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 Wednesday, November 19, 2014. I would now like to turn the conference over to Mr. John Hulbert, Senior Director, Investor Communications. Please go ahead, sir.

Good morning, everyone, and thank you for joining us on our third quarter 2014 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Financial Officer; and Kathee Tesija, Chief Merchandising and Supply Chain Officer. This morning, Brian will discuss our third quarter performance and our priorities for the fourth quarter and beyond. Then Kathee will provide more detail on recent performance and outline our plans for the fourth quarter, including the holiday season. And finally, John will provide more detail on our financial performance and outlook for the rest of the year. Following their 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 and I 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 EPS is included in this morning's press release posted on our Investor Relations website. With that, I'll turn it over to Brian for his comments on the third quarter and our priorities going forward. Brian?

Thanks, John, and good morning to all of you. We're pleased with Target's third quarter financial performance, which we announced earlier this morning. Our adjusted earnings per share of $0.54 was better than our guidance of $0.40 to $0.50, driven by U.S. Segment comp sales growth of 1.2%, which is also better than our expectations. Importantly, the U.S. Segment saw positive comps in all 3 months of the quarter, and we're encouraged that the pace of U.S. traffic continues to recover from a very challenging trend earlier in the year. While U.S. traffic still declined slightly in the third quarter, performance was more than a full percentage point stronger than traffic trends through the first half of the year. As we mentioned in our second quarter earning call, we saw a strong start to Back-to-School and to the Back-to-College season, and that strength continued in September. Like many others, our sales slowed as we entered October but recovered nicely towards the end of the month as we approached Halloween. While our Canadian Segment continues to see robust year-over-year growth, third quarter sales in Canada fell short of our expectations. As Kathee outlined in our last earnings call, the team in Canada has been working diligently to make improvements to operations, assortment and pricing in preparation for the fourth quarter. With these changes, we believe we're better positioned to serve our guests at a time of the year when traffic will naturally be higher. The guests' response to these changes, both in their shopping behavior and overall sentiment towards Target, will inform our perspective as we continue to assess our longer-term potential in Canada. As I've visited stores across the U.S. and Canada and worked with the Target team, I've been continually impressed with the level of their talent and passion…

Thanks, Brian. On our last conference call, we outlined that we'd already seen a strong start to the third quarter, driven by initial results in the Back-to-School and Back-to-College seasons. A key question at the time was whether this early strength would prove to be temporary, resulting in a pullback later in the quarter. With the quarter now behind us, I'm happy to report that we continue to outperform our U.S. forecast throughout the quarter and saw positive U.S. comps all 3 months. As Brian mentioned earlier, third quarter U.S. traffic was down slightly from a year ago, but we're encouraged that our traffic trend has improved meaningfully every quarter this year. Consistent with year-to-date trends, average ticket increased 1.6% in the third quarter, driven by growth in average retail per item, particularly -- partially offset by a decline in items per basket. At a category level in the U.S., third quarter comparable sales performance was strongest in Health Care and Beauty, led by Beauty, which continues to benefit from this year's store fixture innovations and the introduction of new brands. Third quarter comps in Home were up in the low single digits, with particular strength in Seasonal categories benefiting from Back-to-School, Back-to-College sales early in the quarter and late-quarter strength in Halloween. Third quarter comp sales in Grocery were up in the low single digits, and Hardlines was up slightly, led by Toys, which saw a high single-digit increase on strength in licenses like Frozen and Teenage Mutant Ninja Turtles. Comp sales in Apparel were down slightly as strength in Baby and Kids was offset by softness in Jewelry, Accessories and Intimates. From a mix perspective, it's worth noting that our combined Home -- our combined comp in Home and Apparel was the strongest we've seen in 2 years.…

Thanks, Kathee. Our third quarter financial performance was better than expected, driven by stronger-than-expected sales and operating margin performance in our U.S. Segment. Adjusted EPS of $0.54 was $0.02, or 2.9%, below last year, reflecting a decline in U.S. Segment profit, partially offset by the benefit of reduced losses in our Canadian Segment. GAAP EPS of $0.55 was $0.01, or 2.7%, higher than last year, benefiting from the resolution of tax matters in the quarter. Our third quarter U.S. comparable sales increase of 1.2% matches our best performance in the last 2 years. Digital sales in the U.S., including flexible fulfillment, grew more than 30%, contributing about 60 basis points to our U.S. comparable sales. With ship-from-store capabilities now fully in place, we expect digital sales growth to accelerate to nearly 40% in the fourth quarter. Our third quarter U.S. Segment EBITDA margin rate of 8.5% was ahead of our expectations, driven by a better-than-expected SG&A expense rate of 21%, which is about 20 basis points lower than last year. This performance was the result of our expense optimization efforts, better leverage on stronger-than-expected sales and retiming of some expenses into the fourth quarter. U.S. REDcard penetration was 21% in the third quarter, up about 110 basis points from last year, driven by growth in both credit and debit penetration. As we described last quarter, applications for new REDcard debit cards are running below last year, causing penetration growth to decelerate from last year's pace. We believe this trend will continue in the fourth quarter, when we expect U.S. REDcard penetration will be flat or up slightly compared with last year. With the success of recent initiatives designed to increase REDcard applications, we expect the fourth quarter will mark the low point in year-over-year penetration growth, after which, we should…

[Operator Instructions] Your first question comes from Sean Naughton from Piper Jaffray.

So, John, you mentioned this. There has been a lot of talk about gas prices and the potential positive benefit on the consumer. But just curious if you could speak to the potential benefits you may receive on the P&L from a distribution standpoint. And if those are savings that are there, how would you guys look to use those additional distribution savings between flowing through the earnings and potentially reinvesting to drive traffic?

Yes, I think a couple of things. Certainly, there would likely be some benefits if we continue to see fuel prices come down, but we haven't reached the threshold where fuel surcharges begin to come out of our contracts. And I think importantly, given the great work the team has done to manage the -- some of the port issues out West, we're working around that and moving some freight further, expediting some freight, flying some freight. And I think net-net, that will probably be more of a drag than any fuel savings we will see.

Okay. So -- and then I guess just a second question on the overall basket. The UPT continues to be -- to decline and actually looks like it decelerated a little bit on a 2-year basis. Just wondering if you could give us a little bit more color around that particular dynamic, either at the store level perspective -- given the higher Food concentration, I would be expecting that to improve, but maybe this is being offset by online. And I guess the follow-up would be is how do you improve that dynamic moving forward?

Sean, this is Kathee. You know that it's predominantly a mix story for us. So we have higher-ticket items like all the Apple products, including the launch of the iPhone 6 in the quarter. We've got video game consoles that are higher. We have a lot of trade-up strategies, both in essentials like you talked about like in Grocery with organics, but also in areas like skincare, which I described a little bit earlier. So this is really a mix story.

Okay. So it's less about the shift between online and store.

Correct. Correct, yes.

Your next question comes from Matt Nemer from Wells Fargo.

My first question is on expenses in the U.S. They basically have been running flat on a dollar basis this year, down a little bit per foot. I'm wondering if you can get into a little more detail on what's driving the cost savings. And then in terms of the outlook, is this a line that you think you can run flat to up in dollars, up slightly in dollars over the next year or so? Or should we expect it to grow a little faster than that?

Matt, yes, I think the expense savings, I would tell you, we've talked about the expense optimization efforts all year, been very focused on that and has been across the entire enterprise. And we've seen good news in SG&A and also in the cost of goods. The couple of areas I would point out: The stores' performance has been outstanding, driving productivity increases while still continuing to remain very strong; guest service scores, frankly, our guest service scores historically. So we've seen great performance there. And then it's just really many other areas. There's been great work done in marketing around the circular. There's been great work done in our transportation in how we optimize our network of transportation. So really, across the enterprise. I think, importantly, to your question about the stores, we believe there continues to be significant opportunity for us to continue to take expense out. And so for the foreseeable future, we would expect to continue to see expenses very well-controlled and to lever expenses at really relatively modest increases in sales.

Matt, it's Brian. And to build on John's point, and as I discussed in my prepared comments, as we move forward, we recognize that we're going to continue the need to focus on expense management to fuel the investments we're going to make to drive continued growth across our store base and our digital platform. So as we come back to you in the spring and we talk more specifically about our strategies, you should expect us to continue to talk about cost-optimization efforts and how we'll use those efforts to reinvest in the fuel that's going to drive our growth.

Okay. That's great. And then secondly, on target.com, I wanted to ask a question about the free shipping program. Does the incremental volume offset the incremental shipping expense? Is it profit-accretive? And do you think that the customers that are utilizing this offer are high-lifetime-value customers?

Yes, it's not accretive. I will tell you, we do ship -- even prior to the holiday free shipping, we do free ship a lot more than perhaps you would think and certainly more than some of our competitors, given REDcard and the fact that, that ships free all year round. So we have seen -- we know it's the #1 frustration with our guests and the #1 reason for abandoned carts. And so it was important for us this holiday season to be able to take that friction away, and we have seen a meaningful move in orders and conversion because of it. So we are very pleased with the results so far.

Yes, Matt. The only thing I'd add, while not accretive, the other thing I would add is it's not material either to our results in the fourth quarter.

Your next question comes from Oliver Chen from Cowen and Company.

Regarding the great idea regarding signature categories and where you're focusing there, how would you help us just prioritize which categories have the most opportunities in terms of lead time and revenue mix and timing of impact? And is the extrapolation there that traffic will be the biggest kind of comp upside driver as you do focus on these categories?

Yes, Oliver. I think as we go forward and as Kathee and the team really elevate our focus around those signature categories, categories like Baby and Kids, Wellness and Style, you should expect to see additional focus in-store. You should see additional innovation partnerships, but really ensuring that we're leading with trend. We're anticipating what our guest is looking for in those categories, and those are categories that Target becomes famous for. And we're certainly going to double-down our efforts in those categories because our guest has asked us to. They are categories that are very important to our guests. They're synonymous with the Target experience the guest is expecting, and you'll see signs of that as we move into 2015 and beyond. Certainly, some of the work that Kathee and her team have done in preparation for the fourth quarter are already bringing our efforts to life in Apparel, some of the things that we've done in Home, the partnerships that Kathee talked about in her prepared comments, our continued focus on Baby and Kids. And we know how important Toys are during the holiday season. So we're already making progress in those spaces, but I also want to make sure it's really clear: That does not mean we're walking away from other categories in our stores. They just play a different role in our future strategy, and they'll continue to be areas where we're going to look to improve our execution and performance. But from a prioritization standpoint, we think those signature categories that we've talked about are key to the guest. The guest has told us those are critically important to them, and Kathee and her team are working rapidly to ensure that we continue to build our position, enhance our assortment and bring great newness and innovation to those key categories.

So a couple of things that I would add to that, that you will already see in stores right now. Brian talked about those 4 areas: Baby, Kids, Wellness and Style. So in Baby, about 200 stores have a new presentation where we've invested in labor in the stores to help guests create registry and gift-givers find the perfect gift. We've added mannequins and things that help the presentation. I also shared today the registry that we've redone completely, the whole experience, from the in-store hardware to the software that we use and how that helps guests create registries much easier. We're already seeing the benefit of that. Wellness, we've talked a lot about "Made to Matter" and better-for-you products, so you see that already this year. And then in Style, just to touch on that for a minute, we now have about 650 stores that have our new presentation in Apparel, including mannequins. So already some progress, and we will continue to push forward in those areas, and you'll see more and more as the months and year goes on.

Oliver, the final point I'd add as we think about Style, certainly Apparel and Home are critically important in that space, but so is Beauty. And as John and Kathee have referenced, Beauty was one of our standout categories in the third quarter, and we expect continued strong performance as we exit the year.

And just as a follow-up and it's related. There seems to be a lot energized agility, Brian, regarding thinking about what Target stands for from a bigger-picture perspective. What are some of the initial thoughts on where you see that opportunity as you work to further differentiate and innovate yourself?

Oliver, I think we're making progress across a number of different areas. Certainly, we talked about omni-channel and really making sure that we are a significant player in this space, and we're seeing very strong performance, up over 30% in the third quarter. John talked about the fact we expect that performance to accelerate in Q4. We clearly took away the pain point of shipping by announcing free ship in the fourth quarter, and we think that's another way for us to declare we are significantly committed to this space. We're seeing a great response to Cartwheel, 11 million users today, and we're going to use that to make sure that we use digital as the front door to connect to the Target brand going forward. We've talked about some of the progress that's being made in merchandising, and we've added 35,000 new items in stores for the holiday. And we're going to continue to test and partner as we continue to make sure we're bringing the right solutions to our guests. If you haven't seen some of the holiday creative, I think it's some of the best Target's delivered in years. And I'm getting e-mails and comments from guests and friends and people I know every day talking about their reaction to the holiday creative and how the creative campaign is uniquely Target. And we're certainly upping our game both in-store but we're also going to spend significantly more in digital this year to touch our guests no matter how they're connecting with the brand. In-store, we've made significant progress in a very short period of time, going from testing ship-from-store, to now we're in 38 markets, 136 stores, where our stores are acting like flexible fulfillment centers. You can shop there. You can pick up there, but they're also shipping to -- directly to our guests and allows us to cover 90% of our marketplace in a very short period of time. It takes the pain away from that last mile. So I think you're going to continue to see us make these points. And that's a sneak peek of Target in the future, and I think that is creating positive energy in the organization. Kathee and I are hearing really positive things from our vendors. Our organization knows we've got to be more -- we've got to show more agility. We've got to be responsive. We've got to make sure we're externally focused and following the guests. But I think you're seeing some of those things take shape today.

Your next question comes from Wayne Hood from BMO Capital.

Yes, Kathee, I had a question, and this maybe is a little bit longer-term and it places the context of how you evolve the company, and that is related to where you see AUR turning because you're talking about more emphasis in Kids and Baby, which typically is lower ticket, and maybe pulling back on promotions in Electronics because that's not core. And I'm just wondering where you think your AUR might land over the next few years in light of kind of the 2% to 3% growth you've been experiencing under the existing strategy. And then if you could talk about -- John, if you could talk about the growth in inventory next year and its impact on working capital as you think about being better in stock on the ad merchandise and the like.

Wayne, we haven't modeled exactly what that will be yet, but I would tell you I think that it will be moving up for a couple of reasons. So you heard Brian talk about those areas that we're going to focus on and really being famous for them and delighting our guests. And when we are at our best, we offer both Expect More, Pay Less together in all of these categories, and that means a really thoughtful balance of good, better, best; having clear features and benefits as we move up that ladder; allowing guests to be able to buy whatever's important to them, but importantly, offering really good trade-up opportunities. So you're seeing some of that right now in some categories, but I think as we move forward and we become famous again for some of these categories, there will be a lot of trade-up opportunities. So I would say, overall, seeing it moving up.

And then, Wayne, your second question, inventory. I think the one thing I'd say, if you look at our number this quarter, 6% to 7% all of the U.S., really only about 1/3 of that do we view as temporary. The vast majority of that was receipt timing. But that 1/3 we expect to stay around. We started that in second quarter this year. We'll cycle it again next year in second quarter, somewhere around a 2% to 3% increase for the first half of next year. But offsetting it ultimately, as we start to get back to positive comp sales, we should see a faster turn that should ultimately lead to better payables leverage. So not a meaningful impact overall once we get past fourth quarter here on our working capital.

Your next question is from Greg Melich from Evercore ISI.

I have 2 questions that are maybe a little bit linked. John, if we start on dot-com, which if my algebra's right, is around 2.5% of sales in the quarter, what does that do to the margin going forward? I know you mentioned it's sort of immaterial for the fourth quarter, but could you tell us what it did in the third quarter and how we should think about it? I mean, it's probably dilutive of some effect and whether it's more in gross margin or SG&A, and then I had a follow-up.

On margin, it's definitely dilutive, Greg, if for no other reason than the shipping expense. And I think as it continues to grow, that will put margin pressure on the P&L. And we've talked a little bit about this. There are lots of puts and takes in gross margin as we think about it going forward that we're working through today. As that business grows, it will be margin-dilutive. But as we increase penetration of ship-from-store and Pickup in Store, that significantly not only improves our guest experience, but significantly improves the P&L. We're also balancing how we look at pricing right now and balancing inventories across the network as we ship-from-store. So some of those are up. Some of those are down. And we're working through right now where ultimately gross margin will land.

And then the follow-up and maybe, Brian, you -- in your comments, you talked about making sure in the -- those were 5 key operating principles, the invest-to-build capabilities. I love your perspective on this year CapEx is down a lot, and we're running, I guess a little over $2 billion as the run rate. What do you think does the CapEx need sort of going forward to invest in what Target really needs to do to be the best it can be?

Greg, we're assessing that right now as we think about 2015 and beyond? But you should expect us to be investing in the capabilities to continue to build out our digital experience, to continue to enhance our in-store experience, to make sure we have the analytical tools to properly manage expenses in margin even more surgically going forward. And I talked about, while certainly in the early stages, we're going to continue to look at smaller formats and how we use smaller formats to penetrate urban markets, allow our guest the chance to interact with the Target brand both in-store, but also continue to build out the opportunity for them to purchase online. So we're in the early stages of assessing our long-term capital needs, but you should expect us to be investing in the right capabilities and tools to provide long-term shareholder value and allow us to continue to fuel our growth and enhance both margins and continue to manage operating expenses effectively.

Would that mean CapEx would be above D&A at some point in the future? Or do you think you can stay below that?

Greg, we think -- at least Brian said, I think, with the caveat that we're working through this right now, we think we're probably in about the right range right now. The spend may move around a little bit. I think the one wildcard is the point Brian made about small formats. But I would note that, obviously, the investment there is significantly below what a prototypical Target would look like. So it would take a lot of those to meaningfully move our CapEx number. So like we've talked about, something in -- for the U.S. in that $2 billion, $2.5 billion range still makes sense, but we're doing the work right now.

Your next question comes from Matthew Fassler from Goldman Sachs.

I know there's a lot of big-picture questions to discuss, but actually, I have 2 quantitative ones related to the quarter. First of all, John, can you talk about the expense -- the magnitude of the expense dollars that shifted from the third quarter to the fourth, and talk about perhaps, functionally speaking, what they're related to?

Yes. Most of it is marketing moved around. And the magnitude, if you think about us beating by somewhere in the neighborhood of $0.09, it is a little bit less than half the beat. So somewhere in that $30 million to $40 million move between the quarters.

Got it. And then secondly, you talked about running ahead of the fourth quarter plan. Just as we think about the cadence of that plan, obviously you had a tough January, as did many retailers, particularly given the breach. So when you say running ahead, is that running ahead of the 2% number as we speak? Or running ahead of a plan that's maybe a bit more nuanced than that as we think about where we are in the progression of the quarter and your comparison a year ago?

Well, I wouldn't want to get into that level of detail. Clearly, last year, pre-breach was stronger than post-breach, and we took that into account as we thought about the calendarization of the plan. And right now, we're running ahead of that and we feel good about where we're at, not only relative to the plan but on an absolute basis is what I'd say. But there is a lot of business left to be done before we get to the end of January.

Your final question comes from Michael Lasser from UBS.

It's on the Food category and recognizing that you're not going to de-emphasize it, you're just going to streamline it, how are you thinking about the return profile of that base within the store? And then could there be any differences in -- amongst how space is allocated? Could that area get less over time?

Yes, let's drop back and we make sure we clarify our point on the Food category. We have no intentions today to streamline those categories, but Kathee and the team are certainly stepping back, listening to the guest, really understanding what the Target guest is looking for in Food, from an assortment standpoint, from a newness standpoint. We talked about the fact that as we go forward, you should expect to see more natural and organic offerings. We've seen a terrific response from the guest to something that we call "Made to Matter," a collection of items that are on trend for our Target guests, feature a number of exclusive items to Target from manufacturers that are in the organic and natural space, that can bring great innovation, gluten-free, on-trend products to our guests. And we certainly recognize that we have an opportunity to connect with the guest in a different way when it comes to Food. But you shouldn't expect us to de-emphasize those categories. That's not the point. We're not streamlining our Food offering, but we are stepping back and really listening to the guest, making sure we curate on their behalf the right items that are uniquely Target, that meet the needs of our guests in the Food categories. So a lot more to come as we talk about this in the first quarter. But to make sure we're really clear, we're not streamlining Food. We're not de-emphasizing Food. We're not walking away from Food, but we certainly want to make sure we put our mark on the Food category with items that are uniquely Target, that are right for our guests, that are on trend, and you should certainly expect to see more natural, organic offerings in that space, because the Target guest has asked for them.

Okay. That's very helpful, and do you think you can manage the return profile on that space to generally meet the hurdle rates that you expect from it?

We would certainly expect to see that. And Kathee talked about some of the changes we're seeing in mix. And certainly when we talk about natural organic, when we talk about some of these unique items, they tend to have a higher average unit rank. So you should expect to see some mix changes, but importantly, Food is an important part of our future. We're not going to de-emphasize the category. We're not looking to take away space. We want it to be more impactful, more on trend, and we want to fill it with items that the Target guest is looking for.

That concludes Target's third quarter 2014 earnings conference call. Thank you, all, for your participation.

This concludes today's conference call. Thank you for participating. At this time, you may now disconnect.