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Target 4th Quarter 2005 Earnings Conference Call Transcript (NYSE:TGT)

February 16, 2006

Executives

Bob Ullrich, Chairman and CEO

Doug Scovanner, EVP and CFO

Greg Steinhafel, President

Bart Butzer, EVP Stores

Analysts

Jeff Kleinfelder, Piper Jaffrey.

Virginia Genereau, Merrill Lynch

Deborah Wenzig, Citigroup

Charles Grohm, JP Morgan Chase

Bob Zerbal, Lehman Brothers

Mark Miller from William Blair

Adrianne Shakira, Goldman Sachs

Christine Augustine from Bear Stearns

Michael Eckstein with Credit Suisse

Mark Hassan, HSBC

Greg Selig, Morgan Stanley

Dan Bender from Buckingham Research

Neil Curry from UBS

David Strasser, Bank of America

Bob Ullrich, Chairman and CEO.

Thank you. Good morning and welcome to our 2005 Q4 and year end earnings conference call. On the line with me today are Doug Scovanner, EVP and CFO, Greg Steinhafel, President and Bart Butzer, EVP Stores. During this call, Doug will first review our financial results for the quarter and describe our outlook for the coming year. Then Greg will provide an update on Target’s recent business and new merchandise initiatives. And finally I will wrap up our remarks and we will open the phone lines for a question and answer session.

Now Doug will review our results which were released earlier this morning.

Doug Scovanner, EVP and CFO.

Thanks, Bob. As a reminder, we are joined on this conference cal by investors and others who are listening to our comments today live via web cast. We plan to keep today’s call to 60 minutes, including our Q&A session. But as always, Susan Kahn and I will be available to address any follow up questions you may have. Also, any forward looking statements that we make in our remarks this morning should be considered in conjunction with precautionary statements contained in our SEC filings. This morning, Target announced another quarter of outstanding financial results, concluding a year in which our sales and profitability grew well in excess of both internal and external expectations. For the 4th quarter of 2005, our total revenue grew 11.5%, EBIT grew 14.0%, earnings from continuing operations grew 15.9% and on the same basis, diluted EPS rose 18.4% to $1.06 from $.90 a year ago.

The key drivers of our EBIT growth in the quarter included a same store sales increase of 4.2%, primarily attributable to growth in average transaction amount, a slight improvement in gross margin rate, in line with our earlier guidance, a somewhat higher expense rate, reflecting lower transition services income related to discontinued operations and the effect of a planned shift in the timing of some advertising, which in conjunction with several additional factors more than offset the year over year favorability resulting from last year’s lease accounting adjustments. And, a strong contribution to EBIT from our credit card operations, reflecting continued strong underlying portfolio performance and the beneficial effect of rising interest rates on our finance charge revenue.

The combination of these factors produced fourth quarter EBIT of $1.6 billion, an increase of 14% from $1.4 billion in the fourth quarter of 2004. Net interest expense increased $17 million in the quarter from $107 million a year ago to $124 million this year, driven by higher average funded balances, partially offset by a lower average portfolio interest rate.

Earnings from continuing operations and EPS grew even faster than EBIT due in part to the net effect of several non-recurring favorable elements of our provision for income taxes. In total, these elements added about $.02 per share to fourth quarter and full year EPS, relative to our expectations for EPS and income tax rate at the end of the 3rd quarter. In the future we are likely to continue to settle tax uncertainties or refine or provision to reflect non-recurring tax events and that will affect our underlying tax rate.

Separately, based on our annual analysis of retail prices, which was completed during the 4th quarter, we experienced no inflation or deflation during 2005 and we expect no LIFO charge or credit for the foreseeable future.

Two comments on the balance sheet.

First, net accounts receivable at the end of the fourth quarter were $5.7 billion, 11.8% above our receivables level at this time last year. Over the same period, we’ve increased our allowance for doubtful accounts at a slightly faster pace, to $451 million or 7.4% of gross receivables at quarter end.

Next, our balance sheet inventory position grew 8.4% from a year ago, in line with AP growth and overall, our inventory content and levels remained in very good position.

Finally, we continued to repurchase shares of Target common stock during the 4th quarter under our aggregate $5 billion authorization. Specifically, we repurchased 5.5 million shares of common stock at an average price of $54.41 per share for a total investment of $300 million in the quarter. As a result, weighted average diluted shares outstanding in the quarter reflected a reduction of nearly 20 million shares or a little over 2% from a corresponding figure last year.

For the full year, we repurchased just over 23 million shares of common stock, at an average price of $51.88 per share, for a total investment of nearly $1.2 billion. Under the current program, we now have about $2.5 billion of remaining authorization and our recent pace of execution remains consistent with our expectation to complete the aggregate program over the next 2-3 years.

Looking at our overall balance sheet, we funded the growth in our balance sheet in 2005 through more or less equal parts debt and equity. Specifically, about a $1 billion increase in shareholder’s investment and about a $1 billion increase in debt, net of marketable securities.

Now let’s put our full year 2005 operating results in perspective and use them to provide some guidance for 2006.

As a reminder, our accounting calendar in 2006 includes a 53rd week. But this is not meaningful to our outlook for annual EPS.

From the full year 2005, our merchandise sales, our gross margin rate and the overall performance of our credit card operations exceeded our internal expectations. And, in combination, these factors allowed us to exceed our EPS expectations. Our actual EPS results from continuing operations for 2005 reflect a 31% increase over 2004 and are $.16 above the first call EPS consensus for this period when the year began.

As we plan our business for 2006, we expect that Target will continue to achieve profitable market share gains. Specifically, again we expect to invest in a group of new high quality stores which, in total, will add about 8% net to our square footage and yet again we expect o generate a 4-6% increase in same store sales.

Our outlook also reflects the expectation that we will be able to replicate our record 2005 retail EBIT margin rate, without meaningful full year changes in either our gross margin rate or expense rate.

In addition, our 2006 outlook for our credit card operations remains bright. We again expect to grow our receivables at a low double-digit percentage rate while maintaining our underwriting disciplines. And while our delinquencies and write off rates will likely increase from today’s artificially low levels, we believe we are already amply reserved for this expectation.

Finally, we’ll continue to enjoy higher yields because the vast majority of our portfolio now earns finance charges on a variable rate basis.

In summary, we expect another great year at Target. While we participate in a hotly competitive, overall US retail marketplace, which is likely to continue to grow at about a 4-5% aggregate rate, we expect to grow our revenue at 2-3 times this rate of growth.

This would again result in a low double-digit percentage revenue growth and would reflect continued market share gains. And again, we expect our EPS to grow somewhat faster than our revenue, at a rate likely consistent with our long term, average annual mid-teens percentage growth objectives.

Now Greg will provide a brief review and update on Target’s merchandising initiatives. Greg?

Greg Steinhafel, President.

Thanks Doug. Target delivered another year of outstanding performance in 2005 fueled by a 5.6% increase in comparable store sales, gross margin rate expansion of 71 basis points and a strong contribution from our credit card operation. By focusing on great design, innovation and disciplined execution of our strategy, we continue to offer differentiated merchandise and compelling value to delight our guests and profitably increase our overall market share.

Specifically, we provided newness and excitement with brand launches such as Fieldcrest, LA Looks, California Closets and Fiorucci and design collections from Isaac Mizrahi and Thomas O’Brien. Introduction of new on brand foods including Troxie and Sutton and Dodge and an entirely new post holiday presentation of global bazaar. We launched PRX and innovate new pharmacy system in bottle design; we generated increases in guest traffic with the expansion of our food offerings in Target general merchandise stores and our continued super Target store growth.

We continue to improve operational speed, reliability and consistency through advances in our supply chain and new application of technology and we remain dedicated to preserving the integrity of our Target brand by continuing to invest in our existing stores, through remodel and right-sizing projects.

During eh past year, we opened 109 total new stores in 32 states. Net of relocations and store closings, this expansion program includes 67 general merchandise stores and 22 super Target stores, representing a net increase in s.f. of 8% for the year.

In 2006, we plan to add approximately 110 total new stores and open 3 new distribution centers to support our continue growth. Our first cycle of store openings, in March, includes 24 general merchandise stores and 1 super Target.

In 2006, we also plan to continue striving to do the best for our guests, our team, our shareholders and our community by supporting programs that improve the health and safety of the local communities in which we operate, by creating a workplace that attracts and retains a team of talented and diverse individuals by demanding integrity, discipline, speed and innovation throughout our entire organization and by reinforcing our commitment to our expect more/pay less brand promise.

Reflecting these principles, several of our current merchandise initiatives combine unique design with distinctly affordable prices exciting our guests with fashion freshness and exceptional value that keeps them coming back to shop at Target.

For example, earlier this month we launched O international, a series of limited engagement apparel collections from internationally renowned designers, geared to our credit-conscious, junior and contemporary guests. The debut collection, which is available through April, features British designer Lewella Bartley and beginning in May, Target will introduce exclusive styles and accessories from Canadian born Paris Rave .

Two additional design collections, each available in our stores for about 90 days, will be launched later this fall. To compliment our indoor home assortment, our partnership with Smith and Hawken provides an exclusive line of garden accessories and décor. The collection is now available in our garden centers and next month will be in our stores nationwide.

We also recently introduced time to play, an assortment of affordably price, premium quality, European manufactured toys. Our offering includes specialty brands such as Schlenk, Educational insights and Olenhart, as well as our own brand of wooden toys called Play Wonder. In addition, we are undertaking significant reinvention in both our intimate apparel and both and body assortment.

Within our intimate apparel category, which includes sleepwear, foundations, hosiery and performance apparel, we are intensifying our focus on quality, process and the overall shopping experience. In particular, we are enhancing the quality and fit of foundations and sleepwear, delivering a more coherent, high quality fit hosiery selection with exclusive brands from industry leaders such as Lushen and package shapewear, extending our offering of performance apparel in uptrending categories such as performance swimwear, women’s field sports and rugged terrain sports. And, leveraging our in-house design and sourcing capabilities to improve speed to market, order flexibility.

Within bath and body we are launching a new collection of over 500 items for both men and women. The collection includes exclusive brands that typically only available in US and European specialty stores and a stylized line of matching accessories and cosmetic bags.

Finally, we have significantly improved our soft lines presentation and finding with the introduction of enhanced pictures in intimates, ladies apparel, men’s and kids. These new pictures allow us to more prominently display our designer brands and make it easier and faster for all our guests to make their clothing selections.

We also continue to enhance our grocery assortment within our general merchandise and super Target stores to provide greater guests convenience and drive more frequent guests visits.

At the end of 2005, approximately half of our store base contained the expanded food assortment, consistent with our key 2004 prototype format and we expect to remodel or right-size a meaningful number of additional stores in the coming years. In addition, at Super Target we plan to add more self-service deli items and more offerings including soup, sides, salads, value-added meats and desserts that make meal preparation fast and easy.

We are proud of our many 2005 achievements at Target and we are dedicated to building on this performance in 2006.

Throughout our company we are unwavering in our commitment to delight our guests with great designs, outstanding value and superior reliability. We remain focused on delivering fast, fun and friendly guest service in every store, every day.

As Doug indicated, we expect to deliver strong financial results in 2006 and believe we will continue to enjoy substantial market share gains in 2006 and for many years to come.

Now, Bob has a few concluding remarks.

Bob Ullrich.

As you’ve just heard in detail, we are very pleased at our 9overall results in the 4th quarter and for the full year of 2005. Through our continued strategic investments and unwavering focus on delighting our guests, we have delivered another year of outstanding performance.

As we look to 2006 and beyond, we believe that we can continue to deliver an exceptional shopping experience for our guests, a workplace that is preferred by our team members a supportive environment for the communities where we operate and a superior return for our shareholders. This concludes our prepared remarks and now Doug, Greg, Bart and I will be happy to respond to your questions.

Questions-and-Answer Session

Operator:

At this time I would like to remind everyone if you would like to ask a question, please press * “1” on your teleph9one. If you would like to withdraw your question, press * “2”.

Your first question comes from Deborah Wenzig with Citigroup.

Deborah Wenzig.

Good morning. With regard, I just want to make sure I correctly understood guidance for 2006. Basically you’re looking at flat gross margin rates with 2005? Is that correct?

Bob Ullrich.

Yes, that is the essence of our gross margin rate guidance. About an equal number of issues from our point of view that will effect gross margin rate in each direction.

Deborah Wenzig.

Obviously, you guys have been absolutely I’d say tremendous in terms of improvement in gross margins as a result of direct sourcing, etc. What would be the kind of offsets to that in 2006?

Bob Ullrich.

Well first of all we do expect to continue to enjoy substantial benefits year over year from direct sourcing in 2006. Although at an annual year over year pace it’s probably not as large as we’ve enjoyed on average in the last several years. The biggest issue is moving in the other direction. Our sales mix related in one form or another. An example, it’s by no means the key issue, but it’s been there for years and years, is that our pharmacy business continues to enjoy double digit rates of same store sales growth. And the pharmacy business is a sharply lower gross margin rate business than our averages. Food, obviously, is a key element in this mix as well, as we continue to add super Target stores at a much faster pace than we add general merchandise square footage and separately as we continue to merchandise more food in our assortments in the general merchandise stores, as well.

Deborah Wenzig.

Okay, that’s very helpful. And then, Greg, you talked about the fact that half of your store base now has the expanded food PT2004 prototype. Can you talk about, or if there are any differences with regard generally to traffic or transaction size or anything else you’re seeing that’s different in those stores?

Greg Steinhafel, President.

Overall, we’re not seeing anything materially different than at our other stores although then we continue to gain loyalty over time by the increased emphasis we have placed on consumable and food. Over time, they’re going to continue to generate strong returns and as we continue to right-size and remodel other stores, they too will benefit from the incremental traffic that those categories generate.

Bob Ullrich.

We do pick up a little bit in terms of frequency and a little bit in terms of size of ticket and we get a very good financial return for those right-size remodelings.

Deborah Wenzig.

Okay, great. Thanks so much.

Operator:

Our next question comes from Jeff Kleinfelder with Piper Jaffrey.

Jeff Kleinfelder.

A couple of questions. Congratulations first on a great year. In terms of the apparel business, Greg, could you talk a little bit about capitalizing on the very strong performance this year in that category? What do you anticipate learning or doing with the Go International program? Are you using that to sort of test the boundaries of where you can go with your fashion offering? Are you attempting to potentially drive in a different customer or transact apparel with a different customer? What can we expect from that? And with the success of apparel, are there any changes that you need to make in terms of the floor pad itself? Will there be an updated floor pad in apparel to sort of further highlight that category? Any differences in the service that you provide in that area?

Greg Steinhafel.

Well, we’re very pleased as you know at our apparel and footwear business in 2005 and we still think that there’s plenty of upside in 2006 in both ladies apparel, in kids and in footwear. So, we’re still very bullish. Go International is focused on the junior and contemporary guest; she’s already shopping our stores but it’s another way for us to add freshness, newness and excitement on a 90 days basis. We’re excited about it. We just launched Lewella; she’s off to a great start and we’re very pleased with her and we expect that the subsequent designer launches will be equally successful. At this point we’re not planning any major shifts in space or re-engineering of the store to expand or contract any of the businesses on the apparel floor pad. We’re very comfortable with what the share of total store space represents, but we continue to work on things like a fixture package through the enhancement fixtures we have in the stores so that we can present our assortments clear and make the shopping experience even better than it is today.

Jeff Kleinfelder.

Okay and then just a follow up on Global Bazaar. Can you talk a little bit about the performance year 2 of Global Bazaar? How it’s performing versus your expectations, what you’re learning from that and again, how you might leverage that in the rest of your home assortment.

Greg Steinhafel, President.

We have modest expectations for year 2 Global Bazaar. Our intention was to increase the sell through from year 1 and we focused on the authenticity of the product. We upgraded the assortments and we’ve slightly edited down the number of SKUs that we offer. It is not meeting our planned projections this year. We’re slightly disappointed in that the regular priced business has not been stronger than it is. But overall, it’s been still very solid and again, we expect it to … with products that are higher quality, good value priced products continue to sell in our home assortment. is important and her pieces are doing better as we have reinvented and recategorized and remerchandised our existing assortments in home we continue to see that fewer, better items within those assortments continue to sell well. So again, it’s a learning process. We’re going to continue to refine and tweak it. Not everything that we do is going to work exceptionally well, but overall we’re pretty pleased with the performance.

Jeff Kleinfelder.

Great. One last question, in terms of you comp guidance anticipation for transaction value versus traffic in the upcoming year, is that similar to this last year?

Bob Ullrich.

I’ll tackle that one. Traffic for the full year of 2005 was in the range of 2 percentage points of contribution to our overall comps. It was stronger earlier in the year, still quite positive but not as positive in the 4th quarter. And I think that our business on average over time has statistically run between positive 1 and positive 2; obviously there are some outlier years that are worse, but that remains our expectation for ’06. Somewhere between +1 and +2 in all likelihood.

Operator:

Your next question comes from Virginia Genereau from Merrill Lynch.

Virginia Genereau.

Good morning and thank you. Two questions if I may. On the negative merchandise mix, is that something you guys have been…and the margin implications of that, flat margins on the retail side this year, you guys have been facing that for a while and sort of through October your margins were up so big on the retail side. Are you assuming in the flat margins in January and sort of your expectation in ’06, are you assuming that maybe the apparel business, something else gets a little tougher for you guy? Or is it just that the rate of direct sourcing growth is slowing and you’ve got the continued negative merchandise mix. Are you assuming anything on the apparel soft line side?

Bob Ullrich.

We look forward to a strong apparel business in 2006. Ultimately, trees to not grow to the sky and we are delighted with our current mix and with our current gross margin rate performance. And I personally would be thrilled to be able to replicate our gross margin rate and our expense rate that we’re currently enjoying, marry that to a mid-single digit same source sales performance and enj0y another year of mid-teens EPS growth straight out of our long term play book.

Virginia Genereau.

You guys are knocking the cover off the ball. Was there anything Doug, sort of January versus the prior 9 months of the year? We couldn’t figure out the math. You’ve been well beating, the margins have been well beating this kind of negative mix shift of merchandise, you know, offset by direct sourcing. Was there anything in January, may I ask? And I’m new to this story?

Bob Ullrich.

This is not a January phenomenon. This is not a change in January. We, 90 days ago, talked about our outlook for the 4th quarter in these very terms. Through the full year, the 2 big contributors to gross margin rate expansion have been expanded mark ups and favorable inventory shrink. To a lesser extent there are some interesting GAAP accounting issues in the background that tend to increase year over year or gross margin rate and also increase our expense rate. And I think what I meant by my earlier comment is that there’s a pragmatic limit dictated by many things, especially the competitive environment, that we wouldn’t want to chase our mark up to a point that is going to adversely effect our ability to delivery reliable mid-single digit same store sales performance.

Virginia Genereau.

Thank you. And then secondly just on the credit margins, listening to you, you’re benefiting from higher floating rates and you’re amply reserved and you’ve had such nice expansion there. Would that not continue given that you are, even if bad debt expense increases, give that you are pretty well reserved. Would you not expect margins to continue…?

Bob Ullrich.

We expect another very strong year in our credit card operations. One clarifying comment on the effect of floating rates. As we measure the contribution of our credit card business to EBIT, floating rates are a benefit. But of course EBIT is a very strange measure for a financial services business because we do need to fund those receivables. And by and large we fund our floating rate receivables with floating rate borrowing. So increases or decreases of floating rates really don’t have much of an impact on Target corporation’s EPS but certainly do affect EBIT. As we move forward in ’06, especially in light of what has happened to the fed funds rate over time, I think we will attempt to be clearer quarter by quarter in terms of the differential between the EBIT impact and growth in our profitability in our credit card business and the actual impact on the bottom line.

Virginia Genereau.

Understood. You’ll see higher interest expense. Thank you.

Operator:

Your next question comes from Charles Grohm, from JP Morgan Chase.

Charles Grohm.

Hi good morning. Just to follow up on the credit card. Last quarter Greg, you commented that the spread between your earnings rate and your funding was about 800 bps. What was it in the 4th quarter and what are your expectations for ’06?

Greg Steinhafel.

Our fourth quarter performance was in line with that 800 bps actually a little wider, but not materially so. And I think that differential will likely remain that wide next year as well.

Charles Grohm.

Okay. And then on SG&A, could you quantify the impact from the lower servicing comment advertising expense during the quarter? I guess what I’m trying to get at is, absent those factors, what would the SG&A picture have looked like?

Bob Ullrich.

On an overall basis our SG&A rates deteriorated by 23 basis points. On a net basis, that 23 basis points is fully explained by the combination of lower transition services income and from the expected, the planned refining of our advertising expense. In fairness, we benefited in SG&A year over year from cycling the lease accounting entries from last year and there’s a rather lengthy list of relatively small items that on a net basis tended to offset that.

Charles Grohm.

Okay, great. And one last one Greg, beyond smith and Hawken could you provide some color on what else is in the pipeline, what product areas you’re going to be targeting in ’06?

Greg Steinhafel.

I mentioned the beauty reinvention and what we’ve done in toys. We’re going to work on trying to get our home business back on track and so we’ve got a lot of refinement and presentation and content and good, better, best rebalancing that we’re doing there. We’re going to continue to focus on food as strategic priority and within that, our own brand penetration of food. Like I said we’ve got Go international, intimate apparel, and other things that are smaller in nature. In every business that we operate there will be innovations and reinventions along the way.

Operator:

Your next question comes from Bob Zerbal from Lehman Brothers.

Bob Zerbal.

Hi, good morning. Two questions. First, can you talk a little about how the electronics categories perform for you? Specifically tru-tech and related to that, can you just give us an update on your hardline sourcing penetration on the direct sourcing side?

Bob Ullrich.

Electronics are very healthy. TruTech which is our own private brand of electronic products performed very well as well. We expect this year to be another very strong year in electronics with the continued advancement of digital technologies and the new gaming platforms that are coming out. Hardline penetrations in direct imports continue to grow. Not at the same rates that we have enjoyed in the past, but we still have opportunities to increase our own brand penetration or direct import penetration in hardline. Beyond our own brands, over time we will continue to work with our branded manufacturers to see if we can’t move some of our domestic purchasing through them to our direct source program with some of them. So that would be the next phase of evolution of direct importing.

Bob Zerbal.

Great. And Greg, can you maybe elaborate more in terms of any of the experiences you’re having as you probe the higher price points. Are you getting resistance in any categories?

Greg Steinhafel.

It’s really category by category. Certainly we ran a flat panel television ad pre-super bowl just under $1,000 and it did exceptionally well. So we saw absolutely no price resistance whatsoever there. In global Bazaar some of our best selling items were some of the items that were between $300-$400. So we didn’t really see a lot of price resistance there. But, there are other categories, especially when they’re within a package, like in home textiles, where periodically we do see some price resistance because they can’t touch or feel or see the product as well as they can when it’s out of package and so we have to do a better job of communicating the value and the intrinsic benefits of those products that aren’t as tactile as some of the other things that we have in the store. So our marketing message and our POS opportunities for us to just better communicate those features and benefits and why those products are priced where they are.

Bob Zerbal.

Great. Thank you.

Operator:

Our next question comes from Mark Miller from William Blair.

Mark Miller.

Good morning. Question on the P2004 stores. How man of those are now in the comp phase an how might that impact comps, do you think, as those roll in?

Bob Ullrich.

I think that’s probably a question that’s best for Susan Kahn to follow up on.

Mark Miller.

Okay. What’s your current outlook for sales distribution in food?

Greg Steinhafel.

Well, we currently are very satisfied with our relationship with super value, they’re doing a great job for us as we gain scale in food, and we add more food in our general merchandise stores and we expand the number of super Targets, we recognize that at some point in time we will move toward a more direct model of distribution. And that point in time will come in the future. We haven’t determined exactly when that will be but it is still a couple of years off.

Operator:

Your next question comes from Adrianne Shakira from Goldman Sachs.

Adrianne Shakira.

Thank you. Greg you had just mentioned earlier about the home business getting back on track and perhaps the good, better and best rebalancing. Is that the only category that needs to be addressed across the good, better and best repositioning?

Greg Steinhafel.

It’s really only some selected categories within our home business because actually, our stationary business is quite strong, our domestic business last year – we had a very good first half of the year, it softened up in the 2nd half of the year. We were pretty confident that when we transition in about 10 days that that business will be back on track. And then within the house wares and decorative home area, it’s really been a mixed bag. Our furniture business has been very strong, our decorative accessories and lighting business has been very soft. As we have remerchandised some of these categories, we’re starting to see some strength in those businesses. So as we transition those categories throughout the year, we are very confident that those businesses will start to run chain store increases.

Adrianne Shakira.

Okay. So the softlines categories don’t have any issues across good, better and best? You’re pretty clearly defined the customer gets it.

Greg Steinhafel.

Yeah we are pretty well defined there in good, better, best. We’re very dialed in. our style preferences, our internal design development, global sourcing organizations are working very well together. So the issues that we have in apparel are frankly chasing down instocks on some of our top performing categories like footwear right now.

Adrianne Shakira.

Okay. And then Doug, on the gross margin, last quarter we hear about 2/3 of the improvement in gross margin related to better markups. Could you break down the components of the gross margin expansion we saw?

Doug Scovanner.

The gross margin expansion was 10 basis points, so there are certainly issues on both sides. It would be easy for me to say that on a net basis that that kind of a benefited in the quarter from improved inventory shrinks. But there are many issues, not large ones, but many issues pulling gross margin rate in both directions; essentially 10 basis points is even with last year.

Adrianne Shakira.

Okay. And then lastly, perhaps Greg, a lot of introductions planned for this. Any changes to marketing? What should we expect this year in terms of are you going to make a big splash about some of these new lines coming?

Greg Steinhafel.

First of all, we wouldn’t comment in advance. But you know the innovation and creativity of our marketing staff and while we don’t have any mega changes and we still plan to spend relatively the same percentage of sales on marketing, we know that those people associated with our marketing will come up with some unique things and I guess we’ll just have to wait and see.

Operator:

Your next question comes from Christine Augustine from Bear Stearns.

Christine Augustine.

Thank you. Doug, as far as the expectation for 4-6% comps for ’06, do you anticipate any variation first half versus 2nd half? Just because the compares are a little bit tougher here in the first half. And I guess just even within the 1st and 2nd quarter there’s a late Easter, mother’s Day is later. Should we be looking for any variation there?

Doug Scovanner.

Well certainly month to month there will be quite a bit of variation. But there’s no big picture this year. We do not expect softer sales in the front half of the year than in the back half of the year. We do have to pay attention to what we’re comparing against. Obviously our guidance in February was a mid-single digit kind of figure. Bear in mind that we had an 8 comp 2 years ago in February and a 9 comp last year. So the cycles do matter. But big picture, perhaps it’s a little softer in the front of the year than the back end, but that’s a speculative comment at best.

Christine Augustine.

Could you provide us an update on some of the more major initiatives that you’re working on, on the supply chain side with six sigma and also could you let us know how Target.com ended the year and what the out look is for that division? Thank you.

Greg Steinhafel.

Supply chain enhancements are ongoing. It’s a lot of small refinements to technology and processes. There isn’t any major engineering that is going on but we continue to look at ways to better service our stores, take unproductive inventory out of the network, how to shorten our lead times, how to increase our speed to market. There’s just a host of initiatives directed at those kinds of activities. Target.com had a very good year as it relates to sales and the number of unique visitors to the site. We’re very pleased with how that business is scaling up. So it continues to attract many guests and the performance is solid.

Christine Augustine.

Was the growth rate better then the industry which was kind of mid 20%?

Greg Steinhafel.

It was significantly better than mid’ 20%.

Operator:

Your next question comes from Michael Eckstein with Credit Suisse.

Michael Eckstein.

Thank you so much. A couple of quick questions. One how much going to add to the earnings, do you think roughly? Secondly, you’re very heavily overweighted in terms of the west coast. announcement that they are going to enter that market. How do you think that’s going to force you to look at that market and do things differently going forward? And finally, when we do pricing studies, particularly in the Midwest, it appears that you are very aggressive on the consumables side and I’m sort of wondering what is generating that and how far you’re willing to take that going forward? Thank you.

Bob Ullrich.

I’ll take the first two. The 53rd week does not have any impact on EPS. It certainly does have interesting effects at different level of the P&L. For example, it is then a much lower gross margin rate we then average during the year; that’ll become a much more important to quantify as we move toward the 4th quarter. But even across the full year at 5-10 basis point drag on the figures. Bottom line: no real impact at all.

Tesco’s announcement in terms of the west coast is very interesting but I don’t believe it ha any particularly relevance from our standpoint. And actually, Michael, I would not agree that we’re quite that heavily concentrated on the West Coast. California is a very important state to us. But, so are Texas, Florida and lots and lots of states in the Midwest and the Northeast as well.

Greg Steinhafel.

As it relates to the pricing, we have a consistent pricing strategy across the entire US and I’m not sure what you’re really seeing in the Midwest but we are very market based, we are very focused on maintaining the appropriate prices to our key competitors by store. And there’s nothing unusual happening in the Midwest that you wouldn’t expect to see somewhere else. We’re not the price leader. We respond to what’s happening in the market place and pay very close attention to what’s happening at Wal-Mart and if there are some unique things that you’re seeing in the Midwest, it must be an anomaly in a particular store or market. But we’re focused on maintaining a competitive price versus Wal-Mart.

Michael Eckstein.

Just following up on that. How much of your guidance in terms of those margins is because you’re so on top of Wal-Mart now?

Greg Steinhafel.

That strategy has not changed. We have been focused and our pricing strategy has been very consistent for the last decade.

Operator:

Your next question comes from Mark Hassan with HSBC.

Mark Hassan.

Yes, two questions. Sorry to carry on about the gross margin but one backward looking and one forward looking. The backward looking one, after black Friday your sales seemed to get a shot of adrenaline. Was gross margin investment part of the reason why sales then picked up? And the forward looking one is really about sourcing from Asia. A couple of things you said on the call. One was that you wanted to emphasize speed to market, which is not something you associate necessarily with Asia. And also, you said you wanted to source some product from Europe, which is the first time I’ve heard that in an awful long time. Is there any kind of slackening off in the pace of growth in sourcing from Asia? Can we deduce that from what you said or not?

Bob Ullrich.

Let me take the first question and let me clarify what happened in the fourth quarter. We had some sales softness in the front half of November, but the back half of November including thanksgiving weekend, our sales fully met our expectations and for the rest of the quarter as well. Our gross margin development in the 4th quarter laid out essentially in line with our expectations, line item by line item and in the aggregate up 10 basis points is right where we expected it to be for the fourth quarter.

And we also executed our marketing and merchandising plan through the fourth quarter. We did not change or react to the shortfall in a couple of weeks. We executed our plan and come through with very strong results.

Greg Steinhafel.

As it relates to the question on sourcing, we maintain a balanced strategy throughout the globe as it related to sourcing and the countries with which we are penetrated. We are very committed to the far East, we’re very committed to central America and there are speed opportunities throughout the globe and when I’m referencing some of the speed to market things, we still have opportunities to take lead time out of the market in China and clearly when we’re doing business in Mexico or central America there is ample opportunity to certain that supply chain. And those markets in particular are very responsive for us and it enhances our ability to improve our speed to market.

Bob Ullrich.

The time for shipping and so on from China is a little longer. What we’re talking about a lot is taking time out of our development cycle, and sampling cycle and design cycle to overall shorten the time from when we want the product til when it’s delivered in our stores.

Mark Hassan.

Is there anything on the dollar exchange rate right now or quota issues that are having an effect on the realized gross margin?

Bob Ullrich.

Not really.

Operator:

Your next question comes from Greg Selig from Morgan Stanley.

Greg Selig.

Two questions. One, Doug it looks like Cap Ex finished up 10% last year. Is that the normal run rate that we should expect or were there any changes in terms of percentages of leased versus owned stores?

Doug Scovanner.

No meaningful change there. Cap Ex, you’re correct, is up about 10.4% in dollars, year over year. And I would expect Cap Ex to again be up in line with sales here in ’06, maybe even a little faster than sales. There’s obviously a little different mix of unique kinds of projects every year. Distribution centers and so forth. But we have for the last couple of years described our current relationships of Cap Ex to sales, Cap Ex to other kinds of metrics as being a fairly typical, fairly normalized set of relationships.

Greg Selig.

And you’re still finding that roughly 85% of the new sites you can own?

Doug Scovanner.

Typically, yes, but that number obviously varies from quarter to quarter, year to year, but that’s still a pretty good benchmark. And we’ll lay out all those statistics one more time in the 10K.

Greg Selig.

Okay great. And then a second question. When you gave your guidance you talked about credit being another good year for credit. I know we’ve had a big change with the bankruptcy laws that hurt you for a few months in terms of charge offs and provisions, but then could help you a lot going forward. Do you think what you saw in January in terms of your charge off rates, etc. is a new rate going forward? Or was it unusually low?

Bob Ullrich.

First of all let me clarify what happened and then I’ll comment on where we are and where we’re going. Long term, that bankruptcy change is certainly something we welcome. We had been working together with others on that for a long time. If didn’t really effect our provision rate in the short run, because we were amply reserved by and large for almost all of what occurred. We’re now in a period in the short run where we have artificially low rates of write-off and artificially low rates of delinquency, because in essence anybody who remotely thought about filing any time in the future rushed to the exit by mid-October. And so right now, we are getting kind of an echo period of a terrific benefit. As we move through ’06, that will tend to normalize back to pre-bankruptcy reform law levels or approaching those levels. So there’s a little different story for each period. Bottom line, it doesn’t affect our report profit stream very much at all because we’ve tried to very carefully build our reserves in anticipation of all of this information.

Greg Selig.

So the guidance is based on the growth of receivables and the spreads not anything to do with charge offs or provisions or anything?

Bob Ullrich.

Correct. We expect receivables to grow one more time in line with sales, give or take. No double-digit rates or growth and we expect to be able to maintain the generally 800 basis point or so spread between what we earn on the credit card business and what is costs us to fund it. And that is a terrific set of important metrics to be able to grow a business with double digit rates while enjoying that wide of a spread.

Greg Selig.

And there is one follow up. Bob I think you mentioned in a question before about shortening the supply chain and taking down the design cycle. Could you give us some information on that? Some examples? For example do you plan on increasing the number of flows of seasonal product in either apparel or soft lines as a result of this change?

Greg Steinhafel.

We have already made some of those changes where we have increased the number of sets in apparel. But as bob described, it’s really the front end of the process. It is from the time that we identify what is going into the that happens throughout that entire process. Making sure that all of that design, approval, fit, fabric, process is much shorter and tighter than it has been in the past.

Greg Selig.

Just to somehow quantify that, if now you were flowing say 8 different seasons would it go to 12 in a certain category? If you…?

Greg Steinhafel.

It’s not really about increasing the number of deliveries we’re going to have. That is dependent upon the business requirements. It’s more about for that delivery period, what’s the starting point, how long does that cycle take versus…today or in the future, how do we collapse that entire cycle from transportation production and all the up front? It’s collapsing it.

Greg Selig.

Okay so it’s about reducing mark down risk, etc.?

Greg Steinhafel.

That’s one of the benefits. If wee can wait longer before we make that product determination, we’ll have better market intelligence so we’re more apt to be quicker, because we have current reads, we know what’s selling and we can get back in to the right colors and silhouettes and styles and we can make more adjustments more timely.

Bob Ullrich.

So it benefits sales as much or more so as it affects gross margin rates.

Operator:

Your next question comes from Dan Bender from Buckingham Research.

Dan Bender.

Good morning. Just a question with all the work that you’ve done with adding consumables to the stores, is there any chance that at some point in the future that we’ll start to see what I would regard as the missing link in the food offering as you start to add a little fresh food in the core Target stores? That’s the first question. The second question was is there anything new that you’re doing in the pet supply area this year? Experimenting with new products anything like that?

Greg Steinhafel.

I’ll take your second question first. We will transition pets in another month and the majority of that non-food assortment will be updated fashion product and will be fun and unique just like it was with last year’s reinvention. Food is an evolutionary process. Here at Target we’re going to continue to focus on delivering in our stores what our guests want. And over time we’re going to continue to provide the kinds of assortments that they expect to find in our stores.

Dan Bender.

And just one follow up. What is your current cost of funding on credit?

Bob Ullrich.

The lion’s share of our credit cards are on a floating rate basis. And we fund ourselves at a handful of basis points in excess of LIBOR.

Operator:

Your next question comes from David Strasser with Bank of America.

David Strasser.

Quick question on super Target, did you say 1 super Target in March during our first opening?

Bob Ullrich.

Yeah, that’s just the way it happens if all is...it was similar last year and we opened a substantially larger number later in the year.

David Strasser.

Do you know how many you’re going to open?

Bob Ullrich.

We can follow up in detailed comments, but I’ll give you some color around that. If you look at one of the schedules to our press release we outlined kind of a year over year roll forward of store count and square footage as well. Over the past year on a net basis, our square footage grew 8%. It grew over 16% in terms of super Target s.f. and between 6-7% for our general merchandise stores. It’s a fairly typical set of relationships. It will move around a little bit, but we continue to grow super Target s.f. at a sharply faster rate than our general merchandise s.f.

Operator:

Your final question comes from Neil Curry from UBS.

Neil Curry.

Good morning. Thank you. If you take out the credit business and look at the retail EBIT, it grew about 11% in the quarter, which is half the rate of the first three quarters of the year. What were the significant factors behind that and what gives you confidence for the next 4 quarters that you’ll be able to see a retail performance closer to your long term guidance that’s for the mid-teens group?

Bob Ullrich.

At the EBIT level, this is a very instructive question, at the EBIT level we expect to grow our retail contribution in line with our revenues at a low double digit percentage rate of growth. So the fourth quarter looks rather typical in terms of what we’re trying to accomplish in 2006 and over the long term. The big difference of course is that during the first three quarters our retail business benefited from sharp increases in gross margin rate that drove retail EBIT growth at a sharply higher than 11% pace. So what you just saw in the 4th quarter is what we would love to replicate quarter after quarter after quarter in ’06 and beyond. It’s the beneficial leverage of marrying that performance together with our credit card business and across interest expense and share counts to the bottom line, where we would expect to continue to enjoy several hundred basis points faster growth in EPS than the growth in retail EBIT. That occurred in the 4th quarter, it’s in our plans for ’06 and beyond as well.

Neil Curry.

Thanks. Just a second question if I may. How much of the store base now, of the general merchandise stores, have a consumable section that is consistent with the P2004 format? And how quickly do you think you will get the rest of the chain up to that standard?

Bob Ullrich.

There are about half of our chain at this point have elements of the P2004, either through representing new stores that have been built since we adopted that prototype or through complete remodels or through some of the right-sizing projects that we’ve executed. As we move forward in ’06, each of those three categories will increase as well. All of our new stores will incorporate those elements, all of our major remodels will incorporate those elements and we intend to execute another wave, another significant wave of right-sizing as well.

Neil Curry.

Thanks and are there any anecdotes in terms of what the new models have done for the traffic and sort of average visits to the store?

Bob Ullrich.

The right-sizing we obviously continue to do because we do increase traffic and we increase transaction size and that’s all been very financially justified. And remodels, when remodels include and expansion and addition of categories like food, we get a very good return on them as well.

Neil Curry.

Thank you.

Bob Ullrich.

Okay that concludes Target’s 4th quarter and year end 2005 earnings conference call and thank you all for your participation.

Operator:

Ladies and gentlemen, thank you for participating. You may now disconnect.

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Source: Target Q4 2005 Earnings Conference Call Transcript (TGT)

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