Q3 2019 Earnings Call
Ladies and gentlemen, thank you for standing by welcome to the target Corporation third quarter earnings release Conference call. During the presentation, all participants will be in a listen only mode.
Afterwards, we will invite you to participate in a question and answer session at that time. If you have a question you will need to press star one on your telephone as a reminder, this conference is being recorded Wednesday November Twentyth 2019, I would now like to turn the conference over to Mr., John Gilbert based.
President Investor Relations. Please go ahead Sir.
Good morning, everyone and thank you for joining us on our third quarter 2019 earnings conference call on the line with me today, our Brian Cornell Chairman and Chief Executive Officer.
John Mulligan, Chief operating Officer, and Michael said, Alky, Chief Financial Officer.
In a few months, Brian John and Michael will provide their perspective, our third quarter performance and our plans and financial outlook for the fourth quarter and full year.
During their remarks, well 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. 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 mornings press release, which is posted on our Investor Relations website.
With that I'll turn it over to Brian for his thoughts on our third quarter performance and our outlook for the remainder of the year Brian .
Thanks, John and good morning, everybody.
We're really pleased with our third quarter financial results, which were well ahead of our expectations on nearly every measure.
Comparable sales grew 4.5% in the quarter about a point ahead of our guidance driven by an acceleration of sales in our stores.
This call performance is on top of 5.1% in last year's third quarter meeting that we've grown our comparable sales nearly 10% over the last two years.
Third quarter profitability was also stronger than expected.
Then by a much larger than expected increase in our gross margin rate.
With this upside operating margin dollars increased more than 22% compared with a year ago, resulting in a nearly 25% increase in adjusted EPS.
In light of this performance and our updated expectations for the fourth quarter, we raised the midpoint of our full year adjusted EPS expectations like 30 cents.
This reflects really strong performance well ahead of our expectations going into 2018.
Got it demonstrates the power of the durable operational and financial model, we've been developing over the last several years.
None of these results would be possible without the amazing efforts by our team well designed and implemented meaningful changes across multiple parts of our business.
Source service and operating model to our unmatched digital fulfillment capabilities and our inventory replenishment routines.
And well there's much more to do it's incredibly gratifying to see how these efforts are already driving outstanding operational and financial performance.
When we analyze the components of our comp sales.
We're pleased that traffic continues to be the primary driver of our growth.
Overall, our traffic grew 3.1% in the third quarter.
Hazard, a guess chose to shop with us more often bolt in stores and through our digital options.
Among our sales channels store comps were up 2.8% in the quarter.
More than a percentage point faster than the second quarter.
Digital comps grew 31% and drove 1.7 percentage points of the company's comp growth.
Notably this year's digital growth was on top of a 49% comp increase last year.
While these numbers add up to 80% when you're talking about growth rates of this magnitude the power of compounding really matters, specifically, what do you do the math, you'll see that our third quarter digital comp sales of actually grow more than 95% over the last two years.
Within our digital sales, 80% of our third quarter growth was driven by same day fulfillment options in store pickup drive up and shipped.
Given that these same be options rely on or start assets team and inventory they are much more profitable than traditional e-commerce fulfillment.
As we look back at trends within the quarter, we continue to see the benefit our balanced multicategory assortment, which gives us the flexibility lean into different seasons and important moments in our guest lives.
At the beginning of the quarter, we enjoy favorable results are back to school and back to college assortment.
And later in the quarter as colder weather spread across the country, we saw a rapid acceleration sales where weather sensitive categories.
Beyond the seasonal moments, we continue to benefit from our frequency categories, food and beverage essential and beauty would drive everyday traffic guest engagement and sales.
We're happy to see continued broad market share gains across many of our core merchandising categories.
Apparel saw the most dramatic share gains in the quarter.
But comp sales growth of more than 10%.
This was driven by even stronger trends in jewelry accessories, and shoes, intimates, and sleepwear youngkin temporary and women's ready to wear.
In the home category, which was Annualizing really strong growth a year ago, we saw low single digit comp increases the third quarter driven by strength in the kitchen and home storage categories.
Among our frequency categories, we continue to benefit from amazing strength in beauty, and cosmetics, which delivered high single digit comp growth in the quarter.
We also saw high single digit growth in or over the counter assortment and mid single digit growth in household essentials and paper products.
Within our hardline categories, we saw particular strength in mobile and continued growth and toys offset by comp sales declines electronics and entertainment.
And finally in food and beverage categories. We saw low single digit comp increase led by double digit growth in adult beverages, well with strength in non alcoholic beverages and in our bakery and deli areas.
In September we were excited to launch our new food and beverage on brand good and gather.
The idea behind the brand is simple.
Great food made for real life.
Couldn't gather incorporate simple high quality ingredients without any artificial flavors synthetic colors artificial sweeteners or high fructose corn syrup.
We saw encouraging results from our launch of 650 items during the quarter and expect that gooden gather will become our largest owned brand once we roll out the full 2000, I know assortment by the end of next year.
Across all of our merchandising categories, we continue to focus on delivering newness and innovation combining the best National brands with a powerful set of owned and exclusive brands.
Early in the third quarter, we announced a new creative collaboration with Disney designed to bring the magic of Disney to the Joy of shopping a target.
We launched 25 Disney stores within select target locations last month.
Featuring an immersive experience and an enhanced Disney assortment more than 450 items, including more than 100 items that were previously available only at Disney retail locations.
On those markets, we offer this extended assortment to all of our guests through the Disney store on target Dotcom and the target App will expand this collaboration to another 40 locations with a Disney shop in shop in 2020.
And we're planning a new target location on the Walt Disney World property in 2021.
And of course, the fourth quarter will benefit from target circle, our new loyalty program launched nationwide last months.
Even though the program is brand new target circle already has more than 35 million members, making in Americas fastest growing loyalty program.
During an 18 month test period guests enrolled in target circle save more shop, more frequently and spent 2% to 5% more than guess who weren't in the program.
Joining target circle is simple and fast and this holiday season members will receive a number of exclusive benefits beyond the perks. They receive all year long such is there any 1% back on future trips to target.
And the opportunity to benefit their local communities by voting to direct targets given.
Looking ahead to the holidays. Our plans are designed to deliver the joy the season inspired guess with unique items and services and save them time and money.
On November Onest, we rolled out free shipping on hundreds of thousands of items available for all of our gas during the holiday season.
And while Black Friday, and cyber Monday are still ahead of us we've already been delivering compelling promotions, including the launch of holiday meals, which will feature throughout the season.
And our Black Friday to day preview sale, which was kicked off earlier this month.
And of course for our Red card and targets circle members will be offering early access to select Black Friday deals beginning on the day before Thanksgiving.
Throughout the season, I guess, we'll find unique items for more than 40 own an exclusive brands, including holiday favorites like hard on hand, with Magnolia and threshold.
Our home decor assortment will feature more than 2000, new items and 70% of those items in our holiday Wonder shop will be new this year.
To make gift, giving easy will be offering 1000 curated gifts and holiday essentials under $50, along with more than 10000, new an exclusive toys.
As you've seen in past years, our digital fulfillment capabilities become even more important during the fourth quarter as they help gets save time during the busiest season of the year.
As we enter this holiday season I'm pleased that target is the first retailer to offer drive up service in all 50 states encompassing more than 1700 50 of our locations.
Also knew this holiday same day delivery with shipped which offers delivery in as little as one hour will be available directly from target dot com and in the target out.
Additionally, guests will have the option to pay per order.
Use their red card to get 5% off their purchases and receive targets circle perks.
Shipped is now available in more than 1500, our stores across 48 states and of course reorder pick up is available in all of our stores, allowing guests to shop online or in the target up and pick up their purchases in store with most orders ready within an hour.
For the holiday season, we've added nearly $50 million and payroll compared to last year to ensure that more team members are available assist guess during peak times.
In addition, we've doubled the number of team members dedicated to fulfillment, including same day services. So I guess orders will continue to be ready and as soon as an hour.
And to ensure our team members continue to deliver a high level service, we have invested more than half a million additional hours in team member training compared with last year.
So now before I turn the call over to John and Michael I want to pause and thank Cathy Smith and more tritan, both of whom step down from their leadership positions during the third quarter.
Both Kathy and Mark have made important contributions to our business over the last few years, helping us to achieve the high level performance that we're delivering today.
While Kathy will continue with us for a time in advisory role, we want to wish both of them well in their future pursuits.
At the same time I want to congratulate Michael Fidelity on his new responsibilities.
Michael knows our business incredibly well, having worked across multiple parts, our business and operations over the last 15 years.
I'd also like to thank Joe Sandow, and Kristina Hennington for their continued leadership within merchandising.
With Joe overseeing home and apparel and Kristina responsible for a hard lines beauty and essential categories. I'm confident we'll continue to deliver strong performance and market share gains in the fourth quarter and beyond.
As I've mentioned before.
One of the things that attracted me to target was its reputation as an Academy company.
One that develops world class talent.
And in my time here I've seen firsthand that this reputation as well earned and well deserved.
These three leaders are shiny examples of the quality of the talent the target develops and I'm excited to see what our team achieved together in the months in years ahead.
Now I'll turn the call over John will provide an update on our plans to deliver an outstanding experience for our guests in the holiday season and beyond John .
Thanks, Brian as we approach the peak holiday period, our stores and supply chain teams are energized and ready to deliver our unique combination of inspiration speed and convenience for our guests.
As I mentioned last quarter, our stores are now fully rolled out a new operating model across the chain.
This new model is oriented around our guess matter on tasks, including the creation of dedicated store teams with overall business ownership in key categories like beauty apparel home electronics and food and beverage.
The key to this new model is to continue delivering efficiency when accomplishing tasks, but orient team goals around gas and business outcomes, rather than merely checking off a box on a two lists the rollout of this model has involved a major evolution in the culture of how we run our stores, but we've been really pleased with the results we've been seeing so far and we're confident this.
New model will allow our team to provide an elevated experience for our guests throughout the holidays.
Yeah and experience convenience is important to our guests all year round, but it becomes even more important during the holidays and this year with six fewer days between Thanksgiving and Christmas our guest me find themselves with even less time than usual.
These are the times that our same day services can feel like a lifesaver.
I guess can place an order and our team who haven't ready at the front of the store or in the parking lot and less than an hour.
Orphaned guest wants their order delivered to their home. They can request same day delivery and one of more than 100000 ship shoppers will deliver there or at the front door in an hour or too.
And as Brian mentioned, we're excited that we now have ships capabilities fully integrated into our web site and the target App, which will provide a streamlined experience for guests who want to use this service.
We've been rapidly rolling out drive up in shipped across the country for the last couple of years and order pickup has been available in all of our stores for more than five years.
But as we've been highlighting all year the growth rate of all three of these services in 2019 has been nothing short of remarkable.
In the third quarter, the slowest growing of these services was order pickup which grew more than 50%.
Target sales volume fulfilled by ship grew more than 100% and drive up our highest rated service saw astounding growth of more than 500%.
Obviously, a portion of the growth for drive up was driven by the addition of more than 800 locations compared with a year ago, but.
But more than half of the growth occurred in mature locations as more and more guests in those markets tried to service loved it and chose to use it again and again.
As Brian mentioned earlier digital sales become a notably higher percentage of sales in the fourth quarter as guests look for options to save time during the busiest season of the year.
And given that we've already been seeing rapid growth in the sales penetration of these services all year, we're planning for them to play a really important role in the fourth quarter.
We've made dedicated investments in hours training tools and fixtures to prepare stores to accommodate a meaningful spike in volume of the same day options during the holidays, while still maintaining service standards that make them so popular.
Well, we aren't just focused on enhancing our digital capabilities as I pointed out before even in the fourth quarter. The vast majority of our sales still occur in our stores.
And we continue to see outstanding results from the investments we've made in our stores over the last several years.
In the third quarter, we completed another 153 remodels, putting us at just under 300 for the year.
Given our ongoing efforts to improve the process, we've realized efficiencies that have delivered spending favorability compared to our plan.
Also encouraging we found ways to reduce the sales disruption that occurs in stores undergoing a remodel driving a notable improvement in the average disruption compared with last year. We continue to see remodel sales lifts inline with our assumptions and we've seen a meaningful second year lift that wasn't originally part of our modeling for these projects.
We plan to maintain our current pace of Remodels for one additional year in 2020, and then ramp down to a longer term pace of 150 to 200 per year beginning in 2021.
In addition to our Remodels, we continue to see encouraging results from our investments in new small format stores.
We opened seven small format locations in the third quarter plus another six in November and sales from this year's entire group of new stores are running ahead of our plan.
We plan to continue opening about 30 of the smaller stores per year, because they drive guest engagement and deliver strong financial performance, including much higher than average sales productivity and meaningfully higher gross margin rates compared with our larger format stores.
And behind the scenes our teams continue their work to modernize our supply chain, enabling growth inefficiency in an increasingly complex omnichannel retail environment.
One of these investments isn't the development of a new inventory planning control system, which is designed to deliver enhanced precision in the placement and positioning of our inventory throughout our supply chain. The benefits of this new system include lower back room inventory levels better on shelf availability of our store inventory and a higher percentage of replenished items that flow straight to the.
Shelf.
We've been developing the system over the last couple of years and we've been ramping up the percent of our assortment being managed by this new system.
It's currently active on approximately 15% of our assortment, representing 20% to 30% of total replenishment that flows to our stores.
The items being managed by this new system, we are seeing favorable outcomes, including lower out of stocks and lower levels of back room inventory.
We're also testing and rolling out distribution center automation designed to increase our speed and simultaneously reduce store backroom labor and inventory.
Well, the new technology at our Perth Amboy facility as one example of this capability. We're also testing a complimentary technology at our distribution center here in the twin cities.
This new technology is focused on moving sortation labor out of store backrooms organizing shipments to minimize the number of footsteps needed to restock ourselves floors, and reducing the amount of excess inventory in our store backrooms.
We've been testing this new technology, which is integrated into a new warehouse management system and our twin cities DC This year and based on learnings and encouraging early results. We plan to extend the test into several other facilities next year.
And finally, our store teams have been rolling out a system designed to optimize intraday replenishment between our store backrooms and the sales floor. A goal of this new system has to have fuller shelves and enhanced availability for our guests while simultaneously reducing backroom inventory levels.
Since rolling out this new system in August we've seen very encouraging results, including a 17% reduction in backroom inventory units.
Our teams are telling us that their backrooms have never been so well organized going into holiday season.
Something what should translate into strong execution during our busiest time of the year.
And one final note ive spoken several times and prior earnings calls about our work to improve processes and drive efficiency in our store fulfillment capabilities like ship from store order pickup and drive up.
I don't know is one thing to hear about these improvements and another to see how they work.
So our communications team in cooperation with our store and headquarters team put together a video showing how our team accomplishes these tasks and how these capabilities work for our guests.
This video can be accessed by visiting corporate that target dot com and I encourage you to take a look.
So before I turn the call over to Michael I want to pause and thank the entire team from our team at headquarters through the supply chain in our stores for all the work that has gotten as to where we are today.
In many ways, we are still early in the journey, but that doesn't mean, there's been a small amount of effort. We've designed and are now implementing comprehensive changes to how we move product how we replenish our store inventory, how we operate our stores, how we interact with our guests and how we fulfill their digital orders.
Any of these changes in isolation will be big but when you put them altogether, it's been an incredible effort.
In the face of challenges I've seen our team respond with passion enthusiasm and seemingly endless energy to move from theory to reality.
And today I'm proud to share with the team has already accomplished and equally excited about what lies ahead.
Now I'll turn the call over to Michael who are share his thoughts on third quarter financial performance and our outlook for the fourth quarter and full year.
Thanks, John and good morning, everyone I'm really excited to join you on this morning's call I look forward to meeting with many of you in the months ahead.
As Brian mentioned earlier, our third quarter financial results were outstanding reflecting unexpected strength across multiple parts of our business. As a result, we delivered EPS well above our expectations and we have increased the midpoint of our full year adjusted EPS guidance by 30 cents compared with the previous range.
Third quarter comparable sales increased 4.5% about two percentage points higher than both our second quarter growth and our expectations. When you compound this growth on top of our 5.1% increase last year, you will see the comparable sales have grown nearly 10% over the last two years.
Among sales channels store comparable sales increased 2.8% in the quarter more than a percentage point faster than our second quarter pace of 1.5%.
Digital comp sales grew 31% in the quarter on top of 49% last year and contributed 1.7 percentage points to our total company top.
As you know we focus first on driving traffic in our business because it indicates the continued relevance of our brand and growing engagement among or guess that's why we're pleased that traffic continues to be the primary driver of our growth comparable traffic was up 3.1% in the third quarter driven by increases in both our stores and digital channels growth in ever.
Just ticket drove another 1.4 percentage points of our comp growth.
On the operating income line, we saw a rate increase of about 80 basis points compared with last year. This was well ahead of our expectations, reflecting multiple beneficial factors.
The first was category mix, which contributed about 30 basis points of gross margin improvement in the quarter. This was the result of exceptional strength in apparel combined with soft sales trends in our electronics and entertainment categories.
On top of the mix benefit from stronger than expected apparel sales. We also saw rate to benefit within that category as the business delivered a higher than expected mix a full price sales.
Outside of category mix, we also enjoyed a favorable mix and fulfillment, which took two forms. The first was a stronger than expected mix of sales in our stores, which is our lowest cost fulfillment channel in the third quarter all of the upsides to our comp expectations occurred in our stores.
In addition, within our digital fulfillment options same day services drove 80% of our growth and as we've outlined in prior calls these options have much more favorable cost and profit dynamics compared with shipping to our guests homes.
On top of category and fulfillment mix are buying teams continue to develop merchandising strategies that deliver strong margin performance based on their ongoing efforts to optimize cost pricing promotions that assortment within each of their individual categories.
In total our third quarter gross margin rate was up about 110 basis points from a year ago, reflecting the benefits I've cited above combined with a favorable comparison over some elevated costs reflected in last year's gross margin results.
Specifically as you'll recall last year, we experienced elevated supply chain expenses in the third quarter, driven by meaningful investments and toy and baby inventory in a rapid buildup of holiday receipts, reflecting the earliest possible timing for the Thanksgiving holiday.
This year, given the moderation in our inventory levels and a much later timing for Thanksgiving, we did not experience the same spike in our supply chain costs.
Moving down the piano, our third quarter SGN, a expense rate increased about 20 basis points compared with last year inline with our expectations.
This increase reflected the retiming of both marketing expenses and store labor from the second quarter, driven primarily by the October launch of target circle year to date, our SGN a expense rate has improved about 30 basis points from last year. This improvement reflects outstanding expense discipline across the organization along with the benefit of lower asset impairments.
Which are offsetting the impact of investments in store service and training along with wage pressures trip and by very tight labor market conditions across the country.
On the depreciation and amortization expense line, we saw an increase of $45 million for 8.5% compared with last year. This increase reflects a number of factors, including based investment trends our decision to roll out new flexible store fixtures, which accommodate incremental peak capacity for pickup and drive up orders and the impact of timing compared with.
Last year.
In total third quarter operating margin dollars were up more than 22% from last year, reflecting the combination of unexpectedly strong sales and rate performance.
Interest expense was down slightly in the third quarter, reflecting lower average debt balances, while our income tax provision increased approximately 100% compared with last year.
This increase reflected higher pre tax earnings this year combined with the impact of discrete items in last year's results, which made last year is effective tax rate unusually low.
Altogether, our operations generated adjusted EPS of $1.36, an increase of nearly 25% compared with a dollar nine last year.
Third quarter GAAP EPS from continuing operations of $1.37 was up more than 18% from last year. When we recorded seven cents of benefit from the discrete tax items mentioned previously.
Now I want to turn to cash flow and our priorities for capital deployment and I first want to briefly reiterate those priorities, which have remained consistent for decades, we first look to fully invested capital and projects that meet our strategic and financial criteria seconds, we support our dividend and seek to extend the company record of annual increases in dividend.
Per share something we've accomplished every year since 1971.
And finally, we will share repurchase to return any excess cash beyond those first two uses with the goal of maintaining our middle a credit ratings.
Turning first to Capex, we now expect to spend to somewhat less than our original plan of $3.5 billion in 2019.
And have an updated spending expectation of approximately $3.1 billion for this year.
Savings from our original plan are primarily driven by efficiencies we've realized on a portion of our capital projects combined with a smaller benefit from the Retiming of some project spending in the next year.
As we look ahead, we continue to expect to invest about $3.5 billion and Capex in 2020, reflecting our plan to complete nearly 300 additional store remodels for the year.
In 2021 and beyond we expect to moderate the pace of our Remodels to a range of about 150 to 200 stores per year.
With this moderation in the number of remodel projects, we expect our pace of Capex will move into the $2.5 billion to $3 billion range annually closer to the amount of DNA, we record on our cash flow statement.
Turning next to inventory, our third quarter balance sheet showed a decline of nearly $1 billion or about 8% compared with last year. However, given that this inventory position was about 8% higher than two years ago. The year over year decline has largely reflection of the specific inventory investments we made in advance of the fourth quarter last year.
As we approach this year's peak season, we feel very good about both the level and makeup of our inventory, which should position us to extend the strong sales and earnings performance. We've seen so far this year.
So with that as context, let's review our capital deployment priorities have played out so far in 2019.
Through the first three quarters of the year, our operations have generated more than $4.1 billion in cash up more than $500 million from the same period last year.
We have deployed that cash along with a portion of our cash on hand at the beginning of the year to fund $2.4 billion of Capex paid just under $1 billion and dividends and repurchase about $900 million of our shares.
Overtime, the quality of our capital deployment as reflected in our after tax return on invested capital, which we report on a trailing 12 month basis. This measure can be helpful. As you evaluate the quality of accompanies business model and the productivity of their investments overtime.
That basis targets performance stands tall for the trailing 12 months through the third quarter, our business generated an after tax return on invested capital of 15.1%, excluding discrete impacts from federal tax reform.
This is performance many of our peers would love to report.
Now, let's turn to our outlook for the fourth quarter and how that translates into our full year performance. Our outlook is based on a bottoms up view, a fourth quarter sales and profit drivers many of which are distinctly different than the rest of the year, specifically considerations and our outlook for the fourth quarter include the headwinds from six fewer holiday shopping days the benefit from.
Target circle, the rapid acceleration in fourth quarter digital penetration.
Much higher sales mix of toys, and electronics compared with the rest of the year and the highly promotional nature of the competitive environment.
Altogether based on recent trends in our evaluation of all of these factors, we expect our business to generate fourth quarter comparable sales growth of 3% to 4%.
On the operating margin line, our fourth quarter outlook anticipates, a small rate increase driven by a moderate improvements our gross margin rate, partially offset by smaller increases in both our SGN, a and DNA expense rates. This performance would translate into a mid to high single digit increase in operating margin dollars and an expected range for adjust.
EPS of $1.54 to $1.74.
And today based on our third quarter performance in fourth quarter outlook, we raised our full year guidance range for adjusted EPS to 625 to 645, the midpoint of this new ranges 30 cents higher than the midpoint of our prior guidance range.
If we achieve performance at the midpoint of our expectations that would translate into full year comparable sales growth of about 4%.
Operating income dollar growth in the low teens and EPS growth in the mid to high teens. All of these metrics are much stronger than we anticipated at the beginning of the year driven by upside and sales category mix and fulfillment mix within our digital channels.
At the beginning of the year, Kathy articulated our longer term financial expectations for the durable financial model, we have been developing over the last several years.
This model is based on the ability under normal economic conditions for our business to generate low single digit growth in sales mid single digit growth in operating income and high single digit growth in es or better.
Based on what we've seen so far this year, we are clearly on track to deliver performance meaningfully better than this baseline model in 2019, reflecting some of the unique dynamics, we've seen so far.
This outperformance is a testament to the quality of the business model that our teams have been working so hard to create.
And the efforts of our teams as something we never take for granted the last couple of years of involved an amazing amount of change and the way our team works for merchandising to operations from headquarters to our distribution centers and of course in our stores. It's been remarkable to worked closely with these teams and see how they've embraced the change believing it so.
Right long term path for our business results like we are seeing this year are a testament to their efforts in the passion they have for our guests and our brand.
With that I'll turn the call back over to Brian for some closing remarks. Thank.
Thanks, Michael before we move to your questions I want to sum up with a few final remarks.
Obviously as a team we enjoy reporting strong quarterly performance and the last couple of quarters have been really gratifying.
But the goal of our strategy is to make target a leading retailer and a world class company over the long term.
It's about making target more than just a good place to work, but an employer of choice at our headquarters in our stores and throughout our supply chain.
It's about making every target store a valuable part of their local community.
And working with those communities to make them a great place to live and work.
It's about making target a special place where guests when they shop in every channel.
Retailer provides inspiration while helping our against save time and money.
A company like no other focused on bringing the joy of everyday life to all of our guests.
So our current performance feels great, especially because its confirmation that our long term plan is working.
And that's what we'll continue to focus on in the months quarters in years ahead.
With that we want to thank you for your participation our call today.
We'll be moving to questions in a moment.
But I want to cover one last item.
In keeping with past practice, we plan to provide a post holiday update following this year's holiday season, and the date, we're planning on for this year's update is Wednesday January 15th So now Jon Michael and I will be happy to take your questions.
Thank you we will now begin the question and answer session to ask a question. Please press star followed by one to withdraw your request press star too.
Our first question comes from Chris Horvers with JP Morgan you May go ahead.
Thanks. Good morning can you talk can you talk a little more specifically about.
The cadence for the quarter do you think weather had any impact on the business given the warm September and and do you think this was fully made up for given the strong ended the quarter.
Okay, and Chris we saw really balanced performance throughout the 13 weeks of the quarter and I think you saw the really exceptional performance in categories like apparel, where we performed extremely well growing at a rate of over 10% picking up significant market share and as I highlighted in my earlier.
Comment all of those subcategories within apparel perform really well so we saw strength in our business through out the 13 weeks and I think the team saw us really strong performance across all of our categories.
Understood and then as you as you look ahead. There is some countervailing factors, so electronics and toys do go up substantially in the mix. How are you thinking about those categories and the holiday, but then on the other hand, obviously that E. Commerce stack was was very impressive and we use back here in the fourth quarter. So.
How are you thinking about that holiday broadly and electronics toys and E. Commerce as you look ahead.
Chris I think we are really well prepared for the fourth quarter. Our teams have done an exceptional job in putting together the right assortment or the holiday season, and as always we know that during that holiday period, we're going to amplifier focused on electronics and toys were well prepared in those categories with a number of new and exclusive items. So.
So I think we're in a terrific position as we get ready for the upcoming weeks and particularly from a electronics toy and seasonal standpoint, I think we're going to stand tall.
Understood Thanks very much.
Thank you then next question comes from Michael Lasser would you be yes, you May go ahead.
Good morning, Thanks, a lot for taking my question so already Michael Good morning, Brian when we interpret the combination of your very healthy digital growth and the decline in your Redcard penetration is that you're bringing in more marginally attached guest and now you have the ability to transition to the those guests to more regular.
Afterwards, and regular guess is that the right way to think about it and what is the adoption look like as the guest goes from trial of these various fulfillment options to broader adoption.
Yes, Michael I'd start with the real health that we're seeing in overall traffic growth. So obviously, we're seeing more footsteps in our stores more visit storage site.
I think thats going to translate into a guest that shopping more categories and greater relevance and a stronger relationship with that guests. So.
We can try to parse how that guest is changing over time, but I think the important thing is we just continue to see really strong traffic growth.
I guess shopping more categories.
We've talked about the rapid expansion of small format, we're moving into new neighborhoods. Those are guest that we're not shopping target on a regular basis before they are now and I expect overtime, there will be using red card and clearly they're going to be using our new target circle loyalty program.
I mentioned in my prepared comments, while we've only been in market for a few weeks with target circle, we already at 35 million guests who enrolled in the program. So I think we're going to continue to see traffic growth in our business guest that start to visit targeted now may come in for toys that are shopping other categories and beauty and.
Essentially begin to shop, and our style categories more frequently so those are the indicators that we look at as we plan for the future.
That's helpful. My follow up question is as you look towards next year and you think about the algorithm that you laid out.
We will more or the margin expansion inherent in your expectation of mid single digit operating income growth come from gross margin like you've experienced in recent quarters due in part to the mix shift to both better categories and fulfillment options.
Or will it come from for more as she any leverage and how should we think about the drivers between those two factors in the next couple of quarters.
Well, we are going to get into the specifics for 2020 in today's call on but we feel really good about the gross margin strength. We've seen so far this year, we'd expect moderate increase to gross margin rate in Q4 as well.
Okay have a great holiday. Thank you very much thank you Michael.
Thank you then next question comes from Matt Mcclintock with Raymond James You May go ahead.
Hi, Yes, good morning, everyone and congrats Michael and best wishes to both Kathy Mark.
Brian you talked about apparel for little bit, but I wanted to dive more into it because greater than 10% growth in your apparel business probably means you grew in absolute dollars more than anybody in the entire United States apparel industry. So in that and even if that's not the case, it's an acceleration for 5% last quarter. So can you dig more into what's driving that is that.
Private label brands is that national brands like what you saw at Levis and what exactly are you doing in jewelry accessories, that's driving that growth there. Thank you.
So I appreciate the call out Matt we did certainly see a oversized increase in market share during the quarter in apparel I think our teams have done a fabulous job.
Curated and our own brand assortment really having the right assortment.
In front of the guess, we've delivered exceptional quality and value in those categories. I think we've been on trend for the season and I think our commitment to our new store operating model, where we have dedicated business owners in that apparel category that are helping our guest each and every day.
Is really driving great result, so the combination of the work we've done with our own brand assortment, adding some new national brands like Levi's and select stores.
Service that we're delivering in store and the inspiration we're creating online has really come together in the apparel category. So I'm really proud of the work the team's done there I think it's a great example of how our strategy is come together, where we remodeled stores and create an inspiring in store environment, we surround our.
Yes, with exceptionally well trained team members, we're providing on trend styles at a great value and we're providing a similar experience online. So I really really feel great about the work the team's done there and I think it's it's one of the highlights of our quarter if not for the entire year.
Thanks for that color, Brian and then John .
Clearly are excited about same day options. This holiday season, and I was just trying to think about given.
Strategically given that it's a shorter holiday season than in years past as it even more of a street strategic competitive advantage to offer of same day options and and does do you think that that's actually going to accelerate adoption by customers. Thanks.
We do and I mean, I am excited about the great progress. The team has made over the past year in our same day offerings order pickup drive up shipped all the investments we've made there.
Mission C of the team and their ability to ensure that we have a package ready for you in an hour or less regardless of how you're going to interact with us and I think you're right on where people will become times strap digital is an easy way and being able to knock it off your lifts very quickly that day, if you want to pick it up great. If you just want to swing by we'll put it in your car or will deliver it to your home I.
I think that becomes incredibly important and as always I think the stores or epicenter of how we deliver.
That gives us great speed and as you get near the end of the holiday season, the stores become such a huge advantage for us.
We'll be well stock will have a great team there like Brian pointed out providing service and if you again, if you want to ordered online will have its sitting there waiting for you.
To put your car or come in grab it. So we're very excited about the opportunity. This holiday season with the growth we've seen and the growth that's in front of us from a same day perspective.
Thanks for that best of luck.
Thank you.
Thank you. Our next question comes from Scott Mushkin with our five capital you May go ahead.
Hey, guys. Thanks for thanks for taking my questions morning's you've got first quick hey, good morning, Brian when everybody else.
So my first question actually to Michael I.
I think you talked about at the end what surprised you kind of going into the with the performance is versus what it was going into the air.
Was wondering if you just getting a little more detailed why you are above plan in the sustainability of some of those trends.
Sure Scott Thanks for the question.
I think it starts on the gross margin line and kind of back to the key themes from my remarks earlier strength, there when era, when and when apparel is running at 10% that's really healthy on the margin line.
Gross margin rates in that category and we sell more product at Reg price versus discounted ended the season, when our style categories do well.
Second was the stronger than expected store sales Thats always healthy for margin and then finally took maybe piggyback on some of what John just said on where our digital fulfillment growth came from when those same day options that the guest as responding to drive 80% of our digital growth that's healthy from an operating margin rate perspective, as well year over year basis.
Yes.
And the sustainability of some of these trends in your mind.
Hi, good teams worked hard to build an algorithm that Scott good sustainability in the long run when it comes to Q4 Q4 as its own animal. So we both Q4 bottoms up looking at how all those factors fit together. So we'd expect again moderate gross margin rate expansion in Q4, but it will be modest compared to the point expansion side.
In Q3.
Scott I wouldn't describe it as the surprise, but I think as you look at the third quarter.
Right with the strength in traffic up 3.1% the strength in our stores comping. It almost 3% the continued strength in digital in our two year stack in the quarter rounds to 10%. So we're putting good numbers on top of good numbers will continue to do that overtime, but I think the balance in our portfolio.
Leo we're both our style and essential categories are performing our stores are driving growth. Our digital channels are continuing to accelerate and the overall composition of the quarter to me was a very high quality quarter, where all factors our business, we're working together as one.
Great and then my quick follow up question I think there was a comment that the remodels in the second year are performing.
Better than expected and I was just wondering if you could give some of our survey data it's actually showing the same thing. So I was wondering if you could give US reason why you think thats happening and again the sustainability of that.
We.
A few years into this now we have consistently seen the second year performance, we didnt expect that going into this obviously and we didn't model for it as we.
Looked at the financials are the remodels, but it certainly doesn't surprise. So we believe it is sustainable because we continue to see it.
For the second year of the second year, I guess, you would say.
So we're pleased with that I think what drives it is the guests come in it takes a little while to figure out the store, we see them engage with the store immediately because the environment is so much better. The presentation is better you pair that as Brian said earlier with the change in the operating model and better service.
In the store in many parts of the stores great training for our team so that they can be of more assistance to the gas.
And then that you see the guest continued engage in different parts of the store and really experienced the whole everything we have to offer I mean, so it's really the culmination of everything we're doing to create that great in store experience that continues to build as we go through the remodel process and Scott I'll give you a little additional insight when we talk to guests who come into a new.
Newly remodeled store and they might have in a previous target shopper in that store. So that the that we get is how we added new categories have we added new assortment. So because of the changes we've made in the core the lay out the experience they start discover even more categories than they had shot before I think thats a big part of what we're seeing in.
Year to so.
I guess might have been coming to us for household essentials and toys. They are now shopping and apparel and home. They are discovering additional categories and I think thats, helping us pick up market share in those remodeled stores in multiple categories.
Alright, perfect guys. Thanks, I was just sent remodeled super target in Houston and it was pretty amazing. Thank thank you appreciate it.
Thank you. Our next question comes from Ed Yruma with Keybanc capital markets. You May go ahead.
Hey, good morning, guys. Thanks checking the question I guess first to unpack a little bit more on gross margin gains obviously very impressive how much of it I know you call that apparel, but how much of it you think broadly is from success here investments and your process in private label and kind of how do you see penetration moving as we think about 2020 and then second.
You know obviously, you've seen some very strong success and same day pickup I know, you're adding labor there, but how do you feel about your ability to scale that business from even a physical perspective, either from a backroom or from our point of the house perspective. Thanks, Ed one only let Michael start and talk about some of the gross margin gains and obviously the benefits of the 40, new owned brands, we've rolled out over the last couple of.
And then John can talk about the scalability of our fulfillment models.
Yeah. Thanks that on the owned brand front it really starts with.
Providing product that we think the guests will respond to and so curated owned brand product that drives repeat purchase and royalty overtime. So we started there and when that owned brand product. It does well it translates favourably to the gross margin and so a strength we've seen and the growth of owned brands over time is definitely positive on site.
So we will.
The way I'd start as we will pick pack and deliver either in stores, we pick up and drive up or shipped to guess more packages in the next five weeks than we did in the entire year of 2015 and so the teams have done an outstanding job going back redoing processes investing in technology investing in training.
Reengineering our processes.
Continually and this year, we've seen productivity increases in pick prep and pack and ship.
Of close to 60% in store. So we believe we have a significant runway in front of us to continue that the other thing I I compare this to is if you look at our average store does a little bit over $300 a square foot our top quartile of stores approach is $800 a square foot. So we have huge capacity just in those box.
Is to move far more inventory than we do today with far more team members doing it now whether that goes out the for another store or the back in the store, it's still just moving inventory through the store and so we believe we have a long runway to continue to fulfill and we think it is a huge strategic advantage for us given the speed, we see and the cost.
Advantages, we see by fulfilling through our stores.
Thanks, guys.
Thank you.
Thank you. Our next question comes from Kate Mcshane with Goldman Sachs. You May go ahead.
Hi, Thank you for taking my question.
Our question centered around gross margin to I. I wondered if you could help us understand on your comment you talked about selling more at full price during the quarter can you help us reconcile that with any price investment you may have had to do during the quarter and also the values continue to convey to your customers yet.
Why don't I start in for several years now we've been talking about our commitment to being priced right daily.
And making sure that we're communicating to our guest that every time you shot target, we're delivering great value and we've been talking for several quarters now about the benefits of that investment the benefits that communication and the fact that we're seeing a significant portion of our business move to everyday pricing and I really.
I would describe it as everyday value. So that continued in the quarter and I think thats going to continue for some time to calm as we continue to reinforce to our guest that every time you shop, our stores, we're going to deliver great value, we're going to be price right daily on those items that we know are so important to our guest.
And that's a commitment that than in place for several quarters and will continue for years the Khan.
Okay, and if I can just follow up I know tariff continued to be.
Headlines at this point and nothing is.
But could you walk us through if list for B, where to put into effect, how much you've been able to or you can mitigate versus how much price you. Thank you need to take.
Kate we've been watching the headlines as others have each and every day, we've been obviously working for several years now to diversify our sourcing matrix I think we are well positioned to deal with some of the challenges that could be it in front of us.
I think we've said last couple of quarters in Q2 tariffs pressured us by about $50 million.
Q3, that's going to be about $60 million pressure, but our teams, particularly our merchants and our sourcing team have done a phenomenal job really working through this challenging landscape and allowing us to deliver great value to our guest at a time when they needed. Most so we'll watch the next list, we'll see what happens as well.
We go into the next couple of weeks and into the start of 2020, but I think we're well prepared to react and obviously, we're all facing the same tariff issues together I think our size scale, the sophistication of our team and our vendor partners positions us well to going to navigate this uncharted waters.
Thanks.
Thank you. Our next question comes from Karen short with Barclays. You May go ahead.
Hi, Thanks, and congratulations great quarter. Thank you we appreciate that.
Just wanted to actually follow up on that tariff question.
Taking the opposite angle, if if list forward to not be enacted would there may be a little upside.
For Q.
We are well watch it carefully obviously, if some of the tariffs are pulled back theres going to be upside going forward I wish I could tell you what's going to happen, but we're watching the same reports that everyone else is right now. So obviously, we're going to hope for the best and depending on what happens they will give us a chance to either invest in the business.
And drive even greater acceleration in our trends, but we'll watch it carefully Karen and will decide up once we have greater clarity I think for all of US right now the biggest challenges uncertainty and no says we get greater clarity, we'll be able to make better decisions and navigate these choppy waters, but right now.
Target like all of our peers, we're looking for greater clarity greater certainty and as soon as we get that will decide how to deploy those funds.
Okay, and then I wanted to ask about yeah, obviously, there's so much so much going on in apparel, that's positive and and you called out many of that but you actually didn't mention the Twentyth anniversary collection I was just wondering if you could give a little color on that I mean, we now it's not a huge comp driver, but any contacts you could give on that and how Atlanta.
I think it was incredibly well received by our guests I think our teamed up fabulous job executing the plan it built enormous awareness and traffic to our stores and now which is one of those moments, where we can surprise and delight, our guest and going back and thinking about the twentyth anniversary and bringing some of these great collateral.
Ration back to life was well received by the guest and obviously these limited time offers will be part of our playbook gum as we go into 2020 and beyond but that one was incredibly well received by the guest and a lot of excitement when.
Our guests were in the store where shopping online.
Great and just last question, maybe a little color from you Brian in terms of the merchandising structure in general and May obviously, you've chosen a slightly different path in terms of.
Senior Vice President and.
Two senior Vice President in terms of the categories can you maybe just elaborate a little on that decision.
Well I put to really experience and very talented leaders in place over two of our big category groups and this was something that we did all the way back in January so back in January we elevated Jill dando to oversee our apparel and home and style.
Categories I'm at the same time, we elevated Kristina headington to lead beauty and essentials in our hardline businesses toys and electronics, so they've actually been in place in those roll throughout the year they've been with target for.
Many many years the case of Joe over 20 interesting over 15 years. So they are experienced talent did great leaders I have enormous trust in their capabilities to lead us going forward and I think that we are incredibly well positioned from a merchandising standpoint going for.
Lower we appointed Stephanie Lundquist as our leader for food and beverage. So we have some top talents, leading those categories and I feel just terrific about their leadership and the plant they have in place for the fourth quarter and their plans that they're developing for 2020.
Thanks very much thank you.
Thank you. Our next question comes from Paul Lejuez with City you May go ahead.
Hey, Thanks, guys can you talk a little bit about the good and gather line just the initial response also curious what percent of your food and beverage was private label prior to launching through good and gather and where do you expect that to go over the next few years. Thanks. So.
We launched good and gather during the quarter.
We started out with 650 SK use that will expand in 2020 with another 2000 items. The initial response from the guest has been fantastic.
Really really excited about the offering I talked about it being real food.
Having artificial colors artificial ingredients no high fructose corn.
So I think it's really on trend with what the consumers looking for and food and beverage from target.
Our teams done a fabulous job with the packaging our store teams did a really terrific job of making that transition and getting these products on the shelf during the quarter. So while early the brands off to a very good start and as we've talked about previously despite our strength that own brands overall we're.
Underpenetrated from a food beverage standpoint, so low teen development in own brand in food and beverage, we think theres significant upside over time and we think.
Within the next year, so good and get it will likely be our single largest own brand at target. So I'm very optimistic about the potential for the brand it's off to a great start the consumer really seem to be connecting with the brand proposition and I think the best is yet to come for getting gather.
And Bob at what point, you're going to do more of a splashy marketing effort around good good and gather yeah. We've already started to featured in our weekly circular there's some great in store marketing in place right now.
Obviously, we as we get to a point of more critical mass you'll see a more focused marketing initiative around good and gather but if you're in our stores today, it's really obvious that.
Weve introduced its new brand. It's featured on our end caps in featured in our in store marketing and it's a prominent part of our weekly circular.
Operator, we have time for one last call. This morning.
Thank you our last question comes from Seth Sigman with Credit Suisse. You May go ahead.
Hey, guys. Good morning, Thanks for squeezing me in and good morning, I Didnt want to follow up on the inventory being down 8% versus flat last quarter and it's been decelerating all year, John discussed some inventory initiatives and growing penetration of the new system. I'm. Just curious is that already starting to play a role here or I guess, how much is a timing element where.
These sales are just starting later I just love to get your view on your inventory position heading into the holiday and into next year. Thanks.
Well John feel free to add.
New system work I'd say as a small benefit so far this year, what you're really seeing as the on back of just the year over year change from where we were a year ago. If you step back and looked at inventory almost on a two year stack basis, I think you'll see growth relatively in line with our sales over that two year period, and you know versus last year, where we were.
A little bit heavier from an early Thanksgiving.
And working through just higher inventory levels, especially as we invested explicitly ensign plays and baby merchandise on a year over year basis, you're seeing the benefits.
So operator that concludes our third quarter earnings call I want to thank all of you for joining US we look forward to talking to you in January and I want to wish everybody a happy holiday. Thank you.
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