Phone, Tablet and Videogame Segments Rose Q4 at Target

Q4 sales at Target started off better than expected for the first three weeks of the holiday season, but shifted to “meaningfully softer results” following the Dec. 19 announcement that millions of credit cards had been compromised in the breach that affected in-store purchases in the U.S., said CEO Gregg Steinhafel on an earnings call Wednesday. Q4 comp sales dropped 2.5 percent, which aligned with guidance the company gave in January, he said.

Target’s Q4 gross margin was below expectations and “somewhat less favorable” than in previous quarters due to clearance pricing and strong sales in electronics, said Chief Financial Officer John Mulligan. Gross margin slipped to 27.6 percent in Q4 from 27.8 percent in the year ago quarter, he said. Mulligan called the Q4 U.S. segment gross margin rate “strong” given that the company had to “rapidly manage excess inventory” mid-quarter when sales took a sudden dive following the data breach announcement.

Non-discretionary categories delivered the strongest sales in Q4, said Kathryn Tesija, Target executive vice president-merchandising and supply chain, but electronics had an increase in Q4 comp sales led by mobile phones, tablets and videogame hardware and software, she said. On Thanksgiving Day, Target’s highest revenue digital sales day in its history, mobile devices led all categories, at 25 percent of sales, she said.

Target’s initial steps to protect shoppers following the data breach -- including assuring customers they would have “zero liability” for unauthorized charges for Target purchases, offers of free credit monitoring and identity theft protection and improved fraud detection for REDcard holders -- are “part of a longer process,” Steinhafel said. He acknowledged that the breach and other retail-related credit breaches have shaken consumer confidence and said Target is working with third-party companies to determine how the breach occurred and find ways to provide “enhanced protection” for consumers in the future.

Those efforts include a $100 million investment to equip stores with an advanced chip-enabled technology and issue Target-branded smart chip debit and credit cards. Target has long endorsed such technology, Steinhafel said, but “broad adoption has been elusive.” He expressed hope that recent events at Target and elsewhere prove to be a “tipping point” that will result in widespread adoption, and Target is taking a leadership role to make that happen. Target is working on the initiative with banks, retailers, trade associations, payment processors and networks to share best practices and “foster future innovation,” Steinhafel said. The retailer is also investing $500 million in a new coalition with the Better Business Bureau, National Cyber Security Alliance and National Cyber-Forensics & Training Alliance to educate customers about the dangers of consumer scams, he said.

Target isn’t able to estimate future expenses related to the data breach, it said. Future expenses could include payments for claims by the payment card networks for alleged counterfeit fraud losses and non-ordinary course operating expenses related to reissuing credit and debit cards; payments for civil litigation, governmental investigations and enforcement proceedings; expenses for legal, investigative and consulting fees; and incremental expenses and capital investments for remediation activities, Target said. The costs could have a “material adverse effect” on Target’s operations results in Q1, the 2014 calendar year and “future periods,” it said.

In stores, Target is launching in July a pilot for a new format store called Target Express at its headquarters location in Minneapolis, Steinhafel said. The “carefully curated” product assortment of private-label goods includes discretionary products such as electronics, home and seasonal goods along with “household essentials” including food, healthcare and beauty, he said. Target will study “operational and financial results” before it decides to expand the format to other markets, he said. The pilot store is 15 percent the size of a traditional Target store and is geared to customers who don’t have access to Target’s larger locations, he said.

CityTarget stores for urban markets posted single-digit higher comps in their second year, Steinhafel said, and the retailer is looking to increase the size and “enhance the flexibility” of the format in more urban areas, he said.

In Canada, Target “worked diligently” to bring in holiday traffic to move excess inventory, said Steinhafel. Markdowns as part of that effort resulted in a “very low” gross margin rate, but allowed the company to reduce average inventory in the 124 Canadian stores by roughly 30 percent between the beginning and end of Q4, he said. Earnings per share dilution was 40 cents in the quarter, a 5-cent improvement over guidance given last month, and the company is confident that improvement will continue in Canadian stores this year, Steinhafel said.

In coming months, as part of its effort to differentiate content offerings, Target will sell an exclusive Blu-ray edition of Catching Fire, the second release in The Hunger Games trilogy, Tesija said. The Target version adds 45 minutes of exclusive content from previously unreleased footage and cast interviews and a behind-the-scenes look at the making of the film, she said. On the music side, Target will sell an exclusive-edition CD of pop artist Shakira’s 10th album that arrives in stores in March. The Target version has three bonus tracks, she said.

In Q4, Target’s U.S. sales dropped 6.6 percent to $20.9 billion. Profit fell 46 percent in the quarter to $520 million, it said. For Q1 2014, Target projects adjusted earnings per share (EPS) of 60 to 75 cents, including results from U.S. and Canadian operations, but not including expenses related to the data breach, it said. The adjusted EPS forecast for 2014 is $3.85-$4.15. Shares rose 7 percent to $60.49.