Ladies and gentlemen, thank you for standing by. Welcome to Target Corporation's Fourth Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, February 27, 2013. I would now like to turn the conference over to Mr. Gregg Steinhafel, President and Chief Executive Officer. Please go ahead, sir.

Good morning, and welcome to our 2012 Fourth Quarter Earnings Conference Call. On the line with me today are Kathy Tesija: Executive Vice President of Merchandising; and John Mulligan, Executive Vice President and Chief Financial Officer. This morning, I'll provide a high-level summary of our fourth quarter and full year 2012 results and strategic priorities as we enter 2013. Then Kathy will discuss category results, guest insights and upcoming initiatives. And finally, John will provide more detail on our financial performance, along with our outlook for 2013. Following John's remarks, we'll open the phone lines for a Q&A session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments today via webcast. Following this conference call, John Hulbert and John Mulligan will be available throughout the day to answer any follow-up questions you may have. Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Finally, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP results is included in this morning's press release posted on our Investor Relations website. We're very pleased with our fourth quarter financial performance, which reflects outstanding execution by our team during a volatile and promotional holiday season. Our U.S. operations generated fourth quarter adjusted earnings per share of $1.65, 10.1% above last year and in line with our prior-year guidance, even though sales fell short of our expectations. Our fourth quarter GAAP earnings per share were $1.47, reflecting Canadian segment dilution that was slightly favorable to our expectations. As we previously reported, fourth quarter comparable-store sales in our U.S. Retail segment grew 0.4% compared with…

Thanks, Gregg. Though we fell short of our overall sales goal for the fourth quarter, we were pleased that we grew comparable-store sales in 4 of our 5 merchandising categories, and that we sustained our profitability in the face of choppy consumer spending and an intensely competitive environment. Consistent with the rest of the year, fourth quarter comparable-store sales were strongest in our less discretionary frequency businesses, which saw growth in the low- to mid-single digits. In both of our discretionary home and apparel categories, fourth quarter comparable-store sales increased in line with the company average and saw rapid growth in our digital channels. Fourth quarter comparable-store sales in Hardlines declined in the mid-single digit range and were softest in Electronics. Many more Electronics categories are in mature stages of the product cycle, and during the holiday season, Electronics constitutes the primary battleground where competitors engage in their most irrational promotions. In Toys, overall fourth quarter comparable-store sales were down slightly overall but increased about 30% through our digital channels. When we look back at our 2012 results, we're pleased that we also grew full year comparable-store sales in both home and apparel, while research indicated that our guests were focused on reducing discretionary spending overall. We achieved this outcome by gaining meaningful wallet share from our best guests, and our loyalty initiatives played a key role through 3 separate programs in 2012. First, our PFresh remodel program is designed to drive more trips among our core guests by offering them more convenience and the ability to do more of their shopping in a store layout they love. Second, our 5% REDcard Rewards program led our guests, regardless of their previous level of engagement, to increase their shopping frequency and spending dramatically. Our research shows that on average, REDcard guests…

Thanks, Kathy. As Gregg mentioned, we're very pleased with the performance of our business, particularly in the face of an intense holiday season promotional environment. Our fourth quarter adjusted EPS of $1.65 is 10.1% above last year and reflects solid performance in our U.S. Retail segment, combined with continued outstanding performance in our U.S. Credit Card segment. Fourth quarter GAAP EPS was $1.47, $0.02 above last year as growth in adjusted EPS was offset by Canadian segment dilution. Before I provide more detail on our fourth quarter performance and our outlook for 2013, I want to pause briefly to recap our full year 2012 performance. One year ago, in my first quarterly call with all of you, I explained our plans which should keep us on track to attain our long-range financial plan of generating $8 or more in EPS on $100 billion or more in sales in 2017. That 2012 plan was based on the following expectations across our 3 segments: U.S. comp store sales growth of 3% or more; continuation of our very healthy U.S. Retail EBITDA and EBIT margin rates of 10% and 7%, with a moderate decline in our gross margin rate, offset by leverage in SG&A and D&A; an increased REDcard penetration of 300 basis points or more throughout the year; a decline in the size of our Credit Card portfolio of $500 million or more, with a portfolio spread to LIBOR of 7% or better; and about $0.50 of EPS dilution related to our Canadian market launch. I also outlined that in 2012, we expected to invest a total of about $3.3 billion between the U.S. and Canada, continue our uninterrupted record of paying quarterly dividends, increase the annual dividend during the year and invest $1.5 billion or more to repurchase our shares. Altogether,…

That concludes today's prepared remarks. Now, Kathy, John and I will be happy to respond to your questions.

[Operator Instructions] Our first question will come from the line of Mark Wiltamuth with Morgan Stanley.

Could you give us a little outlook on what free cash flow's going to look like once Canada is over on the $1.5 billion of spend? And where do you expect to deploy that? Is it going to be tilted more towards share repurchase or how do you look at that?

Obviously, this year, 2013 will be peak capital investment in Canada, about $1.5 billion. Next year, going forward, CapEx for the U.S., we'd expect something similar, perhaps or growing a little bit to $2.5 billion, something in that range, Canada dropping to somewhere -- we're still opening a fair number of stores, $0.5 billion, perhaps a bit more than that. So we would expect free cash flow to expand, especially in light of Canada operations becoming accretive. As far as what we would intend to do with that, we said first by 2017, assuming we get to $8 a share, we'd expect the dividend to be at $3 a share or more. So we'd expect to continue to increase the dividend at a rate approximately 20% on a compound basis over the next several years. And with the constraint of living within our current strong investment-grade credit ratings, we'd expect to deploy the remainder of our excess cash flow as share repurchase.

Okay. And can you give us a little more color on the Canada dilution of $0.45? I think that's bigger than a lot of people were expecting and it sounds like a lot of it's related to the capital spending decisions. So if you could walk us through that a little bit?

Yes. I think that's right, Mark. When we look back on where we're at right now with Canada, we feel really good about where we're at and our projections for returns in Canada. If we look back a year ago or even 2 years ago when we signed a deal, the projected EBITDA for this quarter -- for this year, excuse me, is essentially right on where we thought it would be. The dilution is a bit higher even than we expected perhaps a year ago, and all of that is attributable to independent capital investment decisions we've made, whether that's investing in 3 distribution centers to build them and own them ourselves or the 40 store expansions that I mentioned that we worked through over the past year. So most of the increase from our vantage point is attributable to incremental depreciation and amortization. And of course, those capital investments were separate economic decisions, and we expect to see economic benefit to that P&L through time, but the sequencing is that the depreciation and amortization shows up first.

Okay. And also, can you talk about the percent rent clauses in Canada? I know you got out of some of those.

Yes, the property development team did an outstanding job working with some very good partners, our landlords in Canada and the vast majority of the percent rent clauses, which of course, never impacted Zellers, have been negotiated away. Percent rent is not a meaningful issue for us going forward.

Your next question will come from the line of Greg Melich with ISI Group.

I have a couple of questions. First, John, on the leverage. Once credit's gone, we get your debt to EBITDA around 1 7, 1 8. Could put some context into how high you think that can or should go given everything in terms of being great credit ratings as you take the dividend out? Should we model sort of a 2 as a cap or how should we think of that?

Yes, I think what I would say, Gregg, is right now as we look at the Retail business and model, that we've always modeled that kind of independently as a credit business given the different leverage characteristics, as you noted. We think the Retail business right now is probably pretty close to the top end. There may be a little bit of room but we think it's near about where the leverage, which will support our current credit rating is at.

Got it. So the incremental buyback is really the equity from the credit business plus the...

Correct. For 2013, that's correct.

Got it. And then secondly, and maybe a bigger question for Kathy or Gregg. The REDcard growth compared to, say, 3 years ago is I think, beating all of our expectations, certainly mine. It looks like last year was up over 50%. Could you help us understand a little bit more about that 50% growth in REDcard sales? How much of it is from new REDcard members, how much of it is existing members spending more? Anything you could provide there would be helpful.

Sure. The increase in REDcard sales is a mix of both, Greg. Certainly, the new accounts are creating a significant amount of that lift. With the amount of accounts, you can see the increased penetration resulting from new accounts. But we have also seen an increase in lift, particularly over the first several quarters that the REDcard was out in existing accounts. The other thing I would mention, the big driver here of the increase in sales as has been the case, the big driver in the increase of the whole program has been the debit card. And I think from our assumptions perhaps, 2 or 3 years ago, when we were talking to you to now, the debit card is the one that has really surprised us. The credit card has probably gone pretty much with what we thought, but the debit card, we're doing 3 accounts to 1 debit to credit now and that has been the one, the product that has been incredibly attractive to consumers who just don't want another credit card, and that's really what has driven the significant increase in our REDcard sales.

The other thing that I would add, Gregg is all of our guests segments love the REDcard somewhat equally, whether you're a VIP, which we would say somebody that visits us a lot and spends a lot, all the through to our enthusiasts, convenience users, least engaged. All of those segments, once they get the REDcard, move toward visiting Target more often and spending more. So this is not just isolated into one group of demographics, it's very well dispersed and balanced. And we think that's a very positive attribute that, that many guest segments love the REDcard.

Your next question will come from the line of Sean Naughton with Piper Jaffray.

Maybe just first, John, a clarification question on the $8 in EPS for 2017. I think before, that was predicated on a 2% or more U.S. annual -- U.S. store growth. Do you still think that, that's the appropriate number to get to that kind of $7.20 from the U.S. business?

The actual assumption for the U.S. business was about a 3 comp through time. And some years, it will be a little bit above that, some years, a little bit below that. But we think 3 comp is about the right level for our business. If you look back at our business over a really, really long period of time, back when we were running 5 comps, a couple of hundred basis points of that were coming from new stores as they annualized and were in about a 3 comp in our base business. And over the last couple of years, since 2010, last year, a little bit lower. 2011, right on. We feel like that's the right neighborhood for where we can run the business.

Okay. And then just also on the guidance for this year and just thinking about the modeling, sounds like you're opening up a few more waves in Canada than your normal kind of store opening cadence. Just from a modeling perspective, how shall we think about some of those store openings this year? And then just as a follow-up to the U.S., how does the real estate development market feel to you guys out there?

Well, typically in the U.S., we open stores in 3 cycles. Due to the number of stores we have in Canada, we're taking approach that we're going to open 5 cycles this year. So think April, May and every couple of months beyond that, we're going to open somewhere between 20 and 28 stores a cycle. We haven't defined all of that yet but we're going to start in the Greater Toronto area then we're going to move to Western Canada, then we'll densify, then we'll go east, and then we'll densify again. So we've got a good plan that is centered around our supply chain investments and the readiness of our distribution centers. And we just think it makes sense to spread out those kinds of openings over more cycles than we typically would do in the U.S. And your other question was?

No, just how does the U.S. just real estate development market feel in the U.S.? Does it feel like it's loosening up a little bit, maybe a few more opportunities or still, you guys are holding back a little bit of this point and looking to be a little bit more prudent in the growth?

No, we're not holding back at all. I mean, we're not capital constrained, and we're pursuing every project that we can find that's going to generate the right kind of return. So I would tell you that the real estate -- commercial real estate market is pretty much status quo and hasn't changed all that much over the last couple of years. There are pockets of opportunities and we're anxious to either codevelop or develop on our own or be a partner in any development that -- where we believe that is the right demographics and we can generate the right kind of returns. So we're not holding back at all. It's just the environment is still a little cautious and a lot slower than we'd like it to be. And hopefully, things will change over the next couple of years.

Your next question will come from the line of Peter Benedict with Robert Baird.

First question. John, maybe can you give us a sense of what the revenue assumption is that's based into that $0.45 Canada dilution number for this year?

The revenue number, I would tell you, it continues to move around even here for the reasons Gregg just outlined. We continue to -- the store openings schedules continue to move around. We've only really set in place in concrete, the first 2. The rest of them is still moving around a little bit. So we're hesitant to provide pretty specific guidance. But what I would tell you is the expectation is that these stores will open and grow and have a very similar annualization process to what we see in the U.S. So I think that's probably the most important assumption and in the revenue and move around based on what stores we get opened when.

Sure, that's fair enough. And then I think in the past, you guys have said that you'd expect to recapture the Canadian losses that you accrue within 2 years of turning profitable. So I mean, if you sum up the last 3 years -- well, last 2 years plus this year, it's a little over $1, maybe $1.10. Do you still expect to get that back in earnings from Canada in '14 or '15 or is the D&A going to make that a longer process?

Yes, I think you hit on it. It will be a little bit longer. We're not talking about 5 years or anything like that. But 2.5, 3 years, something like that, our current modeling we'd say we'll get it back in, something like that. So a bit more than 2 years.

Our next question will come from line of Bob Drbul with Barclays.

I just have a question on, I guess, the fourth quarter in general. Over the past few years, you guys have really made a nice sort of tradeoff between profitability and comps. And this year, it seemed to break down a little bit more than usual where you've made the decision not to be a Black Friday door buster competitor but the gross margins were down 60 basis points or so. Can you talk a little bit about sort of what you learned from the traffic being down and gross margins being down and sort of how you might attack it differently in the fourth quarter of this year?

Bob, I would say that we actually think we performed quite well on Black Friday. We saw the barbell intensify, as Gregg mentioned, between sort of those early sales in Black Friday and then the lull and then coming back strong at the end of the holiday. For us, it was more about pretty weak seasonal businesses. The weather, as you know, was very warm and our seasonal businesses, which normally kick in, in early November, didn't. And then with all of the, we think, economic turmoil and the elections and fiscal cliff and all of that, that it created that lull in between Black Friday and Christmas. So we've talked about planning conservatively for this past year and we will again for next year for the fourth quarter. And we think that the opportunity to pick up sales that are really the other 3 quarters and in particular, the second and third quarter this year. So we continue to manage our business. Our goal is to maintain or grow gross margins within categories. As you know, it was a very competitive year this year and what we dropped was mainly reflecting the ongoing impact of 5% rewards and PFresh, combined with a little higher clearance in some of our seasonal categories. But all in all, I think the team did a great job of managing our inventory. We did come out very clean. Our inventory headed into the first quarter was exactly where it was last year on a per-store basis. So we feel great about that.

Yes. The other thing I would add is you have to take a look at the mix of our business, too. And there was industry softness in Electronics and Toys, which are really important to us. There was not any must-have, really super hot new products that really drove consumers into the stores. And as others have reported, the Toy business was a little softer than expected. The same is true in Electronics as we were post peak in terms of the digital cycles and Videogame business in particular, were softer, and that's a huge business for us. So just a cyclical nature at some of these businesses in addition to what Kathy said, caused comps to be a little bit softer than we expected. But we are not bashful about being hypercompetitive, and we want to be really super competitive every year as we head into the holiday season. But we also want to have a balanced approach in making sure that it's not all about market share. We want to gain market share but do so profitably in trying to find that right mix. And that's the approach we'll continue to take.

Our final question will come from the line of Dan Binder with Jefferies & Co.

On a similar topic of competition, you obviously introduced the price match guarantee as the step in the right direction. But given that, that's such a very low portion of the total transactions, do you think you need to do more on just everyday price and staying more competitive than perhaps, you even are today?

Well, we're competitive day in and day out. I mean, we have always maintained the position that we're going to be competitive in the marketplace. And so it's a position that we've taken. And as we continue to learn more and as more business migrates to the online channels, we're going to continue to sharpen up our online prices in that channel as well and be competitive with those competitors that are most meaningful in that channel. So there would be some sharpening up there, but I would tell you, we offer fantastic value day in and day out, our pricing strategy has not changed and as we look across the competitive landscape, we're very, very well-positioned.

Okay. Just one more, if I could. Can you just walk us through the path to $0.10 dilution getting to neutral over a few years? What causes that to happen on the Credit Card sale?

Sure. The biggest impact is the impact of share repurchase as that levers against growing profits is the short story on that, Dan and we're happy to spend a little bit more time with you, if you'd like but that's the short story.

Okay. Well, thank you very much. That concludes Target's Fourth Quarter 2012 Earnings Conference Call. Thank you, all, for your participation.

Ladies and gentlemen, this concludes today's conference call. Thank you again for joining Target Corporation's Fourth Quarter Earnings Call. You may now disconnect.