Target Corporation Q4 2007 Earnings Call Transcript

Feb.26.08 | About: Target Corporation (TGT)

Target Corporation (NYSE:TGT)

Q4 2007 Earnings Call

February 26, 2008 10:00 am ET

Executives

Robert Ulrich - Chairman and Chief Executive Officer

Gregg Steinhafel - President

Douglas Scovanner - Executive Vice President and Chief Financial Officer

Analysts

Jeffrey Klinefelter – Piper Jaffray

Charles Grom – JP Morgan

Gregory Melich – Morgan Stanley

Christine Augustine – Bear Stearns

Mark Miller - William Blair & Company

Robert Drbul - Lehman Brothers

Neil Currie - UBS

Virginia Genereux - Merrill Lynch

Daniel Binder – Jefferies & Co.

Adrianne Shapira - Goldman Sachs

Michael Exstein - Credit Suisse

Joe Feldman - Telsey Advisory

Todd Slater - Lazard Capital Markets

Operator

Ladies and Gentlemen, thank you for standing by. Welcome to the Target Corporation fourth quarter 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 fourth quarter and year-end earnings conference call. On the line with me today are Gregg Steinhafel, President, and Doug Scovanner, Executive Vice President and Chief Financial Officer.

This morning I will provide a brief overview of our results and the current retail environment. Then Doug will review our 2007 fourth quarter and full year financial results in greater depth and describe our outlook for the remainder of the year. Next, Gregg will provide an update on key strategic, operational and merchandising initiatives for 2008. And finally, I will wrap up our remarks and we will open the phone lines for a question-and-answer session.

This morning we announced our financial results for the fourth quarter and full year, 2007. These results fell short of our expectations as a more difficult economic environment and a hesitant consumer constrained our sales growth - especially in discretionary categories - and adversely affected our overall profitability.

As we enter 2008, it seems likely that we will continue to face a challenging economic climate, at least through the first half of the year. As a result, we are keenly focused on the disciplined execution of our core business operations, continued thoughtful management of our expenses, and an unwavering devotion to deliver the excitement, innovation, design and value that consistently delight our guests.

Target is fortunate to have a powerful brand, a seasoned leadership team and a proven strategy that has successfully navigated economic downturns in the past. We are committed to improving our recent performance without sacrificing any aspect of our brand and without compromising our overall guest experience. By remaining relevant to our guests and consistently delivering on our "Expect More, Pay Less" brand promise we are confident that Target will continue to enjoy profitable market share growth in 2008, and beyond, in a variety of economic conditions.

Now Doug will review our results for the fourth quarter and full year which were released earlier this morning.

Douglas Scovanner

Thanks Bob. As a reminder, we are 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, John Hulbert and I, will be 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.

In my comments this morning I will discuss three topics, each of which has important implications for our future results. First, I will review key aspects of our fourth quarter performance in our core retail and credit card operations. Next, I'll detail our fourth quarter activity under our share repurchase authorization. And finally I'll share our outlook for our business in 2008.

This morning Target Corporation announced financial results for the fourth quarter and full year 2007. As Bob mentioned, we experienced disappointing financial results for the quarter and the year as we faced the challenge of a sharply softer sales trend in the quarter while comparing against an extra week in last years fourth quarter and fiscal year.

Some key elements of our fourth quarter performance were total revenue growth of 0.8% due to the contribution from new stores, a 0.2% increase in same-store sales, growth in revenue from our credit card operations and cycling the impact of an extra week in last year's fourth quarter.

On an equal thirteen-week over thirteen-week basis, our revenues increased 6.3% in the quarter. Our fourth quarter gross margin rate declined 53 basis points from last year. Approximately 60% of this decline was due to the impact of faster sales growth in our lower margin consumable and commodity categories. The magnitude of this mix impact is about half of our experience in the third quarter and more in line with our experience in the first and second quarters of the year. The remaining gross margin rate on favorability in the fourth quarter was driven by clearance related markdown activity resulting from slower than expected sales.

In our third quarter conference call, I commented that we had undertaken an array of initiatives to control the growth of expenses in the fourth quarter and 2008, and I'm pleased with the progress evident in our fourth quarter performance. Our expense rate in the quarter remained essentially flat to last year. This is particularly remarkable in light of our soft same-store sales and the de-leveraging impact of a shorter fiscal period this year. The single biggest driver of this performance was very effective control of hourly payroll expense in our stores. Our year-over-year improvement in this metric for the quarter was the best that we have achieved in the past five years.

Results in our credit card operations during the fourth quarter remained strong with performance in line with the expectations we outlined at the end of the third quarter. Receivables at the end of the quarter were 29% higher than year-end 2007. This growth reflects many factors, including the impact of last summer's actions in which we offered higher limit Target Visa Cards to another group of our better and best credit quality Target Card guests. In addition, our current receivables balance reflects the impact of an industry-wide decline in payment rates that began in the third quarter.

Our write-off in delinquency metrics in the fourth quarter were somewhat higher than a year ago but were consistent with the expectations we have previously discussed. At the bottom line for the fourth quarter, the contribution to earnings before taxes from our credit card operations grew 12% from $122 million in 2006 to $137 million this year. This profit growth is particularly satisfying in light of overall card industry dynamics and our shorter fiscal period in 2007.

Now let's turn our attention to our fourth quarter share repurchase activity. Just 90 days ago we announced a new $10 billion share repurchase authorization which replaced our prior program. At the time, we said that under the right combination of business results, liquidity and share price, that we would expect to complete half or more of this new program by the end of 2008. We took two large steps toward this objective during the fourth quarter. First, we purchased 26.5 million shares in the open market, investing just under $1.5 billion. This equates to a weighted average price of $54.64 per share. Next, we executed a series of derivatives transactions which are highly likely to lead to significant share repurchase activity in 2008.

I think it's useful to describe our motivation to execute in this fashion, and the range of potential outcomes that will follow as well. In December and early January, our shares fell to about $50 which represented a compelling repurchase opportunity in our eyes. Yet we recognized that it would not be fiscally responsible to aggressively pursue significant share repurchase activity until we had the proceeds in hand from our planned January bond offering. The solution we devised was to enter into a series of derivative transactions, allowing us to control the repurchase of an incremental 30 million shares, representing just under 4% of our total shares outstanding, while investing a small fraction of the cash required for an open-market purchase of this size.

We executed this by buying well in-the-money call options and we significantly reduced our cash investment by selling a like number of out-of-the-money call options. The result is that we paid a net option premium averaging $11 per share and we'll likely exercise these options in April through June to acquire 30 million shares for additional payments, averaging $39.68 per share. The effect, if any, of the options we sold would be to increase our aggregate investment to an amount $6.40 per share below the then current stock price, but only if our share price exceeds about $57 at the respective exercise dates.

As we look forward to 2008, in our core retail operations we are planning for sales growth to increase in the 8-9% range, reflecting the continued contribution from new stores and an expected comparable store sales increase in the range of 2-3%. This outlook explicitly assumes that our sales growth will be much better in the second half of the year as we begin to cycle our softer sales results of the second half of 2007.

In light of this sales outlook we think it's prudent to plan for a slight to modest operating margin rate decline in our core retail operations driven by a similar degree of gross margin rate deterioration. We are working very hard to mitigate or even eliminate this outcome, but we think it's more realistic in this environment to assume that we would experience continuing gross margin rate pressure as opposed to enjoying expanding gross margin rates.

However, very importantly, we have plans in place that should allow us to hold our growth in SG&A expenses to a high single-digit percentage increase, similar to or slightly lower than our expected growth in sales. Finally, given our assumed pace of sales growth, we expect to experience slight de-leveraging in depreciation expense which will naturally grow at low double-digit percentage pace.

In our credit card operations in 2008, we expect to enjoy continued growth in contribution to our overall earnings before taxes. Certainly, a more harsh scenario could develop. Many of you have outlined that case for us in detail. We just don't believe that case is very likely. As you know, our receivables balances grew at a very strong pace in the second half of 2007. And while the sequential growth is behind us, we will continue to enjoy the benefit of this growth on a year-over-year basis in the first half of 2008. Our EBT yields will likely remain at industry leading levels, although not likely fully achieving the record levels we set in 2007, especially in the first half of the year.

We expect delinquency rates to remain stable throughout 2008 at recent levels in the range of 4%. And our net write-offs as a percentage of average receivables are not likely to rise much above 7%. In summary, both of these core risk metrics are highly likely to remain well within acceptable ranges for our profit and investment formulas to work well.

Finally, we expect to continue to create significant long-term value by executing share repurchase under the program announced last November. And as stated at that time, I continue to expect that under the right combination of operating results, liquidity and share price, we will have executed half or more of the $10 billion program by the end of 2008. Today, I would only add the comment, that in order to execute more than half of the program by year-end 2008, we would need to enjoy reasonably good operating results during the year.

At this time, the current median first call EPS estimates for Target envision $0.73 in the first quarter and $3.56 for the full year 2008. These estimates lie within a reasonable range of potential outcomes in our view. If achieved, these projections would represent a slight decline in the first quarter as we cycle the strong start we achieved in the first quarter of 2007 and would represent about a 7% increase for the full year.

In summary, while we have clearly felt the impact of the economic slowdown in 2007 and we continue to expect a soft sales environment going into 2008 we remain confident in the strength of our underlying strategy and in our ability to get back to double-digit percentage increases in EPS in a more typical economic environment. Until that time, we remain focused on flawless execution, prudent control of expenses, thoughtful investment in our stores and systems, opportunistic share repurchase and an unwillingness to make short-term decisions that would hamper our potential for success in the longer-term.

Now Gregg will provide a brief summary of current business trends and initiatives we are planning in 2008. Gregg.

Gregg Steinhafel

Thanks Doug. As Bob and Doug have just described, our 2007 financial performance did not meet our expectations as solid sales and earnings results in the first half of the year weakened considerably in the third and fourth quarters. From a merchandise perspective, our sales in 2007 reflected a typical spectrum of relative performance. We experienced strong comparable store sales growth in our Food, Health and Wellness and other commodity categories as well as in both Electronics and Sporting Goods. In addition, we were pleased with the sales growth in 2007 in both our Ladies' Apparel and Newborn Infant and Toddler categories.

In contrast, Toys had a particularly challenging year, especially in the second half of the year, as recall related activity affected the entire industry and sales of prerecorded music and movies continued to decline in 2007. Other weak categories for the year included Jewelry and Accessories, Shoes, Men's Apparel, Domestics and Christmas Seasonal.

Throughout the year we intensified our focus on driving more frequent guest visits, delivering great value and increasing reliability across the chain. We also continued to deliver on the "Expect More" half of our brand promise by providing a constant flow of new designs and innovation throughout the store.

We continued to improve our operational performance and speed-to-market through innovation and investment in our infrastructure, supply chain and technology. In particular, we continued to strengthen our global sourcing capabilities, enabling us to shorten lead times and reduce costs while delivering trend rate quality merchandise.

We remained focused on product safety, launching new technology to improve the process of analyzing the testing and inspection results for factories making our own-brand products. We also expanded our multi-stage testing process to more categories across the store, allowing testing of our own-brand products earlier and throughout the product lifecycle.

And we remain dedicated to delivering a superior guest experience by delivering strong in-stocks, effectively managing inventory and receipts, maintaining our highly competitive position in the marketplace, and by opening new stores and investing in our existing stores through remodel projects.

In 2008, we are diligently working to drive stronger top-line growth by remaining focused on superior execution combined with continuous innovation in support of our brand. As always we will continue to make tactical adjustments in our content and pricing to address the significant near-term challenges presented by the current economic environment, particularly in discretionary home and apparel categories.

However, we will not compromise our long-term commitments to delight our guests, to deliver on our "Expect More, Pay Less" brand promise, and to continue to generate profitable market share growth and shareholder value. In support of these goals we recently launched Converse One-Star apparel in Men’s and Women’s as well as a full footwear assortment. This new brand delivers an elevated level of quality and detail at exceptional value with original and authentic style.

We partnered with leading modern home company Dwell Studio to introduce Dwell Studio for Target. Our exclusive infant and home assortment feature modern bedding, table top and infant furnishings. We are reinventing our Fieldcrest assortment by increasing the value proposition through upgraded quality fabric and exceptional prices. Next month we will expand our beauty offerings to include more natural and organic brands with nine lines from premiere brands, ranging from Dr. Bronners Magic Soap to Giovanni Organic Cosmetics.

We will continue to develop partnerships with emerging designers and introduce fresh and unique designs throughout the store such as our next goal international collection called Jovovich Hawk for Target by designers Milla Jovovich and Carmen Hawk. In accessories we will launch Subversive for Target, an eclectic array of bracelets, earrings and necklaces at an exceptional value by renowned jewelry designer Justin Giunta.

We launched three styles of reusable shopping bags across the chain providing an eco-friendly option that our guests can feel good about using on their future visits to our stores. And we will continue to be our guests' destination for seasonal businesses by offering a balance of unique trend rate offerings and must have basics for every occasion and change of season.

To ensure we are consistently and efficiently executing our business strategies, we remain focused on finding additional opportunities to leverage our world class sourcing technology and supply chain capabilities. Our continued focus on improving our product design and development process is allowing us to enhance quality and reduce cycle times while maintaining our commitment to value. In addition, we are pursuing opportunities to reduce inventory while improving in-stock levels, improving transit time and eliminating costs throughout our supply chain both domestically and internationally.

In addition, we will continue to invest strategically in new stores and our distribution infrastructure. In 2008, we expect to build approximately 116 new stores, adding about 95 new locations net of relocations and closings. Included in those store openings, in October we will open our first two general merchandise stores in Anchorage, Alaska, allowing us to serve more guests and expand our reach to this new market.

Our initial cycle of 2008 store openings scheduled in March includes 18 new general merchandise stores and 8 SuperTarget locations. And later in the year we will open our first Target-owned semi-automated food distribution center in Lake City, Florida. By asserting greater control of the food perishable component of our supply chain we will improve our food margins, better manage freshness and enable continued rapid growth of Target’s own brands in our food assortment.

Also, as Doug discussed earlier, we are keenly focused on controlling the growth of our expenses particularly in light of our current slow pace of comparable store sales. We are pleased with the progress we have made so far, but the evaluation of potential opportunities is far from complete. We remain keenly focused on making smart decisions that eliminate unnecessary expense without compromising anything that makes Target a great place to shop and a great place to work.

While the current environment creates obvious challenges, our seasoned team, winning strategy and culture of disciplined execution position us to emerge from the economic downturn even stronger than before. Our experience shapes our decisions as we maneuver through the everyday challenges but just as importantly, it gives us a perspective to remember who we need to be in the long run. By continuing to deliver a consistent Target brand shopping experience that fulfills our "Expect More, Pay Less" brand promise everyday, we are confident Target will deliver solid results in the year ahead and remain relevant to our guests over time.

Now Bob has a few concluding remarks.

Robert Ulrich

As Gregg has just explained we continue to find new ways to delight our guests and we’re intently focused on elements of our business that will drive stronger financial performance in 2008 while maintaining our commitment to provide continued long-term profitable growth. We believe that Target is well positioned to grow profitably in this economic environment and we feel confident that Target will continue to deliver substantial value for our shareholders over time.

That concludes our prepared remarks and now Doug, Greg 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 Jeff Klinefelter with Piper Jaffray.

Jeffrey Klinefelter – Piper Jaffray

First question is for Doug in terms of the guidance, that was helpful in terms of the bottom line outlook and in several of the other metrics, could you get any more specific on how you’re thinking about that balance of comp gains between the first half and the second half ? You said two to three for the year. I’m curious on how that will build through the year and what would be the drivers. Is there going to be more of a transaction size versus number of transactions at this point?

Douglas Scovanner

A couple comments to put some color around that. I think you can quite usefully model this by taking a careful look at our sales pace in ’07. The sales strength will build throughout the year and will likely be much stronger, particularly in the fourth quarter as we cycle against much weaker numbers in the fourth quarter of 2007. So the base of performance is what’s behind our comments, not some kind of macroeconomic judgment call. As to the make-up of our same-store sales performance between same-store traffic and growth in average ticket, I think that 2008 will continue a string of many, many years where the bulk of our improvement in same-store sales will likely be made up from growth in average ticket as opposed to same-store transaction counts or traffic.

Jeffrey Klinefelter – Piper Jaffray

Okay. So, Doug, you’re not making any assumptions in your plan for a rebound of traffic in the second half of the year like we’ve heard from some other retailers.

Douglas Scovanner

Well, again traffic was quite weak in the fourth quarter so I would expect traffic to be much improved in Q4 ’08 than the trend going into Q4, again having everything to do with the 2007 base.

Jeffrey Klinefelter – Piper Jaffray

Okay. Thank you and then just one for Gregg. In terms of your sourcing initiatives I know you’ve discussed recently your efforts in hard lines. You’ve done a great job in soft lines. You’re going to move to hard lines and look for opportunities for margin expansion there through TSS. Can you give us an update on that and what the margin implication may be for ’08?

Gregg Steinhafel

Well, we’re not expecting any margin expansion in ’08. As you know, we’re fairly fully penetrated in Apparel and we’re reasonably penetrated now in the bulk of hard lines categories, particularly in Home. So, the margin expansion gains in those categories, we benefited from over the last two or three years, I would say.

Jeffrey Klinefelter – Piper Jaffray

Okay. So, are there any other sourcing initiatives on the horizon that you would highlight?

Gregg Steinhafel

Well, it will be a continuation of our efforts to improve our cycle times and get greater control of raw materials in the sourcing process and do what we can to mitigate costs due to raw material input, currency issues, elimination of subsidies and things like that.

Robert Ulrich

We are looking for some market expansion there but that will be the off-set by adverse mix as we continue to expect the lower margin commodities to continue to grow at a higher rate.

Jeffrey Klinefelter – Piper Jaffray

Okay. Great. Thank you.

Operator

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

Charles Grom – JP Morgan

Thanks. Good morning. Could you, Doug or Gregg, could you speak to the composition of the inventory levels are a bit higher than we had expected and how long you expect it will take to align your receipts with the comp trends that you spoke to?

Douglas Scovanner

Well, our square footage is up 8% year-over-year. Our revenues on a constant period basis are up about 8% and our inventories are up 8%. So I am a little, confused by the question.

Charles Grom – JP Morgan

Just on the aging, I mean what’s the composition? Is it some of the Home products, is it the Apparel products, could you just give us a little bit of sense for the composition? I understand the numbers.

Gregg Steinhafel

Yeah. Our composition is excellent right now. We turned the corner into ’08 in very good shape and we have been transitioning to an all fresh in current assortments of Apparel, Home and other hard lines categories. So we feel really good about where we are, today, at the end of the first month of a new fiscal year.

Charles Grom – JP Morgan

Okay, great and then Doug, just to clarify on the call options - we received a few calls this morning - the call options that you did purchase are not included in your fully diluted share count because that would be anti-dilutive. I just wanted to make sure that was the case.

Douglas Scovanner

It isn’t that they’re anti-dilutive, it’s they haven’t been exercised so there’s no impact on our current share count or on the weighted average share count for the period’s just ended of this activity. It will lead to - in a highly likely case - to significant share repurchase in April, May and June and that’s the point in time where these transactions would reduce our share count.

Charles Grom – JP Morgan

Okay, and then last question, when you look at ’08 could you speak to your assumptions for inflation that are imbedded in the outlook that you just provided particularly in the Home area?

Douglas Scovanner

Well, we don’t have a precise and explicit inflation assumption but I would observe that in the year just ended we actually experienced modest amount of net deflation in our top-line - about 2%. Certainly there are some categories that are inflating, food products come to mind in particular, but as you know we don’t sell a lot of food compared to some of our competitors and that food inflation was more than amply offset by deflation in hard lines categories. I think electronics in particular. Looking into ’08, I believe that this equation is reasonably neutral where we continue to have some significant inflation in some categories but on an overall basis I don’t think it will be meaningful to our aggregate sales picture.

Charles Grom – JP Morgan

Okay and Gregg, would 0-4% inflation rate in Apparel seem about right relative to a year ago?

Gregg Steinhafel

I would say that sounds about right. We’re seeing some pressure there, but our best estimates at this point in time would say you’re probably in the right range with more of the pressure coming in the second half of the year than in the first half of the year.

Charles Grom – JP Morgan

Okay, sounds great. Thanks.

Operator

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

Gregory Melich – Morgan Stanley

Hi, thanks. Just a quick one Doug. What should we expect CapEx to be this year and then a follow-up on the SG&A improvement

Douglas Scovanner

We expect CapEx to increase modestly from the year just ended, perhaps in the range of $4.5 billion plus or minus. And could you be more particular on your SG&A question?

Gregory Melich – Morgan Stanley

Sure. The follow-up on that is, given the sharpness of the decline in the sales and in the traffic in the fourth quarter you’ve been able to keep SG&A pretty flat. How did you actually do that and was there anything else there that really helped SG&A? Because I guess going forward that will be a key issue to how your margins progress. So just describe how that was done.

Douglas Scovanner

Well the single biggest factor, of course, is store hourly pay roll and I think our stores' leadership teams deserve at least two or three gold stars for this kind of performance. It was particularly exciting to me in light of the fact that the cycling the extra week naturally de-leveraged this rate and in addition much harder to accomplish in a softer sales environment, as you know. But we saw this one coming. We’ve been talking about this and planning for this for quite some time and I think the performance in our store hourly labor productivity in Q4 is a great leading indicator of what’s likely to happen in 2008 as well.

Certainly, there were other factors in the expense picture, but this was the single biggest factor. In terms of other factors, we have a paper performance system here and it responded as you would expect it should and therefore we benefited year-over-year in incentive compensation as a percent of sales and in stock based compensation as a percent of sales.

Robert Ulrich

I’d like to point out that in store productivity we’ve been making major investments over a period of time as well as logistics and systems technology, and so we were able to do this without impacting the guest experience and still able to get people through the check lanes. So we project that this will continue the same way as we move throughout 2008.

Gregory Melich – Morgan Stanley

Great. Thanks.

Operator

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

Christine Augustine – Bear Stearns

Thank you. Could you give us an update on Target.com and what the growth rate was for that business in '07, and then my second question is, with regard to Home and maybe Global Bazaar specifically, or just anything generally that you might be doing that’s new in that area or perhaps, I don’t know if you might be taking a look at pricing across some of the Home categories for '08. Thank you.

Gregg Steinhafel

Our Target.com business was very strong last year and to a certain extent followed the same patterns of the store-based business. It was stronger in the first half of the year and as we got into the later half of Q3, and certainly into Q4, we saw the sales in .com soften like it did in the store. But overall they had an exceptionally strong year and delivered higher than expected levels of profitability.

With regards to your question in the Home categories; Global Bazaar, which just finished up, did very well for us. We are pleased with the performance this year. We met our sales goals and our profit goals and our sell-throughs were excellent.

Other changes that we’ve been making have been to adjust to the macroeconomic environment. So we’ve been more focused on our good and our better categories, and strengthening our assortment there and ensuring that we’re communicating our values more prominently on end caps and in our marketing vehicles.

We’ve been updating our own brands in those areas. We’ve focused on new initiatives like the Fieldcrest reinvention where we lowered some price points, added quality and some style, and some better fabrications in those areas. So it’s an ongoing evolution of trying to deliver great quality, superior value and terrific in-stocks.

Christine Augustine – Bear Stearns

Thank you.

Operator

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

Mark Miller - William Blair & Company

Hi, good morning. Gregg, following up on your last comment there, could you address the trends you’re seeing across that "good, better, best" spectrum, and can I infer from your comment that you’ve seen perhaps a little more weakness in the best categories? Thanks.

Gregg Steinhafel

Yeah, actually, we’re seeing very strong results in the good category and surprisingly strong results in the best category and there are some parts of the middle where we’re seeing weakness. So where we are very clear on what the value proposition is, we’re seeing good sales results. So we’re slightly surprised that the best is doing as well as it is and some of the better parts of our assortment are showing weaknesses.

Mark Miller - William Blair & Company

I joined the call a little bit late. I don’t know if you addressed it at the outset. But, could you, Doug or anyone else, talk about the credit card strategic review, either that process or the feedback. And then also any thoughts you could share about your real estate portfolio. Are there opportunities as you look at ownership and alternative potential value-creating transactions? Thanks.

Douglas Scovanner

First on the credit card front, as you know, we disclosed in December that this review was taking a bit longer than we had initially planned, and that we expect to be able to have something to say here in the first calendar quarter of 2008. We have not disclosed anything at this point, and from that you can clearly infer that we remain actively engaged in trying to put together a transaction that would make sense for us and for a new owner of some or all of our receivables.

So clearly this is a very live issue today and one where there clearly is no assurance of an outcome of a sale of some, or all, of the receivables, but one in which I remain personally keenly interested in trying to engineer something that makes sense for both parties.

With respect to your real estate question, as you know, we entertain a variety of proposals on all kinds of ideas designed around the theme of generating shareholder value. At the moment, I do not know of any transaction related to our real estate that would accomplish that objective. But we would certainly take a look at something. If you have anything in mind, by all means you should contact us.

Mark Miller - William Blair & Company

Thank you.

Operator

Your next question comes form the line of Robert Drbul with Lehman Brothers.

Robert Drbul - Lehman Brothers

Hi, good morning. Two questions: First, for Gregg; can you maybe comment a little bit on the current trends in the competitive environment that you’re seeing out there, and the second question for Doug on the credit side. When you talked about delinquencies and the allowances and charge-offs, can you maybe just give us a little more flavor for what your expectation is for the bad debt provision throughout 2008?

Gregg Steinhafel

With regards to the competitive environment, we have not seen a material change in the environment. It remains highly competitive with Wal-Mart being a price leader and we maintain our position of being competitively priced with them on like and identical items in the local market. So that position hasn’t changed. So overall, I would just describe it as pretty much rational and consistent to where it’s been in the past. Now, we are facing more price, more cost inputs and so we are trying to pass along those price increases in the marketplace, so we will wait to see how those shake out over the next 60 or 90 days. But overall, we think the environment is fairly consistent to what it’s been in the past.

Douglas Scovanner

Bob I’ll faithfully answer your question regarding trends and bad debt expense. But, I feel compelled to put a little color around it before we talk about that. I mentioned earlier in my remarks that we expect continued growth in contribution to profit to earnings before taxes after financing cost and all costs including bad debt expense for the year in 2008.

Singling out bad debt expense, of course it’s on the rise. It rose in the fourth quarter, and I would expect for it to remain relatively high on a year-over-year basis at least through the front half of 2008. Nonetheless, we believe we can accommodate that increase in that one cost element through a combination of balanced growth and yield management.

Robert Drbul - Lehman Brothers

Great. Thank you very much.

Operator.

You next question comes from the line of Neil Currie with UBS

Neil Currie - UBS

Good morning. Thank you for taking my question. Just the first question is about your assumptions on the economy for this year. Have you made any assumptions about what type of slow-down this is, how long it will last, and whether we will get back to the quite high sales environment or quite robust sales environment we’ve had over the past couple of years.

And then secondly, I’d like to ask a question on rising costs on aggregates and steel, whether that’s impacting your cost to build stores or whether that’s being offset by other factors like lower land prices, lower labor costs and what the net impact might be?

Gregg Steinhafel

Firstly, regarding the general economy, as Doug mentioned earlier, we are not making any major assumptions. We are primarily basing our plans on the fact that our business slowed down somewhat in the third quarter of this last year and slowed down more in the fourth quarter. And so if there is an economic resurgence that would be an upside that we are not anticipating but obviously that would be very welcome.

As far as rising costs in aggregate and steel, there are some increases there. Most of those, we are offsetting with other efficiencies as we build our new stores, so we are not seeing a major overall impact on our costs. There could be a little bit of an increase but it’s not hugely significant.

Douglas Scovanner

In particular to your question about land costs, we have not seen any decrease in the values of the kinds of real estate that would be suitable to build new Target stores.

Neil Currie - UBS

Thank you.

Operator

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

Virginia Genereux - Merrill Lynch

Thank you and good morning. Doug, if I can ask you about the margin outlook a little bit. I think you said slight to modest operating margin rate decline and most of that gross margin driven. So then, can I ask, the mix-shift pressure and any possible sort of clearance - I guess you feel that the mix-shift pressure sort of moderated this quarter was 60 bps in October, 30 bps this quarter. Is your assumption, it stays at the 30 bps and do you think you can fully offset that in the back half? Is it like your comp guidance, do you assume margins sort of are up year-over-year in the second half?

Douglas Scovanner

Well first of all, as you know Virginia, we have averaged 20 or 25 basis points of pressure on gross margin rate each year for the last decade. So the fourth quarter experience is a little bit higher than average, but by no means an outlier as a data point.

It was the third quarter and only the third quarter of 2007 that was an outlier data point on this particular metric.

So as we look forward, we expect throughout the year continued pressure on gross margin rates due to the faster growth of our lower margin commodity and consumable categories. That’s business as usual at Target.

As usual, we also have a wide variety of initiatives designed to try to offset some of that pressure. What I intended to convey in my earlier comments was that we don’t think it’s prudent to plan for those offsets to get us back to neutral or positive. We think it’s appropriate in our thinking to plan for some slight or modest gross margin rate deterioration while we continue to work like dogs to try to mitigate it or eliminate it.

Virginia Genereux - Merrill Lynch

And Doug again, can you just remind us, today, given the input, sort of, cost environment, the contributors, the key levers of improving or maintaining the gross margins are what these days?

Douglas Scovanner

Gregg, do you want to tackle that one?

Gregg Steinhafel

Well, it would be rational, competitive marketplace that accepts the price increases that we’re experiencing. And it’s managing our business appropriately so that we have our sales expectations set appropriately in our Apparel and our seasonal categories so that we don’t take excess mark-downs as we go though a tough spring season. We believe we’ve got our business appropriately planned at the right levels, so we really don’t expect to see deteriorating gross margin rates due to higher mark-down levels in the spring.

Virginia Genereux - Merrill Lynch

Great, and then just, secondly, Doug if I may, on share repurchase and the option contracts. You bought back 25 million shares in the fourth quarter. Is it fair to say, consistent with your communication, that you could utilize more than half of the $10 billion authorization, now that you’ve raised this four billion, that you're going to augment the likely option exercise with additional share repurchase?

Douglas Scovanner

Yes. To be precise, the options that we currently hold give us the right to purchase 30 million shares, exactly 30 million shares, and in addition, the likelihood of exercising those options, it is highly likely, virtually certain, that we will execute yet more share repurchase activity in the open market during 2008.

Virginia Genereux - Merrill Lynch

That’s great. Thank you all.

Operator

Your next question comes from the line of (indiscernible) with Sanford Bernstein.

Unidentified Analyst - Sanford Bernstein

Good morning. I will have two questions actually. I wonder if you could comment specifically about the massive price action we’ve seen at Wal-Mart, where it seems their implementation on price leadership has changed a little bit. Now I wonder how your business is doing during those times of massive price action, for example during back-to-school, to holidays and then the Super Bowl time. And also, I was wondering if you could comment on what might be the replacement for Mizrahi going forward?

Gregg Steinhafel

Sure, with regards to, to use your term, “massive price actions,” we wouldn’t characterize Wal-Mart’s marketing campaign of lower prices as a massive price action or really any change to their normal cadence or rhythm of going to market. They, fairly typically, have reduced prices and initiated rollbacks to the tune of a billion dollars per year as they enter seasonal time frames like Easter and back-to-school, back-to-college, in fourth quarter as we get into the holiday season. So perhaps they’re doing a better job of marketing that message. But in all practicality, what we’re observing in the marketplace is no real change in terms of the number of items they’re marking down or rolling back, or the depth of those discounts.

As it relates to Isaac Mizrahi, we’ve enjoyed a terrific five-year relationship with Isaac, and I think you all are over representing what it means at Target. It’s approximately 3% of our Apparel and Accessories business, and we really view his strength as a niche contemporary collection, and any efforts that we have had to move beyond that were unsuccessful at best. And so when the contract became renewable, we had the opportunity to, he had the opportunity to broaden his involvement with an apparel company, and we took it as an opportunity to move beyond this partnership, because we did not want to pass on higher royalty rates to a small collection business within the stores.

So we believe it’s best for both parties, and we’re focused on our GO International and our Emerging Designer strategy. And we can very easily replace these four or five racks on our apparel floor in the small section that we had in accessories and footwear with these new emerging designers, which frankly have been very successful, and we've got a terrific portfolio of new emerging designers coming on-stream this year, which we'll share with you as the year progresses. Douglas Scovanner

I would add to Gregg's comments regarding Wal-Mart that several of you on this call reached out to me last week after Wal-Mart's fourth quarter and full year release, seeking my comments on some facts that, if I have them straight, were passed along by Wal-Mart. I believe I was told that Wal-Mart's gross margin rate actually increased meaningfully in the fourth quarter, and that separately, I was told that it's a fact that Wal-Mart's advertising and marketing expense in the fourth quarter increased faster than sales. If those are facts, they clearly are not consistent with the notion of some kind of massive price action. Unidentified Analyst - Sanford Bernstein

Thank you. OperatorYour next question comes from the line of Dan Binder with Jefferies.Daniel Binder – Jefferies & Co.Hi, good morning. Two questions; I'm just wondering if you could describe to us a little bit about the controls that you're putting in place to maintain the consistency in the store experience while you're cutting the payroll to adjust to the environment. And then secondly, on the credit card, maybe to address an earlier question, I was wondering, Doug, if you could give us an idea of what the reserve as a percentage of period-end receivables should look like as we trend through the next year. Robert UlrichIn terms of consistency of store experience, as I mentioned, and we have made major investments in logistics and distribution, we have better flow of merchandise to our stores, we have better technology in terms of scheduling our people, there are a wide array of things that allow us to pull down those hours and still deliver a branded experience for our guests and get them through the check lanes. Douglas Scovanner

In terms of your question about looking forward on the allowance as a percentage of receivables, here at year-end of course it's 6.6%, there is some seasonality to that figure, but I would not expect it to change meaningfully as we move through 2008, with the sole exception of normal seasonality that makes some quarters naturally higher and lower than others.

Daniel Binder – Jefferies & Co.

Would you (place) a range of let's say 6.5-7%, does that seem reasonable?Douglas ScovannerWell, part of what you're asking me to predict is what will the credit quality of the portfolio look like 12 months out, and clearly looking across the credit card industry, a lot of people misjudged that one when viewed from 12 months ago, so I think the range needs to be somewhat lighter than what you've just talked about, but generally centered around our current experience. Daniel Binder – Jefferies & Co.

Okay, and then finally on the receivables growth, how should we think about that receivables growth, and when we move beyond the first half of this year, does it go back to perhaps a rate that's more in line with sales. What are you doing to change that behavior, if anything?Douglas ScovannerWell, I mentioned in my earlier remarks that the significant growth in a sequential manner is behind us. That means that as we move through the front half of 2008, the portfolio is not going to be growing even in line with sales on a sequential basis, but year-over-year, at least for the front half of the year, is virtually certain to exhibit growth in average receivables sharply ahead of our pace of sales growth. It becomes a bit more speculative as to what might happen in the back half of the year, because as you know, one of the key drivers this year is that we converted, or offered to our guests, the option to convert a very substantial number of our Target Guest Cards to having the higher credit limits and greater utility of Visa cards.

We'll make the judgment call later in 2008 as to whether we'll have a similar set of accounts or not, and if we do not, then year-over-year period-end receivables growth would likely be slower than sales, meaning that year-end 2008 receivables might not even increase as much as the 8% or 9% sales growth that I predicted earlier. So it all hangs in the balance of what we elect to do in 2008 in terms of making that offer to existing Target Card guests. Daniel Binder – Jefferies & Co.How much of that receivables growth in recent quarters has been driven by the product offering versus, let's say, existing card holders just accessing greater levels of credit or not paying down the receivables as quickly?

Douglas ScovannerMeaningful contribution from both, and there's also a cross-product, because the behavior of the accounts that were newly converted was to run out their open-to-buy to a greater extent much more quickly than similar cohorts of converted accounts in the past. So there's a macroeconomic factor at play here that affected the balance growth in both of those categories.

Daniel Binder – Jefferies& Co.

Great, thanks for the color.OperatorYour next question comes from the line of Adrianne Shapira with Goldman Sachs.Adrianne Shapira - Goldman SachsThank you. I was just hoping you could provide a comment of the owned food DC in Florida. Could you just update your thoughts in terms of self-distribution in food, the time frame, margin implications and perhaps the pace of private label penetration there? Gregg SteinhafelWe are evolving our supply-chain network in food, and as we've discussed, we are in the process right now of converting our first Supervalu food facility to a Target-dedicated facility. We'll open Lake City in the balance of the year. We will convert another Supervalu facility in the early part of '09, and then open a second Target-owned facility in the later half of '09. So we will have a hybrid network for the foreseeable future where we have both a dependence on our own facilities and a reliance on both Supervalu and our other wholesaler (CNM). So I would expect that over the next three or four years this would continue to evolve, and it's unlikely that we would handle all of our own perishable food distribution within a time frame earlier than four or five years. We believe that there is some gross margin upside in this type of conversion and so far, we are experiencing the levels of gross margin upside that we anticipated and expected when we made this investment in additional capital in our own facilities. So we're seeing the right kinds of offset to make the economics work. We've talked about adding about 200-300 basis points of owned brand food penetration on a per annual basis, and that's exactly what we experienced in '07, where we moved from about 15% or so, to just over 18% with the year-ended, and we will be into the 21%-ish range by the end of '08. So we remain committed to adding 200-300 basis points per annum.Adrianne Shapira - Goldman SachsGreat, Gregg, and this hybrid network shouldn't accelerate the pace of that penetration?Gregg SteinhafelNo, it won't accelerate the pace of our penetration at all. We think 200-300% is the appropriate level, and it's more dependent on how fast we initiate our own network versus using an outside third-party facility. Robert UlrichThe outside third-party facilities are also very capable of carrying our owned brand products, so that really isn't going to be different. Adrianne Shapira - Goldman SachsThank you. OperatorYour next question comes from the line of Michael Exstein of Credit Suisse.Michael Exstein - Credit SuisseGood morning everyone, two quick questions for you. One is, you have begun to emphasize, it appears, larger screen TVs and so forth, and how much of that is impacting your margins and what are your plans for that category? And secondly, traditionally it's been a very tough balance for you all to balance between the fashion image and the price image. I'm wondering what your surveys are telling you about your pricing image with the customer, whether you're getting more traction with it this go around in the slowdown or not. Thank you so much.Robert UlrichOur research says that our pricing image is pretty much the same, and you have to recognize that there are some differences in certain categories - commodities, consumables, obviously, to get to looking for prices that are right on Wal-Mart's on like or similar items, as Gregg has said. In other categories, because we offer more fashion and more quality, the costs are higher, so the guests feel that, yes, we are higher-priced in categories like ready-to-wear, but they strongly prefer to shop there because they recognize the improved fashion and quality. Gregg Steinhafel

With regards to your question on LCD or flat panel television, we're really not expecting a change in our gross margin rates. What essentially this is, is a conversion from analog to digital technology, and the gross margin differential in both the analog and flat panel LCD plasma technology is about the same when you fully allocate all the expenses and the competitive position of the marketplace. So there isn't going to be a material change there. Michael Exstein - Credit SuisseThanks a lot. OperatorYour next question comes from the line of Joe Feldman with Telsey Advisory. Joe Feldman - Telsey AdvisoryHi guys, just a couple of quick ones. Can you comment on the regional trends through the quarter and any changes that you've seen throughout the quarter? We've been hearing more, obviously Florida, California have been weak, but we've heard it's really spread throughout the country, and wondering if you're seeing that as well. Robert UlrichWell, obviously the fourth quarter was softer than the third quarter, so on a macro basis, that's true. But there are certain parts of California, central and southern, and Florida, that would stand out in our minds as generally the weakest in the overall country. Joe Feldman - Telsey AdvisoryAnd then, also with regard to the call option that you guys are doing, or options; are there any tax benefits to doing that versus than just simple open market purchases?Douglas ScovannerNo, these are transactions in our own equity, and therefore there are no income tax implications to these transactions. This was simply a method to be able to capture the terrific benefits of share repurchase at a moment in time where we thought it would be imprudent to devote $1.5 billion of capital because of liquidity considerations. We had the ability to access the capital, but it would have rebalanced our risks in a way that we think would be inappropriate for an issue or with the kinds of credit ratings and profile that we have. Joe Feldman - Telsey AdvisoryAnd then one last one. We had heard that you guys are going to start maybe testing some new prototypes, maybe later this year or even in '09, and we're just wondering if you could make any comment on that, and what might be different about the stores that you're looking towards.Robert UlrichWe update our existing prototypes on an ongoing basis. We have evolutionary change in virtually every cycle of new stores, and then about every fifth year, we have a more substantive change. And the last major prototype initiative was in 2004, so we've been focused on our prototype evolution for end of this year and early '09, as we're just essentially calling it our '09 format. So it will be more evolutionary in nature compared to our '04 format change. And essentially the difference is, again, in slightly enhanced food presentation, we're making some architectural element changes, some visual element changes, but overall I would just basically tell you it will be a better version of the existing formats that you see today. At this point in time we have a chance for one more question from another analyst before we conclude the conference call.OperatorAnd your final question comes from the line of Todd Slater with Lazard Capital Markets.Todd Slater - Lazard Capital MarketsJust as to what thoughts you might have or be giving to the concepts of any international penetration. Thanks.Robert Ulrich

As we've mentioned in the past, we still have an outstanding ability to well over double our sales in the US, and could potentially, virtually double our square footage, so we have very, very strong growth available here. We continue to monitor an international situation, and we feel we will be there at some point.

One could also look at the international situation and say that as Target is more focused on better-educated and more affluent higher demographic level guests, it would serve us well to be into some of these major emerging markets as they develop a stronger middle- and upper-middle class. So foreseeable future, still here, but monitoring externally - eventually we'll be there.

Todd Slater - Lazard Capital MarketsThank you.Bob UlrichThat concludes Target's fourth quarter and year-end 2007 earnings conference call, and thank you all for your participation.OperatorLadies and gentlemen, this concludes today's conference call. You may now disconnect.

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