Ladies and gentlemen, thank you for standing by. Welcome to Target Corporation's Third Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, November 16, 2022. 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 2022 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; Christina Hennington, Chief Growth Officer; John Mulligan, Chief Operating Officer; and Michael Fiddelke, Chief Financial Officer. In a few moments, Brian, Christina, John and Michael will provide their perspective on our third quarter performance and our outlook and priorities for the fourth quarter and beyond. Following their remarks, we'll open the phone lines for a question-and-answer session. This morning, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Michael and I will be available to answer your follow-up questions. And finally, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, including those described in this morning's earnings press release and in our most recently filed 10-K. 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 on the third quarter and his perspective on the upcoming holiday season. Brian?

Thanks, John. As I begin the call today, I want to highlight the proactive leadership position we will continue to take as the operating environment changes. Just as we took decisive action in the second quarter to rightsize our inventory, we're moving proactively in a period of rapidly softening demand and elevated uncertainty to successfully navigate near-term challenges alongside our team and in step with our guests. As we look specifically at third quarter results, they demonstrate how our business continues to serve our guests even in the face of an increasingly challenging backdrop. Because of the deepening level of trust we've established with our guests over the last several years, our top line continues to benefit from growth in guest traffic and unit share gains across all of our core categories. This is particularly notable as consumers are showing increasing signs of stress and pulling back from discretionary purchases, and it reinforces the value of having a balanced multi-category portfolio, which allows us to satisfy our guests' ever-changing needs. In today's environment, that means we continue to benefit from strong growth and market share gains in the categories our guests are leaning into most right now, including Food & Beverage, Beauty and Household Essentials. Q3 comparable sales grew 2.7% on top of 12.7% a year ago and 20.7% in the third quarter of 2020. As you recall, early in the second quarter, we announced we would be taking decisive inventory actions based on the rapid change in consumer buying patterns that emerged near the end of the first quarter. These actions were designed to ensure we could continue to provide what our guests know and love about Target. More specifically, the effort was designed to free up space in our stores and hours for our team to continue offering…

Thanks, Brian, and good morning, everyone. The current retail environment requires tremendous levels of flexibility, resilience, stamina and focus, a balance our team continues to carry out at every guest interaction. Consumers are strained as they work to support their families' day-to-day needs while looking for the occasional affordable luxury, prepping for the changing seasons and planning for the holidays. It's a difficult balance to strike in getting increasingly difficult each week as more and more of their household budget goes towards the needs of the family, which limits the amount available for discretionary purchases. So it follows that of the many considerations that our guests are currently juggling, we consistently hear that value remains at the top of the list. We see our guests holding out for and expecting promotions more than ever, spending less on regularly priced items. When they shop our frequency categories, some guests are trading into smaller pack sizes, opening price point options or owned brands to reduce their spending on a single trip. Others are opting for larger pack sizes or stocking up when items are on promotion, knowing they will receive greater per unit value. And these trends only became more pronounced towards the end of the third quarter when spending patterns change dramatically. With inflationary food prices absorbing more of their spending, those costs are crowding out other categories, including spending on discretionary items, and in some cases, even household essentials. However, we also know both from our recent performance and from guest surveys that despite the pressures they're facing, our guests want to celebrate the holidays in person with loved ones, and they're looking for Target to provide them safety, ease and joy as they prepare for every celebration. These themes played out in the third quarter as guests responded increasingly…

Thanks, Christina. Across the operations team, we focus every day on delivering strong execution, even as we continue to keep our eyes on and invest in projects that will support Target's long-term profitable growth. As you know, throughout the year, our supply chain and transportation teams have been continuously navigating through an unpredictable environment, and these volatile conditions continued in the third quarter. The good news is that the lead times in global shipping has started to move in the right direction. More specifically, compared with the second quarter, lead times improved by about 15% in Q3, and we're more than 3 weeks shorter than a year ago. While we were really pleased to see this improvement, the acceleration was faster than we expected, causing many overseas orders to arrive earlier than needed. As a result, the team has been reducing lead times on our future orders just as they extended them during the pandemic. In addition, to prevent early arrivals from entering our distribution and store network before they are needed, the team has implemented multiple strategies and tactics, including new processes to efficiently segment shipping containers as they arrive at domestic ports, allowing early arriving containers to age before sending them downstream into our regional distribution centers. So today, even as we continue to look heavy on the balance sheet, our inventory is in a much healthier position than earlier in the year. Because the heaviness you're seeing today is due to the early arrival of fresh inventory, we are planning to sell. For example, by early November of this year, nearly 90% of our key Q4 programs had already moved into our distribution centers and stores. In contrast, last year, just over half our key programs were in the network as of the same time frame. Similar…

Thanks, John. I want to start where John just ended and reiterate how closely we're listening to our guests, ensuring we understand how they're feeling and how that is affecting their shopping behavior and moving quickly to serve their rapidly-changing needs. Obviously, if recent softening consumer trends continue through the fourth quarter, that will put some pressure on our near-term financial performance. But with a durable model and an agile team, we can navigate those challenges and emerge even stronger in the long term while continuing to deepen our relationship with guests and build long-term preference for Target. Once again, this quarter, I'm going to begin my remarks by covering our inventory position, given that it continues to be an important area of focus. And like last quarter, I'm going to base my discussion on comparisons to 2019, given the highly volatile conditions that have affected inventory since the onset of the pandemic. As you saw on our balance sheet this morning, we owned $17.1 billion of inventory at the end of the third quarter, which is $5.7 billion higher than the end of Q3 2019. In percentage terms, this year's number represents an approximate 50% increase from 3 years ago, a deceleration from 3-year growth of 68% as of the end of the second quarter. Of the dollar increase in our inventory since 2019, about 2/3 or $3.9 billion is aligned with our sales growth over that same 3-year period. The remaining 1/3 or about $1.8 billion is new inventory that's arrived early relative to when it would have been received in pre-pandemic years. This early inventory is being driven by 2 related factors. The first is our explicit decision to add cushion to our lead times this year in order to mitigate the risk we were facing a…

Before we turn to your questions, I want to relay a few thoughts that I shared with our Target team earlier today. While the circumstances we're facing are difficult and certainly not what anyone would wish for, we need to embrace the moment, focus on what we can control and lean into our strengths. Because even as we face multiple challenges, all at the same time, we have an even longer list of strengths on our side. And there are quite a few headwinds, but we've shown time and time again that our strengths can overcome any challenge we face. We have nearly 2,000 well-located, well-maintained store locations. We have a rapidly growing set of owned brands that are already generating more than $30 billion in annual sales. And we have a unique and growing list of national brand partners, including Starbucks, CVS Health, Levi's, Apple, Disney and Ulta Beauty. Our unmatched product design, development and sourcing capabilities allow us to offer an unbeatable combination of price, quality, design and fashion throughout our own brand portfolio. We have a durable operating model and a balanced portfolio of merchandise categories, which allow us to pivot quickly in a rapidly changing environment. Our operations are profitable, generate robust cash flow and are backed by a strong balance sheet that enables continued investment during lean times. And of course, we have a unique, amazing, passionate team that has only grown stronger over the last few years. So this morning, I've asked our team to focus on what they do best, moving with agility and responding to the environment in real time, delivering outstanding execution throughout the holiday season and beyond and doing it all as one team, aligned in support of our guests and each other. While we'd all prefer to be operating in a more robust environment, today, we have the opportunity and all the resources we need to continue playing offense while many others cannot. By harnessing the strength of our assets and our amazing team I'm confident we'll continue to grow guest engagement and deliver compelling growth on both the top and bottom line over time. With that, we can move to Q&A. Now Christina, John, Michael and I will be happy to take your questions.

[Operator Instructions] Our first question is from Christopher Horvers with JPMorgan.

Can you talk about how you're -- so 2 questions. So my first question is, can you talk about how you're looking at your business from a planning perspective and how far the down-low single-digit quarter-to-date trend is relative to your internal plan? Said another way, we knew that holiday was pulled forward last year, given early sort of panic buying. As you think about the past month, is this 3-year trend also deteriorating? And do you think the perhaps the election exacerbated the trend? It seems like you're planning on a 1-year basis, on a 3-year basis, given comparisons into the balance of the quarter.

Sure, Chris. This is Michael. I can take that one. We did see deceleration in the 3-year CAGR in the back part of October as well, and so we're factoring that into our extrapolated trends going forward. And you've heard me say, I think, other times on this call, Q4 is always its own animal, and so extrapolating trends into Q4 is tricky business in a normal year. But we think it's important to focus on the consumer changes that we saw in October and plan the business prudently and cautiously against those trends. It gives us the best position to be able to meet the consumer where we're at and continue to drive that unit share performance that we were pleased to see in the third quarter.

Chris, did you have a second question?

Yes. The second question is really your views about structural margins and how it's changing. You did a 6% operating margin in '19, and you've just added $30 billion in sales. You did a $7 billion in '20 and $8 billion in '21. I guess, what's changing? How do you think about the puts and takes? There's more inflation, it seems like on the SG&A side. And yes, in the near term, there is more inventory moving costs and promotion. But I guess how do you think about the long term, especially in light of the $2 billion to $3 billion cost target?

Yes, Chris, I'll take that one, too. We're definitely not operating at a profit level we expect to over time. And the onetime impacts we've seen this year from the volatility and the change in trend has led us to more markdowns salvage action on inventory than we've seen historically by a wide margin. And so we would expect to get a lot of that margin and that improved markdown performance back. And so that's the factor I'd start with first. And the second thing I'd call out is what you heard us describe in terms of the efficiency opportunities we have in the business. To your exact point, we've generated incredible scale quickly. That opens up a lot of opportunities for us to rethink process technology and create efficiencies throughout the business by taking that scale that came on us quickly, stepping back and optimizing the business against that scale. So we're excited about the efficiencies that should come with the growth that we've seen over time.

The next question is from Michael Lasser with UBS.

Obviously, Target performance this year has been volatile. And Michael Fiddelke, you just mentioned that you do believe you can get the margin that you lost this year to transition your inventory back. But now you're also saying that you need to cut $2 billion to $3 billion in cost to support your profitability over the next few years, which, in a way, undermines the idea that you can get the margin back that you lost. So, a, can you size in aggregate how much you think is recapturable? Is it $2 billion to $3 billion and you add another $2 billion to $3 billion on that. You're playing with a pool of savings that's really $4 billion to $6 billion over the next couple of years. So, a, is that right? And then I have a follow-up question.

Michael, thanks for joining us today. And obviously, we're going to spend a lot more time at our investor conference talking about the efficiency initiative. But it might be helpful for us to share a couple of examples of the work that we think is in front of us. And I might ask John to start first and talk about some of the learning we've seen from a fulfillment standpoint and have Christina talked about some opportunities that we're already looking at from a merchandising standpoint.

Yes, Michael, I think this is -- I think, Michael Fiddelke characterized it well. This is work we always do. We've always done this. And when we look back at fulfillment, this is something we've done year after year. And I remember back in 2017, taking lots of questions about, will you guys have enough capacity in your stores to do all this fulfillment, and taking that question in 2018 and 2019. And here we are with a digital business that's 20% of our business now and 95%, 96% of our fulfillment is done in stores. And so when you look at what we've done there, it is essentially what Michael is talking about, continually going back, looking at the process, modifying the process, reinventing the process, investing some capital in some cases to support things like Drive-Up or extra-pack stations and consistently over that time, increasing our unit productivity as it relates to fulfillment in double digits every year since then. And that's created capacity for us to continue to drive our digital business and improved our economic performance in the digital business along the way. And so when we step back and look at all the scale we've gained, just like that scale we gained in the digital business that allowed us to continually improve fulfillment, we've gained all the scale now in our existing business, the broader business, and that allows us to take a step back look, at what we've been kind of doing in the last couple of years to meet our guest demand as we grew quickly and say, there's a lot of places for us to go back, reinvent process, add additional technology and improve the way we deliver for our guests.

And I would add on a similar note, we think that there is opportunity to do that same step back on how we create, make, buy, move and sell our Apparel business. You think about the exceptional growth that we've had in our business across the board, but certainly in a big category like Apparel and the volatility we've seen in import transportation lead times and ups and downs in the market. For us to take a step back and say, is there process flow, technology, planning decisions, sourcing decisions and opportunities to flow inventory with more efficiency is at the heart of this exercise. We actually have started it a while ago, and we'll really be able to accelerate the investment in that process work and reimagine the opportunity around our Apparel line.

Michael, I want to make sure we're really clear. We see significant opportunities over the next 3 years, two, buying cost savings in the neighborhood of $2 billion to $3 billion as we improve process and simplify our operations. At the same time, we'll continue to be focused on growth and taking market share and meeting our guests and continue to enhance our business position. So it's not an either/or, it's an and. We'll continue to be focused on being a growth company, continuing to build market share, driving traffic to our stores and visit store sites and become a much more efficient organization that leverages the scale we've gained over the last 3 years.

That's super helpful. Let me just clarify that and ask 1 follow-up question. Is the $2 billion to $3 billion on top of what you'll get from recouping the inventory write-downs, the cancellation fees that you paid to cancel orders this year? Or is that -- is $2 billion to $3 billion inclusive of that recapture opportunity? My second question is, do you need to make price investments in the business to improve the perception amongst customers during this difficult economic time, that is taking more front-stage discussion now that your big competitor talked about a good start to its fourth quarter? So there's discussion around whether Target might be losing share to its competitor that's perceived to be more value oriented.

So Michael, there are a couple of questions there. One, we see the savings as being incremental for an operating plan; two, we do expect that the holiday season is going to be very promotional. We're seeing that as we move into the month of November. But as we've mentioned many times, one of the things that really stands out in our quarter is our ability to continue to hold and gain unit market share across all 5 of our merchandising categories. So we're continuing to build share. We're going to continue to see traffic driving our business, and we think it's going to be a promotional holiday season, and we're prepared to compete in this environment.

Our next question is from Ed Yruma with Piper Sandler.

I guess first, you called out shrink a number of times and I know it's been a persistent issue, but it seems like it's intensifying. Is this something you think you can remediate kind of tactically or process? Or is this kind of endemic of other structural issues, namely maybe the location of some of your newer stores and jurisdictions where maybe shrink is just more endemic? And then as a bigger picture question, as you look to '23, with the consumer being volatile, how quickly can you bend the merchandise offering to focus more on those entry price point or those value-seeking items that the consumer is demanding today?

Ed, this is John. I'll take the shrink question. I think, first, I'd say it started probably in some localized geographies originally, but we see those circles expanding and expanding and the impact continuing to grow. I think from a solutions perspective, we see 2 things. One, this is a nationwide problem that we need to address nationwide with other retailers. This is primarily driven by organized crime. And so there is a role for us to work as a retail group with law enforcement with the government to help find solutions. More specific to Target, there are things that we can do from a remediation standpoint. We have put those in place in a number of stores, and we see the impact of that. It's obviously not something we like to do. It's far less convenient for guests as they shop our stores, but we think we can manage that from a service perspective. And you can see us continue to do that. As we see stores that are more impacted, we'll continue to provide additional remediation factors. The biggest focus for us is keeping our team and our guests safe. And so we start there. And so that drives a lot of our behavior, and that's the goal. And then the third thing is to prevent theft. But we really start in a place where it is about keeping our team and our guests safe as they're in our stores.

And on your second question, Ed, on value, price perception and our offerings. I would tell you that we've had a concerted effort to make sure that we demonstrate the balanced value across our assortment for a long period of time. In fact, last quarter, I called it a maniacal focus on opening price points because we need to make sure that we appeal to the range of consumers that shop Target. And as I said in my prepared remarks, some of that is going to be opening price point value options that we can engineer into, especially in our strong owned brand offering. But some of it is actually larger sizes where people are seeking value through the per-unit equation that comes with bigger pack sizes. So we are absolutely focused on it. It comes through in everyday price, it comes through in our own brand assortment, it comes through in our promotions, and it comes to our accessibility with our great RedCard, our free loyalty programs and the solutions in aggregate. And that's part of the Target equation. It's all also relevant with the assortment that's fresh, seasonal and on trend. It doesn't matter what your priced at if the assortment is relevant. And that's why we need to always stay on-Target.

The next question is from Scott Mushkin with R5 Capital.

And you guys got into some good detail about the cost savings you have planned. I was wondering, is there any thought that 2023, we may have an extension of the challenges and thinking about CapEx, thinking about labor hours and how you might attack that in 2023 as the Fed is successful here and engineers a recession?

Scott, as you might imagine, right now, we are laser focused on the holiday season and making sure we end 2022 in a position where we continue to hold and grow share and meet the needs of our guests. For the very early stages of looking at 2023, we'll be back after the first of the year with more details about our overall plans, including CapEx spending and our outlook for the overall consumer environment. So give us a few weeks, we'll be back to you after the first of the year, but obviously, we're going to spend a lot of time right now focused on executing our plan, getting through the holiday season and then assessing the consumer and the overall retail landscape as we look to 2023.

So then another extension of the question, but I wanted to get a second view on this. Imitation is the best form of flattery. And one of the competitors, especially in Apparel and Home, has been copying you guys pretty readily and partnering with other brands. I mean how much do you think that could impact your sales or maybe is impacting your sales in those categories? Or do you think it's really not a factor?

Scott, it's why we spend so much time looking at unit market share performance. And as we continue to perform well across our entire portfolio, we feel like we've got the right mix of great national brand partners that strengthen our own brands. We have a fabulous in-store experience and the ease and simplicity of our digital channels. So we think we're well positioned to continue to hold and grow share across our entire portfolio, not just in the holiday season but for years to come.

The next question is from Robby Ohmes with Bank of America.

Maybe for Christina and maybe Brian can chime in here. I know it's early, but with the kind of shift in trends you're seeing, is there any more you can tell us maybe about the income demographic dissecting of your guests? Has there been any changes in patterns amongst that? So for example, Walmart obviously called out yesterday that they're seeing more of these $100,000-plus people trading into Walmart. Is there anything that you can tell us about your lower-income guests versus your middle or higher income that helps us understand what's going on?

Yes. Our first proof point about how we're performing is obviously the strength of our traffic as well as our market share gains. And those are broad, span across all of our categories. As we look at the guest and where the growth is coming from, it's coming from a deepening engagement with our current guests. And so they are coming more often, and they are spending across more categories. And there are a couple of inflection points in behavior with our Target guests that are really meaningful: One is when they become an omnichannel guests; the second is how much they use our fulfillment capabilities; and the third is the amount that they buy Food & Beverage. And all those 3 are growing at a faster rate than total Target. That gives us confidence that going forward, we'll continue to deepen the engagement with the guests that are most meaningful for our long-term business.

And then just maybe a quick follow-up. Anything on the digital side? Any new initiatives you guys would be thinking about maybe doing more with marketplace or things to get your digital growth a little higher again?

Well, I think there's a couple of things there. One, the digital team is doing a great job. And there -- to Brian's point, right now, they're very focused on delivering a great Q4 for our guests. I think a couple of things we are excited about is first, bringing -- and these are the top 2 requests from our guests, always being led by our guests as it relates to what we're going to provide from a digital perspective. Number one is adding Starbucks to Drive-Up. And we have seen that in the test stores, very, very popular. This has been a request for a long time from guests. "I'm getting milk, I'm getting diapers, why can't I get my latte to go as well?" I think the second one under the heading of continuing to create ease, and this is also a request from our guests, is being able to do returns through Drive-Up. That one's a little bit further behind Starbucks. We're testing that in a small number of stores. It just went guest-facing recently. And so we'll continue to test that through the fourth quarter here and look to hopefully expand that next year. But I think the example there -- the examples there are more important than what we're doing, that is the guest leading us to what they want us to provide from a digital perspective, whether that be on the site or in how we fulfill their services.

The next question is from Simeon Gutman with Morgan Stanley.

I wanted to ask on the sales backdrop for a minute. You took a lot of markdowns and some inventory was released to the market. Walmart had the same, and they've been discounting. Why couldn't this environment just be off-price having a lot of inventory and the market is just stuffed and that could be part of this weakness, and it's going to take some time for that to clear as opposed to the consumer really weakening in fundamentals? I just wanted to throw it out there.

Simeon, I'll go back to some of the syndicated data that we've been looking at. And clearly, across all of retail, we saw a change in shopping behavior in the back half of October leading into November. The most recent information we've seen from NPD would indicate during the first week of November, general merchandise categories contracted by 14%. So a very significant change in shopping behavior. So I think, as Christina pointed out a number of times, we've had a consumer who has been dealing with very stubborn inflation for quarter after quarter now. They're certainly starting to look at higher prices in Food & Beverage, in many cases, prices that are up double digits. They're shopping very carefully on a budget. And I think they're looking at discretionary categories and saying, "All right, if I'm going to buy, I'm looking for a great deal and a great value." So what we've seen overall is a change in consumer behavior over the last few weeks. We're going to watch it carefully throughout the holiday season, but I think it is a byproduct of a consumer who has been facing higher costs throughout the year, is working with their budget, shopping very carefully, looking for value and recognize they've got to start with core staples before they spend dollars in discretionary categories.

Yes. That makes sense. And my follow-up is the $2 billion to $3 billion, it sounds like it's process oriented. But some of the things you mentioned in terms of flowing inventory, it seems like that will require CapEx. And again, I don't want to put words in your mouth, but to be able to drive these efficiencies, is it pure process? Or does CapEx need to step up to make investments in order to realize the savings?

Yes. It's a fair question, Simeon. And sometimes it involves CapEx, and we're happy to invest that CapEx when the return is there. And so if we can put capital into the business that can drive efficiency for the team, I think you've seen us do that with technology in stores and supply chain, so that's a path we've been on, and we certainly aren't shy about making that investment when the return is there. But it won't all require capital. There's a lot of process reengineering and optimization that we can do that shouldn't have a capital price tag associated with it. And again, back to the examples John and Christina provided, so much of that is about the scale we've gained. There's a path of simplifying and taking costs out of the business when you don't have growth. We've got the fortunate position to be looking at the business on the heels of just exceptional growth and that creates a lot of opportunity for us to rebuild process against the business that's substantially bigger than it was a few years ago.

Operator, we got time for one last question today.

Our last question comes from Kate McShane with Goldman Sachs.

We just wanted to ask a couple of follow-up questions on the inventory position, just if there was any inventory left over from the issues that you experienced in the spring. And now that it sounds like maybe Q4 is going to be a little bit weaker, but I think the inventories you probably bought was for more of a low single-digit comp scenario, is the goal to be clean with regards to holiday inventory coming out of Q4 and into 2023?

I will answer that with where you ended your question, Kate, and that is we are committed to being clean at the end of the holiday season. And you're also right in the first half of your question. We accomplished what we wanted to in the first half of the year. We feel good about that work. And you heard me quote some versus 2019 benchmarks. If you were to just look versus last year, you'll see that Q2, out inventory was up 36% year-on-year; in Q3, it's about 14%. And so we made good progress on the plans we had in place. Obviously, we're looking at the change in the trends closely. If that trend we see persists, it will come with more markdowns to make sure we accomplish exactly that goal of ending the season clean.

Operator, that concludes our third quarter call. We wish everyone a safe and happy holiday season and look forward to seeing you in person in 2023. So thank you.