Ladies and gentlemen, thank you for standing by, and welcome to the Target Corporation Third Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, November 15, 2017. 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 2017 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; Mark Triton, Chief Merchandising Officer; and Cathy Smith, Chief Financial Officer. In a few moments, Brian, John, Mark and Cathy will provide their perspective on Target's third quarter performance and our plans and priorities going forward. 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 your follow-up questions. 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 non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP numbers to the most directly comparable GAAP number 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 thoughts in our third quarter performance and our priorities going forward. Brian?

Thanks, John, and good morning, everyone. We are really pleased with Target's third quarter performance, which reflected a continuation of the positive trends that emerged in the second quarter. We saw continued growth in both our comparable traffic and comparable sales in the face of more difficult prior year comparisons on both measures. Digital sales grew 24%, on top of 26% a year ago. And we announced new innovative partnerships with both Google and Pinterest, that will continue to expand the digital reach of our brand. We saw a meaningful increase in the percent of our sales at regular price, reflecting the benefit of our work to communicate value more clearly and provide our guests confidence that Target assortment is priced right daily. We rolled out 4 new own brands across our Home and Apparel categories, all of which are off to a great start. And we generated an unprecedented amount of buzz when we announced an amazing new designer partnerships with Chip and Joanna Gaines called Hearth and Hand with Magnolia, which launched last week. We also remodeled 37 stores in the quarter, in support of our plan to transform 110 stores this year. And we opened 12 new stores in a single week in October. These stores are located in a diverse array of neighborhoods across the country, ranging from our new Herald Square location in New York City all the way to our newest location in Honolulu. Beyond the direct financial returns we're seeing on these investments, our guests continue to confirm for us, both through their feedback and their shopping decisions that our efforts are paying off. And finally, this quarter, we made some meaningful announcements regarding our team. In early September, we announced our intent to hire an additional 100,000 team members for the peak…

Thanks, Brian, and good morning, everyone. As Brian mentioned earlier, a key priority of our work and operations is based on the goal to provide new and reliable fulfillment options for our guests. As of today, we have multiple new fulfillment options that are in some phase of testing or rollout across our network. We offer in-store pickup of digital orders, available in all of our store locations. We have a Drive Up service, which we just began testing at 50 locations in the Twin Cities. We now have same-day delivery, which we're testing at 4 stores in New York City. We offer next-day delivery through Target Restock, which is now available for 90 million guests in 11 markets. And we have a ship-from-store capability, which is now in more than 1,400 of our locations. Of those 5 fulfillment options, only 2 were available as we entered the year: in-store pickup and ship-from-store. And while both of those options are relatively mature, we continue to increase the amount of our digital volume handled by our stores. Today, the stores are already fulfilling more than half of our total digital volumes through the pickup and ship-from-store capabilities, and that will peak at well above 80% in the days leading up to Christmas. In fact, our stores are planning to ship over 30 million units related to digital orders in the peak 4 weeks of the holiday season, up from about 18 million units last year. Among the new fulfillment capabilities we've launched this year, Target Restock has been ramping up quickly. During the third quarter, we rolled out this service to an additional 10 markets across the country. We also extended the deadline for next-day delivery to 7 p.m. and expanded the number of eligible items to more than 15,000. The…

Thanks, John. Going into this year, 2 of our highest strategic priorities in merchandising were: first, to invest in our exclusive own brand portfolio to further reinforce our differentiated positioning in the market; and second, strengthening Target's value proposition and positioning, making sure we're priced right daily every day, which would reinforce with thoughtful, meaningful promotions that resonate with our guests and support our brand. As Brian highlighted earlier, we're encouraged by our progress on both priorities. In the third quarter alone, we launched 4 more new and exclusive own brands across Apparel & Accessories and in Home, which we then followed at the start of the fourth quarter with the blockbuster launch of Hearth and Hand with Magnolia. With this portfolio that we've rolled out this year, we are presenting our guests with new ideas and items across 8 new and exclusive own brands in readiness for the holiday season to create a unique, differentiated offer that builds preference for our guests to choose Target. Beyond the immediate strong sales growth that we've seen from these new brands, consumer survey show they are contributing to the Target brand overall. Specifically, consumer scores for Target differentiation have recently risen to a 10-year high, which will provide a benefit to traffic and sales in all of our categories over time, much like we saw when we launched Cat & Jack. To reinforce our value proposition with guests this year, our team has also moved at a rapid pace, and the response from our guests has exceeded our expectations. Specifically, we've seen a multibillion-dollar increase in sales at regular price so far this year, more than offsetting the decline in sales on discount. This clearly demonstrates that guests are increasingly confident that Target is priced right daily and are not only relying…

Thanks, Mark. Consistent with the second quarter, our third quarter traffic, comparable sales and overall financial performance were all stronger than our expectations. Third quarter comparable sales increased 0.9%, driven by a traffic increase of 1.4%. Both of these numbers decelerated sequentially as we faced a tougher prior year comparison. However, on a 2-year stacked basis, both traffic and comp sales accelerated in the third quarter. Our third quarter adjusted EPS of $0.91 was near the upper end of our guidance range of $0.75 to $0.95. GAAP EPS from continuing operations was $0.87, $0.04 lower than adjusted EPS, driven by the net effect of 2 offsetting factors. The primary impact was $123 million pretax charge related to our October debt repurchase, which lowered GAAP EPS from continuing operations by $0.14. This was largely offset by a $0.10 positive impact related to income tax matters. The majority of this $0.10 benefit was driven by a decrease in our 2016 net taxes related to our global sourcing operations. The remaining benefit was related to the favorable resolution of other income tax matters in the quarter. One other note on our third quarter tax expense. In addition to the matters we've excluded from adjusted EPS, third quarter adjusted and GAAP EPS from continuing operations reflect a $0.03 benefit from our global sourcing operations related to our 2017 taxes. Our third quarter gross margin rate of 29.7% was down about 10 basis points from last year. This decline reflects continued pressure from digital fulfillment and our work on pricing and promotions, mostly offset by our cost-control effort. Merchandise mix had a roughly neutral impact on our third quarter gross margin rate as healthy performance in higher-margin categories was balanced by strength in Hardlines. Our third quarter SG&A expense rate of 21.1% was about 80…

Thanks, Cathy. We're going to quickly move to your questions, but I wanted to add one final note first. We are planning to host our Spring 2018 Financial Community Meeting here in Minneapolis on March 5 and 6. John Hulbert will send out more details in January. But for now, we wanted to let you know the dates so you can hold them on your calendar. We'll be scheduling the meeting to allow attendees to arrive on the afternoon of 5th, and you'll be able to return home before the end of the day on the 6th. We hope to see you at that meeting. So with that, we'll conclude our prepared remarks. Now John, Mark, Cathy and I will be happy to take your questions.

[Operator Instructions] David Schick from Consumer Edge Research.

You mentioned several times throughout the call and, frankly, throughout the year that you're trying to take a conservative approach to planning, but you also mentioned -- and you also mentioned the strength and the confidence you have as this quarter that you just reported in the prior quarter happened in the traffic and the merchandising. Can you, sort of, square that circle for us because this is -- shares are obviously reacting to guidance this morning. So help us frame conservatism versus confidence.

David, I think sitting here today, we feel very confident that we're making very good progress against the plans that we set out earlier this year. If I think about the state of our business today, we're seeing a great response to the 8 new brands that we've launched as we've remodeled now over 100 stores, which we continue to see the list that we're projecting of 2% to 4%. We've seen a tremendous response to our new small formats that we've been opening up in new neighborhoods and on college campuses. And as you know, we opened up a number of new stores in this last quarter. And whether it was the results we've seen in Herald Square or all the way out in Hawaii, the guests have responded very, very well. We continue to see very strong performance from a digital standpoint, outpacing industry by a 2x factor. And during the quarter again, we saw very strong digital growth. And that's been underpinned by the progress we've made from a digital fulfillment standpoint and some of the things that John talked about during his prepared remarks. So sitting here today, I think we're making great progress, and I think we'll continue to see that progress extend into the fourth quarter. So we entered the quarter with a lot of confidence. We know there's a lot of business that has to be done, and we're off to a very good start led by the reaction into Hearth and Hand as well as some of the other initiatives that are in place. So I think we're taking the right approach, but we entered the quarter with a lot of confidence and making a lot of progress against literally every initiative that we set forth earlier this year.

Just a sort of follow-up to that, is there any -- what would be -- do you expect to backslide against any traction in key variables, comp, gross profit dollar comp? Help us understand that with this confidence in the guide.

David, we don't expect to see any deterioration in the progress that we've been making throughout the year. So again, I think we entered the fourth quarter highly confident and a very strong position with our stores performing incredibly well, great merchandise, a terrific marketing campaign, great digital capabilities and an expanded suite of digital fulfillment capabilities. So we feel very good about how the entire business is set to perform in the fourth quarter.

Peter Benedict from Baird.

Just on price perception, the work you've been doing, I mean, it sounds like you're pleased with where you've gotten that now at the end of the third quarter. Just -- I mean, do you think that, that's an ongoing process that you're going to have to do? How are you -- you mentioned some of the measurements you're using on that, but just trying to understand, is that something you let ride here for the fourth quarter and then reassess where you are next year? Or do you feel like you've gotten yourself to a spot where there's going to be no further adjustments required?

Peter, I think Mark and his team have made tremendous progress over the course of the year. And as we've talked about a number of times now, we're seeing a significant shift of our business towards everyday regular price, which is really important over the long term. So we're going to continue to make sure that we're committed to offering great value, that we're priced right daily, and during the fourth quarter, we'll provide exciting promotions to support those items that we know our guests are going to be interested in shopping for at Target. So it's an ongoing commitment. We want to make sure we deliver great value across the season. And we're going to make sure that we couple that with exciting promotions in the fourth quarter.

Okay. And then one maybe follow-up for John. You talked about a lot of the fulfillment options that you guys are working on. Help us through -- how does that impact the store labor model as you see kind of going forward? And within that, the $15 minimum wage plan. I understand it's not a fourth quarter question, it's more just as you look out the next few years. How do you see that -- those having an impact on the labor?

Well, I think, clearly, as we do more fulfillment out of the store, we will add labor to support that. I think we've said since February, we're going to invest in the labor in our stores, invest in training, invest in having experts in the store, invest in having people on the sales floor and changing the operating model for those stores. So that's an important part of what we're doing. Almost separately and independently, we're building teams that -- so that we don't take hours away from everything else we're doing that are handling the fulfillment in the back room. So it's really a question of the operating model in the store that's evolving. And we feel really good about utilizing the stores, they're the closest, fastest and cheapest way to get merchandise to our guests. They have significant capabilities now. We're doing same-day, next-day, 2-day pickup, Drive Up, all kinds of ways to meet the guests' needs, and I think that's the important factor, all centered around using the store as the hub. And we think it's a highly efficient way to use our assets, and we have great teams that can meet the capabilities that we need for our guests.

Our next question comes from Edward Kelley from Wells Fargo.

Yes. So I guess, my first question really is around the fourth quarter and the comparisons that you're facing last year. So in-store comps were particularly soft, the gross margin was down a lot, there was issues around digital fulfillment. I guess -- you talk about the underlying momentum of the business not stalling at all, but can you talk about how you expect to cycle those issues from last year?

Ed, again, as we entered this season, I think we're in much a stronger position. John underscored the fact that we've got an expanded array of digital fulfillment capabilities. Mark's talked about the progress we've made from both a brand standpoint but also a value standpoint. I think we continue to enhance our digital capabilities. So I think we entered this season in a much stronger position. And I think what's really important to recognize is the investments we've made in our team and our stores puts us in a very strong position as we enter the fourth quarter. So I feel great about the investments we've made in wages, in hours, in seasonal hiring. And I think our stores are going to drive both our digital business and our store business throughout the fourth quarter. So I think we entered the season in a very different position versus last year. And I think that's reflected in the start that we've seen to the season and the approach we're taking throughout the fourth quarter.

Okay. And second question for you. I just want to -- I know you don't want to give guidance for next year, but I was hoping that maybe you could talk about the puts and the takes in terms of what we should be thinking about, areas that you could see outsized investment, D&A is going to be headwind next year, wages clearly seem like they'll be a headwind. Your thoughts on price investments from here, the Street's sort of looking for a modest decline in earnings, seems like something like that -- larger than that's possible. It's just -- I don't know how much at this point, Brian, you can help with that, but I think it is an area that we're all sort of wrestling with.

Well, Ed, we're hopeful that you'll join us in March for next year's Financial Community Day. Obviously, we're not going to provide 2018 guidance today. But I'll give you a preview. You're going to hear us talk about many of the same things we've been talking about this year: our commitment to the store experience and continuing to remodel stores across the country, our commitment to opening up new small formats in new neighborhoods and on college campuses, our continued commitment to digital, our commitment to enhancing our fulfillment capabilities, our continued commitment to new brands and building our proprietary fleet of brands and an ongoing commitment to value. And all of that will be underscored by our commitment to our team. So we'll go through that in much more detail in March. But as a preview, we're going to be talking about the exact same suite of initiatives next year that we've been talking about this year. We feel great about the progress. Our strategy is working. Each one of those initiatives is on track or ahead of schedule, and we expect to accelerate those initiatives in 2018.

Chris Horvers from JPMorgan.

Two questions. So first, can you talk about how is the Essentials category? It was down slightly. You mentioned more share being taken on the unit side. Can you talk about unit growth in Essentials and how that's progressed over the past couple of quarters as you've put more muscle behind the price investments?

Sure, Chris. Why don't we let Mark walk you through how we're approaching our investments in Essentials?

Chris, yes, let me share with you. So we've been sharing this year that we took a journey in terms of ensuring we're priced right daily and that we were able to create and communicate to our guests the right value. And that started in April of this year and we completed that through the end of the third quarter. What we've seen with that is we had an expectation that's not an immediate just that [indiscernible] response we need to build ongoing, deeper trust with the guests and get them to connect with that priced right daily ethos, and we've seen a really fast reaction, a positive reaction to that. So we're creating in trips and traffic within our adjustment on -- to be priced right daily. And as a result, we've seen an increase in our unit velocity. We fully expected and banked in some of the short-term sales deflation that we would see as a result. But we're starting to see that equal out, and we expect that stability to continue through the fourth quarter into 2018.

So I think in the second quarter, I think Essentials was up slightly. So did it -- was it essentially that the price investment accelerated and the unit velocity maintained? Or maintained its positive trajectory or did it accelerate?

Chris, I think that's exactly what we're saying, continued investment across multiple categories. And as Mark talked about, the first thing we see is an increase in units, an increase in trips and ultimately that's going to drive positive comps over time. So I think the efforts are paying off relatively quickly, and we feel really good about the guest response.

Our next question comes from Bob Drbul from Guggenheim.

I have two questions. The first one is on in-stocks or out-of-stocks. You look at the inventory levels that Cathy talked about, are you seeing the in-stock levels where you'd like them at this point? And then the second question that I have is around fulfillment costs. When you look at -- I think you said -- I think John said stores are fulfilling more than 50% of digital, take it to 80%. When you think about the fourth quarter and the costs around that increased fulfillment of digital by the stores, is it a one-for-one basis in terms of the level of increases there?

I'll start with the in-stock question. I think, Bob, we talked about in-stocks last year in February. It's a journey for us, we know. I think we've made a lot of progress in in-stocks given our current capabilities. But we also said, in order to really solve the problem, we need to fix some fundamental capabilities in our supply chain around speed, reliability, inventory placement. And that's where we're on the journey. So the inventory increase at the end of Q3, as Mark said, more related to us being sure we're ready for the fourth quarter in categories like Electronics, Hearth and Hand, where we took positions, intentional inventory positions to increase inventories in advance of the fourth quarter. Less to do with our management of day-to-day in-stocks/out-of-stocks. We continue to work on those. And as I said, there is the short term, working within our current capabilities and in the longer term solve that comes as we continue to improve our overall supply chain capabilities. Your second question, I'm not entirely clear, Bob, on where your -- maybe you could clarify how -- your question, the store labor related to fulfillment, I'm not -- I didn't quite understand it.

Sorry. Just from the perspective of the expense levels, like the pressure that you saw in the third quarter versus the expectation of the pressure, fulfilling more than 80% in the stores on the expense lines specifically.

Yes, I wouldn't compare it to third quarter. Compared to last year, we are doing more fulfillment in-store. As we said, we think that's the most cost-effective way given the total P&L. So shipping plus store labor, we think that's the most cost-effective way to do it. Compared to last year, we saw significant spikes last year near the end of the quarter, approaching 80% fulfillment. And I would say, when you get into that 80% range, what really goes up is store pickup, and we'll take that model all day long, highly efficient for us, highly profitable from a digital perspective. So when our mix gets that high in store, we actually like the economics a lot.

Matt Fassler from Goldman Sachs.

I've got 2 questions, and my first relates to gross margin. Just to revisit, the fact that you do have this very depressed compare from a year ago, and you're actually entering Q4 with pretty good gross margin momentum, down only very nominally in Q3 as some of your new brands are really starting to get traction. So is your thinking on the expectation of a decline in gross margin simply a factor of more business being done online each year and the cost of fulfillment associated with that? Or some of the new fulfillment options that you're introducing just somewhat more costly and you're giving yourself room to absorb that pressure?

Matt, this is Cathy. I think I would look about it the way we -- we have all year approaching it, which is, we're trying to be prudent as we plan into the fourth quarter. We're excited about what we've seen so far, but it's early in a very important quarter. The pressure that we are anticipating is around digital fulfillment as well as all the work we continue to do around value, and we're offsetting that with cost savings continuing into the fourth quarter. So I would look at it as just doing what we said we would do all year long, which is be prudent, plan appropriately and make sure that we set the business up for success.

Matt, I'd only build on a couple of comments that Cathy made. One, we feel very good about the performance of our own brands and from a gross margin standpoint, both short term and long term, that's going to be very beneficial to our mix. Two, we are clearly investing in digital and digital capabilities and expect that we're going to continue to see strong digital growth in the fourth quarter. So it is the mix of our business that really makes sure that our gross margin returns stay on track. But the work that Mark and his team have done with our own brands and the results that we're seeing across our 8 new brands is very beneficial, both short term and long term, to our gross margin rate performance.

That's super helpful. The quick follow-up relates to REDcard penetration. So we noted that the year-on-year penetration seems to have stabilized this quarter after having shown some increases for a period of time. Anything to glean from the stabilization of that trend?

We are really excited about some of the capabilities we're adding to REDcard coming into this fourth quarter. I have to tell you, I'm one of the early users for our wallet application and it is phenomenally fast and convenient and great experience for the guests. So as we continue to ramp up some exclusives around REDcard, our guests are responding. We're seeing additional capabilities come into REDcard holders, our best guess, into the fourth quarter. So I would expect that we'll see that trend continue to be favorable.

Yes, Matt, I think we also recognize that as a by-product of the investments we have been making in our stores, our plans moving into new neighborhoods, we're bringing in new guests to Target. So over time, we certainly want to convert them to REDcard holders. But I think what we're seeing is, as we move into new catchments, these are new guests that are shopping at Target. Over time, they'll start adapting to our REDcard. I think our new brands are bringing new guests into our stores, and I think the focus that we placed around value is also attracting a new shopper. So over time that provides us tremendous opportunities to continue to build REDcard penetration. And one of the metrics that we haven't talked about on the call is the fact that traffic was up 1.4% and as existing guests shopping more often, but it also is new guests coming to our stores and our site. So over time, those are potential new prospects for REDcard. And we certainly expect to see that conversion as we go into 2018.

Robbie Ohmes from Bank of America Merrill Lynch.

Just two quick questions. Just on the fourth quarter, the sort of the breadth of the range there, can you just give us the scenarios like, sort of, what brings you to the low end of the fourth quarter range, the $1.05 versus the $1.25? And the other question I had was just -- I was wondering if you would share some of the early results on the pickup customer versus the Drive Up customer? Which is better? Whose basket is bigger? How much bigger is the basket versus the store shopper or just plain online shopper that get shipped to home? Anything you can share about the metrics and what you're excited about there?

Robbie, why don't we let John start by talking about that pickup shopper and then we'll come back to our guidance for the quarter.

I might start up with the Drive Up shopper there. I think our guest survey scores there, NPS scores are, frankly, off the charts. We see a high utility. It's mom with 2 kids in the back, right? A core Target shopper who just doesn't -- it's raining outside and doesn't want to get out of the car. So we've seen very, very high scores there. The baskets are mixed as you'd imagine, right? Sometimes they're larger, sometimes a tiny one thing. And the same is very true for pickup in store, driven by -- it can be driven by promotional cadence, it can be driven by convenience. There's lots of different reasons people choose that option and so the basket varies. There's nothing really to glean from that other than for both of them, we see very high NPS scores for our guests, which is the most important thing from our perspective.

Robbie, why don't I clear up the question around guidance for the quarter and, really, I'll focus on the full year. I think our fourth quarter guidance is a reflection of the performance we've been delivering throughout the year. And I'll go back and note as Cathy discussed, our full year guidance is up $0.50. I'll do the math for it. That's $500 million of improvement versus our original guidance. So we certainly approach the fourth quarter with a level of balance and conservatism, but feel good about the momentum we have. And we think the performance we've been delivering throughout the year will be reflected in our fourth quarter. So we feel confident, we're making good progress, there's a lot of business still to be done in the fourth quarter. And I think our range of comp of flat to 2 and the approach we're taking from an EPS standpoint just reflects the approach we've been taking throughout the year.

Kate McShane from Citi.

My question was around fulfillment as well and a little bit longer term in nature. I had wondered with regards to the Drive Up and the same-day delivery, if there are any early indications of what the limitations might be in terms of where you can introduce that and then also with regards to the profitability of how those 2 fulfillment options relate to the ship-from-store?

Yes, I'll let John talk about the profitability component. But Kate, I think one of the great things about our strategy is the important role our stores play. And as we think about Drive Up, we think about same day, those are going to be enabled by the 1,800 stores that are in neighborhoods around the country. So we should be able to continue to expand that over time and meet the needs of our guests no matter where they live and which store they shop in.

And on your question about profitability, clearly the closer we are to the store, the better we like it. When a guest comes in and picks it off the shelf, great. Only slightly disadvantaged to that would be pickup or Drive Up because there is one more touch. But really, again, economically, a great, great solution for us. As we get into shipping, same-day delivery is more expensive, there's no question about that. And at least today, our guests' research leads us to believe, guests understand that. They want it priced right, they want the convenience and they understand there may be a charge to get it to them at the time they want it during that day, and we've seen that in the 4 stores in New York, no push back at all on the delivery charge. And the great thing is, we see the baskets, as I said, 6x to 9x larger. So that ends up being a highly, highly profitable transaction for us. And so there are markets where that will work, that type of transaction will work really well. There are other markets were, as you said, there will be standard 2-day shipping. And there, we're working hard to reduce costs throughout that shipping while improving the speed. So that's on our team so that the guests gets the great service and we make that a great economic transaction for Target as well. But we feel good about our ability to make it work.

So with that, operator, that concludes our third quarter 2017 earnings conference call. I want to thank everybody for participating and wish everyone a happy holiday season. So thank you.