Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation's First Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, May 22, 2013. I would now like to turn the conference over to Mr. Gregg Steinhafel, Chairman, President and Chief Executive Officer. Please go ahead, sir.

Good morning, and welcome to our 2013 First 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 first quarter results and strategic priorities for the rest of the year. 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 second quarter and the full year. Following John's remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments 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. And finally, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP result is included in this morning's press release posted on our Investor Relations website. Our first quarter earnings fell short of our expectations, as we faced a choppy and challenging environment caused by unfavorable weather and this year's payroll tax increase. Our U.S. business generated softer-than-expected sales and traffic, particularly in our Seasonal categories as we experienced one of the coldest spring seasons on record, following record warmth a year ago. While we are not satisfied with this quarter's performance, we remain highly confident in our strategy and our team's ability to deliver strong results going forward, across a broad range of…

Thanks, Gregg. Those of you who listen to our conference calls over time know that often, when we're asked about weather impacts, we point out that on average, the weather is average. This has certainly proven true in the last 2 spring seasons. Last year, it was an unusually early and warm spring across much of the country; we saw very strong sales in our Seasonal and weather-sensitive categories. This year, in the face of a cold and late spring, sales were quite soft in those same categories. And while we are committed to delivering strong results in all types of environments, we believe it's important to understand the impact of this year's weather on our first quarter sales results. Specifically, first quarter comparable-store sales in weather-dependent categories like Seasonal Apparel, lawn, patio and Sporting Goods, lagged the rest of our assortments by 6 to 7 percentage points. This sales gap was even wider in areas of the country which experienced below-average temperatures, and was much smaller in areas that experienced much more normal spring temperatures like the Western U.S. Looking more broadly at our category results, first quarter comparable-store sales continue to be strongest in less discretionary categories such as Food, Health, Beauty and household essentials, all of which experienced low single-digit increases. Our Home and Apparel categories were both down in the low single-digits, and Hardlines saw a mid single-digit decline in comps. Within Hardlines, Electronics continues to see softness in video games, along with televisions, particularly in the -- early in the quarter, as last year's 53rd accounting week moved Super Bowl-related sales out of the quarter. As Gregg mentioned, our guests continue to shop cautiously, planning their spending and sticking to shopping lists, as they continue to feel the burden of economic pressures. Recent guest surveys…

Thanks, Kathy. As Gregg mentioned, we're disappointed with our first quarter financial performance. Sales in the U.S. were softer than expected, even relative to updated guidance we provided in April, causing our reported earnings per share to fall short of our updated guidance as well. Adjusted earnings per share, which measures the results of our U.S. operations, were $1.05, representing a 5% decrease from last year. First quarter GAAP earnings per share were $0.77, reflecting losses on early retirement of debt, which reduced our EPS by $0.41, EPS dilution related to our Canadian segment of $0.24, and net accounting gains of $0.36 related to the sale of our Credit Card portfolio. Before I turn to our segment results, I want to remind you of a couple of factors that will be affecting our financial reporting this year. First, with the sale of our receivables, beginning with the first quarter, we are no longer reporting a Credit Card segment. And we now have 2 reportable segments, a new U.S. segment and a Canadian segment. In the first quarter, we began recognizing profit-sharing payments from TD, net of operating expenses, within SG&A expense in the U.S. segment. To provide context, in an April 16 8-K, we provided revised quarterly segment reporting for fiscal years 2010 through 2012, in which Credit Card revenues, net of expenses, from our former U.S. Credit Card segment were recognized within SG&A expenses in the new U.S. segment. In this year's financial reporting, revised 2012 U.S. segment results will be presented as prior year results. To provide additional context, this year's rate analysis includes a comparison to last year's performance in the historical U.S. Retail segment. For simplicity, to the extent that's possible, in my discussions today, I will focus only on this year's U.S. segment results compared…

[Operator Instructions] Your first question comes from the line of Peter Benedict of Robert Baird.

Just a couple of questions. Just on the U.S. gross margin performance, can you give us a sense of maybe what that REDcard impact was in the quarter?

The rate impact of the REDcard, Peter?

Yes, John.

Yes, the combination of that, with the store remodel program, very consistent with what we've seen over the past several quarters, somewhere between 25 to 30 basis points of impact.

Okay, that's helpful. And then just a longer-term question, I mean, you kind of said for the year, you're now thinking 2% to 2.5%. I assume that still has a pretty modest view for comping in the fourth quarter. A, is that correct? And then secondly, just when you think out beyond, I mean, do you guys think that maybe 2% to 3% is the longer-term comp profile for the business? Or do you think it could still be north of 3%, just when you think of a more normalized environment on an annual basis?

Yes, I think your view of Q4 is right. I think, in particular, this Q4 will be particularly difficult given the 53rd week and the way the calendar shifts this year. You'll recall, we're going to lose 6 business days between Thanksgiving and Christmas this year, which will make the comp feel much more difficult than it otherwise might. I think over the longer term, we just continue to think a 3% comp is about the right place to be. If you look again at our company over 15 years or 20 years, if you net out the contribution of new store annualization, we essentially ran a, pretty consistently, a 3% comp over time through good times and tougher times. So we think in an economic environment that might just be a little bit better than today -- it doesn't have to improve drastically, but a little better than today, we think a 3% comp makes sense.

Okay, that's helpful. And just one last housekeeping. On the Canadian D&A, what do you think the run rate is for that once you get out -- you've opened a bunch of the stores. Once you get towards the end of the year, what kind of run rates were you thinking about for Canadian D&A?

I think you'll continue to see D&A grow throughout this year as we continue to put significant assets into service, and we'll provide a little bit more color, I think, as we get later into the year and have a little bit more clarity about sales, margin and the entire P&L, we'll provide a little bit more clarity about the entire P&L for Canada.

Your next question comes from the line of Sean Naughton of Piper Jaffray.

In terms of just dissecting the comp in Q1, transaction trends, as you mentioned, were relatively stable on a 2-year basis and did improve from Q4. But the units per transaction were down 50 basis points, and I think that's the first time since '09. Just wondering what would explain that decline given the increase in the remodel program from Q1 last year?

Actually, Sean, I'm not quite clear on your question. Units per transaction in the first quarter were up year-over-year. So help me with that again?

Oh, I thought that was the -- I thought they were down 60 basis points, maybe I'm missing something.

No, selling price per unit was down 60 basis points.

And that was mix related.

Right, entirely mix, but units were up consistently for some of the reasons you described.

Okay, got it. And then I guess, Gregg, you touched briefly on the price matching. Just curious if you are seeing the number of requests for the price match change at all? And has there been any competitive response to that in the marketplace?

Both the stores with the matching of competitors, physical ads and the online match has been fairly stable and has not grown materially over the last quarter. So it still represents a very small portion of our transaction, and that's because our everyday price and our promotional prices are so strong. There is generally not much of a gap, if any. So we continue to watch our competitive prices on a day-in and day-out basis and move where we have to be competitive in the marketplace. And so we expect, over time, this not to change all that much.

Okay, great. And then just lastly on digital, you're obviously seeing some nice traction, nice growth outside of the Seasonal categories. Can you talk about just the impact on margin for that sale today? Is it dilutive or is it accretive to the margin? And what do you think that can be -- how are you planning that over time?

Yes, I think first, I'd start with how we think about this longer term. And we think about, from a longer-term perspective, sales through all of our channels, regardless of the channel, you need to generate a return. I think -- and a return on investment that's similar to what we see in our current U.S. store base. What we see today is -- honestly, we're learning a lot about that channel, and a lot of this depends on how we're going to ultimately settle on a supply chain that our guest wants to interact with us, how much is ship from store, how much is ship to store, that will have a significant impact, ultimately, on the EBITDA margin rates of that particular channel. But I think, once again, depending on where those EBITDA margin rates land, sales or capital will move around. And we feel very confident that we'll get back to a return that makes sense. Having said all of that, I think as it relates to the rates embedded within that channel, we feel very comfortable that ultimately, we'll get back and operate it at that 10% EBITDA rate that we've said is part of our long-range plan.

Your next question comes from line of the Matt Nemer of Wells Fargo Securities.

First, I'm wondering if you can comment on sales in geographic areas that had more neutral weather like Florida? Were the transactions and the comps positive in those markets?

We did see better results in areas that had more normal weather, so that would primarily be the West Coast. And they were toughest in those Seasonal categories where we saw weather off the most, and that would be primarily in the Midwest. So we did see quite a swing between the different geographies.

And then in terms of the second quarter guidance, do we assume that there are some incremental markdown risk in Seasonal categories? You did mention that within categories, the rate improvement would be a little softer in the second quarter than the first quarter. So just wondering what the markdown risk is in the Seasonal categories?

Yes, like we said, the teams did a very good job of responding to the sales shortfall and retiming receipts and making cancellations. We're going to know a heck of a lot more in the next 30 days as we see what happens and what -- how the sales of these categories play out before we have to take markdowns in the 4th of July. And if we get really good weather and we have good sell-throughs, then we're going to be right back on plan. If things stay damp and cool for an extended period of time, there might be some risk. But where [ph] -- we don't expect to see significant risk whatsoever. So we're talking about things on the edges right now.

Yes, Matt, the only thing I'd add is it's a little bit hard to see, with the inventory on the balance sheet. The inventory per store in the U.S. is essentially flat to last year. All of the inventory build year-over-year is attributable to Canada. So we feel really good about where the inventory positions are in aggregate.

That's very helpful. And then just lastly, if we look at your operating expenses in the U.S. Retail segment, growth -- dollar growth accelerated a little bit versus the last few quarters. I'm assuming a lot of that is technology investments. But given the more moderated view of comps for the full year, could we see the dollar growth potentially come back down a little bit?

Yes, I think you're right. First of all, the vast majority of that is multi-channel technology. And we've said, a little bit of missed timing here, we expect to offset that on the year with expense savings and improvements we're making in our business, but the investment coming a little bit ahead of that. To your second point, I think that's absolutely right. And it's interesting, we said this last year, when our sales accelerate or decelerate rapidly from our expectations, we tend to see our SG&A lag both directions. It doesn't climb as fast when sales go up, like last year, and it doesn't come down quite as quickly when we see sales decelerate. And as we adapt to wherever sales are going to be, you'll see our SG&A settle in at a more appropriate level.

Your next question comes from the line of Colin McGranahan of Bernstein.

First question on Canada, I understand that the gross margin rate at 38% is not the long run rate. But where do you think that settles out? And was the 38% above where you expected, even kind of adjusting for the mix that you saw?

Yes, I would say, out of the blocks, 38% was a little higher than we expected because the mix was a little better than we expected out of the blocks. Now whether it's in Canada or the U.S, clearly, when we open a new store, we get a higher gross margin rate, but the mix was even higher than the higher -- than we expected. So we do expect that to settle down and be slightly higher than what it is in the U.S. because we expect the mix to be a little bit better than it is here in the U.S.

Of course, and as the consumables business ramps up, mix is down, but from a productivity perspective, can you tell anything yet on these first stores that are open in terms of opening expectations relative to what you had thought? Or was it just too much hoopla that you can't discern anything yet?

Well, I wouldn't call it hoopla. I would just say that the guests were very, very excited, and we experienced tremendous surges in sales. And it's just very, very early to draw any conclusions. And we really wanted to deliver a great experience, and so to a certain extent, we went in with staffing levels to make sure that we were taking care of the guests both at the front end, that we had the right team members there for the supply chain, and we had the right teams on the sales floors. So we know that over time, and in our run-state condition, we have to work hard at making sure that we get our productivity levels where the business model dictates them to be. And we know our gross margins will settle in, and we've got to become more productive and run the business. Over time, our consumables share will grow because that's the hardest trip to change with the guests. And so we're going to continue to focus on those frequency-oriented categories, so that we can not only get the good mix that we're getting, but we want to now start driving more trip frequency into the store. And we didn't want to come out of the blocks by hitting those categories too hard because we wanted to make sure that we led with our strength. And we wanted to make sure that all the supply chains and the operational disciplines were in place. We feel very confident now that they are. So we're ready to start making those kinds of adjustments in merchandising, in supply chain and in store operations to start refining the model.

Okay. That's helpful. Secondly, on the credit, I actually thought the contribution, $105 million, while you said it was -- you explained it was large, it seemed to me it was higher than I would have expected, especially given the bad debt reserve release last year. Is there anything there that reflects the $105 million profit share?

I think the one thing I'd remind you is we only had a half a quarter's worth of profit-sharing with TD. Next quarter, we'll have a full quarter's worth of profit-sharing with TD.

So the $105 million was really a $210 million quarterly run rate?

No, no, no. Because that's net of our operating expenses as well.

All right. I'll follow up offline with you on that, John.

We can take it offline and walk through that in detail, Colin.

And then finally, just coming back to SG&A, the dollars were up, I think, $233 million. If I'd x out the credit difference of $36 million, the vendor allowance of $13 million, the technology spend, it still looks like the growth is pretty healthy. John, I know you mentioned that there's a lag just in terms of how quickly you can get after that if sales are disappointing. Would you also expect your -- some of the expense things you're doing in a longer-term basis to impact that? And I guess my question is, can we see better performance out of that line, because it sounds like 2Q guidance doesn't get us there?

Yes. No, question in that -- what we're seeing. I think we talked about this a little bit 3 or 4 -- or 5 weeks ago when we were together. You'll see the ramp-up in our expense initiatives throughout the year and through next year, actually. Many of them are a little bit longer lead times to pull out expense, all the easy stuff we've done a long, long time ago. So we do expect, through time, SG&A will come down and manage to a level that is more appropriate.

Your next question comes from line of Bob Drbul of Barclays.

I guess the question that I have for you is a twofold, but it revolves around traffic. When you look at the initiatives that you have in place, REDcard and PFresh, and you consider -- I understand the sort of, the seasonal piece, Q1 this year versus last year. But when you think conceptually, traffic was down in the fourth quarter, and that was down again in the first quarter, how do you sort of get us comfortable with essentially the efficiency and the effectiveness of these initiatives over the longer-term period? And the second question that I have is when you -- the lower comp assumption for this year, can you maybe just break down the traffic component in that new 2% to 2.5% expectation?

I'll take the first one. I think the traffic -- this was a -- it was a disappointing quarter for us. We had very, very strong traffic last year. There was pluses and minuses throughout 2012. And we expect traffic trends to get stronger as the year goes on. And we have all of our initiatives designed to not only deepen the relationship but build frequency. So we'll perhaps be a little bit more aggressive on price. You have to look at the competitive environment. It was a little bit more aggressive than it had been in the past, where there was more emphasis on price, and that, I think, impacted a little bit. But overall, we really expect to be able to generate traffic levels that are flattish, give or take, over normalized periods of time.

Yes, Bob, and the only thing I'd add, I don't think we need to run traffic numbers like we did last year in the first quarter to generate that 3% comp. I think if you look over the past several years, about 0.5 point of traffic combined with ticket gets us to a 3% comp. And that's about the formula that we feel really good about.

The only other thing that I would add is, this time of year, our Seasonal categories can be a big traffic driver for Target. And clearly, they weren't in the quarter, and they were last year. So all of the things you mentioned, 5%, PFresh, help us all year long. But during key Seasonal categories -- key Seasonal timeframes, we need those categories to drive traffic as well.

Your next question comes from the line of Deborah Weinswig of Citigroup.

A lot of conversation regarding mobile and digital traffic, can you also talk about what conversion was like during the quarter?

Our conversion has been improving over the past year, Deb. And we were up slightly in this quarter as well. So we're really pleased with the improvements that we've made on the site. But I'll tell you, we still feel we have a long way to go with conversion, and we are very committed to continuing to work on our navigation and our search function and the basic functionality of our site to continue to make big improvements there.

I think the only thing I'd add, Deb, is we have a little bit of a mixed headwind, which is positive from our perspective. Mobile, in general, has a much lower conversion rate than the site. And our mobile is growing much, much faster than the site. We think that's good because we think that's where things are going, and it also shows that she is spending a lot of time with us on our -- on the mobile applications we have. But conversion is just naturally lower there, and so it creates a little bit of a mixed number as we look at the aggregate.

So if you look at conversion on our site, it's up to last year. If you look at conversion on mobile, it's up to last year, but because of the big growth in mobile, to John's point, conversion comes down slightly in aggregate.

All right. And then maybe just a broader question, can you just talk about how you're positioning yourself in terms of taking advantage of the Affordable Care Act?

I think we've said it a couple of times, the Affordable Care Act, the changes for us will be relatively -- well, they won't be relatively, they will not be material externally. We're still continuing to work through all the regulations and what we will exactly do, but it won't be material changes to what we're doing today or financially, from a financial perspective.

Okay. And I think Gregg touched on segmentation and how you're looking to match local taste and preferences. Where are you -- I know there was a lot of work done in Canada, but where are you domestically in terms of that?

Well, we feel good about where we are. I mean, we've been working on this for a long time, and we continue to deploy resources to get better and better at that. So this is just a long-term initiative that we have to continue to focus on, whether it's in food, whether it's demographics, whether it is ethnic groups. We've just got to continue to get better at our localization efforts. And we think we've made good progress there, and we are going to continue to focus on it.

But was there anything that you learned from Canada that you could go back and apply to the U.S.? Or was it exactly what you expected and you're just continuing on the path?

I would just say, Deb, I think it's a little early to learn from Canada and bring that back to the U.S. I will tell you, though, we learned a lot from CityTargets that we applied to Canada. So as you know, those stores are in dense urban areas, and so are our Canada stores -- so we took a lot of that learning and the testing that we did last year and applied that to what we're doing in Canada. And throughout this year, of course, we'll be reading the Canada results and bringing that back to the U.S. But the same teams work on localization for both countries.

Your final question comes from the line of Chris Horvers of JPMorgan.

A couple of questions. First, on the top line, can you -- in the Home and Apparel categories, can you talk about the stack comps that you had in the first quarter and broadly, how that has trended -- those categories have trended over time, past few quarters?

Well, when we look at the stack comps, we feel a lot better about it. Since you're just looking at this quarter, both were positive, if we look on a stack basis. Going forward, our compare in second quarter is not as nearly as difficult as our first quarter, so we would expect our comps to improve. And over time, we want that 2-year stack to improve. We're not happy with flat or up slightly. We want to make sure that we're making progress there. But it was, on a 2-year basis, better.

I think I'd just add a little color to that. I think Apparel, for instance, the 2-year stack is around a 2, running that consistently through time, we'd feel really good about running 2s in Apparel. And as Kathy said, Home is positive, and that's a big improvement from where Home has been over the past several years. So on a 2-year basis, we feel good about both those businesses.

That's great. And then also -- and thinking about the EPS pressure from Canada, can you talk about how much the expenses in the first quarter are onetime in nature, pre-opens and so forth? And as you think about the guide for the second quarter, a similar question, how much of that expense pressure is actually something that goes away in future quarters?

Yes, that's difficult to parse out, and the example I would give you is exactly what Gregg said, where we started with the stores stacked very heavily. We know through time, we have to refine that model. Is that onetime expense or operating expense? Certainly, the expenses related to hiring team members early and training them as the next cycle of stores will open up. That is all onetime and will drift away. What I'd tell you is, through time, we expect, ultimately well down the road, to get to an SG&A rate that makes sense and productivities that are very similar to the U.S. So as I said before, as we get a little bit more clarity, right now, expense dominates the P&L in Canada. And as we get more clarity on sales, margin, operations later in the year, we'll provide a lot more color about how we expect those stores to operate.

And then one final one. Just in terms of being in the stores, it seems like at times, you're actually too thin on inventory in some of the discretionary categories, whether that's Home and Apparel. And what's the internal discussion around balancing rate versus balancing sales? And do you think that you've leaned too far towards the rate side?

This is something that we are always looking at and adjusting. But I guess I would tell you I don't feel like we've gone too far. Our inventory, as John mentioned, our average inventory per store is flat to last year. It's actually up a bit in apparel, given the softer sales in the first quarter. So we're always looking at that. We look as much at out-of-stocks as we do in-stocks, in trying to improve those stores. So it's a constant focus for us, and we can always improve. But I feel pretty good about where we are right now in terms of in-stocks.

Okay. Thank you. That concludes Target's First Quarter 2013 Earnings Conference Call. Thank you all for your participation.

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