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 15, 2023. 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 2023 earnings conference call. On the line with me today are Brian Cornell, Chair 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 insights on our third quarter performance, along with our outlook and priorities for the fourth quarter. 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 priorities for the remainder of the year. Brian?

Thanks, John. For many years now, we have focused on building a durable business model that allows us to meet guests where they are, developing and enhancing the right tools and capabilities while investing heavily in our team, all in the service of providing an affordable, easy and joyful guest experience. And the flexibility of our multi-category model has served us incredibly well over the last few years, delivering unprecedented growth in both traffic and sales. Today, our business generates well over $100 billion in annual revenue and is successfully navigating through a very challenging environment as consumers continue to rebalance their spending between goods and experiences and make tough choices in the face of persistent inflation. Even as our P&L is being impacted by multiple top line and bottom line challenges, including soft industry trends in discretionary categories, moderating inflation rates in Essentials and Food and Beverage and higher inventory shrink. We've seen a meaningful improvement in profitability compared with last year. More specifically, our EPS through the first 3 quarters of 2023 was more than 40% higher than last year and more than 26% higher than in 2019. Importantly, even beyond this year's rapid progress, we believe we have a significant opportunity to grow both the top line and bottom line in the years ahead. So even as we remain cautious in our near-term outlook, we're not standing still. We're playing the long game, investing in our stores, our supply chain, our team, our digital capabilities and our assortment to provide the newness, value and convenience our guests want for this holiday season and beyond. At the heart of it all is our focus on being our guests' happy place and delivering the joyful shopping experience that makes Target, Target. In the third quarter, Target's comparable sales were…

Thanks, Brian, and good morning, everyone. As we've shared for the past several quarters now, even as our guests face tough choices as they manage their budgets, they're also continuing to celebrate seasonal moments while showing their excitement for new product offerings and compelling value. After all, consumers are feeling the weight of multiple economic pressures and discretionary retail has borne the brunt of this weight for many quarters now. In addition, consumers are facing newly emerging headwinds, including higher interest rates and the return of student loan payments. In the face of this mental and emotional tug of war, consumers are looking for a respite, which is why we are relentless in our pursuit to provide ease, inspiration, joy and comprehensive value every day. And while we are not satisfied with our current performance, I'm confident that our team's empathy and their continued focus on serving our guests' wants and needs, will pay dividends in the years ahead. As Brian mentioned, our third quarter comparable sales decline reflected continued softness in discretionary categories, partially offset by growth in Beauty. Notably, comps within frequency categories slowed between Q2 and Q3, driven entirely by a deceleration in the comp benefit from growth in average retail. More specifically, in both Food and Beverage and Beauty and Essentials, the benefit from average pricing decelerated by about 3 percentage points between the second and third quarters as we move beyond the period of peak inflation from a year ago. As we've said, a lower inflation rate is welcome news as it will reduce pressure on consumer budgets, making room for them to expand back into discretionary categories over time. Beauty-led performance in the quarter with comparable sales growth in the high single digits driven by strength across core Beauty and our Ulta Beauty at…

Thanks, Christina. Over the last 3.5 years, our operations have continually faced unusual and rapidly changing external conditions. In 2020 and 2021, after the onset of the pandemic, we couldn't secure enough inventory to satisfy the explosion in demand for our products, and we saw operating margin rates grow well beyond normal levels. Then in early 2022, the period of rapid growth in discretionary categories suddenly reversed, and we quickly moved from having too little inventory to having way too much. As a result, both our distribution centers and store backrooms filled up well beyond optimal levels and operating margin rates quickly moved to historical lows. So this year, as Brian mentioned, a key priority was to optimize our inventory position so it was better aligned to the current size and growth rate of our business. We were confident that if we were successful in that effort, our operations will become more efficient, markdowns will come back down, and we'd see our profit rate recover back toward more sustainable long-term levels. And through the first 3 quarters of the year, despite unexpectedly soft top line trends, the team has delivered a more rapid recovery in our profitability than we'd even planned at the beginning of the year. Looking ahead, we've maintained this cautious inventory posture and planning for the fourth quarter as well. More specifically, at the end of the third quarter, total inventory on our balance sheet was 14% lower than a year ago with discretionary category inventory down 19%. And importantly, while this ending inventory position was 29% higher than at the end of Q3 2019, that's aligned with growth we've seen on the sales line over those 4 years, making us feel really good about both the size and the health of our inventory position as we…

Thanks, John. Before I begin my formal remarks, I want to thank you for the positive impact you've made on this company, our strategy, our team and on me personally. I've been fortunate to work with you and learn from you since I first arrived at Target 20 years ago. In the third quarter, total revenue was down 4.2%, reflecting a 4.3% decline in total sales and a 0.6% decline in other revenue. Within the other revenue line, declines in credit card revenue and a few smaller items were nearly offset by growth in Roundel ad revenue. Among the drivers of our third quarter comparable sales, traffic was down 4.1%, combined with a 0.8% decrease in average ticket. While we're encouraged that our Q3 comp trend improved 0.5 point compared with Q2 and the traffic trend recovered a little bit faster, we're not at all satisfied with this result, and we're laser-focused on moving both traffic and sales trends back into positive territory. As Christina mentioned, our guests continue to shop around seasonal moments. So not surprisingly, Q3 comp performance was strongest around the Back-to-School and Back-to-College seasons. For the remainder of the quarter, we saw variability week by week with periods of relative strength around promotions. Our third quarter gross margin rate of 27.4% was more than 2.5 points better than last year, driven by multiple benefits within merchandising, including meaningfully lower freight costs and favorable clearance markdowns. In addition, we benefited from year-over-year favorability in digital fulfillment and supply chain costs. And perhaps, surprisingly, merchandise mix drove a small rate benefit compared with last year as we continue to benefit from growth in higher-margin categories like Beauty and we saw the softest performance in very low-margin categories, like electronics. Partially offsetting these tailwinds, the rising cost of inventory…

Thanks, Michael. Before we turn to your questions, I want to pause and acknowledge John's incredible record of service to Target and thank him for his profound impact he's had on this company. I'm sure he'll be glad to know I'm not planning to recap his entire 27-year career this morning. But I do want to highlight the impact he's had since I arrived in 2014, an impact that literally began on my first day when John handed me a large binder, a recap of the comprehensive strategy review he and the Board conducted during his time as interim CEO. That body of work was an invaluable resource that allowed me to hit the ground running. It serves as a blueprint for all the strategic changes we made in those early years. One of those changes was the creation of a Chief Operating Officer role, the first time we've had one at Target. And while John was already an outstanding CFO, I knew he was the right person for this new position. Since becoming COO in 2015, and John has led the transformation of our store portfolio from new stores or remodels through the operating model within those buildings. Similarly, John is leading the transformation of our upstream supply chain completely changing the way our distribution network serves our stores. And of course, John's team developed and implemented our stores as hub strategy. When we launched stores as hubs, it was a completely unique approach in retail. It's a model that has changed the way we serve our guests, including Drive-Up service, now accounts for well over $7 billion in annual sales, $7 billion is larger than the total sales of some other prominent retailers. But beyond the tangible operational changes John has led, it's his focus on team development…

[Operator Instructions] Our first question comes from Robby Ohmes with Bank of America.

First, I just want to say congrats to Brian and team Target on a great quarter in a really tough environment and to John Mulligan on just everything you've accomplished working at Target. But then my question is actually for Mr. Fiddelke. I was hoping that you could talk to us about how to think about the puts and takes on gross margin differences in, say, 4Q versus 3Q. You mentioned shrink was a little better. How should we think about that for the fourth quarter, also freight versus what you saw in the third quarter? What inventory management could bring in expectations for markdown ranges that we should think about for the fourth quarter, say, versus the third quarter, to give us something to think about.

Yes. Happy to start, Robby. And you had a couple of other drivers in your question. The Q3 relative benefits of shrink coming out in a little better than we thought, freight coming in healthy on a year-over-year basis were certainly contributing factors. But the one I just underscore is the continued benefit we see from our strong inventory position. The cautious approach we've taken to inventory and, frankly, the team's good work to drive more productivity with a better inventory position, that inventory position just reaps benefits across our operations. Our stores are more efficient, our DCs are more efficient. All systems run better with inventory where it sits today. And with inventory down 14% on the balance sheet as we exit the quarter, we feel really good about that inventory position heading into Q4.

And do you still expect shrink to be favorable year-over-year in the fourth quarter?

So that's probably worth spending just a second on so that we all interpret what we're likely to see in Q4 the right way. Given the pace of some of our accruals last year, we would expect shrink to not to be quarter-over-quarter headwind in Q4 that we've seen throughout the balance of the year. Important to note that, that doesn't mean we've turned the corner on shrink. We'll continue to watch those trends carefully, and we still saw year-over-year pressure in Q3 as the underlying shrink in the business is still a headwind on a year-over-year basis, but there's some things unique to last year in Q4 that are likely to make it less of a driver of year-over-year variance in that quarter.

Robby, I might build on Michael's comments around inventory. And we certainly feel very good about the actions we've taken and the reduction of inventory by 14%. But if you heard Christina earlier in the call, we've also been leaning into newness and feel really good about our position going into the holiday season with 10,000 new items, and we'll continue to lean in to meet demand during the holiday season. So I think the team has done an exceptional job of managing inventory. The benefits throughout our system have been realized in the third quarter. But we're playing to win in the fourth quarter. And I think Christina highlighted the amount of newness we have in our system and the great value we'll offer our guests throughout the holiday season.

Our next question comes from Rupesh Parikh with Oppenheimer.

Congrats on a nice quarter. So just for the holiday season, just curious if there's any early reads you can share and then any commentary just in terms of what you're seeing quarter-to-date.

Well, as you might expect, we're watching it day by day, almost hour by hour, but we're still really early in the season. The big days, the big weeks are still in front of us. So we'll launch it carefully. Again, I think we're prepared for a really solid holiday season, but it's just way too early to tell.

Great. And then maybe one follow-up question just on the CapEx. So expectations are lower for next year. Any specific buckets where you guys expect to reduce CapEx spending next year? Just any initial color you can share.

You can expect us to unpack that more as we get into the start of next year, Rupesh. But wanted to share our latest thinking of how we think the cadence by year flows, and as you heard me say in my remarks, importantly, we'll continue to invest in the things that will drive growth over time. We're really pleased with the almost $5 billion of investments this year and the returns those will drive. And we feel like that $3 billion to $4 billion number is the right number for next year based on what we see today, but more to come on that front.

The next question comes from Michael Lasser with UBS.

Best of luck to John Mulligan. With sales down around 5% in the third quarter and the guidance calling for a similar decline in the fourth quarter, one of the key debates, and using an example is, are customers not coming to Target right now because they're just not in the market for a coffeemaker, as an example? Or are they buying that coffeemaker somewhere else? And if the latter is the [ key ], how much more promotional will Target need to become in order to get the customer back?

Michael, I'm happy to start, and then I'll ask Christina to provide additional color. But one of the things that we've called out a number of times now is that there's tremendous pressure on the consumer's wallet and the impact of very sticky food and beverage inflation, which compared to prepandemic, food and beverage prices were up on average 25%. And that's certainly pressured consumers as they're making choices and certainly has forced them to make very tough choices when it comes to discretionary goods. We've actually seen in the industry 7 consecutive quarters where discretionary goods have declined both in dollars and units. So there's an overall pressure in the marketplace. So you're seeing a consumer who is focused on managing their budget, buying those household essentials and then carefully shopping for those new items you just mentioned. But Christina, why don't you give Michael some additional color on what we're seeing in some of those categories?

Yes. To build on what Brian said, certainly, when we do have hot promotions, the guest is responding. And the fourth quarter is always very competitive, and we'll be very well positioned with everyday low prices as well as promotions and investments in Circle, our loyalty program. I think the big difference for us this year and this fourth quarter is the amount of newness that we've invested in. If there's one thing that we've seen is in an environment where people are making choices and they might have some constraints with their budget, the motivation to buy is really, is this going to add value to my life? Is this something that is intriguing and feels relevant or is fashion forward or is really for me? And doing more of the same just isn't going to get it done, which is why we've invested in newness. And you'll see that across the store. You'll see it as you walk in, first thing in our women's set. It's right on trend, it's colorful. The price points are very appealing. You walk around to our seasonal business. Right now, you can get everything [indiscernible], your tree skirt to ornaments at a great value. Continue down the path to toys, you've got over 2/3 of our toys below $25. And then around the corner of our store to food, where you can get not only your Thanksgiving meal for under $25, but all the gifting solutions and special trades for Marks & Spencer, only rounded out at Beauty, which has been our strongest business year-to-date and for many years and find gifting solutions at every price point. So we're really pleased with assortment we're putting forward and think this will certainly motivate the guest to buy.

And Michael, one point to clarify. While we've certainly called out the pressure we're seeing both from an industry standpoint and a Target standpoint in discretionary categories, in the third quarter alone, we generated over $25 billion of revenue. And as Michael referenced, on a full year basis, we'll generate over $100 billion of revenue. A significant portion of that comes from discretionary sales. And as Christina pointed out, much of that's tied to combining great newness with affordability. And I think we're well positioned to continue to perform in those categories. So while we've seen some pressure, consumers continue to turn to Target for Apparel and Home, for discretionary categories and items. And I think we're well positioned with the amount of newness and value we'll offer during the holiday season.

My follow-up question is, Brian, over the last couple of years, Target has shown that it can drive sales growth. It's now showing that it can drive profitability. As you look towards 2024, when arguably the consumer is going to continue to face pressure, will your priority being on driving better sales performance or sustaining the profitability that Target has been able to achieve this year?

Michael, it's such a great question. And you heard me say this in my prepared comments, our focus is on obviously doing both. We're certainly not satisfied today with our top line performance, and we are laser-focused on improving traffic, on growing our top line and continuing to advance our profitability. So for Target, it's a combination of doing both. And as we finish this year and build our plans for 2024, you'll see us being focused on driving our top line, building traffic and continue to expand our profitability.

Our next question is from Edward Yruma with Piper Sandler.

John Mulligan, congratulations on all that you've done, and thanks for all the help over the years. Really just a couple of clarification questions. So Michael, on shrink, I know last year you had a significant accrual in the fourth quarter, you said that there's favorability, but just trying to understand the underlying trend. Are you seeing stabilization? And not to conflate 2 things, but I know you did call out kind of more usage of full-service lane. So trying to understand if you kind of at least start to flatten the curve on shrink. And then as a follow-up, on discretionary categories, obviously, nice to see the improvement in Apparel. Are you planning kind of continued improvement within that negative mid-single comp guide?

I'm happy to start with the shrink question, Ed. In the third quarter, we still saw year-over-year pressure, so about 40 basis points of year-over-year headwind. That's less pressure relatively than we saw in the first 2 quarters of the year, and it was a little better than we thought it'd be. And so those are encouraging signs of some progress in the right direction, but to be clear, still a year-over-year headwind in Q3. And so as we've said before, shrink's a lagging metric. We think progress there probably doesn't happen quickly. But we're focused on progress over time, and you'll see us continue to take the actions to get a better outcome there over time, but it's not one that we'd expect overnight.

And on the discretionary side, I said it in my prepared remarks, but there was an underlying shift in the third quarter compared to the second quarter with both Apparel and Home accelerating nicely. And so that's our continued goal, is to make sure that we present the right level of newness to build the business back to positive territory over the long term. We are, however, picking our bets. And so our cautionary planning to inventory has bought so much goodness in the total P&L on the operation that about -- it's about being choiceful and placing our bets.

Our next question is from Kate McShane with Goldman Sachs.

We wonder if you could talk to traffic trends by month throughout the quarter. And just wondered how much better traffic in the third quarter versus second quarter was driven by customers coming back after what we saw in June.

Yes. So when we think about what we see in traffic, as you heard in our prepared remarks, it was good to see sequentially traffic improve quarter-over-quarter at a slightly faster rate than the top line did. And we're excited about the work teams do, that balance of newness and value and the investments we continue to make in the business to turn traffic back in our favor over time. And so that's where you'll see us focused, Kate.

Okay. And then our follow-up question is just around promotions. Are you seeing any kind of increase in vendor support when it comes to promotions versus what you saw last year?

As we've talked about, the consumer is responding to promotions and so the market is responding accordingly. With that said, I'd say it's still a rational environment. And the healthy inventory position that we're in allows us to continue to offer great value to our guests without chasing empty calories.

Kate, I might offer just one more piece of context on traffic. Even with the tougher sales trends that we've seen so far year-to-date, through the first 3 quarters of this year versus prepandemic, traffic is up over 20% in total. And so we feel really good about the engagement that we've built with guests over the last few years. We think that's an asset and a base that will really benefit us well going forward.

And John Mulligan, congratulations.

Our next question is from Joe Feldman with Telsey Advisory Group.

And I wanted to ask, can you talk a little bit more about what you're seeing from unit perspective in terms of unit sales? And I know, as you mentioned in the transcript, that units are down a little bit. But are you starting to see any stabilization there? And how should we think about unit sales going forward? And also if you could touch on the Grocery aspect of that as well, I'd be curious -- or Essentials, I should say.

Yes. So Brian hit on this in his prepared remarks, that the industry has seen a slowdown in unit performance over many quarters in a row. And that is because the pressure on the consumer is really real and they're having to make those choices. I also shared in my remarks that in the frequency businesses, which we think of as Food and Beverage and Essentials and Beauty, that in the third quarter we saw prices come down so that we comped over the peak of inflation. The prices came down, that's an industry-wide phenomenon. And as a result, we did see some improvement in unit velocity. That's a good thing in the long run, is that when consumers can stretch their budget across more things that they want to buy and not have it tied up in any high prices. That's a good thing. But as Brian talked about, the inflation on these categories over the last several years, especially in Food, Household Essentials, even pets and baby, is meaningful. And that's going to take a while to overcome.

Operator, we've got time for 2 more questions today.

Our next question is from Simeon Gutman with Morgan Stanley.

I want to go back to this market share -- or not market share, actually sales versus margin. And I'm curious if you can speak to market share, if that is a gauge you're looking at how -- what happened during the quarter. And is the decision around this trade-off, is it market share dependent? Are there certain categories you're looking at thinking about when to apply promotions or where to apply promotions?

So right now, with total consumer spending soft in the discretionary portfolio, we are not going to chase short-term benefit at the long term -- at the expense of long term. And so it's always a balance. We're always looking to drive both sales and profit. We've also been very clear that this year has -- we put profit on a high priority to recover from last 5 years. But as Brian said, the long-term gain -- the long-term game has to be both.

Again, I'll underscore the point Christina just made. Simeon, I think you know it's all about the balance. And we're always looking to balance our focus on sales and margin and profitability. Early in the year, we talked about the fact that we were going to plan discretionary categories cautiously in this environment. And we said appropriately. And I think that's played out well for us. But at the same time, we've been leaning into categories with strong demand in Food and Beverage, in Household Essentials, in Beauty. We know today's consumers still celebrating seasons. So we lean into Back-to-School and Back-to-College and Halloween. And we know they're going to celebrate the holiday season. So we're leaning into those select categories where we know the guest is looking for newness, affordability, and they're going to celebrate those seasons. But that's what we do each and every day as a good retailer and is constantly a balance category by category of the focus on sales, on market share, on profitability. And I think as you saw in the third quarter, that's the way that [ worked ] for us.

And just quick follow-up, sortation centers. Do you have a sense of what the savings look like? Do you have enough scale and experience with them to know what the savings will be? And is that a '24 -- do we start to see the savings next year?

Well, you've opened up the door for John Mulligan to answer your question today, and I'm really glad you did.

Thanks for that, Simeon. I would start by saying we remain incredibly excited about sort centers. And with that, we have already started to see savings flow through the P&L. We haven't talked about it because I think -- it's been 3 years, but we are still early in the journey. I think there's still much to do in front of us. We're still optimizing routes. We're still just getting into much higher capacity vehicles, which will create more density, which will create more savings. And then what we've said over the next few years, we've got at least 5 more of these to open. And then as we get the digital business growing again, hopefully, that number goes up as well. So we're still in the early days, but we remain very optimistic because we are seeing savings. It's much faster than the alternative, and we know the next best alternative, we are operating well below from a cost perspective.

Operator, we've got time for our final question.

Our final question comes from Chris Horvers with JPMorgan.

Congratulations to John. It's been an incredible journey, and I hope you have a wonderful retirement. So Mike, I'll follow up on the operating margin question for next year. Michael, maybe you could talk about the puts and takes as you think about next year. Clearly, the consumer is the question. But as you think about shrink versus maybe some incremental promotion when you're not so lean on the inventory side versus what you might see from Roundel and you also have the $2 billion to $3 billion cost savings program.

Thanks for the question, Chris. I think the punch line is we'll talk more about next year after we get through a really important holiday season. So that's our team's focus right now. And a lot of what will impact as we get there will be some of the things that you listed in your question. But more to come as we turn the page to next year once we get through a really important fourth quarter.

Yes. Thank you. So operator, that concludes our Q3 call. I want to thank everybody for joining us. I wish everybody a wonderful holiday season, and we look forward to seeing you in March.