this year would position us well to earn $4 or more in 2008. I think it’s a little premature to be giving precise 2008 guidance. We will be happy to do that once we have completed the 2007 holiday season.

Operator

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

Charles Grom - JP Morgan

On Christine’s comment earlier, Wal-Mart said last week that their consumers are trading down to more private brands from national brands, I’m just wondering, Gregg if you are seeing a similar trend there?

Gregg Steinhafel

We are not seeing a similar trend, although, I will tell you that our private brand performance in both health and beauty and food continue to outpace the category growth, but that is not a change in performance. That experience has been consistent for the last couple of years. So, we are really not seeing the same pressure that Wal-Mart is.

Robert Ulrich

Nor due our guest’s view that as trading down, this is a very important comment that, that, I know I’m repeating, but it’s worth repeating.

Charles Grom - JP Morgan

Fair enough. Doug, SG&A expenses were up, I think 44 basis points and half of that was to re-class back to GPM. Could you speak to the factors that led to that increase in the quarter?

Doug Scovanner

Well, there were a number of factors nothing really dominates the picture. I think that, I would point you to the fact that, that combining the first and second quarters, it’s really a lot of the noise in the timing issues, we’re unfavorable 6 basis points year-to-date and more than a 100% of that is those accounting refinements. So, I feel very good about where we are on an expense basis year-to-date, I feel very good about where we will land for the full year as well. Our previous guidance that we expect generally the same gross margin rate and expense rate for the year remains in tact.

Charles Grom - JP Morgan

The last one just on the credit card, when did the late fee tiering go into place and is the to 6.5% run rate as a percentage of receivables a good parameter for the next couple quarters and going forward in general?

Douglas Scovanner

During the quarter, we conformed the terms on all of our cards, previously of the majority of our cards had to tier with late fees but we were not confirmed on those tiers and we were not confirmed in terms of the timing of assessment of the late fees. So generally speaking it’s our proprietary card portfolio whose terms were pulled inline with both the tiering and the timing but late fee income that we had previously put in place in our Visa Card portfolio. I did not understand your question about the 6.5% reference.

Charles Grom - JP Morgan

Just looking at the I think it was $109 million as a percentage of the average receivables, the way we model it was up 120 basis points sequentially and higher than any run rate we have seen in the past. I was just wondering if that’s' a good run rate to use?

Douglas Scovanner

Now I understand your question. Yes a small portion of the late fee income that we have recorded in the quarter represented an acceleration a little more than 90 days worth if you will, but I think that the lion’s share of that increase will be with us for many, many quarters to come.

Operator

Your next question comes from the line of Virginia Genereux - Merrill Lynch.

Virginia Genereux - Merrill Lynch

Doug, you said that late fees will stay at this higher level going forward, is that what we should assume, which in turn helped your entire financial charge revenue?

Douglas Scovanner

Yes.

Virginia Genereux - Merrill Lynch

Is it four quarters of that, because I guess then it will sort of anniversary, but it will stay up there going forward?

Douglas Scovanner

For a while, we would expect year-over-year increases to be larger than normal, and beyond that we would continue to enjoy the benefits of this higher level of late fee income as a percent of average receivables for years to come.

Virginia Genereux - Merrill Lynch

When you say, you have a 25-day grace period, and when you disclosed delinquencies that are 30 plus days past due, how you are treating the grace period in that? Is it really 55 days past due because somebody has 55 days, they have a 25 day grace period?

Douglas Scovanner

Yes, generally you are on the right track.

Virginia Genereux - Merrill Lynch

Okay, okay, so it’s a little more. How about the allowance for doubtful accounts? Now at 7.4%, your cash write-offs are running, the 7.4 is sort of where you were in ‘04 and ‘05 but the cash write-offs are running so much lower today. Is it fair to assume that your reserve levels could also come down?

Douglas Scovanner

Its certainly possible. At every quarter end we take a very careful look at lots and lots of risk-related attributes of our portfolio on a very granular basis and develop the reserve that we think is appropriate in light of the expected future write-offs of the then current period end receivables, we’ve been doing that for many years. So, certainly it’s possible that, if our experience is favorable moving forward, you could see that in that event, you should expect to see that our allowance as a percentages of gross receivables would follow over time. It’s certainly isn’t something that is preordained by the current attributes to the portfolio.

Virginia Genereux - Merrill Lynch

Doug, is there anything that you’re seeing out there that concerns you in terms of the consumer on the consumer credit side? I noticed your receivables jumped up, they increase a little bit, just the rate of receivables growth went up to 14%, some credit analyst out there are saying that is a precursor to potentially some deterioration; people are putting more on their cards. Do you see anything out there that’s concerning to you. I know you gave us a little more disclosure this quarter with this 90 plus days.

Douglas Scovanner

Well, obviously if we felt that deterioration was reasonably possible or reasonably likely we would have reflected it in increased bad debt expense and in increased allowance in the balance sheet. So the mere fact that we report our numbers in this fashion should be a clear indicator that we have a high degree of confidence in a continued health and prosperity of our credit card operations.

Virginia Genereux - Merrill Lynch

To your point, the best indicator of your pace of cash write-offs is really these past due accounts?

Douglas Scovanner

It’s a useful shorthand; I would stop way sort of calling the best indicator.

Virginia Genereux - Merrill Lynch

We can continue offline. Thank you, that was very helpful. My second question, so my second focus was for you Gregg. You made some remarks that basically suggest you guys are better positioned maybe than a year-ago, if you do have a slowdown in sales. I just want you get you to summarize that again. If I go back to April of ‘06, retail margins were down pretty big; I mean, I feel like that was sort of a surprise to your plan. Sales as to your remarks, have been a little slower this year but that the retail margins --

Douglas Scovanner

Excuse me, I think that Gregg was just saying that our inventories are not up as much as sales are, and we are little leaner and we are very clean, and we are very well positioned to respond that we are not anticipating any further slowdown. But if you would like some more specific, maybe you can call in a little bit later with more detail.

Operator

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

Adrianne Shapira - Goldman Sachs

Doug, just following up on the SG&A point, I understand the 42 floors you opened in the quarter, if you stripped out some of that pre-opening expense, could you give us a sense of expense leverage in the quarter?

Douglas Scovanner

Even excluding pre-opening expenses, expenses deleveraged in the quarter. We had payroll and benefits running up faster than sales. Marketing expenses as a percent of sales went in the other direction, a lot of pluses and minuses, but this is not something that on a quarterly basis, we intercede to try to directly manage. We are very focused on how these numbers flow together over time, and over time both year-to-date and expected full year, very comfortable with our expense position.

Adrianne Shapira - Goldman Sachs

Gregg, you talked at the analyst meeting about conversion to the collaborative approach in an effort to collapse lead-times, increase flexibility, perhaps update us on that conversion and give us a sense if that is what is helping perhaps reduce some commitment heading into the back half?

Gregg Steinhafel

Well, that’s an on going long-term process in terms of reducing lead times, adjusting our calendars, working more collaboratively with fewer larger vendors so this isn’t something that over a two or three months timeframe we make a significant amount of progress on, but over the longer-term timeframe, over a couple of years, we expect to continue to do more business with fewer resources, providing greater levels of clarity and transparency with one another so that we can collapse lead times and run our business more efficiently.

Adrianne Shapira - Goldman Sachs

Just on the home, the repositioning on the good, better, and best is obviously sounds like its working. Could you give us an update of those efforts to perhaps reposition the intimates?

Gregg Steinhafel

We have cycled the intimate strategy of ‘06 and we believe the worst is behind us and as we enter into the third quarter we are going to start to see the intimate apparels business start to gain momentum and generate positive same-store sales growth. So, we’ve done a lot of repositioning we have transitioned through probably 80% of the assortment challenges that were facing us and we believe that as we head into the fourth quarter in particular will be 100% of where we want to be in terms of assortment and good, better, best balance and price points and things like that.

Operator

Your next question comes from the line of Peter Benedict - Wachovia.

Peter Benedict - Wachovia

Two questions. Doug, can you confirm this financial reclassification, the accounting change, that goes on for one more quarter, I think the third quarter and then it doesn’t affect the fourth quarter; is that right?

Douglas Scovanner

Generally yes. There is a trivial effect in the fourth quarter, but the significant effect that we’ve experienced for the past several quarters will continue with us through Q3 and generally be gone in Q4.

Peter Benedict - Wachovia

Are you see any changes in new store construction costs out there? I just would be interested in your comments on that.

Douglas Scovanner

Generally, speaking there are some inflationary trends in construction costs; having said that, we continue to develop a very high quality pipeline of new stores one store at a time that have preserved our going in or expected economics over time. So given our current business model, those pressures are easily afforded and preserving metrics like ROIC and EVA over time.

Operator

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

Bob Drbul - Lehman Brothers

Good morning. A couple of quick questions. On the traffic versus ticket, have you seen any dramatic changes in traffic throughout the last several months and can you give us the breakdown, the exact number during the second quarter?

Gregg Steinhafel

We haven’t seen dramatic changes and our comp store sales increase was split about evenly in terms of material traffic increases and basket size increases.

Bob Drbul - Lehman Brothers

On the SuperTarget comp versus the general merchandise store comp. Can you maybe break that down for us, as well the trends that you are seeing?

Gregg Steinhafel

They are running very, very similar to one another. In any given quarter or season, you will get it working both ways, but on average they are very close to one another.

Bob Drbul - Lehman Brothers

On the gross margin side, are there any categories that pricing is really significantly impacting your margin performance competitively from what Wal-Mart is seeing? Are they pressuring you in any specific areas?

Gregg Steinhafel

Well, we saw a slightly more aggressive positioning in terms of pricing at the beginning of back-to-school, but that was more related to office superstores rather than Wal-Mart. Wal-Mart was, in our belief, fairly consistent with their approach last year. While we have seen Wal-Mart become more aggressive in some of the top-tier branded health and beauty aids and consumables like laundry and paper goods that’s were they have taken a particularly aggressive position over the last 90 days.

Operator

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

Mark Miller - William Blair

Doug, could you provide a little more perspective on the acceleration in the receivables? How much of the growth is coming from increasing accounts relative to balance per account, and how does that trend look versus prior periods? Just the longer-term perspective on how much growth you see in the receivables, if you could talk about receivable spending, how much if it is at Target or what does the penetration look like? Thanks.

Douglas Scovanner

A lot of those relationships are very consistent, if I would single out one feature that has more recently caused our receivables growth to slightly outpace sales, it is that the growth in spending on the Target Visa card outside our store is outpacing the growth inside the store. That in large part is responsible for that slight percentage favorability of receivables growth relative to sales growth in our stores.

Generally though, we are still in the same arena, we’ve been in the past, generally about 30% of the charge activity on Target Visa cards is inside our stores and about 70% outside the stores. It would take a continuation of these trends for a long, long period of time to move the needle say to even 25/75.

Over the long term, I do expect, and we work very hard towards the objective of being able to grow our receivables inline with or faster than sales, while continuing to focus intently on the portfolio quality, in light of the core loyalty programs on this card, that outside spend is not irrelevant to us, it ends up helping our guests along the way toward earning reward certificates redeemable only in our store, and last year, we’ve redeemed certificates collectively driving a $1 billion of retail sales in our stores, a huge portion of that $1 billion represented incremental sales. So, this isn’t simply a nuisance that comes along for the ride, we love it when our guests choose to use this card more often, because they are doing it for a specific purpose.

Mark Miller - William Blair

Can you talk about the overall representation of food and consumables in the business today versus where we were last time it got rough for the consumer say five to seven years ago in ballpark terms? Thanks.

Gregg Steinhafel

We continue to focus on food as a priority, and as we’ve talked in the past, each innovation of our prototype and remodels we have expanded the footprints in the store and our commitments to the business in general. If you go back five or seven years ago, we had on average in a new store approximately 16 or 18 sides of food in a new store; a remodeled store today it would be in the neighborhood of 34 sides of food. So, we’ve nearly doubled our commitment to food over a five to seven-year timeframe.

Douglas Scovanner

As we define the categories, consumables and commodities in the aggregate represented 32% of our sales in 2006, if you turn the clock back five to seven years with an equivalent definition would have been in the lower middle 20’s; part of that is driven by the higher rates of growth in those categories, part of that is driven of course by the increased penetration of SuperTarget stores in our mix over that period.

Operator

Your next question comes from the line of Jack Balif - Midwood Research.

Jack Balif - Midwood Research

I would like to ask you about your payroll control, because it seems as though you need over 4% comps to even try to reduce it. Do you have any plans in case sales get weaker going forward to better control payroll?

Gregg Steinhafel

We control our payroll and manage our store business in a variety of economic climates and we are very capable of flexing down modestly or flexing up modestly depending upon, what the sales environment is all about. When we are operating at anything north of 4% same-store sales, we are leveraging our payroll and leveraging our expense rate and we are performing at that levels. So, we are seeing leverage on the expense side of the equation.

Jack Balif - Midwood Research

So 4% is the break point, and above 4% you get positive payroll ratios, is that right?

Gregg Steinhafel

Well, I wouldn’t tell you that there is a hard and fast rule as it relates to 4%, I mean that’s give or take; it could be in the 3.5% to 4% range, but as we grow our same-store sales that 4% or greater 3.5% or greater, we see expense leverage in our stores, in our headquarters and other expense centers.

Jack Balif - Midwood Research

I was under the impression that was not occurring in most of ‘06 and most of ‘07.

Douglas Scovanner

I think we’re trying to put too fine a point in this. Gregg has focused on payroll in-stores and in headquarters expense centers. There is a lot of other expense activity beyond these areas, I would generalized to say that for quite some time it has required something in the range of 4% to 5% to be expensed neutral and if we’re meaningfully below that. We have deleveraging and if we’re meaningfully above it you should expect to see a favorable leveraging. Of course, our same-store sales performance in the period your citing has not been above that 4% to 5% range.

Operator

Your final question comes from the line of Chris Brown - Banc of America.

Chris Brown - Banc of America

On financing, given the turmoil in the debt markets, as you look at the next six months given the buybacks and given some inventory ramp for the holidays how do you see financing your business? Do you expect to come to the unsecured bond markets, et cetera?

Douglas Scovanner

We have remain well-positioned at this moment to be able to fund ourselves for our seasonal working capital peak here in 2007, and as I stated earlier in the call, our short-term ratings in particular provide us with the foundation to enjoy ample liquidity to continue to aggressively reinvest in our business to repurchase the shares that we think are appropriate to repurchase and to continue executing our strategy over the long-term. There certainly has been quite a seachange in the fixed income markets, but we continue to have ample opportunities to access those markets to provide the liquidity to implement our strategy.

Chris Brown - Banc of America

As you look at what some of the other large companies like yourselves have done, adding a little moderate leverage to their capital structure and balance sheet, do you guys have targets per se from a ratings or a ratio perspective?

Douglas Scovanner

We don’t have any hard and fast targets, we -- as you can tell from my comments -- value our strong investment grade credit ratings quite highly, but that’s not meant to focus intently on any one particular ratio or on the precise long-term ratings that we have today.

Robert Ulrich

That concludes Target’s second quarter 2007 earnings conference call. Thank you all for your participation.

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Source: Target F2Q07 (Qtr End 8/4/07) Earnings Call Transcript
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