Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation Third Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Thursday, November 21, 2013. I would now like to turn the conference over to Mr. Gregg Steinhafel, Chairman, President and Chief Executive Officer. Please go ahead, sir.

Thank you. Good morning, and welcome to our 2013 third quarter earnings conference call. On the line with me today are Kathee 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 third quarter results and strategic priorities for the remainder of the year; then Kathee will discuss category results, guest insights and plans for the holiday season; and finally, John will provide more detail on our financial performance, along with our financial outlook for the fourth quarter and the 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. 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. Target's third quarter financial results reflect continued strong operating performance in the U.S., despite an environment in which traffic and sales remain challenging. Comparable sales increased 0.9% in the quarter, near the low end of our guidance, and our U.S. operations generated adjusted earnings per share of $0.84, near the midpoint of our expected range. We continue to manage our business thoughtfully, investing to maintain our relevance over the long term while we focus on disciplined execution to drive current performance. We continually…

Thanks, Gregg. We are pleased with the ability of our team to manage the business in the third quarter, maintaining profitability in a soft sales environment while we continue to develop digital capabilities that allow us to connect with our guests in new ways. Across our merchandising categories, we saw a relatively balanced mix of third quarter sales between lower-margin and higher-margin categories. Among the lower-margin categories, need-based areas like Food and health care continue to outpace our overall comp. And Electronics had a greater -- had a great quarter, driven by sales in mobile devices and video games. Our discretionary higher-margin Apparel and Home categories both saw small declines in comparable sales. In Apparel, third quarter trends were strongest in Jewelry, Accessories and newborn/infant/toddler. In Home, sales trends were strongest in Domestics. In our digital channels, we saw very strong growth in Apparel, Hardlines and Beauty. Early in the quarter, we were pleased with the comparable sales results in our Back-to-School categories, which outpaced both the industry and our overall results. Results were particularly strong in supplies, which saw a big increase in penetration of our up&up brand. Performance in Back-to-College was also stronger than average, both in-store and online. In September, our collaboration with Phillip Lim was one of our most successful to date. Sell-through levels were very strong overall, and particularly high in our digital channels. The most popular items in the collaboration include handbags, men's shoes and women's dresses. In October, this year's calendar shift benefited comparable sales, as a portion of Halloween-related sales moved into the month from November last year. However, as Gregg mentioned, in conjunction with the government shutdown and pullback in consumer confidence, we saw a slowdown in our sales trends, leading to the lower-than-expected sell-throughs on Halloween merchandise at the end…

Thanks, Kathee. Our third quarter financial performance reflected continued strong execution in our U.S. segment and higher-than-expected dilution on our Canadian segment as we continue to refine operations and clear excess inventory. This morning, we reported adjusted EPS of $0.84, near the midpoint of our guidance, despite comparable sales near the low end of our planned range. Our GAAP EPS of $0.54 was below expectations, reflecting $0.29 of dilution from our Canadian segment. In the U.S., comparable sales trends were fairly consistent throughout the quarter. As Kathee mentioned, trends were softer than expected in October as consumers witnessed the dysfunction in Washington. However, on a reported basis, this weakness was offset by the calendar shift, which moved a meaningful amount of Halloween sales into the third quarter. Our sales continue to be driven by a small decline in transactions, which is being more than offset by an increase in average transaction size. In the third quarter, this increase in basket was entirely driven by an increase in average retail per item, driven largely by Electronics, which, as Kathee mentioned, saw a much stronger comp in the third quarter than we saw earlier in the year. Sales penetrations on our REDcards continue to grow as more and more guests understand the compelling value of our 5% Rewards program and decided to deepen their relationship with Target. We continue to see a consistent response to households who apply for and activate a new REDcard, increasing their spending at Target by about 50%, on average, as they respond to the ability to save with REDcard Rewards. Third quarter U.S. segment EBITDA and EBIT margin rates were consistent with the guidance provided at the beginning of the quarter. Among the drivers of EBITDA margin, we saw a moderate decline in gross margin rate, reflecting…

[Operator Instructions] And our first question comes from the line of Greg Melich with ISI Group.

I wanted to start right with REDcard and traffic. That's a trend this year that has sort of gotten locked in at this down 1% to 1.5%, and you just gave some goals a few weeks ago where comps would be 2% or better over the next few years. How do you get to the 2% over time if traffic's still down 1% to 1.5%, or what initiatives with REDcard or anything else that you have which will really get that traffic stabilized?

So I'll start, Greg. I think a couple of things. One, I think, first of all, the stress on low-income consumers is certainly playing a role. We've seen that all year long. The payroll tax increase has been a portion of that, for sure. I think we get to cycle past that in January, and we'll get better information about what that looks like going forward. But beyond that and the things that we actually control, as you said, we continue to see meaningful growth in REDcard. That continues to drive 50% lifts in sales, all of that driven by traffic. Kansas City is above 25% penetration now, so it continues to grow hundreds of basis points a year. And then beyond that, I think it's all about our multichannel initiatives and everything we're doing there. And as I said, we're starting to see strong digital sales growth. That, combined with the flex-fulfillment activities that we're implementing now, piloting a little later this year and will begin to roll out next year, we think all of that put together will continue to drive meaningful traffic increases.

And the only thing that I would add, Greg -- this is Kathee -- is just that as guests are consolidating their trips and they're coming less frequently, it's really important for us to get them to shop around the store and to buy more. And you do see in our basket that we've been able to accomplish that for the past several quarters as well. So we will stay focused on how do we ensure that we get more of their wallet when they do come.

And maybe a direct follow-up to that. I know that with all the multichannel initiatives, and you outlined them all on the call, how have you changed how store managers and associates are incentivized so that they give the sort of level of service to the online guest that's coming in to pickup in-store? Do they get credit for that, or how should we look for that to be changing going forward?

Yes, they do. They get total credit for anything that is bought online, picked up in-store, or things that are in-store, where there's an extended aisle sale and it's in it. So we're incenting this. Actually, we have a parallel environment where both teams, both our dotcom team and our store teams, get credit for growing the business in a collaborative way. So there's no penalties or there's no internal conflict at all as it relates to who's going to get that credit for the sale. So we're double-crediting everybody from an internal standpoint, and then we take it out at the an enterprise level to make sure that it all washes through on a consolidated basis.

Is that true if I have it shipped to my home?

If it's shipped to your home from the store, yes.

And your next question comes from the line of Wayne Hood with BMO Capital.

Kathee, just on the average ticket size -- Gregg was talking about transactions, but just to get to the ticket. I mean, there's sequentially been a pretty nice acceleration in AUR throughout the year, and you talked a little bit in the third quarter, Electronics impacting that with the UPT being down. As you plan the business into the fourth quarter, would you still expect your AUR to be up kind of 3% and UPT to be down? Or how should we think about the dynamics that's driving average ticket? And also, that points to -- if AUR is up, which points people are maybe buying up -- you're moving them up, how do you square that with a consumer that's constrained?

Most of what's driving it up for the fourth quarter will be those hot categories like Electronics that are most popular in the holiday season, and there's a lot of newness there that drive up the average selling price. So think of iPads, think of all the new video game consoles and games, which Target does very well with. And we are really excited about that business for the holiday season. So I would anticipate it will continue into the fourth quarter.

Yes. So think of it more as a change in the mix of what we're selling at this time of year, versus trading up within category.

Got it. And then my kind of question related to this, Kathee, and it gets back to the trip issue. With what you've seen with Cartwheel, what trips is that group -- you've seen an extra trip, and how do you really jump on that at a faster rate to drive trips the way you did with REDcard?

Yes, first, I would tell you it's pretty early. I think we've got about 6 months in with Cartwheel. But as we mentioned, very excited. We have got over 3 million users right now that are very engaged. I think it's helping trips. I also think it's really helping basket because they're using Cartwheel in the store, on their mobile device, looking for deals on things that they want to buy, and they're adding more to their basket. So it's still really early to see trends, but we are very excited about it and are talking about it more and more. We're going to be using Cartwheel as one of our vehicles to help drive value this holiday season. And hopefully, more and more people will hear about it and sign up for it. But we think this is a big success story for us that we can continue to grow.

And your next question comes from the line of Sean Naughton with Piper Jaffray.

I have a couple of core questions here on Canada, and I think most of them are related. John, I think you talked about the gross margin being impacted by some inventory issues in Canada late in the quarter. Can you just give us a little bit more color there on what happened there? And then maybe also outline where are some of the pockets of excess inventory that you're looking to move through? And then just secondly, are there any signs of hope in the business or glimmers of hope that you can kind of point to, whether it's by region or category, that are kind of going better than expected at this point in that market?

There's always hope, Sean. We're highly confident that we're going to be successful. To your inventory question, we talked a lot last time about, given the sales shortfall and the fact that we planned inventories to protect on the upside, given all the excitement, there's a pretty large inventory overhang. And as the teams have worked hard over the past 90 days, assessing the best way to handle that, and it depends on the various categories, about the best way to handle that, we've clearly seen some markdowns come through. We're taking advantage of that, actually, to drive value messaging in Canada and get across how sharp our prices are. And then we're also assessing what of the inventory do we think we're going to sell, ultimately, below cost or end up salvaging because there's just flat-out too much of it. And that's the inventory reserves that we assess at the end of the third quarter. We do that every quarter anyways, as a matter of course, and we'll do that again at the end of the fourth quarter. But that was a large piece of what happened at the end of the third quarter. I think as far as lumpiness of inventories, as you'd expect, it's the long-lead categories where we tend to be lumpy. The stuff that turns quicker or that is domestically sourced, we can, obviously, shut down receipts much, much quicker. But stuff that is long lead -- and we'll see this continue, actually, a little bit in the spring. And here, think about categories like bikes, where those are a long-lead item and it just -- we can't get out of the receipts once we've made commitments. So those are the type of items that'll take us a little bit longer to clear through. I think on signs of hope -- we wouldn't call it hope, but on signs of our execution starting to improve, we are seeing, and I think this is consistent with what Gregg said, as we start to get sales histories, we can start to replenish stores more accurately, balance our inventories and meet guest need when they need that. And we're starting to see success there. As we look at our current results, we're pretty much hitting our current forecast, but we're seeing much stronger results in the cycles that have been open longer. Cycle 1, Cycle 2, Cycle 3 have actually begun to exceed our expectations a bit. So we're a little bit hopeful -- not hopeful, we're optimistic that we are seeing the right trend with those cycles improving, and we believe we'll continue to see that as we get more age behind the Cycle 4 and Cycle 5 stores.

That's helpful. And then just secondly, in terms of expense optimization in the U.S. business, looks like you did a great job of controlling that there in Q3, maybe even below what you would expect moving forward. Do you feel like you're in the right position now there? And what type of comp do you feel like you need right now to leverage that SG&A moving forward, maybe in Q4 and then kind of the first half of 2014?

Yes, I think our efforts on expense optimization continue to be very successful. The teams are very engaged across the company and continuing to look for new ideas of ways that we can reduce expense. And I think part of this is about lowering our center of gravity that you're referring to. But a big part of it, too, is in reinvesting that in other parts of the business. And you've really seen that this year. We had significant incremental investments in technology, supply chain. That will happen again next year, particularly around technology and flexible fulfillment. We'll make SG&A investments, and expense optimization really allows us to offset that. So I think leverage probably hasn't changed a whole lot, somewhere between that 1 and 2 range, but it gives us a lot of capacity to invest in the business as we continue to grow our multichannel capabilities.

And our next question comes from the line of Matthew Fassler with Goldman Sachs.

My first question relates to Canada. What kind of insight can you give us into the average number of stores opened over the course of the quarter as it relates to timing of openings, just to give us the ability to measure an accurate sales productivity number. We obviously try to get sales per store and sales per foot, but the growth is moving so quickly on such a small base that it's very easy for those numbers to get distorted.

We agree with the last part of that comment, and we've continued to say it's very early here, and we're going to see it move around again in the fourth quarter, given we see the surge in holiday sales. I don't have the exact weighted average on the store timing, Matt. But John Hulbert will get that to you -- we can get that to you today.

That would be very, very helpful. Second question I would ask relates to the Electronics business. Clearly, the video cycle is here and is very prominent, and I know that mobile is still a relatively new business for you. If you look at the legacy consumer electronics businesses, and you mentioned tablets, where I know you had a fairly high-profile promotion recently, and TV and other businesses that have less kind of industry-wide going on year-on-year, what's your experience, then, in those categories, or what was it in the third quarter, and what's your sense of the promotional environment here in Q4?

Well, Matt, I'd say it's strong overall. Certainly, that varies by category, but there are a lot of great trends in our business in Electronics. I mentioned a couple that we're excited about for Black Friday and going into Cyber Monday and the rest of the holiday season. Things like Beats by Dr. Dre, that -- the whole headphone category has been fantastic, and that's a lead item. Speaker systems, like Sonos, have been fantastic. So there are many different categories that are performing well. Some are a little bit softer, like cameras. But in total, a really strong business in Electronics right now.

And your next question comes from the line of Chris Horvers with JPMorgan.

Wanted to follow up on the Canadian and gross margin and just your thoughts about how that proceeds going forward. I think originally, you had talked about the Canadian gross margin being above the U.S. I always interpret that as maybe a couple of hundred basis points above the U.S. rate. But you have these competing factors right now, where the markdown pressure is a negative but the mix factor is a positive. So as you look into the crystal ball, how do you think -- how might your -- are your gross margin expectations shifting based on those 2 competing factors over what the long-term opportunity could be relative to your original expectations?

Yes, Chris, this is Gregg. Over the long term, our expectations haven't changed at all. What we're experiencing now is, and as John talked about it, it's those long lead time businesses that are markdown sensitive, particularly Home and Apparel, that we have to exit, and it's costly to do so. Remember, the first cycle of stores didn't open until April. And the second cycle followed shortly after that, and that was only a handful number of stores. By the time we really got a good, clear indication in terms of where the sales were going to level out for this year, in our long-cycle businesses, and think 6, 7, 8 months, these receipts were already planned and in production and on the way. So it's really the lump of inventory that we've got to work through. And once we do that, we're very confident that we're going to be back in the mid-30s, like we talked about, in terms of the overall gross margin because our mix continues to be strong. And we're very pleased with that, and we don't see any signs of that abating. Now it might come down a little bit as we get more aggressive in terms of building that trip frequency. And we'll start those efforts in earnest when we turn the corner in 2014. But on an absolute basis, we're really pleased with where we are in Home and Apparel. And we've got to get through this next quarter and the early part of the beginnings of 2014 until we really get that sales history developed by item, by store and eliminate some of the huge variability that we have in the supply chain so that we can get a more even balance between receipt flow and what we're selling. And at that point in time, we fully believe that we're going to be back to where our initial expectations were from a gross margin standpoint.

And then, you mentioned that some of the early-cycle stores were starting to, I guess, exceed your expectations a bit. You had a really interesting chart at the Analyst Day that talked about where they expected ramp in the stores initially, versus where it's sitting now. Could you just reference for us what you mean by exceeding your expectations a bit? Is that versus, I guess, your original expectation on new year, first-year sales or versus what you rethought?

No, these are against the new, most recent level-setting expectations that we shared at the Analyst Day that said that they're not where they were when we originally planned the business, but now that we've had enough experience, we see where they were, and we established and rebooted, essentially, our expectations for Canada. So against that new, most current forecast, what we're seeing is encouraging signs out of those earlier-cycle stores. They are exceeding these newer, revised forecasts more than the later-cycle stores because they've had a chance to operate on their own. They're 6 months into it now. The inventories are flowing better, in-stock levels have improved, the guest is getting used to our stores, they're converting from more of a browser to a shopper. And so it's still very, very early, but we like what we see in some of those early-cycle stores. And so at this stage, we're just encouraged by the fact that they're performing better against most revised, revised forecast.

And then one just quick last one. Can you just share with us what your share in the gaming category is in the U.S.?

I don't know that number off the top of my head. It is definitely higher than our typical market share, but we can get back to you with that number.

It's much higher than our aggregate store or Electronics market shares.

And your next question comes from the line of Jason DeRise with UBS.

Yes, it's Jason DeRise here from UBS. Can I ask, I guess, about the comps? I just want to get your thoughts on a few of these items, if you would maybe quantify them. So one is the -- how much of the shift from the timing of the calendar between Q3 and Q4 in your reporting benefited the current quarter that was reported and pulled forward from Q4? And then get your thoughts about if you think there's any impact on your comps from SNAP, whether that's directly in your Food sales or your general merchandise sales. If you could quantify what kind of uplift you expect from video games? And also, one thing that didn't come up yet, but lower fuel prices, how you're thinking about that?

Well, that's a lot of questions. On the third quarter, I think, clearly, Halloween moving into the quarter benefited it. I would remind you that we also said, at the end of last quarter, our Back-to-School week moved out of the quarter into second quarter. That benefited second quarter. Net-net, probably a wash, maybe 10, plus or minus 10, 20 basis points. I don't really know, but net-net, a wash. Let's see, WIC -- any time there's a decrease like that, there's an impact. But for us, Grocery, Food is about 20% of our business, roughly, and it's a very different kind of trip for us than most grocers. So certainly, there's an impact. But for us, meaningfully, that's just not -- again, this is a small impact relative to what we might see at other retailers who sell significantly more food as a percentage of their business than we do. And then Electronics, what was the question on Electronics, I'm sorry?

I guess, the video game cycle itself, what kind of comp uplift you would expect just from that? And the last part of that was about fuel prices coming down, if you see that as a benefit for yourselves or not?

Well, we don't necessarily talk about categories and how big they are. But with 2 new console releases and all the games that will go with them, as you know, it's been a declining category for several years, given the maturity. It's been over 7 years since we had a new console. So having 2 in the same year is very meaningful for the category. It's also very meaningful for Electronics and the store. So we think it's going to be one of the biggest gifts -- gifting category of the year, and we will certainly benefit from that.

And then on fuel, there's no question that, in a time when, particularly, lower-income consumers have very constrained budgets, having less -- having to spend less on fuel, it helps in some way. For us, I'll tell you, through time, we have looked at this many, many ways, and it's really hard to quantify fuel price moves in our sales. There's times when fuel prices are going up in a good economy, and that's good for everybody, which is different than today. So it's hard to quantify. But overall, lower fuel prices is definitely good for consumers. It just puts more money in their pocket.

If I can ask one more about comp trends, the Apparel part of the business. I mean, it sounds like the branded stuff is going well for you. Can you talk about your private label trends in Apparel? Is that maybe where some of the weakness is and what you're doing to try and turn that around?

Apparel, I think, was -- most of what we have is owned-brand product and exclusive designer partnerships that we do. So that is the bulk of our business. Certainly, we do a lot of basics with branded manufacturers, Hanes, for example. But our comp in Apparel was down slightly. It was much stronger online, so we're seeing some shifting happening there. We are pleased with the new releases that we've had. Phillip Lim was probably our best designer launch ever, very clean sell-throughs, both in stores and online. Our launch of our holiday product is off to a good start, while it's still early. So we're feeling pretty good about Apparel overall. I would say that the softest part of Apparel has been in kids. And we are working on ways to make sure that we can drive that business and have the right price-value relationship for our guests to help drive better market share gains. But the rest, I feel pretty confident in.

And our final question comes from the line of Paul Trussell with Deutsche Bank.

Just looking at the U.S. business from a gross margin standpoint, if we exclude the vendor agreements accounting shift, I think gross margins would have been down about 50 basis points year-over-year. Can you just kind of prioritize or rank for us the impact from markdowns versus category rate pressures and other factors, and just how we should think about that going into the fourth quarter, given the promotional intensity?

The 50 basis points is about right, and I would say about half of that was due to the ongoing pressure we've seen for several years now related to REDcard and the store remodel program. The other half, like we talked a little bit about, was really related to markdowns we took given the Halloween sell-through that we saw. And we saw sales soften up, like we said, in the middle of the quarter. Given everything that was going on with consumer confidence and in Washington, we saw sales soften up a bit. And really, just some promotional markdowns to sell through our Halloween inventory. I think as we think about fourth quarter, as we talked about, it's going to be very promotional, there's no doubt about that. But the primary driver of our performance versus last year is, last year, we took significant clearance markdowns last -- which you'll see be the primary variance year-over-year in our gross margin rate.

Okay. So improved performance on gross margin in 4Q versus 3Q?

Yes.

Absolutely.

Got it, got it. And then just lastly, on Canada, you mentioned that there was a lot of investment -- or a lot of markdowns in inventory. Is some of the gross margin hit also related to price investments being made in certain categories? If you can just give us an update on that, along with a reminder, John, on what the drag was from startup expenses in Canada this year.

Yes, we haven't disclosed the drag from startup expenses all year long. So we haven't really talked about that a whole lot. As it relates to price investments and markdowns, I think it's all -- we view that as all one big bucket, really, and it's really the total value message we're able to give to the guests in Canada right now. And as we said, we have a little bit of excess inventory. We'll take advantage of that. To be sure, we're giving a great value message. But beyond that, as we look at our pricing in Canada on like items, we are right on where we want to be. We are locally competitive and right on the price leaders in Canada. So we feel really good about our pricing in Canada on like-for-like items.

Great. Well, that concludes Target's Third Quarter 2013 Earnings Conference Call. Thank you, all, for your participation.

And thank you. This concludes today's conference call, and you may now disconnect.