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 18, 2015. I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.

Good morning, everyone, and thank you for joining us on our third quarter 2015 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; and Cathy Smith, Chief Financial Officer. This morning, Brian will discuss our third quarter performance, including results across our merchandise categories and plans for the fourth quarter and remainder of the year. Then John will provide an update on our operations and priorities going forward. And finally, Cathy will offer more detail on our third quarter financial performance and discuss our outlook for the remainder 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 the call, Cathy and I will be available 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. Also in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure, and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalized operating leases. Reconciliations to our GAAP EPS and to our GAAP total rent expense are included in this morning's press release, which is posted on our Investor Relations website. With that, I'll turn it over to Brian for his perspective on our third quarter performance. Brian?

Thanks, John, and good morning, everyone. As we step back and look at our third quarter results and our year-to-date performance, it's clear that our strategy is working and we're delivering on the financial commitments we laid out last March. Following an extended period of declines, traffic has turned positive over the last 4 quarters and has been accelerating on a 2-year basis. Sales in signature categories have been growing much faster than our overall sales, and they are clearly exceeding industry benchmarks. So while consumers continue to spend cautiously, we feel confident as we enter the holiday season, and we're focused on continuing to deliver on both our strategic priorities and our financial goals. As we mentioned in our last conference call, our third quarter plans were based on the knowledge that we were facing stronger prior-year comparisons than we had experienced earlier in the year. Now with the quarter behind us, I'm pleased to report that not only did we meet our forecast, we saw continued progress on our strategy. Specifically, 2-year growth trends in comp sales, traffic and signature category performances each accelerated in the third quarter, following strong performance in the second quarter. Our third quarter adjusted EPS of $0.86 was 8.6% higher than last year and above the midpoint of our guidance range we provided at the beginning of the quarter. Third quarter comparable sales were up 1.9%, also near the high end of our guidance and driven primarily by growth in traffic. We're really pleased that our guests are responding to the investments we're making in our assortment, presentation and shopping experience, and we're focused on building on this year's traffic increases in both stores and our digital platforms in the quarters and years ahead. Our third quarter gross margin rate was down slightly…

Thanks, Brian, and good morning, everyone. Today, I'm going to provide an update on our initial efforts to reinforce our retail fundamentals, particularly our in-stock position, and I'll cover our priorities and progress in our work to modernize the supply chain in support of our strategic initiatives. The good news is that while we have lots of work still ahead of us, we have seen meaningful improvement in key in-stock measures based on changes we've made in the last few months. While we strive to be in stock on every item in every store throughout every day, we know that need-based commodity categories are the most critical. If our guests don't believe that they can rely on Target to have their shopping list items available every time they shop, they'll begin to skip some trips to Target even though they enjoy shopping our more discretionary categories. As a result, when in-stock metrics on our core commodity categories began deteriorating this year, we created an out-of-stock action team to conduct deep dives by category to identify both short-term and long-term solutions. When a team identifies solutions within a category, we can quickly test them to confirm they improve our performance and then determine if those solutions can be applied more broadly. This team focused first on our Household, Personal, Baby category and more recently, they've done work on our center store Grocery category. In a short amount of time, they have identified opportunities related to the way we generate vendor orders, optimize tradeoffs between order quantities and frequency and our reliance on system-generated solutions versus manual processes. In high-volume stores, the team has implemented adjustments to planograms to enhance holding capacity on fast-turning SKUs, reducing the need for frequent store replenishment. And in our distribution centers, the team has identified opportunities…

Thanks, John, and hello, everyone. As Brian mentioned earlier, we are pleased that this quarter's performance was near the high end of our guidance for both sales and adjusted EPS. As is often the case, when you get into the detailed P&L, there were some ins and outs within the quarter that generally offset each other, which I'll cover in a few minutes. This quarter, adjusted EPS was $0.86, above the midpoint of our guidance range and 8.6% above last year. GAAP EPS from continuing operations was $0.76, $0.10 lower than adjusted EPS, driven by $0.05 of asset impairment, $0.03 of data breach expense and $0.02 related to the corporate restructuring we announced last spring. Third quarter GAAP EPS was $0.87 compared with the $0.55 a year ago, as this year we recognized $0.11 of tax benefit related to our investment losses in Canada, while last year we incurred $0.27 of after-tax losses related to Canadian operations. Let's turn to third quarter segment results. Among the drivers of our 1.9% comparable sales growth, we are pleased that traffic grew a very healthy 1.4% in the third quarter. This growth is even more encouraging when we look at performance on a 2-year basis, as we faced a tougher comparison in the third quarter than either of the first 2 quarters of the year. October marked our 12th straight month of traffic growth, and we are laser-focused on this metric as a key indicator of the health of our business over time. Breaking out our sales growth between stores and our digital platforms, the stores accounted for a little over 3/4 of our comparable sales growth, while digital contributed about 40 basis points to our third quarter comp. Consistent with results from earlier in the year, our digital growth continues to be…

[Operator Instructions] Your first question comes from Matt Nemer from Wells Fargo Securities.

First, Brian, I'm hoping that we can get a little bit of the pulse of the consumer from you. Clearly, there's been some weather impact in September and October, but we're hearing negative comments about November from another -- a number of retailers. So it feels like there's something else happening either from a macro or maybe a competitive standpoint. I'd love to get your sense for what you're hearing from your customers, your guests.

Well, Matt, I would tell you we're feeling really good about the trends we're seeing, the reaction we're getting from the guests. Certainly, the growth in traffic for us is really encouraging. So we're seeing more Target guests come back to our stores and visit our sites, and they're continuing to respond very positively to the work we've done in signature categories. So sitting here today, we're very confident about our position. We think we're connecting with the consumer and our guests, and I feel fantastic about the plans we have in place for the fourth quarter. So while obviously still cautious as we sit here early in November, we feel very good about the way the consumer and the guest is responding to our brand, and I feel as if we're really well positioned for the fourth quarter.

That's great to hear. And then just shifting gears to gross margins, I'm wondering if you can call out the impact of the reimbursement pressure in health care and any sense for the total impact or run rate impact following the closure of your deal with CVS, how that could help you next year. And then secondly on gross margin, you did call out in the press release private brand investments, and I'm just wondering if you could dimensionalize the potential size of that over the next few years.

Let me talk about the owned brand investments we're making, and then let Cathy talk through the Rx implications. But as we've consistently talked about throughout the last year and 1.5 years now, we think one of the things that differentiates Target is the value, the quality, the innovation we bring to our own brands. So we're clearly looking to make sure we bring more value to our own brands. I talked about the number of handcrafted items we're going to have for the fourth quarter. And we're being very surgical with those investments, but we're seeing a great reaction from the guest as we elevate the value we offer in our own brands. So we'll be very surgical, very selective, but we're certainly seeing a great return for the investments we're making.

And, Matt, this is Cathy. On -- with regards to the pharmacy reimbursement pressure as we said when we announced the transaction with CVS, that we lack scale and we knew that we were going to continue to see pressure here over time. So what we're seeing in this quarter is in the range of 15 to 20 basis points of pressure in the quarter and -- which is why we're excited to be partnering with CVS because they'll be able to help with that scale.

Your next question comes from David Schick from Stifel.

I wonder if you could give us any extra color update on the localization work in Chicago.

Right now, we're still very focused on testing localization in Chicago. We're very pleased with the results, and certainly a lot of the localization's taking place in our Food and beverage offerings. We're seeing the guest respond to that, and we're going to take the learning from Chicago and apply it to the 25 stores we're remodeling in Los Angeles. So we'll continue to expand the learning, take it from Chicago to L.A., but I am very pleased with the progress we're making. And we're partnering with John and the store and supply chain teams to make sure, over time, we can scale the learning from Chicago and Los Angeles to multiple markets around the country.

So last time you had updated us, I think you said 100 to 200 basis point comp lift is very pleased, sort of mean it's -- we're continuing to see that.

We are consistently seeing those kinds of returns.

Got it. And then on the -- quick on the dotcom side of the business, there was some deceleration, still good growth in that line. Can you talk about any other metrics that help us understand the shift? Is it spent -- time spent on the site, capabilities? What is driving the difference in the growth rate? And it sounds like a growth rate you're comfortable with for next quarter.

Well, I think the most important measure to look at is what's happening with online growth overall. And just in the last 24 months -- or 24 hours, we saw the October e-commerce growth rates in the U.S., and it was up about 8.6%. The outlook that NRF has for e-commerce growth in the fourth quarter is somewhere between 6% and 8%. So while our 20% growth rate is not in line with our expectations, it's still dramatically outperforming the industry. And I think the most important measure we're looking at is the fact that over 80% of our guests start their shopping journey online, either at home on their desktop or with a mobile device, and that digitally influenced guest is coming into our stores more often. So as we've talked about our strategy, our strategy is to make sure we allow our guest to shop anywhere, anytime they want with Target. And what we're seeing right now is they're voting with their feet to spend more time in our stores. They're downloading our Cartwheel app, and 20 million downloads so far to date. So I think we're seeing an overall slowdown in digital growth across retail, and we're really pleased that we continue to outpace the industry -- dramatically outpace the industry, but our digital efforts are driving more traffic into our stores and helping us grow our overall comps. So while there's been a slowdown broadly across the sector, we continue to outpace the industry, and that's our fundamental goal.

Your next question is from Kate McShane from Citi Research.

It's encouraging to hear that a lot of the investments, especially in the signature categories, are panning out well for you. In your merchandising strategy specifically, where do you think you still have the most work to do? And what can we expect year-over-year when we see those categories for holiday?

I think we're making some very good strides, starting in Apparel. And while 3% in Q3 was slightly less than the growth rate we saw in the second quarter, compared to many of our peers, we recognize that we're continuing to build traffic and growth in an important Apparel category. So the work we've done with mannequins, with changing the in-store experience is clearly paying off. One of the changes that we have announced recently is the addition of 1,400 visual merchandisers to make sure we combine the change in the ranking with mannequins and fixtures and layouts with experts in store that can maintain that great in-store merchandising experience. So that's a new venture for us. We're standing it up for the holidays. We expect that they continue to strengthen the in-store experience. And we know with our signature categories, we're still at the very, very early stages of standing up our Wellness position. But we feel like we're in an excellent position with Baby and Kids. We feel very good about our performance in the third quarter with Kids Apparel. Certainly, Toys has been a highlight throughout the year, and we feel as if we're well positioned coming off of second and third quarter comps in Toys that were up 12%, the reaction we've seen from the guest to our store -- Star Wars assortment, where we captured an industry-leading position and expect to be a destination during the holidays. So while we still have much more work to do, we feel very good about the progress we're making in signature categories, and I think the addition of digital merchandisers in store will help us maintain our merchandising appeal throughout the holidays

Your next question is from Scott Mushkin from Wolfe Research.

So I wanted to get back into the Food discussion, if we could. I mean, I think you're testing stuff in Chicago, you're going to roll that into L.A. Brian, maybe a lot of people don't know this, maybe they do, but you had a good experience back when you were at Safeway and then on to Sam's. I think you talked about 200 basis points you're initially seeing. But what can we expect out of the company? I think Safeway saw more than that as they kind of brought in some kind of refurbishments. And when can we expect to see more from Target as far as refreshing the decor and maybe doing a fuller rollout? And is 200 basis points a good expectation? It seems to me it could actually be higher than that as you refine your lift, but wanted to get some more details there.

Well, Scott, I'm glad you asked the question. I do think one of our highlights in Q3 was the improved performance in Food. Now we've actually seen Food comp acceleration throughout the year. And while we haven't made major changes with fixtures and in-store decor, we've been very focused on assortment changes and bringing more natural, organic, local items into many of our categories, and we're seeing the guests react very favorably. So to me, it's getting the basics right. And before we start making fixture changes and decor changes, it has to start with the right assortment and making sure we have the items, the brands our guest is looking for when they shop food at Target. So the acceleration you're seeing right now is driven by, section by section, getting the assortment right, bringing more appealing items to our guests, adding more natural, organic, gluten-free items that are on trend to those categories. We made some significant changes in yogurt in the third quarter and saw very, very positive responses, high single-digit growth rates in those categories. So while we're not shouting about it, we're making steady progress in Food. We'll learn a lot more in 25 stores in Los Angeles, where you will see some changes in fixtures and decor. And as we learn, we'll continue to grow. So I think we do have significant upside, but Scott, this is about making sure we get it right, and we're going to take a slow, steady approach, solid, consistent results every quarter and continue to deliver what the guest is looking for from an assortment experience standpoint when they shop food at Target.

So I mean, obviously, key. I think Cathy said you're measuring -- one of the big things you look at is frequency and this is obviously a core to that. So we look forward to seeing more, but my follow-up question is on the investment side. We get it a lot whether it be e-commerce, whether it be in the Food, in the logistics. Can you kind of talk us through why there won't be a massive ramp up in investment as we go out the next couple of years, and that you have enough money in the CapEx and then kind of the SG&A to kind of handle what the company needs to do?

Yes, Scott, we've looked at this very carefully, and I know we've talked about it a number of times. We feel very confident that the CapEx budgets we've had in place will be very adequate over time to make the changes we need to make from a technology standpoint, a supply chain standpoint, continue to refresh our stores and maintain our focus on maintenance investments. So sitting here, Cathy and I have spent a lot of time recently. Obviously, John's been a great steward of our CapEx spending, and we feel very comfortable that our current spending levels will allow us to modernize the organization, enhance technology and improve supply chain. And make sure, along the way, we're continuing to enhance the in-store experience and match that up with a great online experience for our guest.

I would offer just real quickly to add to that, because we have kind of pressure tested this one ourselves a lot. We have not -- Target has not underinvested over the years, and I think that bodes well with the state of where you find our stores as well as our technology and supply chain investments we need. So I feel very good about where we are, and with that level of investment, we've been pretty consistent.

Your next question is from Matthew Fassler from Goldman Sachs.

I'd like to ask a 2-part question. The first relates to the cost-cutting initiatives that you discussed at your Analyst Meeting earlier in the year. You spoke about $1.5 billion of SG&A and then $0.5 billion of cost of goods over 2 years. If you could talk about the run rate that you're at now against those goals, and I guess another twist on Scott's question, the degree to which you've had investments in sight that would offset some of those. I think that was also part of the plan that you set forth.

So I'll jump in and take that. I think from a tracking perspective, what we said, right at your point, $1.5 billion of SG&A, $0.5 billion of margin and we would deliver in 2015 about $0.5 billion of that. We're running a little bit ahead of that pace and both in the cost of goods and in the SG&A space, both are running perhaps a little bit ahead of what we envisioned going into the year. So we feel really good about that. I think stepping back and kind of tying this back to Scott's question, the other thing we said at the time was we're taking $2 billion out of the P&L, but we didn't expect EBITDA margin expansion. And our view was that we would need this to fuel the investments, exactly some of the expense investments that perhaps Scott was referring to, and this would provide the capacity to do that, and that is, in fact, what we've seen. We've seen great expense discipline across the corporation, but where we needed to invest, we have had the capacity to do that.

And if I could ask a quick follow-up. You talk about $0.5 billion this year. Is that delivered -- I know it's not being delivered to the bottom line because there are some offsets, but is that annualized run rate achieved? Or is that actual cost cuts that would have come out on a gross basis against your cost base, offset by some of the investments?

We will take out $600 million this year.

Yes.

And then part of next year will be annualization of that and part of it will be incremental.

And then a very quick follow-up. On wages, obviously, Walmart made an incremental announcement since your last call. Any sense as to whether this issue is kind of burning up organically in the field as you think about hiring and you think about intrinsic wage pressure in the marketplace and how you're thinking about that relative to your plan?

Yes. We don't see any material change in the marketplace. Again, we've talked a lot in the past about making sure we're investing to have the best retail team. And we look at this very surgically, year after year, market by market, and we think we're in a great position and we think we're hiring terrific talent, and we're excited that we've got a great team in place as we get ready for the holidays.

Your next question is from Greg Melich from Evercore ISI.

I guess, my 2 questions are a bit of a follow-up, one on the last one. If you look at the fourth quarter guidance, if I'm getting this right, SG&A dollars are kind of flattish. And is that basically that cost out with the reinvestment going in? And then the nature of that question is really -- I think, John, you mentioned 40% of digital you thought would be ship-from-store in the fourth quarter. What has it been running? And what does that do to the labor model?

Yes. So Greg, this is Cathy. I'll take the first part of it. To answer your question, yes, we expect it to be essentially flat and it will be pretty much offset. We'll have pluses and minuses. So the savings we're getting we'll continue to reinvest, as we have planned. John will answer the 40% digital shipment.

Sure, Greg. 40% this quarter, and it'll peak a little bit higher than that actually, typically running more in the 20% to 25% range. But as we peak, this is a great way for us to utilize our store assets. The labor model, what happens here is actually it's quite efficient because we have dedicated teams in those stores to do the picking, do the packing and then we're just able to use -- utilize them more efficiently. And so while there is more store labor that we are using, the offset clearly comes in our shipping expense because we're much closer to the guest we are shipping to. And they aren't on the same P&L line, but it's an outstanding trade for us.

Yes. Greg, I think it's important is you tie-out the math on the ship-from-store, last year at this time, we had just over -- about 120 stores where we were shipping from store. As we sit here today, we're up to 462. So we've expanded the base. We're going to leverage and sweat the assets, I think, much more effectively. But importantly, that enhanced base allows us to deliver to our guests in a much shorter time frame. So we would expect that to grow during the holidays. We've certainly ramped up for it, and we think that's going to provide a much better shopping experience and allow us to deliver product to our guests in a much shorter period of time.

That's helpful. And if I could follow up, I think earlier, you talked about private-label penetration a little bit. Could you talk about how the stronger dollar or falling raw material costs or lower fuel cost could be impacting gross margin today, differently than you would have thought a few quarters ago?

Yes, I'll answer it briefly and then anyone can chime in. We're really not seeing an impact on it in our product cost or in -- obviously, in our margins. So it's really been kind of a nonevent for us.

And remember, Greg, with many of those items, those are long lead-time items. So -- and we'll certainly be watching that over time. But as we sit here today, many of those orders and POs were placed many, many months ago. So we'll continue to monitor that over time, but we certainly like our position with our owned brands as we enter the holidays, and that's an important way that we differentiate.

Your final question comes from Bob Drbul from Nomura.

Just 2 quick questions. The first one is on the Apparel performance, you talked a little bit about margin pressure, I think, in private label and exclusive. Was that new to the third quarter? And how do you see that playing out in the fourth quarter? And then the second question that I have is on the e-commerce business, just give us an update on like the subscription offerings and how that's going from a fulfillment perspective as well?

Yes. Well, Bob, first on the A&A side, again, we think the guest is responding really well to some of the changes we've made with our own brand assortment. And the investments that we talked about today, we've been consistently talking about for over a year now, making sure that we're reinvesting in quality, in innovation, in style, making sure that we deliver that "Expect More. Pay Less." brand promise. So the guest is reacting really, really well to that, and we're going to continue to make sure that we deliver great value in our own brands. So it shouldn't be a new phenomenon. It's something that we've been very clear and transparent about, and we think it's paying off with increased traffic and growth in those core signature categories. So it looks like we've run out of time for today. I do appreciate everyone calling in, and that will conclude our third quarter earnings call. So thanks, everyone, for joining us.

Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. At this time, you may now disconnect.