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Good morning, and welcome to our 2013 Q1 earnings conference call. On the line with me today are Kathy Teshia, 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 Q1 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 Q2 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 results 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 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 conditions. In the Q1, our U.
S. Segment generated adjusted earnings per share of 1 point outstanding performance. Our first quarter GAAP earnings per share were $0.77 $0.28 lower than adjusted EPS, driven primarily by $0.24 of dilution attributable to our to our Canadian segment. As we mentioned in our Q4 call, this year there are several notable changes affecting our financial reporting, which John will cover in detail in a few minutes. In the quarter, comparable store sales declined 0.6% from last year's 5.3% increase.
1st quarter comparable transactions were down 1.9% following last year's increase of 2%, keeping us essentially flat on a 2 year basis. In much of the U. S, traffic in our seasonal categories was unexpectedly soft as guests held off purchasing spring items in the face of cold and wet weather. Our merchandising teams did a great job reacting to the pace of sales in these categories, retiming receipts and adjusting them downward, so we are still in a healthy inventory position today. Despite the weather impact on seasonal categories, sales and traffic in our digital channels continue to grow at a robust pace.
Overall, 1st quarter digital sales grew in the high teens and increased more than 20% net of our most seasonally sensitive categories. Target's mobile traffic and sales continue to grow at a triple digit pace with mobile traffic representing more than 30% of our digital traffic in the Q1. We're pleased with these results as mobile is rapidly becoming the key platform for digital commerce across all of retail and we know that target guests have a particular affinity for mobile engagement. After 2 years of preparation, in March, we opened our first 24 Canadian stores in the Greater Toronto area and we're very pleased with the reception we received from our new Canadian guests. We experienced an unexpectedly strong surge in sales as guests were eager to see their newly opened Target store.
The mix of sales in home and apparel was even higher than expected as guests shopped our assortment of stylish owned brands and national brands responding to the outstanding value we provide on both. Now that we are beyond the grand opening surge in this first cycle of stores, we're encouraging our new Canadian guests to make Target a preferred destination for categories throughout the store including food, health, beauty and household essentials as these categories play a key role in driving trip frequency over time. As it is already in the U. S, RedCard Rewards will be a key differentiator for Target in Canada and we're encouraged that RedCard penetration of sales our Canadian segment was ahead of plan in the Q1. 2 weeks ago, we opened our 2nd wave of 24 Canadian stores in British Columbia, Alberta and Manitoba and we're very pleased with the initial guest response in these markets and the ability of our teams and systems to accommodate the increasing volume of traffic and sales.
We plan to open another 20 stores in Canada later in the quarter on the way to operating 124 Canadian stores by the end of the year. This means we expect to open more Target stores in our 1st year in Canada than we opened in our 1st 10 years in the United States, an incredible accomplishment that has required unprecedented effort by teams throughout the company. In the U. S, we opened 6 new stores in the Q1, including an additional CityTarget location in Los Angeles. We now operate 6 CityTarget locations in 4 cities and we continue to be pleased with the results in these stores.
Sales have essentially met our expectations and the mix of home and apparel has been better than expected. Similar to our Canadian stores, we are focused on our City Target stores on driving sales and visits in our frequency and commodity categories, changing guest habits and inspiring them to visit us more often for both wants and needs. In the Q1, we also closed the sale of our U. S. Credit card receivable portfolio to TD Bank Group and began deploying proceeds to reduce debt and repurchase shares.
We're very pleased to have reached the right agreement with the right partner in a transaction that removes these more volatile assets from our balance sheet. The portfolio continues to perform well generating meaningful income for Target through our profit sharing arrangement with TD. As we look ahead to the Q2 and the remainder of the year, we remain cautiously optimistic about both the macroeconomic environment and consumer behavior. Both of these business drivers continue to reflect slow uneven growth and ongoing cross currents of positive and negative indicators just as they have for the past few years. For example, while we're pleased that the housing market has stabilized and jobless claims have been declining, we're mindful that household formation and job growth remain particularly weak among younger demographic groups.
In addition, guests continue to face the headwinds of this year's payroll tax increase and a meaningful lack of income growth. With these considerations in mind, we remain focused on strategies that position our business for profitable growth both today and in the long term. We continue to invest in initiatives that integrate multiple channels like our recent beta launch of Cartwheel, the result of our collaboration with Facebook along with tests of same day delivery with Google and eBay. And we're testing opportunities within our own supply chain that will leverage our existing store and distribution assets to provide additional services and capabilities our guests value most. We're investing to drive adoption of our 5% RedCard rewards and pharmacy rewards loyalty programs, which have proven to be unique and powerful differentiators and sales drivers for Target.
Both of these programs offer guests the opportunity for even greater savings, leading them to shop more merchandise categories more often. We're investing in efforts to better serve all of our guests, driving traffic and sales by segmenting our stores and assortments to match local tastes and preferences. And we continue to offer digital innovations that create a link between our stores and social media. We're continuing to pursue new and differentiated merchandise in all of our assortments including our recently announced partnership with Warner Brothers and DC Entertainment to feature Justice League merchandise across multiple categories. Kathy will provide more detail on programs like these that create a sense of discovery for our guests while deepening their loyalty for Target.
Beyond the value we provide on exclusive well designed merchandise, we continue to invest in everyday low prices, which we reduced even further in our weekly ad. In addition, we stand behind our prices with policy to match local competitor print ads as well as our largest online competitors. And RedCard Rewards and Pharmacy Rewards, our most loyal guests have the opportunity to save even more. Throughout the company, we take a disciplined approach to the deployment of cash, combining strong financial rigor and capital investment decisions with a focus on returning cash to our shareholders through dividends and share repurchase. And of course, none of our efforts would be possible without the outstanding work of our more than 360,000 team members who greet and serve our guests every day, carefully manage inventory and expenses in this challenging environment and proudly represent our brand in the communities where they live.
In spite of 1st quarter tax increases, unseasonably cold weather and challenging prior year comparisons, our underlying business continues to be stable and healthy. Our team is focused on driving outstanding results across categories, channels, regions and guest segments every day, even while we continue to position our business for success with investments in new stores and formats and more flexible ways of serving our guests. We believe that our outstanding team aligned in support of a well defined strategy will drive strong performance both this year and over time. Before I turn the call over to Kathy, I want to take a moment to thank Terry Scully, who retired from his role as President of Target's Financial and Retail Services team in April. Terry has been a valuable member of the Target team for nearly 35 years and under his leadership, the Financial and Retail Services team has played a key role in strengthening guest loyalty and delivering substantial profitable growth for Target.
Over the last few years, Terry and his team have worked tirelessly to find the right partner to purchase our credit card receivables portfolio culminating in this quarter's sale. And finally, I want to pause to express our condolences to the residents of Moore Oklahoma including Target team members, guests and their families who were affected by this week's devastating tornado. We have been working with emergency responders, community organizations and local schools to evaluate immediate needs and ways that Target can help. And yesterday, we announced that Target is donating $250,000 in support of relief efforts, dollars 200,000 of cash and in kind donations to emergency responders and community organizations including the Red Cross and the Salvation Army and $50,000 to support rebuilding efforts at the 2 elementary schools that were badly damaged by the tornado. Now Kathy will provide more detail on Q1 results and outline initiatives for the Q2 and beyond.
Kathy?
Thanks, Greg. Those of you who've listened 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 two 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, 1st 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 which was much smaller in areas that experienced much more normal spring temperatures like the Western U. S. Looking more broadly at our category results, 1st 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 Greg 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 indicate that 3 quarters of our guests are aware of this year's payroll tax increase. And among those, the majority have noticed the impact of the tax increase on their paychecks and indicate that it's affected their spending.
Basket data confirms that needs based trips have been increasing, while wants based trips focused on discretionary categories have been declining. And notably, recent data from the conference board indicates that while sentiment among consumers regarding their current situation has been improving since late last year, consumer sentiment regarding the future has been declining in recent months. To drive traffic and sales in this environment, we know it's more important than ever to provide value to our guests on a high quality differentiated assortment delivered through a convenient shopping experience. In the digital space, we continue to apply a test and learn approach when rolling out applications and capabilities, so we can determine what works best for our guests. We're pleased that our digital traffic grew faster than industry benchmarks again this quarter.
We continue to explore ways to integrate digital technologies with social media and our stores to provide a unique shopping experience for our guests. This quarter's beta launch of Cartwheel, which we developed in collaboration with Facebook, is a perfect example. This first of a kind experience gives guests a fun way to save on hundreds of items throughout our stores. Upon authenticating this application through their Facebook profile, guests receive 10 spots to fill with deals of their choice from among hundreds of items throughout our store. Depending on the product, the deals feature a range of discounts and expiration dates and guests can switch between offers at any time.
Deals are redeemed at checkout in our stores either by scanning a single barcode on a mobile device or a printout from our desktop computer. Guests can share Cartwheel with their friends on Facebook to show off their latest finds and see what their friends are buying. And the more guests interact with Cartwheel by choosing and redeeming deals and sharing those deals with friends, the more offers they unlock for themselves. We launched Cartwheel in beta and we're encouraging guests to provide feedback so we can make ongoing real time enhancements to the Cartwheel experience. Initial sign ups for Cartwheel have exceeded expectations.
Thousands of guests signed up in the 1st week and we saw a meaningful increase when we added a link to cartwheel on target.com. More than 10% of guests who have signed up already have redeemed cartwheel offers in one of our stores. Also this quarter, we launched a beauty box test to understand our guests' appetite to pay for samples of beauty product. We tested this offer on Target's Facebook style page and sold through our inventory within a week. In addition, the offer generated favorable media coverage and positive feedback in social media.
Based on these results, we will continue to explore ways to surprise and delight guests with box based offers that support our expect more, pay less brand promise. In March, we were very pleased to announce our agreement to acquire Chefs Catalog and assets of cooking.com in 2 separate transactions. These e commerce acquisitions are aimed at expanding Target's presence in the growing cooking and kitchenware market. We've combined the assets of cooking.com with Chefs Catalog to create a new wholly owned subsidiary, which will continue to operate the 2 brands under their current names. We believe these transactions present a strategic growth opportunity to serve guests who are increasingly looking online for cooking solutions to make their lives easier, from utensils and cooking cookware to recipes.
These strategic transactions provide us a great way to address this growing opportunity and provide expanded online options for our guests. In select markets, we're continuing to test same day delivery in partnership with Google and eBay. Our focus in these tests is to understand the level of guest engagement and this fulfillment opportunity. These projects, which are still in the test phase, continue to provide valuable information on the store backroom capabilities and processes needed to support this offering. And as we mentioned last quarter, this year we're launching our own test of fulfillment flexible fulfillment in the Minneapolis market.
This month, we launched a test in which team members are given the opportunity to order online and pick up in store. We will use our team members' feedback to improve the process and experience before the pilot becomes guest facing later in the year. 2 other team member pilots, pay in store to pick up at another store and pay online and ship from store are planned for late in the year. In both our stores and online, we feature great designers and continue to roll out new unique merchandise that creates a sense of discovery for our guests. Our goal is to show guests that design means more than fashion and that great design doesn't have to mean high prices.
In home, we continue to be pleased with results from our partnership with Nate Berkus. The collection includes a growing list of products in a wide range of categories, including bedding, bath, accessories, lighting, rugs and stationery. We also continue to see great results from the rollout of the Threshold brand, which is replacing Target Home, our largest owned brand. We debuted Threshold last fall and guests continue to respond to this fully redesigned high quality collection that's inspiring them to update their homes. To celebrate this new brand, earlier this month Target constructed a life-sized dollhouse in New York's iconic Grand Central Terminal, where guests could explore a 2 story, 7 room dollhouse decorated with more than 3,500 pieces from the Threshold collection.
Select furnishings were tagged with QR codes to be shoppable right from the dollhouse. In our stationery category, we're excited about our collaboration with Todd Oldham on the Kids Made Modern collection, which offers creative activity kits and supplies to inspire kids through art. The collection has a clean, simple and fresh design that's gender neutral and age appropriate to inspire all children and parents. We launched this collection of creative design tools late last year and set a new collection this spring. Following our successful Q1 partnership with Prabal Gurung and Kate Young, we recently announced our latest design collaboration with Lauren Busch Lauren and the rollout of the Feed USA Plus Target collection.
In late June, we'll feature a lifestyle collection of stylish products in home, sporting goods, stationery, apparel and accessories. The collection, which reflects a modern Americana aesthetic while supporting an important cause, includes more than 50 products across a range of price points, with most items less than $25 Each item in the collection has an associated number of meals listed with it. And with each sale, Target will donate the monetary equivalent of that number of meals to Feeding America, the nation's leading domestic hunger relief charity and a partner of Target since 2,001. During the time that the products will be available, we expect to provide more than 10,000,000 meals for families across the U. S.
In Canada, we've been very pleased with results from our partnership with Roots Outfitters, an iconic Canadian brand that offers quality craftsmanship and comfortable styling on a line of apparel for men, women and kids. And we're very excited that we recently announced a fall partnership with Beaver Canoe, a member of the Roots Canada family, to offer an exclusive collection of cabin chic apparel and home items in our Canadian stores this fall. Entertainment had a great Q1, including the release of our exclusive deluxe version of the 2020 experience from Justin Timberlake. The strength of the guest response put this release among the top 3 at Target in the last 10 years. We followed this success with releases of exclusive albums from the band Perry and Michael Buble in April.
In electronics, we've partnered with Wired Magazine to offer a custom curated assortment of consumer electronics and gadgets tested by their editors, featuring their expert tips on usage and key features. And in April, Target became the exclusive mass retailer to debut the Beats by Doctor. Dre Neon Mixer Headphones, available in eye catching green, orange, pink, yellow and blue. We've long known the value we can create through segmentation of our stores and assortments based on store location and demographics. We continue to develop tools and processes that allow us to further localize assortments and experiences to match the specific markets where our stores are located.
We are focused on providing a deeper presence of locally relevant products and brands across the store, including categories like food, beauty, home and entertainment. And we continue to invest in unique multichannel experiences like Heartwheel that allow guests to choose their own offers and further integrate their Target experience into their social networks. Now John will share his insights on our Q1 financial performance and our outlook for the Q2 and
full year. John? Thanks, Kathy. As Greg mentioned, we're disappointed with our Q1 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.
1st 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. 1st, with the sale of our receivables, beginning with the Q1, 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 Q1, we began recognizing profit sharing payments from TD net of operating expenses within SG and A expense in the U. S. Segment. To provide context, in April 16, 8 ks, 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 and 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 with last year's revised U. S. Segment results. 2nd, as I mentioned in our conference call last conference call, we've made changes to our vendor agreements regarding payments received in support of our marketing programs.
As a result, in fiscal 2013, these payments will be recognized as a reduction in our cost of sales rather than a reduction to SG and A expense. This change is expected to create equivalent year over year increases in our U. S. Segment gross margin and SG and A expense rates of 20 to 25 basis points without affecting EBITDA and EBIT margin rates. With that as context, I'll turn to the Q1 performance in our new U.
S. Segment. Total sales increased 0.5% on a 0 point 6% decline in comparable store sales combined with the contribution from new stores. Among the drivers of comparable store sales, traffic was down 1.9%, partially offset by a 1.3% increase in average ticket. Our Q1 traffic decline essentially offset a 2% increase a year ago.
As we told you at the time, we believed Q1 2012 traffic was unusually strong due to the warm weather and that proved to be the case as full year 2012 traffic was up 0.5%. While we expect traffic will continue to be challenging given our near term outlook for the economy and the consumer, we don't expect to continue to see traffic declines of the magnitude we saw in the Q1. With the added pressure on household budgets from the recent payroll tax increase, the simplicity and compelling nature of our 5% RedCard rewards discount is clearly attracting an increasing number of guests. The penetration of sales on RedCard's reached 17.1% in the Q1, up from less than 12% a year ago. While discounts from this program continue to put pressure on our gross margin rate, this investment pays back through the benefit of increased loyalty and sales.
We continue to see households increase their spending more than 50% on average when they begin using a RedCard. And in Kansas City, which is a year ahead of the rest of the country, penetration is above 20% and the rate of increase has shown no sign of slowing down. Our U. S. Segment gross margin rate was 30.7% in the 1st quarter, up about 50 basis points from a year ago.
The change in recognition of vendor payments explained about 20 basis points of this increase. The remainder of the improvement was driven by rate increases within categories, more than offset continuing gross margin rate pressure from our sales driving RedCard Rewards and remodel programs. Every year, Kathy's team works hard to incrementally improve gross margin rates within categories and the year over year benefit from these efforts can vary meaningfully from quarter to quarter. In the Q1, the magnitude of category rate improvement was stronger than normal and we're expecting to see a more modest benefit in upcoming quarters. Our Q1 U.
S. Segment SG and A rate of 20.3 percent was about 130 basis points higher than last year's revised U. S. Segment rate. The primary drivers of this variance are about 50 basis points resulting from lower earnings on the credit card portfolio and about 40 basis points related to technology including our multi channel efforts.
In addition, the change in vendor payments drove the rate higher by about 20 basis points. And of course, with lower than expected sales, we saw less overall expense leverage than we anticipated. On this last point, it's important to note that our Q1 results reflected meaningful store productivity improvements and the entire organization did a great job controlling expenses. As I mentioned in the last call, we're anticipating incremental expense pressure from technology investments throughout 2013 and we plan to offset that pressure through disciplined expense management across the enterprise as the year progresses. Also, I think it's important to provide more context for the decline in our earnings from the credit card portfolio, because the portfolio continues to experience outstanding performance.
However, there are 3 separate reasons, which drove lower earnings from the credit card portfolio in the Q1. First, the asset is smaller than a year ago. 2nd, we're annualizing a $35,000,000 reserve release in the Q1 of 2012. And finally, we began sharing portfolio profits with TD after the sale closed in March. Notably, among these three reasons, profit sharing drove less than half of the year over year reduction in Target's earnings from the credit card portfolio and we expect all of these pressures will continue for the next several quarters.
Moving down the U. S. Segment P and L, we reported a Q1 EBITDA rate of 10.4 percent, about 80 basis points lower than last year's revised U. S. Segment rate.
With about 50 basis points related to our credit card portfolio, that means our U. S. Retail operations accounted for only a 30 basis point decline in the EBIT rate compared with last year, which is relatively stable when one considers that sales were unexpectedly soft this year and we were annualizing a 5.3% comp last year. In our Canadian segment, we generated $86,000,000 in sales from 24 stores that were open on average a little more than half the quarter. Whenever we open a new store in the U.
S, there is a rush of traffic and sales as curious guests shop it for the first time, but the rush in Canada exceeded our expectations. The Q1 gross margin rate in Canada was more than 38%, which is much stronger than our long term expectations for a couple of reasons. First, in new stores, we experienced a strong initial mix of home and apparel sales as guests tend to shop these categories on their first trip to these stores. In addition, given the short time these stores have been opened, they have not yet experienced any meaningful transitions or clearance activity. So this quarter's Canadian gross margin rate didn't reflect the impact of markdowns we'd expect to see over time.
The Q1 Canadian segment P and L was dominated by startup expenses related to the 100 additional stores we're preparing to open later in the quarter. For the quarter, Canadian segment operations drove $0.24 of dilution to our consolidated earnings per share. With the sale of our credit card portfolio in March, we recognized a pre tax accounting gain of $391,000,000 of which $166,000,000 was cash received in excess of book value and $225,000,000 was related to a beneficial interest asset. This asset effectively represents a receivable for the present value of future profit sharing payments we expect to receive from TD on the credit card balances transferred at the time of the sale. Going forward, a portion of the profit sharing payments from TD will be applied to unwind the beneficial interest assets.
We expect to fully unwind it in 3 to 4 years and expect to reduce its size by about 50% in the 1st 12 months following the sale. Also following the portfolio sale, we began deploying proceeds to retire debt and repurchase shares. Concurrent with the sale, we repaid at par $1,500,000,000 in funding that was previously backed by the receivables. We also launched debt tender offers to repurchase another $1,000,000,000 in high coupon debt, which led to losses recorded in interest expense of $445,000,000 in the quarter. Of course, these tender offers created a meaningful economic benefit not reflected in the accounting for these losses.
During the quarter, we also paid off commercial paper that we had used to provide short term funding following the $2,000,000,000 in debt maturities last January. Finally, there is another $500,000,000 maturity in June, which we expect to fund with proceeds from the sale. We're pleased that with the completion of the sale, we were able to remove these more volatile assets from our balance sheet and quickly reduce a meaningful amount of debt that was funding them. Over time, we expect to apply the remainder of the proceeds from the portfolio sale to repurchase shares. In the Q1, we invested $547,000,000 to repurchase 8,500,000 target shares at an average price of just over $64 For the full year, we continue to expect to invest in more than $2,000,000,000 to retire shares and we'll continue to govern the pace of execution in support of our goal to maintain our strong investment grade credit ratings.
We paid 1st quarter dividends of $232,000,000 marking the 182nd consecutive quarterly dividend we've paid since becoming a public company. We will recommend that the Board approve an increase in the dividend later this year, which would make 2013 our 42nd straight year in which we increased the annual dividend. Now let's turn to our expectations for the Q2 and the year. In the U. S, we remain cautious about the near term sales environment given the economic and consumer challenges Kathy and Greg just mentioned earlier.
Yet with the recent weather challenge behind us and an easier comparison from last year, we expect 2nd quarter comparable store sales will recover into the 2% to 3% range. So far in May, we've continued to see cautious buying behavior from our guests, but the pace of sale has supported our view of the quarter. In the U. S. Segment, we expect the 2nd quarter gross margin rate will be up slightly from last year, driven entirely by the change in recognition of vendor payments.
We expect our Q2 SG and A expense rate will be just over 21%, nearly a full percentage point higher than last year's revised U. S. Segment rate, driven primarily by a smaller benefit from credit card income and the change in recognition of vendor payments. This would put our 2nd quarter EBITDA margin rate at about 10.5% and with expected leverage on D and A, an EBIT margin rate of 7.5%. In Canada, 2nd quarter sales will ramp up meaningfully from the Q1 pace, yet start up expenses will continue to dominate the P and L.
As a result, for the quarter, we anticipate expenses from our Canadian operations, including interest expense measured outside the segment will create $0.16 of dilution to our earnings per share. We continue to expect Canadian dilution will come down further in the Q3 and by the Q4 we expect our Canadian operations will be slightly accretive to our consolidated earnings. Altogether, we expect 2nd quarter adjusted EPS of $1.09 to $1.19 We expect our GAAP EPS will be $0.19 lower than adjusted EPS in the range of $0.90 to $1 reflecting $0.16 of dilution due to Canada and $0.03 of dilution related to the unwind of the beneficial interest asset related to the receivable sale. For the year, we have an even more tempered view of sales than we did 3 months ago. Without some unexpected improvement in the economy and the consumer, our full year comparable store sales will likely grow in the 2% to 2.5% range, somewhat below the 2.7% we outlined at the beginning of the year.
This updated view of sales has also tempered our view of full year earnings per share, costing us to take our expected range for adjusted EPS down $0.15
to the
$4.70 to $4.90 range. We expect full year GAAP EPS to be $0.58 lower than adjusted EPS in the $4.12 to $4.32 range, reflecting Canadian segment dilution, losses on early debt retirement and net gains from the credit card portfolio sale. Longer term, we continue to feel very good about the health of our business and the steps we are taking to keep our business relevant over time. We continue to invest in our remodel program, loyalty initiatives, technology, the integration of our store and digital experience, the new Citi target format and our Canadian segment. Yet even with those initiatives, we continue to expect to generate far more cash than we need to invest in our business, giving us the opportunity to return 1,000,000,000 of dollars to our shareholders through dividends and share repurchase.
As a result, we continue to expect Target will deliver earnings per share of $8 or more by 2017 combined with a dividend of $3 or more that same year. That concludes today's prepared remarks. Now Greg, Kathy and I will be happy to respond to your questions.
Your first question comes from the line of Peter Benedict of Robert Baird.
Great. Thanks guys. Just a couple of questions. Just on the U. S.
Gross margin performance, can you give us a sense of maybe what that red card 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 Q4.
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? Thanks.
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 much feel much more difficult than it otherwise might. I think over the longer term, we 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 and 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 and A? Thank you.
I think you'll continue to see D and 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 and L, we'll provide a little bit more clarity about the entire P and L for Canada.
Okay. Fair enough. Thank you.
Your next question comes from the line of Sean Naughton of Piper Jaffray.
Hi. Thanks for taking the questions. 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 2009. Just wondering what would explain that decline given the increase in the remodel program from Q1 last
year? Actually, Sean, I'm not clear quite clear on your question. Units per transaction in the Q1 were up year over year. So help me with that again.
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. 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, Greg, 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 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 the supply chain that our guests want to interact with us, how much is shipped from store, how much is shipped 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 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 at that 10% EBITDA rate that we've said is part of our long range plan.
Got it. That's helpful. Thanks and best of luck in Q2. Thank you.
Your next question comes from the line of Matt Namer of Wells Fargo Securities.
Thanks for taking my questions. 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 Q2 guidance, do we assume that there's some incremental markdown risk in seasonal categories? You did mention that within categories, the rate improvement would be a little softer in the Q2 than the Q1. So just wondering what the markdown risk is in 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 how the sales of these categories play out before we have to take markdowns in the 4th 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 we don't expect to see a significant risk whatsoever. So we're talking about things on the edges right now.
Yes. Matt, the other thing I'd add is 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 last few quarters. And 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 multichannel 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 and A lag both directions. It doesn't climb as fast when sales go up like last year and 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 and A settle in at a more appropriate level.
Great. That's helpful. Good luck this quarter. Thanks.
Your next question comes from the line of Colin McRanahan of Bernstein.
Good morning. Thank you. First question on Canada. Understand that the gross margin rate of 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 the 38% was a little higher we expected because the mix was a little bit 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 that 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, it mixes 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 guest board at the front end and we had the right team members there for the supply chain and we had the right teams on the sales floor. 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 consumable share will grow because that's the hardest trip to change with the guest. 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 and supply chain and in store operations to start refining the model.
Okay. That's helpful. By the way, Hoopla is a technical term we use here on Wall Street.
We use that sometimes
here too.
Secondly, on the credit, I actually thought the contribution of $105,000,000 while you said it was you explained it was lower. 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 $105,000,000 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 $105,000,000 was really a $210,000,000 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.
You can take that offline and walk through that in detail Colin.
And then finally just coming back to SG and A, The dollars were up
I think $233,000,000 If I ex out the credit difference of $36,000,000 the vendor allowance of $13,000,000 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 some of the expense things you're doing on 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. And 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 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 long, long time ago. So we do expect through time SG and A will come down and manage to a level that is more appropriate.
Okay. Thank you.
Your next question comes from the line of Bob Drbul of Barclays.
I guess the question that I
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 P Fresh 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 Q4 and that was down again in the Q1, 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. No, I think
that the traffic this 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 other thing I'd add, I don't think we need to run traffic numbers like we did last year in Q1 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%, P fresh help us all year long, but during key seasonal categories key seasonal timeframes, we need those categories to drive traffic as well. Okay.
Thank you very much.
Your next question comes from the line of Debra Weinswig of Citigroup. Thank you so much and we appreciate all the color. A lot of conversation regarding mobile and digital traffic. Can you also talk about what conversion was like during the quarter?
Yes. 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 other 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 mobile 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 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 then I think Greg touched on segmentation and how you're looking to match local and preferences. Where are you? I know there is 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.
Was there anything that you learned from Canada that you go back and apply to the U. S? Or was it exactly what you expected and you're just continuing on the path?
Go ahead. I would just say, Deb, I think it's a little early to learn from Canada and bring that back to the U. I will tell you though we learned a lot from city targets 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.
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.
Great. Thanks so much and best of luck.
Thank
you. We have time for one more question.
Your final question comes from the line of Chris Horvers of JPMorgan.
Good morning. 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 Q1? 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. And if you do, 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 Q1, 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 in thinking about the EPS pressure from Canada, can you talk about how much of the expenses in the Q1 are one time in nature preopens and so forth? And as you think about the guide for the Q2, 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 Greg said where we started with the stores staffed very heavily. We know through time we have to refine that model. Is that one time 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 one time and will drift away. What I'd tell you is through time, we expect ultimately well down the road to get to SG and A rates that make 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 and 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. What's the internal discussion around balancing rate versus balancing sales? And do you think that you've leaned too far on towards the rate side? Thanks.
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 Q1. So we're always looking at that.
We look as much at out of stock as we do in stocks and 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 Q1 2013 earnings conference call. Thank you all for your participation.