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Target Corporation
TGT · US · NYSE
133.47
USD
-0.38
(0.28%)
Executives
Name Title Pay
Ms. Melissa K. Kremer Executive Vice President & Chief HR Officer --
Ms. Lisa Roath Executive Vice President & Chief Marketing Officer --
Mr. Brian C. Cornell Chairman of the Board & Chief Executive Officer 4.48M
Ms. A. Christina Hennington Executive Vice President & Chief Growth & Strategy Officer 1.53M
Mr. Michael J. Fiddelke Executive Vice President, Chief Operating Officer & Chief Financial Officer 1.59M
Mr. Don H. Liu Executive Vice President, Chief Legal & Compliance Officer and Corporate Secretary 1.35M
Mr. Matthew A. Liegel Senior Vice President, Chief Accounting Officer & Controller --
Mr. John Hulbert Vice President of Investor Relations --
Mr. Brett R. Craig Executive Vice President & Chief Information Officer --
Ms. Katie M. Boylan Executive Vice President & Chief Communications Officer --
Insider Transactions
Date Name Title Acquisition Or Disposition Stock / Options # of Shares Price
2024-07-07 Gomez Richard H. Executive Officer D - Common Stock 0 0
2024-07-07 Gomez Richard H. Executive Officer I - Common Stock 0 0
2024-06-04 Cornell Brian C Executive Officer D - S-Sale Common Stock 45000 151.3611
2024-04-09 LIU DON H Executive Officer A - A-Award Common Stock 10595 0
2024-04-09 LIU DON H Executive Officer D - F-InKind Common Stock 4832 170.5
2024-04-09 FIDDELKE MICHAEL J Executive Officer A - A-Award Common Stock 9537 0
2024-04-09 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 4349 170.5
2024-04-09 ZABEL MATTHEW L Executive Officer A - A-Award Common Stock 1701 0
2024-04-09 ZABEL MATTHEW L Executive Officer D - F-InKind Common Stock 776 170.5
2024-04-09 SYLVESTER CARA A Executive Officer A - A-Award Common Stock 3394 0
2024-04-09 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 1100 170.5
2024-04-09 Cornell Brian C Executive Officer A - A-Award Common Stock 56331 0
2024-04-09 Cornell Brian C Executive Officer D - F-InKind Common Stock 24030 170.5
2024-04-09 Kremer Melissa K Executive Officer A - A-Award Common Stock 5936 0
2024-04-09 Kremer Melissa K Executive Officer D - F-InKind Common Stock 2299 170.5
2024-04-09 LIEGEL MATTHEW A Chief Accounting Officer A - A-Award Common Stock 502 0
2024-04-09 LIEGEL MATTHEW A Chief Accounting Officer D - F-InKind Common Stock 154 170.5
2024-04-09 HENNINGTON CHRISTINA Executive Officer A - A-Award Common Stock 5303 0
2024-04-09 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 1985 170.5
2024-03-21 HENNINGTON CHRISTINA Executive Officer D - S-Sale Common Stock 4600 170.88
2024-03-13 Whiteford Grace Puma director A - A-Award Common Stock 1148 0
2024-03-13 SYLVESTER CARA A Executive Officer A - A-Award Common Stock 3715 0
2024-03-13 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 442 165.87
2024-03-13 Cornell Brian C Executive Officer A - A-Award Common Stock 27723 0
2024-03-13 Cornell Brian C Executive Officer D - F-InKind Common Stock 9308 165.87
2024-03-13 Barrett George S director A - A-Award Common Stock 2024 0
2024-03-13 HENNINGTON CHRISTINA Executive Officer A - A-Award Common Stock 5165 0
2024-03-13 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 688 165.87
2024-03-13 HENNINGTON CHRISTINA Executive Officer D - S-Sale Deferred Compensation Units 7680.2259 0
2024-03-13 EDWARDS ROBERT L director A - A-Award Common Stock 1148 0
2024-03-13 FIDDELKE MICHAEL J Executive Officer A - A-Award Common Stock 8517 0
2024-03-13 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 1240 165.87
2024-03-13 Kremer Melissa K Executive Officer A - A-Award Common Stock 4077 0
2024-03-14 Kremer Melissa K Executive Officer D - S-Sale Common Stock 3000 165.05
2024-03-13 Kremer Melissa K Executive Officer D - F-InKind Common Stock 775 165.87
2024-03-13 Rice Derica W director A - A-Award Common Stock 1873 0
2024-03-13 ZABEL MATTHEW L Executive Officer A - A-Award Common Stock 2447 0
2024-03-13 LIU DON H Executive Officer A - A-Award Common Stock 4893 0
2024-03-13 LIU DON H Executive Officer D - F-InKind Common Stock 1377 165.87
2024-03-13 STOCKTON DMITRI L director A - A-Award Common Stock 1873 0
2024-03-13 LEAHY CHRISTINE A director A - A-Award Common Stock 1873 0
2024-03-13 KNAUSS DONALD R director A - A-Award Common Stock 1148 0
2024-03-13 LOZANO MONICA C director A - A-Award Common Stock 1148 0
2024-03-13 ABNEY DAVID P director A - A-Award Common Stock 1148 0
2024-03-13 LIEGEL MATTHEW A Chief Accounting Officer A - A-Award Common Stock 4410 0
2024-03-13 BOUDREAUX GAIL director A - A-Award Common Stock 1873 0
2024-03-13 BAKER DOUGLAS M JR director A - A-Award Common Stock 1148 0
2024-03-11 ZABEL MATTHEW L Executive Officer D - F-InKind Common Stock 285 168.63
2024-03-11 ZABEL MATTHEW L Executive Officer D - F-InKind Common Stock 168 168.63
2024-03-11 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 212 168.63
2024-03-11 Cornell Brian C Executive Officer D - S-Sale Common Stock 45000 167.5232
2024-03-08 LIEGEL MATTHEW A Chief Accounting Officer D - F-InKind Common Stock 161 170.87
2024-03-11 LIEGEL MATTHEW A Chief Accounting Officer D - F-InKind Common Stock 126 168.63
2024-03-11 LIEGEL MATTHEW A Chief Accounting Officer D - F-InKind Common Stock 50 168.63
2024-03-11 LIEGEL MATTHEW A Chief Accounting Officer D - F-InKind Common Stock 79 168.63
2024-03-07 ZABEL MATTHEW L Executive Officer D - S-Sale Common Stock 4000 175
2024-03-08 SYLVESTER CARA A Executive Officer D - S-Sale Common Stock 4125 171.8343
2024-03-06 LIU DON H Executive Officer D - S-Sale Common Stock 21000 171.7764
2024-03-06 FIDDELKE MICHAEL J Executive Officer D - S-Sale Common Stock 5750 172.8034
2024-01-29 ZABEL MATTHEW L Executive Officer D - F-InKind Common Stock 163 139.66
2023-11-28 ZABEL MATTHEW L Executive Officer D - S-Sale Common Stock 4000 131.33
2023-11-22 HENNINGTON CHRISTINA Executive Officer D - S-Sale Common Stock 4000 130.5487
2023-11-22 HENNINGTON CHRISTINA Executive Officer A - I-Discretionary Deferred Compensation Units 3984.6743 0
2023-11-24 Cornell Brian C Executive Officer D - G-Gift Common Stock 7750 0
2023-11-16 LIU DON H Executive Officer D - S-Sale Common Stock 16000 130
2023-10-31 ZABEL MATTHEW L Executive Officer A - A-Award Common Stock 870 0
2023-10-15 ZABEL MATTHEW L Executive Officer D - Common Stock 0 0
2023-08-18 Cornell Brian C Executive Officer D - S-Sale Common Stock 30000 130.7045
2023-06-28 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 427 132.63
2023-05-18 LIEGEL MATTHEW A Chief Accounting Officer D - S-Sale Common Stock 1459 160.7459
2023-04-04 Ward Laysha Executive Officer A - A-Award Common Stock 14896 0
2023-04-04 Ward Laysha Executive Officer D - F-InKind Common Stock 6793 165.99
2023-04-04 SYLVESTER CARA A Executive Officer A - A-Award Common Stock 2561 0
2023-04-04 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 1168 165.99
2023-04-04 Mulligan John J Executive Officer A - A-Award Common Stock 42538 0
2023-04-04 Mulligan John J Executive Officer D - F-InKind Common Stock 19398 165.99
2023-04-04 LIU DON H Executive Officer A - A-Award Common Stock 21273 0
2023-04-04 LIU DON H Executive Officer D - F-InKind Common Stock 9701 165.99
2023-04-04 LIEGEL MATTHEW A Chief Accounting Officer A - A-Award Common Stock 974 0
2023-04-04 LIEGEL MATTHEW A Chief Accounting Officer D - F-InKind Common Stock 299 165.99
2023-04-04 Kremer Melissa K Executive Officer A - A-Award Common Stock 9367 0
2023-04-04 Kremer Melissa K Executive Officer D - F-InKind Common Stock 4272 165.99
2023-04-04 HENNINGTON CHRISTINA Executive Officer A - A-Award Common Stock 8516 0
2023-04-04 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 3884 165.99
2023-04-04 Cornell Brian C Executive Officer A - A-Award Common Stock 99522 0
2023-04-04 Cornell Brian C Executive Officer D - F-InKind Common Stock 41884 165.99
2023-04-04 FIDDELKE MICHAEL J Executive Officer A - A-Award Common Stock 14045 0
2023-04-04 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 6405 165.99
2023-04-04 BOYLAN KATIE M Executive Officer A - A-Award Common Stock 3411 0
2023-04-04 BOYLAN KATIE M Executive Officer D - F-InKind Common Stock 1556 165.99
2023-03-31 LIU DON H Executive Officer D - S-Sale Common Stock 6000 165
2023-04-03 LIU DON H Executive Officer D - S-Sale Common Stock 6000 167
2023-03-10 LIEGEL MATTHEW A Chief Accounting Officer D - F-InKind Common Stock 1 159.69
2023-03-10 LIEGEL MATTHEW A Chief Accounting Officer D - F-InKind Common Stock 48 159.69
2023-03-11 LIEGEL MATTHEW A Chief Accounting Officer D - F-InKind Common Stock 78 158.48
2023-03-13 LIEGEL MATTHEW A Chief Accounting Officer D - F-InKind Common Stock 102 158.48
2023-03-10 Ward Laysha Executive Officer D - F-InKind Common Stock 22 159.69
2023-03-10 Ward Laysha Executive Officer D - F-InKind Common Stock 39 159.69
2023-03-10 Mulligan John J Executive Officer D - F-InKind Common Stock 63 159.69
2023-03-10 Mulligan John J Executive Officer D - F-InKind Common Stock 65 159.69
2023-03-10 LIU DON H Executive Officer D - F-InKind Common Stock 32 159.69
2023-03-10 LIU DON H Executive Officer D - F-InKind Common Stock 52 159.69
2023-03-10 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 21 159.69
2023-03-10 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 65 159.69
2023-03-13 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 477 158.48
2023-03-10 Kremer Melissa K Executive Officer D - F-InKind Common Stock 14 159.69
2023-03-10 Kremer Melissa K Executive Officer D - F-InKind Common Stock 65 159.69
2023-03-10 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 26 159.69
2023-03-11 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 316 158.48
2023-03-13 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 203 158.48
2023-03-10 BOYLAN KATIE M Executive Officer D - F-InKind Common Stock 26 159.69
2023-03-11 BOYLAN KATIE M Executive Officer D - F-InKind Common Stock 417 158.48
2023-03-13 BOYLAN KATIE M Executive Officer D - F-InKind Common Stock 382 158.48
2023-03-10 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 13 159.69
2023-03-10 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 39 159.69
2023-03-13 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 575 158.48
2023-03-10 Cornell Brian C Executive Officer D - F-InKind Common Stock 114 159.69
2023-03-10 Cornell Brian C Executive Officer D - F-InKind Common Stock 129 159.69
2023-03-14 Cornell Brian C Executive Officer D - S-Sale Common Stock 2300 160.117
2023-03-14 Cornell Brian C Executive Officer D - S-Sale Common Stock 5200 158.3806
2023-03-14 Cornell Brian C Executive Officer D - S-Sale Common Stock 7100 157.4804
2023-03-14 Cornell Brian C Executive Officer D - S-Sale Common Stock 20400 159.5182
2023-03-08 Ward Laysha Executive Officer A - A-Award Common Stock 1752 0
2023-03-08 Ward Laysha Executive Officer A - A-Award Common Stock 3405 0
2023-03-08 Ward Laysha Executive Officer D - F-InKind Common Stock 2294 162.95
2023-03-08 Ward Laysha Executive Officer A - A-Award Common Stock 12472 0
2023-03-08 Ward Laysha Executive Officer D - F-InKind Common Stock 5688 162.95
2023-03-08 SYLVESTER CARA A Executive Officer A - A-Award Common Stock 2946 0
2023-03-08 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 2883 162.95
2023-03-08 SYLVESTER CARA A Executive Officer A - A-Award Common Stock 8319 0
2023-03-08 Mulligan John J Executive Officer A - A-Award Common Stock 5005 0
2023-03-08 Mulligan John J Executive Officer A - A-Award Common Stock 10123 0
2023-03-08 Mulligan John J Executive Officer D - F-InKind Common Stock 8469 162.95
2023-03-08 Mulligan John J Executive Officer A - A-Award Common Stock 20778 0
2023-03-08 Mulligan John J Executive Officer D - F-InKind Common Stock 9475 162.95
2023-03-08 LIU DON H Executive Officer A - A-Award Common Stock 2503 0
2023-03-08 LIU DON H Executive Officer A - A-Award Common Stock 4970 0
2023-03-08 LIU DON H Executive Officer D - F-InKind Common Stock 3654 162.95
2023-03-08 LIU DON H Executive Officer A - A-Award Common Stock 16624 0
2023-03-08 LIU DON H Executive Officer D - F-InKind Common Stock 7581 162.95
2023-03-08 Kremer Melissa K Executive Officer A - A-Award Common Stock 1102 0
2023-03-08 Kremer Melissa K Executive Officer A - A-Award Common Stock 3681 0
2023-03-08 Kremer Melissa K Executive Officer D - F-InKind Common Stock 1446 162.95
2023-03-08 Kremer Melissa K Executive Officer A - A-Award Common Stock 20778 0
2023-03-08 Kremer Melissa K Executive Officer D - F-InKind Common Stock 9475 162.95
2023-03-08 HENNINGTON CHRISTINA Executive Officer A - A-Award Common Stock 1002 0
2023-03-08 HENNINGTON CHRISTINA Executive Officer A - A-Award Common Stock 4878 0
2023-03-08 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 1232 162.95
2023-03-08 HENNINGTON CHRISTINA Executive Officer A - A-Award Common Stock 12472 0
2023-03-08 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 5369 162.95
2023-03-08 FIDDELKE MICHAEL J Executive Officer A - A-Award Common Stock 1653 0
2023-03-08 FIDDELKE MICHAEL J Executive Officer A - A-Award Common Stock 5706 0
2023-03-08 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 2099 162.95
2023-03-08 FIDDELKE MICHAEL J Executive Officer A - A-Award Common Stock 20778 0
2023-03-08 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 9475 162.95
2023-03-08 BOYLAN KATIE M Executive Officer A - A-Award Common Stock 1565 0
2023-03-08 BOYLAN KATIE M Executive Officer A - A-Award Common Stock 8319 0
2023-03-08 BOYLAN KATIE M Executive Officer D - F-InKind Common Stock 2893 162.95
2022-06-06 Cornell Brian C Executive Officer A - G-Gift Common Stock 60000 0
2022-11-29 Cornell Brian C Executive Officer D - G-Gift Common Stock 6000 0
2022-05-10 Cornell Brian C Executive Officer A - G-Gift Common Stock 139905 0
2023-03-08 Cornell Brian C Executive Officer A - A-Award Common Stock 11710 0
2023-03-08 Cornell Brian C Executive Officer A - A-Award Common Stock 25767 0
2022-12-06 Cornell Brian C Executive Officer D - G-Gift Common Stock 105000 0
2023-03-08 Cornell Brian C Executive Officer D - F-InKind Common Stock 17526 162.95
2023-03-08 Cornell Brian C Executive Officer D - F-InKind Common Stock 18794 162.95
2023-03-08 Cornell Brian C Executive Officer A - A-Award Common Stock 41540 0
2022-12-06 Cornell Brian C Executive Officer A - G-Gift Common Stock 105000 0
2022-05-10 Cornell Brian C Executive Officer D - G-Gift Common Stock 139905 0
2022-06-06 Cornell Brian C Executive Officer D - G-Gift Common Stock 60000 0
2023-03-08 STOCKTON DMITRI L director A - A-Award Common Stock 1902 0
2023-03-08 Whiteford Grace Puma director A - A-Award Common Stock 1902 0
2023-03-08 Rice Derica W director A - A-Award Common Stock 1902 0
2023-03-08 LOZANO MONICA C director A - A-Award Common Stock 1166 0
2023-03-08 LEAHY CHRISTINE A director A - A-Award Common Stock 1902 0
2023-03-08 KNAUSS DONALD R director A - A-Award Common Stock 1166 0
2023-03-08 Healey Melanie director A - A-Award Common Stock 1166 0
2023-03-08 EDWARDS ROBERT L director A - A-Award Common Stock 1166 0
2023-03-08 BOUDREAUX GAIL director A - A-Award Common Stock 1902 0
2023-03-08 Barrett George S director A - A-Award Common Stock 1902 0
2023-03-08 BAKER DOUGLAS M JR director A - A-Award Common Stock 2056 0
2023-03-08 ABNEY DAVID P director A - A-Award Common Stock 1166 0
2023-03-08 LIEGEL MATTHEW A Chief Accounting Officer A - A-Award Common Stock 2025 0
2023-03-09 LIEGEL MATTHEW A Chief Accounting Officer D - F-InKind Common Stock 141 162.58
2022-12-16 Mulligan John J Executive Officer D - S-Sale Common Stock 8300 147.1024
2022-12-16 Mulligan John J Executive Officer D - S-Sale Common Stock 16408 146.0671
2022-09-14 Mulligan John J Executive Officer D - S-Sale Common Stock 100 168.53
2022-09-14 Mulligan John J Executive Officer D - S-Sale Common Stock 5389 163.9334
2022-09-14 Mulligan John J Executive Officer D - S-Sale Common Stock 6749 167.8432
2022-09-14 Mulligan John J Executive Officer D - S-Sale Common Stock 8415 166.1875
2022-09-14 Mulligan John J Executive Officer D - S-Sale Common Stock 8451 167.0935
2022-09-14 Mulligan John J Executive Officer D - S-Sale Common Stock 9997 164.8465
2022-08-18 LIEGEL MATTHEW A Chief Accounting Officer D - S-Sale Common Stock 1226 173.8046
2022-08-10 Whiteford Grace Puma A - A-Award Common Stock 849 0
2022-08-10 Whiteford Grace Puma director D - Common Stock 0 0
2022-06-28 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 423 147.82
2022-06-23 HENNINGTON CHRISTINA Executive Officer A - I-Discretionary Deferred Compensation Units 3405.7626 146.81
2022-06-23 HENNINGTON CHRISTINA Executive Officer A - I-Discretionary Deferred Compensation Units 3405.7626 0
2022-06-17 Mulligan John J Executive Officer D - S-Sale Common Stock 19244 139.4344
2022-05-20 LIEGEL MATTHEW A Chief Accounting Officer A - I-Discretionary Deferred Compensation Units 643.6663 155.36
2022-04-20 SYLVESTER CARA A Executive Officer D - S-Sale Common Stock 2030 250
2022-04-20 SANDO JILL Executive Officer D - S-Sale Common Stock 2000 250
2022-04-20 Kremer Melissa K Executive Officer D - S-Sale Common Stock 8602 250
2022-04-18 LIU DON H Executive Officer D - S-Sale Common Stock 8500 240
2022-04-07 LIU DON H Executive Officer D - S-Sale Common Stock 8500 233
2022-04-05 Ward Laysha Executive Officer A - A-Award Common Stock 27917 0
2022-04-05 Ward Laysha Executive Officer D - F-InKind Common Stock 12731 215.78
2022-04-05 SYLVESTER CARA A Executive Officer A - A-Award Common Stock 2301 0
2022-04-05 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 1050 215.78
2022-04-05 SCHINDELE MARK Executive Officer A - A-Award Common Stock 5857 0
2022-04-05 SCHINDELE MARK Executive Officer D - F-InKind Common Stock 2671 215.78
2022-04-05 SANDO JILL Executive Officer A - A-Award Common Stock 6389 0
2022-04-05 SANDO JILL Executive Officer D - F-InKind Common Stock 2914 215.78
2022-04-05 Mulligan John J Executive Officer A - A-Award Common Stock 79731 0
2022-04-05 Mulligan John J Executive Officer D - F-InKind Common Stock 36358 215.78
2022-04-05 McNamara Michael Edward Executive Officer A - A-Award Common Stock 53423 0
2022-04-05 McNamara Michael Edward Executive Officer D - F-InKind Common Stock 24361 215.78
2022-04-05 LIU DON H Executive Officer A - A-Award Common Stock 39872 0
2022-04-05 LIU DON H Executive Officer D - F-InKind Common Stock 18182 215.78
2022-04-05 LIEGEL MATTHEW A Chief Accounting Officer A - A-Award Common Stock 1767 0
2022-04-05 LIEGEL MATTHEW A Chief Accounting Officer D - F-InKind Common Stock 541 215.78
2022-04-05 Kremer Melissa K Executive Officer A - A-Award Common Stock 11972 0
2022-04-05 Kremer Melissa K Executive Officer D - F-InKind Common Stock 5460 215.78
2022-04-05 HENNINGTON CHRISTINA Executive Officer A - A-Award Common Stock 6389 0
2022-04-05 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 2658 215.78
2022-04-05 Gomez Richard H. Executive Officer A - A-Award Common Stock 19943 0
2022-04-05 Gomez Richard H. Executive Officer D - F-InKind Common Stock 9095 215.78
2022-04-05 FIDDELKE MICHAEL J Executive Officer A - A-Award Common Stock 10057 0
2022-04-05 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 4587 215.78
2022-04-05 Cornell Brian C Executive Officer A - A-Award Common Stock 169177 0
2022-04-05 Cornell Brian C Executive Officer D - F-InKind Common Stock 71899 215.78
2022-04-05 BOYLAN KATIE M Executive Officer A - A-Award Common Stock 4267 0
2022-04-05 BOYLAN KATIE M Executive Officer D - F-InKind Common Stock 1946 215.78
2022-04-03 LIEGEL MATTHEW A Chief Accounting Officer D - Common Stock 0 0
2022-04-03 LIEGEL MATTHEW A Chief Accounting Officer D - Deferred Compensation Units 2601.7872 0
2022-04-04 FIDDELKE MICHAEL J Executive Officer D - S-Sale Common Stock 5000 210.19
2022-03-30 BAKER DOUGLAS M JR A - M-Exempt Common Stock 5570 67.12
2022-03-30 BAKER DOUGLAS M JR D - F-InKind Common Stock 1675 223.26
2022-03-30 BAKER DOUGLAS M JR director D - M-Exempt Stock Option 5570 67.12
2022-03-22 BOYLAN KATIE M Executive Officer D - S-Sale Common Stock 3617 223.71
2022-03-18 Mulligan John J Executive Officer D - S-Sale Common Stock 1535 220.4137
2022-03-16 HARRISON ROBERT M Chief Accounting Officer D - S-Sale Common Stock 2080 217.868
2022-03-16 Cornell Brian C Executive Officer D - S-Sale Common Stock 5891 217.9511
2022-03-14 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 139 207.93
2022-03-14 SCHINDELE MARK Executive Officer D - F-InKind Common Stock 350 207.93
2022-03-14 SCHINDELE MARK Executive Officer D - F-InKind Common Stock 545 207.93
2022-03-14 SANDO JILL Executive Officer D - F-InKind Common Stock 376 207.93
2022-03-14 SANDO JILL Executive Officer D - F-InKind Common Stock 382 207.93
2022-03-14 Kremer Melissa K Executive Officer D - F-InKind Common Stock 366 207.93
2022-03-14 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 297 207.93
2022-03-14 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 382 207.93
2022-03-14 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 442 207.93
2022-03-14 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 476 207.93
2022-03-14 HARRISON ROBERT M Chief Accounting Officer D - F-InKind Common Stock 286 207.93
2022-03-14 HARRISON ROBERT M Chief Accounting Officer D - F-InKind Common Stock 317 207.93
2022-03-14 BOYLAN KATIE M Executive Officer D - F-InKind Common Stock 359 207.93
2022-03-11 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 205 211.67
2022-03-10 HARRISON ROBERT M Chief Accounting Officer D - F-InKind Common Stock 131 212.78
2022-03-10 HARRISON ROBERT M Chief Accounting Officer D - F-InKind Common Stock 204 211.67
2022-03-10 SANDO JILL Executive Officer D - F-InKind Common Stock 218 212.78
2022-03-11 BOYLAN KATIE M Executive Officer D - F-InKind Common Stock 273 211.67
2022-03-09 Ward Laysha Executive Officer A - A-Award Common Stock 2564 0
2022-03-09 Ward Laysha Executive Officer A - A-Award Common Stock 4795 0
2022-03-09 Ward Laysha Executive Officer D - F-InKind Common Stock 24 212.78
2022-03-09 Ward Laysha Executive Officer D - F-InKind Common Stock 4782 215.93
2022-03-09 Mulligan John J Executive Officer A - A-Award Common Stock 13693 0
2022-03-09 Mulligan John J Executive Officer D - F-InKind Common Stock 67 212.78
2022-03-09 McNamara Michael Edward Executive Officer A - A-Award Common Stock 9176 0
2022-03-09 McNamara Michael Edward Executive Officer D - F-InKind Common Stock 45 212.78
2022-03-09 McNamara Michael Edward Executive Officer D - F-InKind Common Stock 9774 215.93
2022-03-09 LIU DON H Executive Officer A - A-Award Common Stock 3741 0
2022-03-09 LIU DON H Executive Officer D - F-InKind Common Stock 34 212.78
2022-03-09 LIU DON H Executive Officer A - G-Gift Common Stock 9337 0
2022-03-09 Kremer Melissa K Executive Officer A - A-Award Common Stock 2056 0
2022-03-09 Kremer Melissa K Executive Officer D - F-InKind Common Stock 1842 215.93
2022-03-09 Gomez Richard H. Executive Officer A - A-Award Common Stock 3049 0
2022-03-09 Gomez Richard H. Executive Officer A - A-Award Common Stock 3425 0
2022-03-10 Gomez Richard H. Executive Officer D - F-InKind Common Stock 17 212.78
2022-03-09 Gomez Richard H. Executive Officer D - F-InKind Common Stock 3211 215.93
2022-03-09 Cornell Brian C Executive Officer A - A-Award Common Stock 19398 0
2022-03-09 Cornell Brian C Executive Officer D - F-InKind Common Stock 128 212.78
2022-03-09 Cornell Brian C Executive Officer D - G-Gift Common Stock 4100 0
2022-03-09 FIDDELKE MICHAEL J Executive Officer A - A-Award Common Stock 813 0
2022-03-09 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 5 212.78
2022-03-09 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 622 215.93
2022-03-09 FIDDELKE MICHAEL J Executive Officer A - A-Award Common Stock 4157 0
2022-03-09 SYLVESTER CARA A Executive Officer A - A-Award Common Stock 2010 0
2022-03-09 SCHINDELE MARK Executive Officer A - A-Award Common Stock 2495 0
2022-03-09 SANDO JILL Executive Officer A - A-Award Common Stock 1941 0
2022-03-09 HENNINGTON CHRISTINA Executive Officer A - A-Award Common Stock 3395 0
2022-03-09 HARRISON ROBERT M Chief Accounting Officer A - A-Award Common Stock 763 0
2022-03-09 BOYLAN KATIE M Executive Officer A - A-Award Common Stock 1040 0
2022-03-09 BOYLAN KATIE M Executive Officer D - G-Gift Common Stock 210 0
2022-03-09 MINNICK MARY E A - A-Award Common Stock 1548 0
2022-03-09 STOCKTON DMITRI L A - A-Award Common Stock 1432 0
2022-03-09 Rice Derica W A - A-Award Common Stock 1432 0
2022-03-09 LEAHY CHRISTINE A A - A-Award Common Stock 1432 0
2022-03-09 LOZANO MONICA C A - A-Award Common Stock 878 0
2022-03-09 KNAUSS DONALD R A - A-Award Common Stock 878 0
2022-03-09 EDWARDS ROBERT L A - A-Award Common Stock 878 0
2022-03-09 BOUDREAUX GAIL A - A-Award Common Stock 1432 0
2022-03-09 Barrett George S A - A-Award Common Stock 1432 0
2022-03-09 Healey Melanie A - A-Award Common Stock 878 0
2022-03-09 BAKER DOUGLAS M JR A - A-Award Common Stock 878 0
2022-03-09 ABNEY DAVID P A - A-Award Common Stock 878 0
2021-12-17 Mulligan John J Executive Officer D - S-Sale Common Stock 300 225.9083
2021-12-17 Mulligan John J Executive Officer D - S-Sale Common Stock 1838 225.2126
2021-12-17 Mulligan John J Executive Officer D - S-Sale Common Stock 2200 222.2573
2021-12-17 Mulligan John J Executive Officer D - S-Sale Common Stock 10274 223.955
2021-12-17 Mulligan John J Executive Officer D - S-Sale Common Stock 14306 223.2919
2021-09-13 Cornell Brian C Executive Officer A - G-Gift Common Stock 95931 0
2021-09-29 Cornell Brian C Executive Officer A - G-Gift Common Stock 120000 0
2021-12-02 Cornell Brian C Executive Officer D - S-Sale Common Stock 1500 242.4273
2021-12-02 Cornell Brian C Executive Officer D - S-Sale Common Stock 4066 246.1321
2021-12-02 Cornell Brian C Executive Officer D - S-Sale Common Stock 5900 243.4978
2021-12-02 Cornell Brian C Executive Officer D - S-Sale Common Stock 9234 244.4378
2021-12-02 Cornell Brian C Executive Officer D - S-Sale Common Stock 9300 245.5272
2021-09-29 Cornell Brian C Executive Officer D - G-Gift Common Stock 120000 0
2021-09-13 Cornell Brian C Executive Officer D - G-Gift Common Stock 95931 0
2021-11-24 SANDO JILL Executive Officer A - M-Exempt Common Stock 3186 60.48
2021-11-24 SANDO JILL Executive Officer D - S-Sale Common Stock 3186 247.61
2021-11-24 SANDO JILL Executive Officer D - M-Exempt Stock Option 3186 60.48
2021-04-14 HENNINGTON CHRISTINA Executive Officer D - G-Gift Common Stock 1500 0
2021-11-19 HENNINGTON CHRISTINA Executive Officer D - S-Sale Common Stock 4173 250.95
2021-11-19 Gomez Richard H. Executive Officer A - M-Exempt Common Stock 44183 55.6
2021-11-19 Gomez Richard H. Executive Officer D - S-Sale Common Stock 22242 250.95
2021-11-19 Gomez Richard H. Executive Officer D - F-InKind Common Stock 25470 251.1
2021-11-19 Gomez Richard H. Executive Officer D - M-Exempt Stock Option 44183 55.6
2021-09-23 BOUDREAUX GAIL director A - A-Award Common Stock 514 0
2021-09-23 BOUDREAUX GAIL - 0 0
2021-06-18 Cornell Brian C Executive Officer A - G-Gift Common Stock 25000 0
2021-05-13 Cornell Brian C Executive Officer A - G-Gift Common Stock 124788 0
2021-09-02 Cornell Brian C Executive Officer D - S-Sale Common Stock 9236 246.4106
2021-09-02 Cornell Brian C Executive Officer D - S-Sale Common Stock 15764 245.7256
2021-05-13 Cornell Brian C Executive Officer D - G-Gift Common Stock 124788 0
2021-06-18 Cornell Brian C Executive Officer D - G-Gift Common Stock 25000 0
2021-08-19 Mulligan John J Executive Officer D - S-Sale Common Stock 2410 249.2169
2021-08-19 Mulligan John J Executive Officer D - S-Sale Common Stock 17188 246.5693
2021-08-19 Mulligan John J Executive Officer D - S-Sale Common Stock 19314 245.6173
2021-08-19 Mulligan John J Executive Officer D - S-Sale Common Stock 19947 248.5205
2021-08-19 Mulligan John J Executive Officer D - S-Sale Common Stock 21923 247.6767
2021-08-11 ABNEY DAVID P director A - A-Award Common Stock 531 0
2021-08-11 ABNEY DAVID P director A - A-Award Common Stock 531 0
2021-08-11 ABNEY DAVID P - 0 0
2021-08-06 LIU DON H Executive Officer D - S-Sale Common Stock 3000 261.93
2021-08-04 LIU DON H Executive Officer D - S-Sale Common Stock 13977 261.2
2021-07-16 LIU DON H Executive Officer D - G-Gift Common Stock 3000 0
2021-07-16 LIU DON H Executive Officer D - S-Sale Common Stock 13985 253.9
2021-06-28 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 375 241.01
2021-06-29 SANDO JILL Executive Officer D - F-InKind Common Stock 644 242.24
2021-05-27 SYLVESTER CARA A Executive Officer D - S-Sale Common Stock 1950 227.555
2021-05-27 Kremer Melissa K Executive Officer D - S-Sale Common Stock 2603 226.19
2021-05-20 SCHINDELE MARK Executive Officer D - S-Sale Common Stock 4758 218.05
2021-05-20 FIDDELKE MICHAEL J Executive Officer D - S-Sale Common Stock 5265 218.05
2021-05-20 LIU DON H Executive Officer D - S-Sale Common Stock 7225 218.05
2021-04-13 McNamara Michael Edward Executive Officer D - S-Sale Common Stock 10821 204.8087
2021-04-13 McNamara Michael Edward Executive Officer D - S-Sale Common Stock 20602 204.0695
2021-04-09 Kremer Melissa K Executive Officer D - S-Sale Common Stock 1930 204
2021-04-09 HENNINGTON CHRISTINA Executive Officer D - S-Sale Common Stock 2121 204
2021-04-06 Ward Laysha Executive Officer A - A-Award Common Stock 24032 0
2021-04-06 Ward Laysha Executive Officer D - F-InKind Common Stock 10959 205.17
2021-04-06 SYLVESTER CARA A Executive Officer A - A-Award Common Stock 1107 0
2021-04-06 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 339 205.17
2021-04-06 SCHINDELE MARK Executive Officer A - A-Award Common Stock 4816 0
2021-04-06 SCHINDELE MARK Executive Officer D - F-InKind Common Stock 2197 205.17
2021-04-06 SANDO JILL Executive Officer A - A-Award Common Stock 3900 0
2021-04-06 SANDO JILL Executive Officer D - F-InKind Common Stock 1779 205.17
2021-04-06 Mulligan John J Executive Officer A - A-Award Common Stock 68642 0
2021-04-06 Mulligan John J Executive Officer D - F-InKind Common Stock 31301 205.17
2021-04-06 McNamara Michael Edward Executive Officer A - A-Award Common Stock 44621 0
2021-04-06 McNamara Michael Edward Executive Officer D - F-InKind Common Stock 20348 205.17
2021-04-06 LIU DON H Executive Officer A - A-Award Common Stock 34328 0
2021-04-06 LIU DON H Executive Officer D - F-InKind Common Stock 15654 205.17
2021-04-06 Kremer Melissa K Executive Officer A - A-Award Common Stock 3214 0
2021-04-06 Kremer Melissa K Executive Officer D - F-InKind Common Stock 1284 205.17
2021-04-06 HENNINGTON CHRISTINA Executive Officer A - A-Award Common Stock 3900 0
2021-04-06 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 1779 205.17
2021-04-06 Gomez Richard H. Executive Officer A - A-Award Common Stock 15108 0
2021-04-06 Gomez Richard H. Executive Officer D - F-InKind Common Stock 6890 205.17
2021-04-06 FIDDELKE MICHAEL J Executive Officer A - A-Award Common Stock 3900 0
2021-04-06 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 1779 205.17
2021-04-06 Cornell Brian C Executive Officer A - A-Award Common Stock 133842 0
2021-04-06 Cornell Brian C Executive Officer D - F-InKind Common Stock 57909 205.17
2021-04-06 HARRISON ROBERT M Chief Accounting Officer A - A-Award Common Stock 4130 0
2021-04-06 HARRISON ROBERT M Chief Accounting Officer D - F-InKind Common Stock 1777 205.17
2021-04-08 HARRISON ROBERT M Chief Accounting Officer D - S-Sale Common Stock 2353 203.61
2021-04-06 BOYLAN KATIE M Executive Officer A - A-Award Common Stock 3214 0
2021-04-06 BOYLAN KATIE M Executive Officer D - F-InKind Common Stock 1466 205.17
2021-04-08 BOYLAN KATIE M Executive Officer D - S-Sale Common Stock 1600 203.1241
2021-03-25 HARRISON ROBERT M Chief Accounting Officer D - S-Sale Common Stock 2282 192.4481
2021-03-19 HENNINGTON CHRISTINA Executive Officer D - S-Sale Common Stock 1852 183
2021-03-19 Kremer Melissa K Executive Officer D - S-Sale Common Stock 716 188
2021-03-10 Gomez Richard H. Executive Officer A - A-Award Common Stock 3096 0
2021-03-10 Gomez Richard H. Executive Officer A - A-Award Common Stock 3347 0
2021-03-10 Gomez Richard H. Executive Officer D - F-InKind Common Stock 3817 179.86
2021-03-10 Ward Laysha Executive Officer A - A-Award Common Stock 2928 0
2021-03-10 SCHINDELE MARK Executive Officer A - A-Award Common Stock 2092 0
2021-03-10 SANDO JILL Executive Officer A - A-Award Common Stock 1841 0
2021-03-10 Mulligan John J Executive Officer A - A-Award Common Stock 8366 0
2021-03-10 McNamara Michael Edward Executive Officer A - A-Award Common Stock 5606 0
2021-03-10 LIU DON H Executive Officer A - A-Award Common Stock 4183 0
2021-03-10 Kremer Melissa K Executive Officer A - A-Award Common Stock 2343 0
2021-03-10 HENNINGTON CHRISTINA Executive Officer A - A-Award Common Stock 2092 0
2021-03-10 FIDDELKE MICHAEL J Executive Officer A - A-Award Common Stock 3765 0
2021-03-10 Cornell Brian C Executive Officer A - A-Award Common Stock 22253 0
2021-03-10 Cornell Brian C Executive Officer A - A-Award Common Stock 29645 0
2021-03-10 Cornell Brian C Executive Officer D - F-InKind Common Stock 32059 179.86
2021-03-10 SYLVESTER CARA A Executive Officer A - A-Award Common Stock 1339 0
2021-03-10 BOYLAN KATIE M Executive Officer A - A-Award Common Stock 1089 0
2021-03-15 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 223 180.18
2021-03-15 SCHINDELE MARK Executive Officer D - F-InKind Common Stock 1062 180.18
2021-03-15 SANDO JILL Executive Officer D - F-InKind Common Stock 938 180.18
2021-03-15 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 1007 180.18
2021-03-15 HARRISON ROBERT M Chief Accounting Officer D - F-InKind Common Stock 600 180.18
2021-03-15 Kremer Melissa K Executive Officer D - F-InKind Common Stock 248 180.18
2021-03-15 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 915 180.18
2021-03-15 BOYLAN KATIE M Executive Officer D - F-InKind Common Stock 945 180.18
2021-03-12 FIDDELKE MICHAEL J Executive Officer A - M-Exempt Common Stock 17819 55.6
2021-03-12 FIDDELKE MICHAEL J Executive Officer D - S-Sale Common Stock 450 179.4826
2021-03-12 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 11127 179.59
2021-03-12 FIDDELKE MICHAEL J Executive Officer D - M-Exempt Stock Option 17819 55.6
2021-03-10 SYLVESTER CARA A Executive Officer A - A-Award Common Stock 2008 0
2021-03-10 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 201 178.75
2021-03-10 HARRISON ROBERT M Chief Accounting Officer A - A-Award Common Stock 1506 0
2021-03-10 HARRISON ROBERT M Chief Accounting Officer D - F-InKind Common Stock 1 179.86
2021-03-11 HARRISON ROBERT M Chief Accounting Officer D - F-InKind Common Stock 267 178.75
2021-03-10 BOYLAN KATIE M Executive Officer A - A-Award Common Stock 1632 0
2021-03-11 BOYLAN KATIE M Executive Officer D - F-InKind Common Stock 201 178.75
2021-03-10 Ward Laysha Executive Officer A - A-Award Common Stock 4392 0
2021-03-10 Ward Laysha Executive Officer A - A-Award Common Stock 5323 0
2021-03-10 Ward Laysha Executive Officer D - F-InKind Common Stock 5890 179.86
2021-03-10 Cornell Brian C Executive Officer A - G-Gift Common Stock 93364 0
2021-03-10 Cornell Brian C Executive Officer A - A-Award Common Stock 29645 0
2021-03-10 Cornell Brian C Executive Officer A - A-Award Common Stock 33378 0
2021-03-10 Cornell Brian C Executive Officer D - F-InKind Common Stock 32059 179.86
2021-03-10 Cornell Brian C Executive Officer D - G-Gift Common Stock 93364 0
2021-03-10 SCHINDELE MARK Executive Officer A - A-Award Common Stock 3138 0
2021-03-10 SCHINDELE MARK Executive Officer D - F-InKind Common Stock 3 179.86
2021-03-10 SANDO JILL Executive Officer A - A-Award Common Stock 2761 0
2021-03-10 SANDO JILL Executive Officer D - F-InKind Common Stock 2 179.86
2021-03-10 SANDO JILL Executive Officer A - A-Award Common Stock 2789 0
2021-03-10 Mulligan John J Executive Officer A - A-Award Common Stock 12549 0
2021-03-10 Mulligan John J Executive Officer A - A-Award Common Stock 15203 0
2021-03-10 Mulligan John J Executive Officer D - F-InKind Common Stock 17333 179.86
2021-03-10 McNamara Michael Edward Executive Officer A - A-Award Common Stock 8408 0
2021-03-10 McNamara Michael Edward Executive Officer A - A-Award Common Stock 9883 0
2021-03-10 McNamara Michael Edward Executive Officer D - F-InKind Common Stock 10658 179.86
2021-03-10 LIU DON H Executive Officer A - A-Award Common Stock 6275 0
2021-03-10 LIU DON H Executive Officer A - A-Award Common Stock 7604 0
2021-03-10 LIU DON H Executive Officer D - F-InKind Common Stock 8669 179.86
2021-03-10 Kremer Melissa K Executive Officer A - A-Award Common Stock 3514 0
2021-03-10 Kremer Melissa K Executive Officer D - F-InKind Common Stock 2 179.86
2021-03-10 HENNINGTON CHRISTINA Executive Officer A - A-Award Common Stock 3138 0
2021-03-10 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 3 179.86
2021-03-10 Gomez Richard H. Executive Officer A - A-Award Common Stock 3347 0
2021-03-10 Gomez Richard H. Executive Officer A - A-Award Common Stock 4644 0
2021-03-10 Gomez Richard H. Executive Officer D - F-InKind Common Stock 3817 179.86
2021-03-10 FIDDELKE MICHAEL J Executive Officer A - A-Award Common Stock 5647 0
2021-03-10 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 2 179.86
2021-03-10 STOCKTON DMITRI L director A - A-Award Common Stock 1646 0
2021-03-10 Salazar Kenneth L. director A - A-Award Common Stock 1004 0
2021-03-10 Salazar Kenneth L. director A - A-Award Common Stock 1004 0
2021-03-10 Rice Derica W director A - A-Award Common Stock 1646 0
2021-03-10 MINNICK MARY E director A - A-Award Common Stock 1743 0
2021-03-10 LOZANO MONICA C director A - A-Award Common Stock 1004 0
2021-03-10 LEAHY CHRISTINE A director A - A-Award Common Stock 1004 0
2021-03-10 KNAUSS DONALD R director A - A-Award Common Stock 1004 0
2021-03-10 Healey Melanie director A - A-Award Common Stock 1004 0
2021-03-10 EDWARDS ROBERT L director A - A-Award Common Stock 1004 0
2021-03-10 DARDEN CALVIN director A - A-Award Common Stock 1004 0
2021-03-10 Barrett George S director A - A-Award Common Stock 1646 0
2021-03-10 BAKER DOUGLAS M JR director A - A-Award Common Stock 1004 0
2021-03-08 SYLVESTER CARA A Executive Officer D - F-InKind Common Stock 65 176.04
2021-03-08 SCHINDELE MARK Executive Officer D - F-InKind Common Stock 385 176.04
2021-03-08 SANDO JILL Executive Officer D - F-InKind Common Stock 373 176.04
2021-03-08 Kremer Melissa K Executive Officer D - F-InKind Common Stock 324 176.04
2021-03-08 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 548 176.04
2021-03-08 HARRISON ROBERT M Chief Accounting Officer D - F-InKind Common Stock 228 176.04
2021-03-08 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 280 176.04
2021-03-08 BOYLAN KATIE M Executive Officer D - F-InKind Common Stock 86 176.04
2021-03-03 Cornell Brian C Executive Officer D - S-Sale Common Stock 93364 174.2295
2021-02-14 BOYLAN KATIE M Executive Officer D - Common Stock 0 0
2021-02-14 SYLVESTER CARA A Executive Officer D - Common Stock 0 0
2021-01-20 HENNINGTON CHRISTINA Executive Officer A - M-Exempt Common Stock 12273 55.6
2021-01-20 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 6804 187.17
2021-01-20 HENNINGTON CHRISTINA Executive Officer D - M-Exempt Stock Option 12273 0
2021-01-20 HENNINGTON CHRISTINA Executive Officer D - M-Exempt Stock Option 12273 55.6
2021-01-14 Lundquist Stephanie A Executive Officer D - S-Sale Common Stock 16894 198.3355
2021-01-01 LEAHY CHRISTINE A director A - A-Award Common Stock 369 0
2020-11-19 HARRISON ROBERT M Chief Accounting Officer D - S-Sale Common Stock 1220 169.5
2020-10-07 Lundquist Stephanie A Executive Officer D - S-Sale Common Stock 4471 161
2020-09-29 McNamara Michael Edward Executive Officer A - M-Exempt Common Stock 147276 55.6
2020-09-29 McNamara Michael Edward Executive Officer D - S-Sale Common Stock 27726 157.1464
2020-09-29 McNamara Michael Edward Executive Officer D - F-InKind Common Stock 95386 157.81
2020-09-29 McNamara Michael Edward Executive Officer D - M-Exempt Stock Option 147276 0
2020-09-29 McNamara Michael Edward Executive Officer D - M-Exempt Stock Option 147276 55.6
2020-09-21 SCHINDELE MARK Executive Officer D - S-Sale Common Stock 2405 148.53
2020-09-22 SCHINDELE MARK Executive Officer D - S-Sale Common Stock 2404 151.15
2020-09-23 SCHINDELE MARK Executive Officer D - S-Sale Common Stock 2404 155
2020-09-17 HENNINGTON CHRISTINA Executive Officer A - M-Exempt Common Stock 24546 55.6
2020-09-17 HENNINGTON CHRISTINA Executive Officer D - S-Sale Common Stock 5825 148.166
2020-09-17 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 16201 148.27
2020-09-17 HENNINGTON CHRISTINA Executive Officer D - M-Exempt Stock Option 24546 0
2020-09-17 HENNINGTON CHRISTINA Executive Officer D - M-Exempt Stock Option 24546 55.6
2020-08-31 Rice Derica W director A - A-Award Common Stock 927 0
2020-08-31 Rice Derica W - 0 0
2020-08-24 LIU DON H Executive Officer D - G-Gift Common Stock 654 0
2020-08-25 LIU DON H Executive Officer D - S-Sale Common Stock 2487 154.28
2020-08-20 Cornell Brian C Executive Officer A - M-Exempt Common Stock 294551 55.6
2020-08-20 Cornell Brian C Executive Officer D - S-Sale Common Stock 1400 155.879
2020-08-20 Cornell Brian C Executive Officer D - S-Sale Common Stock 7400 155.1437
2020-08-20 Cornell Brian C Executive Officer D - S-Sale Common Stock 11801 154.1944
2020-08-20 Cornell Brian C Executive Officer D - S-Sale Common Stock 26229 153.2283
2020-08-20 Cornell Brian C Executive Officer D - S-Sale Common Stock 53170 152.4609
2020-05-18 Cornell Brian C Executive Officer A - G-Gift Common Stock 89091 0
2020-05-27 Cornell Brian C Executive Officer D - G-Gift Common Stock 1630 0
2020-08-20 Cornell Brian C Executive Officer D - F-InKind Common Stock 191820 154.93
2020-06-26 Cornell Brian C Executive Officer A - G-Gift Common Stock 100000 0
2020-06-26 Cornell Brian C Executive Officer D - G-Gift Common Stock 100000 0
2020-05-18 Cornell Brian C Executive Officer D - G-Gift Common Stock 89091 0
2020-08-20 Cornell Brian C Executive Officer D - M-Exempt Stock Option 294551 55.6
2020-08-20 HENNINGTON CHRISTINA Executive Officer D - S-Sale Common Stock 3564 154.93
2020-08-20 FIDDELKE MICHAEL J Executive Officer A - M-Exempt Common Stock 19000 55.6
2020-08-20 FIDDELKE MICHAEL J Executive Officer D - S-Sale Common Stock 391 154.93
2020-08-20 FIDDELKE MICHAEL J Executive Officer D - F-InKind Common Stock 12374 154.93
2020-08-20 FIDDELKE MICHAEL J Executive Officer D - M-Exempt Stock Option 19000 55.6
2020-08-20 Kremer Melissa K Executive Officer A - M-Exempt Common Stock 889 70.71
2020-08-20 Kremer Melissa K Executive Officer A - M-Exempt Common Stock 2317 60.48
2020-08-20 Kremer Melissa K Executive Officer D - S-Sale Common Stock 8206 152.4003
2020-08-20 Kremer Melissa K Executive Officer D - M-Exempt Stock Option 2317 60.48
2020-08-20 Kremer Melissa K Executive Officer D - M-Exempt Stock Option 889 70.71
2020-08-20 Lundquist Stephanie A Executive Officer D - S-Sale Common Stock 6631 153.09
2020-08-20 Ward Laysha Executive Officer A - M-Exempt Common Stock 61094 60.48
2020-08-20 Ward Laysha Executive Officer D - S-Sale Common Stock 61094 154.0404
2020-08-20 Ward Laysha Executive Officer D - M-Exempt Stock Option 61094 60.48
2020-08-19 Mulligan John J Executive Officer D - S-Sale Common Stock 28571 148.931
2020-08-05 LIU DON H Executive Officer A - M-Exempt Common Stock 49092 55.6
2020-08-05 LIU DON H Executive Officer D - F-InKind Common Stock 33743 130.75
2020-08-04 LIU DON H Executive Officer D - S-Sale Common Stock 8000 130
2020-08-05 LIU DON H Executive Officer D - M-Exempt Stock Option 49092 55.6
2020-08-05 Gomez Richard H. Executive Officer D - M-Exempt Stock Option 22091 55.6
2020-08-05 Gomez Richard H. Executive Officer A - M-Exempt Common Stock 22091 55.6
2020-08-05 Gomez Richard H. Executive Officer D - F-InKind Common Stock 15184 130.75
2020-08-03 LIU DON H Executive Officer A - M-Exempt Common Stock 49092 55.6
2020-08-03 LIU DON H Executive Officer D - F-InKind Common Stock 34124 126.5
2020-08-03 LIU DON H Executive Officer D - M-Exempt Stock Option 49092 55.6
2020-08-03 Lundquist Stephanie A Executive Officer A - M-Exempt Common Stock 73638 55.6
2020-08-03 Lundquist Stephanie A Executive Officer D - F-InKind Common Stock 51186 126.5
2020-08-03 Lundquist Stephanie A Executive Officer D - M-Exempt Stock Option 73638 55.6
2020-08-03 Gomez Richard H. Executive Officer D - M-Exempt Stock Option 22091 55.6
2020-08-03 Gomez Richard H. Executive Officer A - M-Exempt Common Stock 22091 55.6
2020-08-03 Gomez Richard H. Executive Officer D - F-InKind Common Stock 15356 126.5
2020-07-23 Mulligan John J Executive Officer A - M-Exempt Common Stock 147276 55.6
2020-07-23 Mulligan John J Executive Officer D - F-InKind Common Stock 103242 123.45
2020-07-23 Mulligan John J Executive Officer D - M-Exempt Stock Option 147276 55.6
2020-07-23 Lundquist Stephanie A Executive Officer A - M-Exempt Common Stock 73638 55.6
2020-07-23 Lundquist Stephanie A Executive Officer D - M-Exempt Stock Option 73638 55.6
2020-07-23 Lundquist Stephanie A Executive Officer D - F-InKind Common Stock 51621 123.45
2020-07-24 LIU DON H Executive Officer D - S-Sale Common Stock 4000 125
2020-07-15 Gomez Richard H. Executive Officer D - M-Exempt Stock Option 14728 0
2020-07-15 Gomez Richard H. Executive Officer D - M-Exempt Stock Option 14728 55.6
2020-07-15 Gomez Richard H. Executive Officer A - M-Exempt Common Stock 14728 55.6
2020-07-15 Gomez Richard H. Executive Officer D - F-InKind Common Stock 10389 121.31
2020-07-15 LIU DON H Executive Officer A - M-Exempt Common Stock 49092 55.6
2020-07-15 LIU DON H Executive Officer D - M-Exempt Stock Option 49092 55.6
2020-07-15 LIU DON H Executive Officer D - F-InKind Common Stock 34627 121.31
2020-06-29 SANDO JILL Executive Officer D - F-InKind Common Stock 633 118.03
2020-06-30 LIU DON H Executive Officer D - S-Sale Common Stock 4000 120
2020-06-02 AUSTIN ROXANNE S director A - M-Exempt Common Stock 7415 60.48
2020-06-02 AUSTIN ROXANNE S director D - S-Sale Common Stock 7415 120.01
2020-06-04 AUSTIN ROXANNE S director D - S-Sale Common Stock 10000 122.01
2020-06-02 AUSTIN ROXANNE S director D - M-Exempt Stock Option 7415 60.48
2020-05-29 AUSTIN ROXANNE S director A - M-Exempt Common Stock 4109 55.46
2020-05-29 AUSTIN ROXANNE S director D - S-Sale Common Stock 4109 120.0413
2020-05-29 AUSTIN ROXANNE S director D - M-Exempt Stock Option 4109 55.46
2020-05-21 HARRISON ROBERT M Chief Accounting Officer D - S-Sale Common Stock 2500 119.344
2020-05-22 SANDO JILL Executive Officer D - S-Sale Common Stock 2435 118.712
2020-05-11 Cornell Brian C Executive Officer D - S-Sale Common Stock 110000 120
2020-04-09 Cornell Brian C Executive Officer D - G-Gift Common Stock 7900 0
2020-04-07 Ward Laysha Executive Officer A - A-Award Common Stock 21175 0
2020-04-07 Ward Laysha Executive Officer D - F-InKind Common Stock 9656 99.35
2020-04-07 SCHINDELE MARK Executive Officer A - A-Award Common Stock 7755 0
2020-04-07 SCHINDELE MARK Executive Officer D - F-InKind Common Stock 2994 99.35
2020-04-07 SANDO JILL Executive Officer A - A-Award Common Stock 7447 0
2020-04-07 SANDO JILL Executive Officer D - F-InKind Common Stock 2825 99.35
2020-04-07 Mulligan John J Executive Officer A - A-Award Common Stock 60480 0
2020-04-07 Mulligan John J Executive Officer D - F-InKind Common Stock 27579 99.35
2020-04-07 McNamara Michael Edward Executive Officer A - A-Award Common Stock 39313 0
2020-04-07 McNamara Michael Edward Executive Officer D - F-InKind Common Stock 17927 99.35
2020-04-07 Lundquist Stephanie A Executive Officer A - A-Award Common Stock 16940 0
2020-04-07 Lundquist Stephanie A Executive Officer D - F-InKind Common Stock 7725 99.35
2020-04-07 LIU DON H Executive Officer A - A-Award Common Stock 30244 0
2020-04-07 LIU DON H Executive Officer D - F-InKind Common Stock 13792 99.35
2020-04-07 Kremer Melissa K Executive Officer A - A-Award Common Stock 1866 0
2020-04-07 Kremer Melissa K Executive Officer D - F-InKind Common Stock 571 99.35
2020-04-07 HENNINGTON CHRISTINA Executive Officer A - A-Award Common Stock 7447 0
2020-04-07 HENNINGTON CHRISTINA Executive Officer D - F-InKind Common Stock 3048 99.35
2020-04-07 HARRISON ROBERT M Chief Accounting Officer A - A-Award Common Stock 4347 0
2020-04-07 HARRISON ROBERT M Chief Accounting Officer D - F-InKind Common Stock 1331 99.35
2020-04-07 Gomez Richard H. Executive Officer A - A-Award Common Stock 13555 0
Transcripts
John Hulbert:
Good morning, everyone, and welcome to our 2024 Financial Community Meeting. I'd like to start by welcoming the investors and others who are attending this meeting in person with us. And of course, we're happy that many, many more of you are attending the meeting remotely. Brian is going to kick off the meeting in a minute, but first, I have a couple of important disclosures.
First, 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. And second, in today's remarks, we refer to non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP measures to the most directly comparable GAAP measure are included in our financial press releases, financial presentations and SEC filings, which are posted on our Investor Relations website. With that, I'll turn it over to Brian to get things started. [Presentation]
Brian Cornell:
Good morning, and thanks for joining us. We're looking forward to providing our perspective on the results we shared this morning, and I can't wait for you to hear from several of our top leaders, including Christina Hennington, Rick Gomez, Jill Sando, Cara Sylvester and Michael Fiddelke. While Michael still has his hands firmly on the wheel as CFO, this is his first FCM in his new role as our Chief Operating Officer. I can tell you, we're looking forward to discussing Target's growth horizon and how it transcends volatility over any particular quarter or year. Our preference is always to think long term.
It's why for years now, we've emphasized the durability of our business model. And many of you have validated that orientation in the conversations we've had with you over the years. So our session today will focus squarely on the long-term thinking that has driven top and bottom line growth over the last decade and positions us for continued profitable growth in the years ahead. You might be asking, why focus on decades? In part because that feels like a long enough time frame to be meaningful. But it's also because we look at longer horizons when evaluating growth potential for investments like new stores, supply chain and other assets. And it's good to ask what else would need to be true for those investments to succeed? So we'll analyze our 2023 performance in that context. We'll provide insights on how our '24 plans and guidance fit into that vision. And we'll spend time outlining our plan for sustained growth as well as our capacity to react to unforeseen realities. Both have been important over the last 10 years. By designing for steady growth before 2020, we were positioned to absorb exponential growth during a demand boom that none of us could have anticipated. Even now the country and the retail industry, are in a prolonged, post-pandemic return to normal, which has been nearly as unpredictable as a pandemic itself from a consumer, social, political and economic perspective. By staying agile as a team and by continuously refining our approach and innovating, we've been able to navigate this time frame. In fact, if you think back to our earlier algorithms and long-range plans, we're well ahead of where we believe we'd be just a few short years ago. At the same time, we recognize this is a unique moment to clarify our road map for growth. Let me be really clear. Our goal is to recapture profitable sales, traffic and market share gains by expanding what makes Target different and better for our guests, amplifying our appeal to consumers beyond our existing guest base, and reinforcing the innovation and investment that drive durable and consistent results for our business and shareholders. So I might start today with the elements of the overall strategy that have been staples all along and will continue to be staples going forward. Starting with our stores. The most visible and tangible proof of our long-term planning and investment. When I arrived at Target, we had just over 1,800 stores that didn't quite cover all 50 states. Since then, we built more than 200 new stores. We've invested in more than 1,200 existing locations through remodels and partnerships, and our store footprint has expanded to cover the entire U.S. While retail is decades in the new digital era, on any given day, 2/3 or 3/4 of all U.S. shopping is still done in stores. And thanks to the stores-as-hub model, we invented in the last decade, nearly all Target shopping, including our significant digital penetration growth and our $30-plus billion in revenue growth was made possible by our stores. So if you think store shopping will wind down anytime in the next decade, we'll politely disagree on that point once again. Over the next decade, we expect to open more than 300 new mostly full-size stores and [ make ] billions of dollars in incremental growth, while continuing to remodel stores with plans to invest in the vast majority of our nearly 2,000 stores in the next 10 years. We'll also continue to invest in our supply chain and technology. In less than 10 years, we've created, acquired and constantly advanced sortation centers, upstreamed distribution centers, food distribution centers, and a steady stream of replenishment, technology and logistics innovation. At least 10 additional supply chain facilities are in the pipeline, and will be operating within the next decade. Underpinning all of this is our long-standing and ongoing investment in technology. This includes a leading team of engineers, data scientists and product managers focused on further integrating AI and machine learning and driving early adoption of generative AI, all geared towards making it easier for our team to best serve our guests across both the digital and physical assets. Take same-day fulfillment. Our initial investments gave us an early lead in same-day. Today, same-day is much more competitive but continued innovation and better integration with our Target ecosystem means we're ready to expand same-day delivery for our guests while also building on our next-day capabilities. You'll hear more about this from Christina and Cara including big moves we're making with Target Circle, a program that didn't exist 10 years ago, but today has well over 100 million members. Cara will talk about the incredible progress the team has made with Target Circle and where we're headed next. For now, I'll just emphasize the focus we're placing on unlimited same-day delivery through a new membership feature called Target Circle 360, which is launching next month. Here's the takeaway. Without huge investments in stores, supply chain and tech, there is no drive-up or order pickup, which were monumental growth drivers during COVID and today. And without stores, supply chain and tech and providers like UPS, FedEx and Shipt, there is no home delivery which is ready for a step change in guest acquisition, satisfaction and loyalty. As we move forward, we'll leverage our 2017 acquisition of Shipt to help us build unmistakable recognition for Target same-day delivery. Target's Roundel advertising business is another example of something that didn't exist 10 years ago. But today, it's the fastest-growing contributor to the other revenue line on our P&L. In a crowded field of similar offerings, we're punching way above our weight relative to the scale of our retail footprint. The unique relationship we have with our guests and the value our ad business unlocks for the brands that advertise with us are at the heart of Roundel's performance to date. And since our road map for growth focuses on strengthening our relationship with guests, and converting more consumers into guests, we see tremendous growth potential for Roundel for years to come. There are a number of other points of continuity and cohesion in our strategy. But for this intro, I'll focus on just one more. That's the strength of our multi-category portfolio and the balance and stability offered by our mix of frequency and discretionary categories. The way we bring those categories to consumers is a stand-out strength we'll continue to build on. The curation, the authority and trend in newness and the competitive advantage and assortment built around beloved national brands, world-class brand partnerships and a fleet of owned brands that drives about 1/3 of our business and puts us in a league of our own. Ten years ago, our Starbucks and Disney collaborations were strong and growing, and we're building our partnership with Apple. Those 3 relationships continue to grow throughout this time frame, and we added and expanded outstanding partnerships with CVS, Levi's, Hearth & Hand with Magnolia and Ulta Beauty at Target that drive traffic, sales and loyalty. This element of our strategy has been a bright part of our future. It will continue to play a big role in the decade ahead. And our team's expertise and product design and development and brand creation and management, they're towering strengths that really fuel our own brand portfolio. Brands like Cat & Jack, Threshold, Good & Gather, they bring millions of guests to Target. There are 3 of the 11 brands that generate $1 billion or more in sales each year, a lineup that looked much more modest a decade ago. And they lead a roster of Target brands that contribute to more than $30 billion in annual sales, plus outstanding margins for our bottom line. A steady cadence of brand launches like Figmint last year, and dealworthy last month, help keep our edges sharp on the newness, discovery and affordability consumers crave in the market and find at Target. I believe our own brand capabilities will only become more prominent in the decade ahead, which is why we'll spend time this morning taking you behind the scenes on where we're headed with our owned brands. Another area where we'll continue to excel is our commitment to our team. In the last decade, we've taken a leadership position in both pay and benefits and learning and development and we'll continue to be a pacesetter as we ensure our team has all the support they need to take care of our guests, themselves and their families. So as we start to pull all this together, you might be saying, Brian, clearly, Target has some strong assets and advantages and cultivated a great team. But what does that mean for 2024 or 2034? I can tell you, our team has been humble enough as that and many other related questions. We're not taking anything for granted. There's no complacency about our past success. And while we recognize that a rebound in discretionary spending will favor our brand and our business. We're not waiting for economic changes or a different consumer outlook. I've been on the road nonstop since November, walking our stores, distribution floors. And I can tell you, the energy and initiative of our front-line team. What they're bringing to our business this year simply can't be conveyed on the slides behind me. This team has shifted to their front foot, and they're changing the momentum of our business, which is why we've seen sequential improvement from Q2 to Q3 to Q4. Discretionary declines moderated. Traffic trends rebounded. Our Q4 comps were the high end of our guidance. We drove major gains in efficiency and outperformed our guidance of $1 billion in full year profit growth. Recognizing that we needed to clear the volatility and the challenges in the last 2 years, our team buckled down and said, "Go time." But in recent weeks, I've seen the spelling expand by 2 letters. And I've seen the ambition, expand even more than that. What our team is talking about now is grow time. That's the mantra I hear bubbling up from the front line, all with the commitment to recapturing top line growth, traffic and share gains in the years immediately ahead. That starts with ensuring our team can deliver for our guests each and every day. A major step is coming soon with the upgrades we're launching in Target Circle. Upgrades that will make it even easier to unlock the best of Target. At the same time, a focused list of priorities, along with a continued concentration on retail fundamentals, like affordability and in-stock reliability, will make our guest experience easy and dependable in every interaction. We'll continue to focus on delighting our guests with the products, partnerships and value that make Target feel both elevated and accessible. The hallmarks here are expert curation, style and trend authority, newness, great design and incredible value. We'll also accelerate our progress in omnichannel discovery. We've all seen how shopping is changing into an always-on activity that's integrated across several aspects of our lives, well beyond physical and digital stores. Discovery and inspiration has always been a hallmark of our shopping experience. We started by providing inspiration and easy access at our stores with no barriers between impulse and purchase. But we see an opportunity to do even more, to think differently about the intersection of physical, digital and social. So consumers can discover Target products wherever they're spending their time. So you'll hear from Christina and Cara this morning, we're going to keep building our capabilities in omnichannel discovery since we see this as an advantage that's ownable over our retail rivals. So I've thrown a lot on the table, and there's more definition and detail to come. Having tackled both industry and in-house challenges over the last couple of years, I can tell you, I'm not satisfied. And our team is not satisfied with our recent top line results. We wanted to be even further along than we are today, but we're confident in our path forward, and we're eager to share what's next. Target is not just a bigger company than it was 10 years ago. It's stronger, healthier and more resilient, a company that's flipping the switch from go time to grow time. Over the next hour or so, I'll ask Christina, Rick, Jill, Cara and Michael, to add some texture to those claims. Thanks again for being here. Christina, over to you.
A. Hennington:
Thanks, Brian, and good morning, everyone. Continuing on what you've heard so far this morning, I want to emphasize 2 key themes. First, we build the foundation for long-term growth with a strategy that is both unique to Target and durable. And second, we're committed to building on that foundation for years to come. So this morning, I'll walk through the ways we're leaning into our core strengths, capabilities and differentiators we've built and refined over time to meet consumers where they are and drive long-term market share gains, sales growth and profitability.
I want to start with an outlook on the consumer, which remains mixed. While there are some encouraging signs in the economy, there are also stubborn pressures impacting families and retails. Consumers say they still feel stretched, they're balancing a lot and having to make trade-offs to meet their needs of their families while sprinkling in the occasional luxury. And yet their affinity for style and newness plus early signs of disinflation contributed to a sequential uptick in discretionary category performance over the last 2 quarters, something we aim to build on and accelerate. At the same time, we expect consumers will remain highly value conscious, hunting for great promotions and seeking comprehensive value in their purchases. Consumers are also creating stability with small doses of everyday joy. After the volatility of the global pandemic, they're now coping with geopolitical tensions, social and political divisiveness and uncertainty around personal finances. This all demonstrates that our purpose to help all families discover the joy of everyday life remains incredibly relevant. And the assets and capabilities we've [ culted ] over time, like new and remodeled stores, investments in digital shopping, supply chain and loyalty, they've all increased consumers' view of us as an omnichannel powerhouse. Those enhanced strengths were built on long-established differentiators like design, curation, a well-balanced multi-category assortment and outstanding value. And those are just some of the elements we'll build upon and amplify through our strategy as we move through 2024 and beyond. Think about the opportunities around something like omnichannel discovery, designing experiences that support discovery has always been one of our strengths. Our stores are famous or perhaps infamous for inspiring guests to discover more than they expected. Millions of guests have experienced the joy of entering a Target store for a few items and end up leaving with extra treasures they didn't anticipate. This is a key aspect of how we set ourselves apart from our competitors and something we'll continue to build on, regardless of where or how the shopping trip begins. After all, shopping looks very different now than it did a few years ago. It's no longer a point-in-time transactional event. Consumers today are constantly taking in new information and seeking inspiration from influencers and trendsetters. Target is already a trend shaper, but there's an opportunity to accelerate this further on both the platforms we own and on external platforms like TikTok and Instagram. Cara will share more specifics later. So I'll just say that our team's energy and engagement in building these discovery-driven experiences are truly inspiring. It's indicative of an ambition to meet consumers where they are. So that wherever and however a shopping journey starts, the path leads back to Target as a destination. We have long been known for delighting guests through a carefully curated set of products and partnerships. We believe that a well-curated assortment isn't just good for managing inventory. It can be additive to the shopping experience, too. Here's an extreme example. Imagine a restaurant with a seemingly infinite menu with countless of -- pages of every type of cuisine and no cohesive point of view. Endless choice creates decision fatigue, taking away from an otherwise joyful outing. Sometimes less is truly more. We make choices that allow us to offer a menu of products, designing to serve a wide variety of guest needs, helping to guide their shopping journey while ensuring a joyful and productive trip. Now to be clear, this does take balance. We don't offer an endless aisle, but we do offer a compelling range of choices and price points throughout our assortment. We think of our assortment like a 3-legged stool. It works best when we develop owned brands that offer unmatched value and quality, provide the best industry-leading national brands and cultivate partnerships that enhance our assortment. So let's start with our owned brands. We've invested heavily over the past several years to continue to innovate and differentiate through our owned brands, and we're not slowing down. Across the portfolio, we're launching new brands and expanding upon those already loved by our guests. In fact, owned brands are so core to who we are, following my remarks, I've asked Jill Sando and Rick Gomez to join me and highlight how our unique skills and assets allow us to sustain and grow this massive owned brand portfolio. And it's because of these differentiated end-to-end capabilities that we're able to rapidly scale affordable owned brands without compromising quality. These capabilities also make us an attractive partner to some of the greatest designers around. Recently, we announced an upcoming partnership with iconic fashion designer, Diane von Furstenberg. This collection will feature the signature patterns and colors that DVF is known for, along with her iconic wrap dresses. With a multigenerational appeal and offerings in extended sizes as well as options for kids, this collection features more than 200 items spanning apparel, accessories, beauty and home, combining timeless fashion with only at Target prices and value. Our second priority is to extend our assortment with the best national brand consumers want from Target. Stanley Drinkware is a timely example. Well before it became a cultural moment, we were early to recognize this brand's potential allowing us to get a big jump on this trend. We secured great allocations across the portfolio and partnered with Stanley to create exclusive colors for our guests, both in the core line and through our only at Target brand Hearth & Hand with Magnolia. Similarly, celebrity-founded Beauty brands are taking over social media, and our guests say they want to find them at Target. That's why we partnered with Ashley Tisdale, on our exclusive to Target launch of Being Frenshe, a line of personal care products powered by mood boosting scents and self-care rituals. It's also why we've recently added Lemme, Kourtney Kardashian Barker's new line of vitamin and botanical supplements to our assortment. These trending brands add to the credibility we built in the Beauty space and will continue to support our leadership role in these categories. Our third priority is to round out our assortment with a focus on partnerships, which provide deeper expertise and brand recognition for our guests. We've had tremendous success attracting and cultivating these unique collaborations and, in the years ahead we expect they'll play an even bigger role given the incrementality they've delivered. We continue to expand the presence of Ulta Beauty at Target, Levi's, Apple, Disney and more bringing industry-leading offerings and continued differentiation for Target. And last year, we launched a new partnership with Kendra Scott, and our guests couldn't get enough. These colorful jewelry and accessory pieces not only look good, but they do good too. With a shared vision for philanthropy, this collaboration shines bright on multiple levels. Expect plenty of new offerings in this partnership in 2024 and for years to come. Surrounding all our assortment choices is an unwavering focus on value, which starts with price but encompasses so much more. We continue to offer fantastic everyday low prices, and we're focused on clearly and effectively communicating our value proposition. One way we've done this is by simplifying our end caps to feature single price points and promotions. This allows us to clarify the incredible value we offer while helping our guests to effortlessly recognize the value. No games, no confusion. Additionally, our efficiency efforts and the greater size and scale we've achieved in the recent years have allowed us to further sharpen price points across our assortment. We continuously find ways to add quality and newness to our own brand portfolio without increasing prices. And of course, our focus on retail fundamentals serves as a through line supporting guests on their shopping journey before, during and after they make a purchase. These efforts are always on focus, and we continue to deliver a unique blend of physical and digital shopping, will further leverage our fleet of nearly 2,000 stores to serve as inspiring shopping destinations and as fulfillment hubs for digital orders. And in the same way we focus on our store and digital assets, we continually invest in our team. We take care of our team so they can take care of our guests. From providing world-class service to ensuring we're in stock, we want our guests to feel confident that they will be cared for and find what they seek on every Target run. In fact, it was a dedication of our team that allowed us to maintain leaner, healthier inventory levels last year, which positions us well as we enter a new year. This led to stronger profit outcomes, improved in-stocks and perhaps, most importantly, increased flexibility, allowing us to react quickly to changing trends. We're also using technology to reduce costs, increase delivery speed and improve consistency in our operations. Years ago, we took a bold stance when we outlined our plans to invest in stores at a time when the role of brick-and-mortar was in question. Investing to automate upstream replenishment and optimize last-mile delivery, we develop new ways to increase our delivery speed and reduce operating costs. These technology investments, which increased through the throughput of our existing store locations helped to quiet the store-versus-digital debate. As we pioneered the stores-as-hub strategy in support of the omnichannel services we provide. We're excited about the impact of continued advancements in technology like generative AI and the additive ways these tools will empower our teams. But we also want to make sure that human connection remains at the center of the Target experience. This is why we'll continue to invest in technology while never losing sight of what makes life rich. The relationships and interactions we have with one another. Just as we uniquely saw the importance of combining physical stores and digital capabilities, we want to make sure we lean into emerging technologies and focus on placing them in the hands of our incredible Target team. And finally, we'll continue to invest in technology to support segmentation and personalization. We love it when guests walk into one of our nearly 2,000 locations and says, "This is my Target." In the same way, we want to design an experience in which a guest places an item in their cart and says, "This was made just for me." This balance of scale and personalization is unique in retail, something we do well and can continue to build on. After all, we have an enviable consumer base that is highly engaged with our brand and they shop us frequently across our multi-category assortment, allowing us to gain invaluable insights across nearly all retail segments, not just 1 or 2. It's also why our Roundel advertising business is so powerful. We're constantly listening and learning from our guest base, allowing us to offer rich insights to our vendors, offer compelling and personalized advertisements to our guests and grow this aspect of the business in meaningful and lasting ways. You'll hear more from Cara on enhancements to our loyalty ecosystem, Roundel's growing reach and our digital experience aimed at enhancing digital discovery. It's one thing to hear about these strategic initiatives, and it's another thing to see them in action. I'm often on the road to witness firsthand how our guests are experiencing joy through our assortment, shopping experience and our teams' dedication in serving them every day. On a recent trip to Orlando, I visited one of our smaller stores near Disney World. Our segmentation and assortment planning work, let us focus on serving 2 very distinct segments in this market. One segment consists of the many Disney cast members who utilize this Target store to meet their everyday wants and needs on their way to and from work. The other segment is comprised of families who are visiting the area looking to get everything they need to support their family vacations. These guest segments have very different Target run missions, and yet we're able to provide a cohesive experience that satisfies both of them. Similarly, a few weeks back, I traveled to Texas with members of my Beauty and Apparel teams. We heard directly from guests about the love of finding all their styling needs under one roof. From cosmetics and skin care items in Ulta Beauty, to apparel assortments only available at Target to bold jewelry pieces from Kendra Scott. These powerhouse brands have all come together to offer consumers at this store, a sum that is greater than the individual parts. On another trip, I visited a store in Mississippi, where we had recently completed a wall-to-wall remodel. We elevated the shopping experience, refreshed the assortment and even added a Starbucks, the first one ever in this area. Our local team is incredibly proud that their Target store has become the social hub of this tight-knit community. These examples illustrate the interplay of our strategies, assortment, experience and capabilities. Showing how we're positioning Target to play a unique role in American retail. So now before I turn things over to Cara, I'm going to invite Jill and Rick to the stage for a discussion on the power of Target's owned brand capabilities, and how they help Target stand out in a crowded marketplace.
A. Hennington:
Okay. Well, thanks for joining me. Why don't we start Jill and Rick by telling us a little bit about yourselves and your careers.
Jill Sando:
Good morning. I am Jill Sando and I lead the Apparel & Accessories, Home and Hardlines merchandising organization. I've been with Target for over 25 years. The majority of that time has been in merchandising, running different businesses across our discretionary portfolio. Also spent some time in planning and help stand up our product design and development capabilities for our non-apparel businesses.
Richard Gomez:
Hello. Good morning. I'm Rick Gomez, I lead Target's Food, Essentials and Beauty businesses. I've had the opportunity to lead a variety of different disciplines at Target, including marketing, digital strategy. And then before Target, I spent over 20 years working in the CPG industry developing, launching and managing a bunch of different Food & Beverage brands.
A. Hennington:
We're happy to have you here. Okay. Our owned brand portfolio on its own would be a Fortune 100 company. More than $30 billion in sales and nearly 1/3 of our total revenue and even more of our gross margin. That's because we have amazing capabilities that allow us to produce brands our guests genuinely love. Jill, let's start with one I know you're particularly excited about a new brand in toys called Gigglescape.
Jill Sando:
Kids related categories are huge for Target and toys plays a key role in keeping Target relevant with families. National brands like LEGO and exclusive brands like Our Generation have made Target one of the biggest toy retailers in America. And the addition of Gigglescape gives consumers on more only-at-Target reason to shop toys. Gigglescape is important for a few reasons. It's consumer-centric. It's our first owned brand design specifically for generation alpha and their unique needs. It's filling white space in our owned brand assortment and it has us poised to drive growth in a high-margin category.
And Gigglescape is priced to be accessible to all families. Just a few weeks ago, we launched our stuffed animals. Most are priced under $10 and soon we'll launch books, puzzles and toys with all items in our spring assortment priced under $20. That kind of pricing makes it perfect for gifts and for the spur-of-the-moment purchases because your child is being good today. This is a brand that makes our toys destination -- our toys department a destination even when your Target run was inspired by something else and makes Target an even stronger destination for toys.
A. Hennington:
I love them. They're super cute. Okay. Rick, our frequency categories play such a crucial role in driving trips. And with up & up and dealworthy, we're giving our guests new reasons to choose Target. Can you tell us about that?
Richard Gomez:
Yes. Well, as you know, Christina, we invest a lot of time listening to consumers to better understand their needs. And one of the themes that we are consistently hearing is the need for value and affordability. So to address this consumer need, we are relaunching up & up and introducing dealworthy. up & up is one of Target's most popular brands, delivering nearly $3 billion in sales, offering over 2,000 everyday items at affordable prices. And now we are making it even bigger and even better. We have developed product improvements across 40% of the line. We are also introducing hundreds of new items, and we are offering great prices with the average item priced under $7.
We're also launching dealworthy. It's our new low-priced brand with items across the store, ranging from socks, laundry detergent, phone chargers, and I can't stress enough what a great value dealworthy will be. The most items will be priced under $10. And some of those electronics items will be priced at 50% lower than what was previously offered at Target. dealworthy will be the lowest-priced item in each category offering absolutely incredible value.
A. Hennington:
Indeed, our frequency businesses are an important part of driving trips to Target, meeting guest critical needs but our discretionaries have the -- categories have the opportunity to do that as well. Jill, can you tell us a little bit about Cat & Jack?
Jill Sando:
Yes. Kids apparel is another area where we have outsized market share and Cat & Jack is a big part of that. This is the kids brand that we launched in 2016. Today, it's a $3 billion brand, the biggest kids brand in America. To put that into perspective, consider this, we sell well over 300 million units of Cat & Jack a year, which comes out to about 8 Cat & Jack items for every child in America under the age of 12. This is part of a discretionary category, but Cat & Jack is a brand that drives repeat business for Target because of great prices and great quality, which parents love and great design that kids love.
And when you think about kids style, the success of Cat & Jack pays dividends across our portfolio. It drives trips and sales across the store during key moments like back-to-school and throughout the year as kids grow into new sizes. Cat & Jack also complements brands like Wild Fable. That's our juniors brand, worn by millions of teens and tweens who started in Cat & Jack. It's one of the biggest juniors brands in the country and one we just extended into swim. Wild Fable is a great brand on its own, one fueled by our speed to trend in a very dynamic category, but it also has an important advantage since families are already in the habit of turning to Target for clothes for their kids.
A. Hennington:
Thank you, Jill. Rick, let's switch gears a little bit and talk about Good & Gather because that's a brand that's helped us reimagine our grocery space and experience and really build our credibility in food.
Richard Gomez:
Yes. Absolutely. I'd love to talk about Food & Beverage. Our Food & Beverage business delivers over $20 billion in sales, and that's up $8 billion in sales since 2019. That's because over the last few years, we've been making big strides in improving the Food & Beverage experience. I'd like to say that we have gone from being a retailer that just sells food to a retailer that truly celebrates food. And in doing that, we have made Target a destination for food. Now, Good & Gather has played a key role in that at nearly $4 billion in sales. Good & Gather delivers a great value proposition, delicious products that the whole family will enjoy, high-quality ingredients with no artificial colors, no artificial flavors, no high-fructose corn syrup. And importantly, great pricing with most items under $5.
And we're not done growing the Good & Gather brand. Last fall, we expanded Good & Gather into new incremental spaces that are important to our guests like Good & Gather Baby and Toddler creating another go-to Target -- another go-to category for parents with young children at Target.
A. Hennington:
Well, it's abundantly clear that our guests rely on our owned brands. Jill, you've been a part of these launches for so many years in your career. What makes us a leader in this space?
Jill Sando:
We have unrivaled design capabilities, amazing talent across our team, hundreds of patents, it is no exaggeration to say that Target pioneered cheap [indiscernible]. And what we're doing is so hard to replicate because we didn't decide to make a play in owned brands 5 or even 10 years ago. We've been doing this for decades. We've had an in-house sourcing capability for 25 years. Now today, it spans 20 offices across 14 countries. Because we own our end-to-end sourcing business, we control our own destiny. When you think about issues like country of production and raw material costs. We're more cost-effective with far fewer intermediaries in our network, which allows us to grow our bottom line even as we pass savings on to our guest.
We can adapt quickly to emerging trends, which keeps us relevant and we're able to pursue bold sustainability goals, which is important to driving growth by delivering on something that matters so much to millions of consumers. And those sustainability goals will also help ensure both the resiliency of our business model through responsible stewardship of the resources that we rely on and our ability to deliver the quality that our guests rely on.
Richard Gomez:
And these capabilities, they really do set Target apart, especially considering the scale at which we operate, delivering a steady drumbeat of newness to consumers. In my previous role in the CPG industry, it was a big year if we launched a few dozen new products. But for our food scientists, that's a couple of weeks' worth of work. In Food & Beverage alone this year, we'll add hundreds of new items to Good & Gather and Favorite Day and that's on top of the hundreds of new items that we launched last year. We are delivering innovation at scale that is unmatched by others.
A. Hennington:
Well, our capabilities certainly are first rate. But that human touch, fueled by the power of insights, can't be stressed enough.
Jill Sando:
That's right. When we designed All In Motion, our performance brand, the first thing that we did was to engage with 15,000 consumers. We talked to fitness coaches, we attended dozens of workout classes because if you're designing for the consumer, it starts with listening to the consumer. And we're not just consumer-led when we're launching a product, we're consumer-led in how we continue to grow and develop our owned brands because you can't mistake performance for potential.
Cat & Jack has been a runaway success, but we also learned through listing that we had opportunities to make the brand more appealing to more guests. Among other things, that led to the adaptive items we created to help all kids look and feel their best and the expansions we made to our dressy and mid-dressy assortment, giving families more reasons to choose Cat & Jack and Target.
Richard Gomez:
Consumer insight has also helped to continue to develop and grow Favorite Day. We launched the brand during the pandemic, and we've seen it drive trips, build baskets, delivering double-digit growth year after year. So as Food & Beverage has become a go-to category for Target during the holidays, we've expanded the role of Favorite Day to offer key seasonal items. You saw that in November and December with gingerbread kits, hot cocoa-bombs, a huge range of snack mixes. And just a few weeks ago, Favorite Day was front and center for Valentine's Day. And we'll continue to expand Favorite Day into those big seasonal moments that are so important to our guests and important to keeping Target relevant.
A. Hennington:
Well, Jill, this leads the enhanced approach we take into brand management, including a team under your leadership.
Jill Sando:
We launched our brand management capability years ago and created an end-to-end process to successfully launch owned brands. And that has enabled an accelerated rollout of owned brands over the past 5 years. And we've been evolving our capabilities and are now operating more like a CPG company, the research, the market analysis, looking hard at the white space. That's shaped our decision making around existing brands, like prioritizing Threshold as our flagship home brand and then offering a range of styles within it. That's critical because Target is one of the biggest home retailers in the country, and this is making it easier for our consumers to navigate our assortment and our brand management work was critical to the success of our new kitchenware brand Figmint, which debuted last fall.
This isn't the first time selling kitchenware as part of an owned brand, but it is our first owned brand devoted solely to Kitchenware and our guests love it. Baskets with Figmint items are 25% larger than our previous owned brand offering. And Figmint was one of several factors that helped us accelerate our Kitchenware business by more than 500 basis points between Q3 and Q4 taking us from a negative comp to a positive comp. Guests respond to newness and innovation and great design and Figmint is just one example of that.
Richard Gomez:
There's been a lot of work in Food & Beverage to sharpen the focus of our brand portfolio. The launch of a flagship brand, Good & Gather was the first step. We focused Market Pantry on family favorites at our most affordable prices and we've also retired our previous snack and dessert brand, Archer Farms and replaced with Favorite Day, a brand with a much stronger identity around indulgent treats for the whole family.
All of this helps Target make consumer-centric decisions about our assortment, like the addition of 50 new F&B items for Easter and dozens more that we're launching just in time for the summer season, including a Favorite Day soda. Now it sounds simple, but the thoughtful, deliberate, holistic approach to designing, launching and managing our brands, it's the difference between rolling out catchall brands and the difference between that and building brands that consumers love because we're meeting their needs in a really meaningful way.
A. Hennington:
Well, thank you both. I love that, and that's a perfect note to close on, consumer centricity. That's a theme running through everything we've covered today, new brands like Gigglescape, Figmint and dealworthy. Our relaunched up & up and powerhouses like Gather and Cat & Jack. So thank you, Rick and Jill for that look into our owned brand work, it really is incredible.
When I think about Target's right to win in this environment and our ability to meet key consumer needs, our owned brand is foundational to so many of our plans. That's because the investments we made in our capabilities and our team over more than 2 decades, combined to form competitive advantage that few retailers anywhere can match. And it's not just a competitive moat we're talking about here because we're not hunkering down, playing defense. This work is our springboard into the future. And through the incredible value we -- value our owned brands offer across each of our key categories, and the compelling newness they're adding to our entire assortment, we'll continue to deepen our relationships with our guests and will give all consumers compelling reasons to choose Target. Now I'll hand it off to Cara Sylvester, who will tell us more about how we're getting these products in front of consumers and engaging with our guests and potential guests more broadly. Thank you. Cara?
Cara Sylvester:
Thanks, Christina, and hello, everyone. Today, I'm excited to talk about our guest experience. And you might ask Cara, how do we define guest experience at Target? Well, we think of it as the way we engage across America. From simply saying hello to consumers in a warm-Target way to deepening the relationships we have with existing Target guests, to how we create moments of discovery, connection and joy that invite people to choose Target again and again.
But before we look back at the previous year and preview what's ahead, I want to ground us in a consumer point of view because to understand how Target designs its guest experience, we should start with how people are shopping today. As you heard from Christina gone are the days when people would follow a consistent and well-defined path from discovery to purchase. Today, shopping is nonlinear and simply a part of the general ecosystem of our lives. Instead of a stand-alone experience that feels planned or predictable, shopping has become immersive, always on and fully integrated into how we all go about our days. A large portion of U.S. consumers, about 40%, start their purchase online and 20% start on social platforms. And those are just the people who are actively looking to shop. Many more are enticed to shop by the inspiration they find scrolling their social feeds for hours every day. This is expansive retail, nontraditional entry points, seamless transition between stores, online and social and fully in tune with what shoppers want and need. To meet these shoppers where they are, we spend a lot of time getting to know what matters to them and seeing the Target experience through their eyes. Our guest base is broad and diverse. In fact, 96% of U.S. adults have shopped Target at some point in their life. Yet we know that your shopping experience in mind are going to look and feel very different based on a variety of factors. Our families, our interest, our budgets, our schedule and simply what brings us joy. Expectations also differ by category. If you're on a grocery run, you're looking for reliability and value. And if I'm shopping for one of my daughter's birthdays, I'm looking for inspiration and fun. These nuances are especially important for Target given our diverse multi-category portfolio. Yet even though your shop -- even though shopping journeys vary, after gathering feedback from millions of guests about what they care about and how Target fits into their lives, there are a few important truths that unite our guests and shape how we design our experience. First, Target guests love to shop. They consistently list shopping as one of their favorite activities, more so than your average consumer. 90% of guests tell us they're looking for quality products. They also want a meaningful connection with the brand, and they're ahead of the curve when it comes to keeping up with trends. Second, our guests are whenever-wherever-however shoppers, using multiple channels to create the experience that fits into their lives. They're in the driver's seat when it comes to creating the experience that works best for them. And we have to meet them where, when and how they need us. Finally, one more important factor that defines Target guests. They are loyal, really loyal. Our most engaged guest account for a greater share of sales than we see at other competitors. Showing that the connection we have with guests is sticky and drives growth and profitability. Quite simply, guests look to target for inspiration, to find on-trend, high-quality items at a great price and to have some fun. Are we affordable? Yes. Are we fast and convenient? Absolutely. Can you check off everything on your list no matter how you prefer to shop? You bet. But there are other retailers who can say the same. What makes Target different, what makes guests consistently choose us over any other retailer is how we make them feel when they interact with us. How we design our experience to elevate ordinary moments into extraordinary ones with a carefully curated assortment, bursts of discovery and delight and plenty of human connection along the way. There, of course, are the big splashes of the Target brand that grab headlines, generate buzz and make people smile. Like our Halloween Ghoul Lewis, who took the season by storm or the ugly squirrel sweater that we created in 48 hours to pay homage to the version worn by Taylor and Travis over the holidays or turning the Las Vegas Sphere into a huge holiday snow globe complete with Bullseye in resonance. But there are also millions of smaller everyday moments that strengthen the bonds we have with our guests making their lives a little bit easier and a little bit brighter. So when visiting one of our stores in San Antonio, Texas last year, I kept hearing about a team member who I needed to meet. In fact, even some guests stopped me and said, "I absolutely needed to meet her." And they were right. She was somebody I absolutely needed to meet, and I wanted you to meet her too. Let me introduce you to Amelia. [Presentation]
Cara Sylvester:
So I love that video because it captures who we are as a brand and what we aim to deliver across our entire guest experience. Our team brings so much empathy to their work. And it's not just the face-to-face interactions at checkout or in the aisles. Empathy is infused into how we design every part of the guest experience.
Drive Up is a perfect example. The reason guests love Drive Up at Target because it's a -- service reflects what's most important to them. It's easy. Swing by, we'll bring out your order to you or even pick up your return. It's fast. Just tell us you're on your way. We'll be ready when you are, no pickup windows to worry about because we work on your schedule. It's fun at a Starbucks to make your trip that much more relaxing and it's all free. This is what we mean by designing an experience for our guests. Looking at a service through their eyes, using Target technology to rapidly iterate and introduce new capabilities and finding ways to not only meet their needs but add something extra to make their day. That's the Target experience. You saw that from us in 2023 as we continued on our path to be America's favorite discovery destination. Our stores are known as a getaway spot. Somewhere you can go and enjoy a few minutes or a few hours, browsing the aisles with friendly team members to help you find just what you need. We're bringing that same sense of exploration and relaxation to guests who walk through our digital front door. Last year, shoppers visited us more than 6 billion times on our digital channels, looking for the same warmth, newness and discovery that greets them when they walk into one of our front doors. In fact, more than half of guests who make a purchase in our stores have visited our app or our site that very same day, reinforcing how shoppers move fluidly from physical to online and back again. And Target is uniquely suited to be there for our guests when inspiration strikes because of our agile technology and the pathways we create between stores, digital, social, marketing and more. The experience we created this past holiday season is a great example. This year, there was clear connectivity across our experience to create a memorable and meaningful visit no matter how you choose to shop with us. Holiday gateways, in-store and online, digital gifting stations, product packaging to make you smile, in-store playlist to set the mood, festive TikTok content and Target Wonderland community pop-up events. These all work together to celebrate the holidays with our guests in a way that only Target can. Our ongoing investment in our digital capabilities enabled this year's fully connected holiday celebration. In 2023, we transformed our digital experience from a utilitarian shopping platform that was one-size-fits-all to one that is filled with warmth, greets you personally just like Amelia would and delivers a custom blend of newness, trend, value and ease just for you. And it's not just what the guests see but what's happening behind the scenes to power these personalized experiences. We're using generative AI to power our product detail pages to provide more friendly and relevant explanations of what guests want to know about our assortment. AI also powers features like shop the look and our get it now assistant, which lets you know when items in your cart are available for pickup at a nearby store. It's also the engine behind the insights we use to give guests more personal experiences and rewards through our loyalty program, Target Circle. And it's a key element of how we create thoughtfully curated campaigns for consumers through our advertising business, Roundel. This might be a good time to talk about how Roundel seamlessly integrates into the guest experience and continues to drive more than $1.5 billion in value for our business. Growing more than 20% in 2023, Roundel is the powerful bridge between our guests and the brands they love. Roundel works with more than 2,600 vendors to deliver creative that is resonant and wholly consistent with the Target experience. In return, our guests receive content that speaks directly to their interest and preferences. Take our holiday campaign with Apple. Tech products top many guests holiday gift list. So we worked with Apple on a comprehensive campaign to keep their products front and center for our guests this holiday season. With custom content designed to reach our guests across a number of platforms, including Connected TV, YouTube and social media. Our co-created holiday video ad made us the first Apple partner to highlight the new double tap feature on its Watch Series 9 in a spot. To add relevance, we used AI on our site to position the right products in the right moments. Think serving up promotions to RedCard holders, so they get the best deal plus extra 5% off by using their card or helping a guest find a perfect gift for their teenager, hint, go for the AirPods Pro. This integrated campaign tapped into our powerful ecosystem of digital, social, marketing and merchandising and absolutely resonated with shoppers. We deepened relationships with existing fans and attracted new ones with a significantly higher new guest rate compared to prior Apple campaigns at Target. In addition to the way Roundel powers the guest experience when guests are browsing our app or website unique to Target is our media mix with 35% of revenue being generated outside of our owned properties. That means that we're able to connect with consumers wherever they are, like on social or streaming platforms, driving more than 250 million visits to Target properties in 2023. And social is increasingly where our guests are. We have more followers than any other mass retailer on TikTok with incredibly high engagement, which underscores our opportunity to connect the love that guests have for us on social to a smooth path to purchase in stores and on our digital properties. Our guests use social to stay in touch with the latest trends in a way that feels specifically designed for them. So we're working across the spectrum of social, from user-generated content and Target creators to our talent partners and Target owned platforms to make it easier for guests to maintain that discovery mindset as they shop. Over the coming year, you'll see us experimenting to bring off-platform content on to our digital properties, so guests can find inspiration right on their sight in our app. And we'll blend social and commerce to create an experience that taps into real-time trends and makes off-line inspiration to online purchase intuitive and easy. So imagine a guest looking for just the right things for a housewarming celebration. They open our app, which is personalized just for them and type in housewarming party ideas. Using generative AI search, they see the latest products that fit their style and preferences, including delicious snacks from Good & Gather, cheap party supplies, modern glassware and even some new party outfits. We brought the fun of wandering the aisles of our stores alongside inspiration from lifestyle influencers to spark new finds, like beautiful living room decor. Our guest uses 3D visualization to see it in their space and AI-powered reviews to learn more. They love it and snap it up along with their must-have party supplies. Within a few hours, their haul arrives thanks to same-day delivery, they love the items so much. They share their finds on social media, inspiring other guests to shop Target. This is the future our teams are working on today, a seamless fluid shopping experience across stores, digital and social, and centered on what our guests want and need. And knowing what our guests want and need, deepening our connection with them and making millions of guests feel that every visit is made just for them is at the heart of our loyalty program Target Circle. We introduced the program in 2019 as a way to say thank you to guests with deals, rewards and perks. Today, we have more than 100 million members who have earned $2 billion in rewards. Members have told us how much they value the program, and it shows. Last year, they visited us 5x more often and spent 5x more than guests who aren't members of Target Circle, yet. And our personalized deals and bonus offers powered by our proprietary technology drove $1.5 billion in incremental sales last year. Yet members have also told us that it could be even easier to save and know how much they're saving. So we took this opportunity not just to improve our program but to reimagine how we think about loyalty across the entirety of our experience. So today, I am thrilled to introduce a new Target Circle, one that brings the best of Target together under one loyalty program. Here's a short video that we created to sum up with new and what's next. [Presentation]
Cara Sylvester:
So bringing together Target Circle, Target Circle Card and Target Circle 360 simplifies and expands how we deliver value to our guests. And as we've been talking about, we've designed the program to give guests flexibility and control in how they shop. There's the Target Circle our guests know and love today that gives every member access to the best deals and rewards at Target. There's absolutely no cost to join. What's new is they can now shop target without having to search for and add offers. Deals are automatically applied at checkout, plus they'll continue to receive partner perks with Ulta Beauty and Apple and even more rewards through personalized bonuses based on their shopping behavior. For those guests who want to save even more, Target Circle Card offers an extra 5% off each trip. This is on top of the automatic savings they receive as Target Circle members, plus free 2-day shipping, extended time for returns and no annual fee.
And with credit card, debit card or reloadable card options, consumers can find the product that's right for them. And finally, for those who want the magic of Target delivered to their door in as little as 1 hour, there's Target Circle 360, an extension of the same-day capabilities we've built since our acquisition of Shipt in 2017. Target Circle 360 members can order everything from groceries, to household essentials, to the newest must-have item with no additional fees, no markups and support from a preferred shopper. Members even have access to Shipt's multi-retailer marketplace, which gives them access to even more items from their favorite local stores. No waiting for days for boxes to arrive on your doorstep, just unlimited same-day delivery that we're rolling out to guests at the promotional price of $49, which will be the standard price for Target Circle cardholders. Guests will have access to the new Target Circle starting April 7 and we can't wait for them to feel the difference. This is just the beginning for Target Circle. Our AI-powered models will continue to deepen our relationship with guests and enable us to deliver one-on-one personalization at scale. And with this new foundation in place, we'll continue adding benefits and perks based on what matters most to our guests, like exclusive partnerships, product offers and more so they can get the most out of shopping at Target. This goes back full circle, pun intended to how people are shopping today. Shopping is dynamic and so are we. The investments we're making reflect our focus on consumers' preferences and needs, so we continue to be their first choice for discovery, delight and experiences that make them smile. That's Target's guest experience at its best, building connection and celebrating everyday moments in meaningful and memorable ways. Moving with our guests through their lives. So we're able to bring joy whenever we can. That's the Target magic, and it's what fuels our future. Now I'd like to welcome a familiar face with an expanded title to the stage, Michael Fiddelke.
Michael Fiddelke:
Thanks, and good morning, everyone. As Cara just mentioned, I've recently taken on a new role. And while I'll be staying on as CFO for a little while longer, I'm honored and excited to be leading our incredible operations team as Chief Operating Officer. As an engineer by training, I've always had a passion and respect for the work of my new team. And I've learned a lot working with them and alongside them during my 20-plus years at Target. As John Hulbert would tell you, over the years, I've often added complexity to our investor travel. So we could squeeze in just one more store visit.
And throughout the recent holiday season and so far this new year, it's been great to have an opportunity to spend even more time with teams in both our stores and supply chain facilities. While our financial conversations often focus on the metrics we use to assess our performance, there's no substitute for seeing firsthand the strength of our operations, the benefits that come from well-managed inventory and newness and hearing our talented team is focused on building for the future. So before I move into the financial portion of my remarks, I'm going to spend a few minutes on my priorities as I move into this new role. And as I've mentioned to my new team, I'm coming into this job at a time when our operations are in a very strong position. As such, my top priority is to build on the foundation that John Mulligan and the team have already established, and I'm fortunate to have an outstanding group of leaders already in place. As you've heard from John over the years, the operations team is focused on advancing multiple long-term initiatives to expand our footprint, modernize how we support our business and advance our company strategy. These efforts begin with investments in our store network, developing new locations, remodeling existing ones, supporting key partnerships like Ulta Beauty, enhancing our same-day services and more. We're also transforming our supply chain. This includes our journey to automate upstream replenishment with a focus on reducing store workload and increasing reliability. It also includes the build-out of our sortation center network, which offers faster delivery times while meaningfully reducing the cost of last mile delivery. Beyond this investment in our infrastructure, we're partnering with teams across the company to enhance our inventory positioning and demand forecasting, leveraging AI and machine learning to enhance our speed, consistency and efficiency. And of course, we're focused on the support and development of our team, including their pay, benefits, training and well-being. As I've said consistently, during my time as CFO, our team is our most valuable asset, and I'm bringing that perspective into my new role. As Christina mentioned earlier, beginning last year, our team renewed their focus on retail fundamentals after several years of managing through unusually high volatility. These efforts focus first on in-stocks, but encompass a broad array of measures relating to guest experience. In total last year, our store teams rolled out new training on 25 separate best practices, and we've seen the benefit in our recent guest surveys. While those initial improvements are encouraging, we'll continue on that journey throughout this year to ensure we're setting the standard for the shopping experience in U.S. retail. So now let me turn to our financial results. And while our focus today is on the future, I'm also going to give a look back for perspective on our longer-term trajectory. I'll begin with a review of last year's financial performance and then compare and then examine how it compares with a decade ago. With that context, I'll look ahead to our aspirations over the next 10 years and conclude with our outlook for 2024. It's clear that last year was unusual as top line results came in below our guidance, but our bottom line performance came in well ahead of expectations. For the full year, we saw a 3.7% decline in our comparable sales, reflecting quarterly traffic trends that varied widely from the strongest performance in Q1 to the softest in Q2 and an improving trend in Q3 and Q4. As traffic improved, we saw a better comp sales trend, better digital sales and a dramatic improvement in discretionary categories. On the operating margin line, our business delivered dollar growth of nearly $2 billion last year, well beyond our initial guidance of $1 billion or more. This was driven by a rebound in our operating margin rate from historic lows in 2022, a year where we faced unusually high markdown rates, sky high freight and transportation costs and rising rates of inventory shrink. Last year, as the team managed inventory really well, markdown rates improved dramatically, and we saw a huge reduction in freight and transportation costs more than we expected as we entered the year. Healthy inventory levels also helped our operations, without the need to manage overfilled backrooms, store teams were able to flow product onto their sales floor more easily and increase their focus on guest-facing work. Similarly, our supply chain facilities were able to operate more smoothly without the necessary labor hours and extra touch is required to manage overly full buildings. Last year, we also benefited meaningfully from the efficiency efforts we launched about a year ago. When we began this work, we said we expected to realize $2 billion to $3 billion in permanent efficiency gains over a 3-year period. And with the first of those 3 years behind us, we continue to feel very good about our progress. More specifically, we estimate that these efforts delivered savings of more than $0.5 billion last year helping to offset other profit pressures, including the deleveraging effect of a soft top line, continued investments and paying benefits for our team and higher inventory shrink. And finally, last year, we continued to benefit from our Roundel ad business, which grew more than 20% in a year when we were facing challenging trends on the top line. Altogether, last year's profit performance led to growth in our GAAP and adjusted EPS of nearly $3 or just under 50% compared with the prior year. In addition, cash from operations more than doubled from $4 billion in 2022 to $8.6 billion last year. And finally, after-tax return on invested capital expanded by well over 3 percentage points from 12.6% in 2022 to 16.1% last year. Before I include my recap of 2023, I want to provide an update on inventory shrink, which includes the impact of retail theft. Last year, consistent with expectations, shrink cost increased more than $500 million compared with 2022, representing about 50 basis points of incremental rate pressure. Even more notable, compared with 2019, shrink costs have reduced our operating margin rate by a cumulative 1.2 percentage points over a 4-year period. Happily, we've seen some encouraging trends recently resulting from both the actions we've taken and the community efforts we're seeing across the country. I want to pause and give a quick shout out to our assets protection and information security teams who are working around the clock to protect the safety of our team and our guests. I'll add, however, that because it's a lagging metric, we're planning for shrink rates to remain approximately flat in 2024. So now with last year in the books, I want to briefly pull back the lens and look back over the last decade, which is a very long time in retail. This will help to highlight the journey we've been on and the capabilities we've developed serving as the foundation for the next decade of profitable growth. As you all know, the last 10 years were a time of rapid change in retail. This led to some sluggish results at Target in the early years as our business faced some significant challenges. Those periods were followed by rapid progress in later years based on the steps we took to address those challenges. Let's start with the top line. In 2013, our U.S. business generated about $71 billion in sales, while 2023 sales were about $34.5 billion higher, representing an average growth rate of about 4% per year, breaking down that growth by channel, about $16.5 billion occurred in our stores, while digital sales grew by another $18 billion becoming nearly 13x larger over that decade. Within our digital sales, same-day services, which didn't exist 10 years ago, accounted for $12.5 billion or 70% of our digital growth between 2013 and 2023. On the bottom line, our adjusted EPS in the U.S. grew by an average of about 7.6% per year from $4.29 in 2013 to $8.94 last year, while GAAP EPS from continuing operations grew slightly faster. On top of those EPS gains, our per share dividend grew at an average rate of 10.7% per year from $1.58 in 2013 to $4.36 last year. I'd note that these bottom line returns were delivered during a decade in which our operating profitability experienced a meaningful amount of compression from a 6.7% operating margin rate in 2013 to 5.3% last year. As we experienced significant pressure from inventory shrink and higher digital penetration. Going forward, we expect to offset at least a portion of this decline over time as we work to achieve an optimal and sustainable operating margin rate. Turning to capital deployment. Our priorities have remained consistent for decades. So I'll briefly reiterate them here. We first look to reinvest capital in our business in projects that meet our strategic and financial criteria. Second, we look to support the dividend and build on our 52-year record of annual increases in the dividend per share. And finally, we deploy any excess cash after these first two uses to repurchase shares within the limits of our middle A credit ratings. Over the last decade, our operations generated just over $67 billion of cash. And during that time, the lowest level of any single year was still more than $4 billion. These cash returns demonstrate the durability of our business as we navigated through several challenging periods over those 10 years. They also give us a lot of confidence in our prospects for making continued productive investments in the years ahead. Throughout that entire decade, deployment of cash was consistent with our long-term priorities. Just over $30 billion was devoted to CapEx, accounting for about 45% of the total. Another $14.5 billion was paid as dividends and cumulative share repurchases accounted for the remainder of just over $22 billion as we retired more than 206 million shares at an average price of about $108, all while maintaining our Middle A ratings over the entire period.
So now with that long-term look back as context, I want to turn to what we expect to achieve over the next 10 years, beginning with the top line, where we're focused on 3 separate growth drivers:
comparable sales, new stores and other revenue. Comps are expected to be the primary source of growth with increases in the low to mid-single-digit range in a normal year, consistent with our average over the last decade. We'll support this comp growth with continued investments in our business in remodels, own brands, national brands, signature partnerships and value-added services across all channels.
Turning to remodels. We plan to invest in the vast majority of our nearly 2,000 store fleet over the next 10 years. Each year, projects will range from full-scale remodels in which we touch the entire store to more surgical investments, including the addition of Ulta Beauty locations, fixture upgrades, support of our same-day services and more. On top of existing stores, we'll continue opening new locations based on the strong financial returns they generate. As Brian mentioned, most of these new stores will be larger on average than we've opened in recent years. Based on the opportunities we've already identified, we expect to open more than 300 additional stores over the next decade, meaningfully extending our reach into new neighborhoods. By the end of those 10 years, we expect those new stores will be generating incremental sales of around $15 billion annually. Beyond our buildings, we'll continue to focus on the well-being of our team members who enable our growth and serve as the face of Target every day. As Christina and Cara highlighted earlier, the human element as exemplified by our team as a continued differentiator for Target in a world where commerce is becoming increasingly mechanized and impersonal. Finally, over the next decade, we expect to continue seeing outsized growth in other revenue. This has been driven in recent years by our Roundel ad business, which contributed more than $1.5 billion of value to Target last year to the benefit of both gross margin and other revenue. On top of Roundel, we also expect our digital marketplace, Target Plus, to make a more meaningful contribution over the next 10 years. Putting this all together, over the next decade, we expect our total revenue will grow by an average rate of roughly 4% per year over the next 10 years. If we attain that goal, our business will add more than $50 billion of revenue on top of the $107 billion we delivered in 2023. That growth will enable our business to further benefit from scale efficiencies as we continue to extend our reach in the U.S. market. On the operating margin line, our ambition is to reach the optimal rate to maximize profit dollar growth over time. While we don't yet know what that rate will be, we believe it will be at least the size our prepandemic rate of 6%. We made enormous progress and moving back towards 6% last year and expect to make continued progress in 2024 and beyond. Once we reach that 6% milestone, we'd be happy to continue moving higher as long as we're seeing appropriate dollar growth. For example, if we're successful in reducing shrink over the next few years, that might support our ability to sustainably operate above 6% over time. Regarding CapEx, we don't apply a rule of thumb to determine annual spending. Rather, we maintain a bottom-up plan and allocate capital to all the projects that meet our strategic and financial criteria. As you've seen in recent years, annual CapEx will vary based on the external backdrop and individual project investments, which naturally follow the evolving needs of the business will vary as we snap this chalk line in a specific year. For example, while in 2022, we needed to rapidly expand our upstream replenishment capacity. We're no longer feeling that same urgency today. Similarly, while we love what we're seeing in our sortation centers and expect to meaningfully grow their capacity over time, the pacing of sort center investments has slowed somewhat in the near term given the brown box last mile delivery volumes declined significantly last year. When we put together all of those considerations, along with our long-term growth ambitions, we believe annual CapEx will typically range between $3.5 billion and $5.5 billion in 2025 and beyond. Regarding our second capital priority, we expect to continue growing the per share dividend over the next decade and we'll manage the rate of annual increases with a goal of reaching a 40% payout ratio over time. As for our third capital priority, we expect share repurchases will continue to play a meaningful role in our EPS growth in years ahead. Our strong balance sheet successfully absorbed a number of powerful shocks in 2022. And last year, we made significant progress in moving our debt metrics back to appropriate levels. This sets the stage for a potential resumption and repurchase activity later this year. Altogether, we believe we can deliver high single-digit growth in earnings per share in a typical year, at or above the average you've seen over the last 10 years. And lastly, we believe our after-tax ROIC can continue to move higher into the teens over the next decade -- into the high teens over the next decade. So now let me turn briefly to our expectations for 2024. On the top line, we're still planning cautiously, given the consumer spending patterns we've seen for 2 full years now. More specifically, on the discretionary side of our business, even as we've seen improving trends over the last 2 quarters, overall demand remains soft as spending patterns continue to normalize from pandemic peaks. In our frequency businesses, we're anticipating a further recovery in unit trends this year as inflation continues to moderate. Altogether, we're planning for a modest increase in comparable sales in the 0% to 2% range for the year. Within the year, our top line will face the highest hurdle in the first quarter, while over the remainder of the year, we'll be comparing over notably softer results. As a result, while we're looking to build on the momentum we've seen in recent quarters, our plans anticipate a comp decline in the first quarter. After that, we're planning for a resumption of top line growth over the remaining 3 quarters of the year. On the operating margin line, we expect the impact of inventory shrink will be roughly flat to last year. In addition, given our cautious top line expectations and continued investments in long-term growth, we'll likely see some deleveraging on the SG&A line. In terms of tailwinds, we're planning for modest improvement -- modest rate improvement in shipping and transportation as we annualize the benefit of the lower rate contracts negotiated throughout 2023. We're also planning for continued outsized growth in our Roundel ad business, contributing to both gross margin and other revenue. And of course, we expect our efficiency work will benefit both our gross margin and SG&A expense rates. Altogether, in 2024, we're planning for a modest increase from last year's 5.3% operating margin rate as we continue moving towards our 6% goal. On the bottom line, our 2024 expectations translate to a full year range for both GAAP and adjusted EPS of $8.60 to $9.60. On first glance, the midpoint of this range represents growth of just under 2% versus 2023. However, I'd note that it's equivalent to a mid- to high single-digit increase on a 52- to 52-week basis, given that last year had an extra week. Regarding the first quarter, our full year plans translate to a range of $1.70 to $2.10 for both GAAP and adjusted EPS on an expected 3% to 5% decline in comparable sales. Turning to our balance sheet and capital deployment. We continue to expect a CapEx range of $3 billion to $4 billion for the year and are planning for another strong year of cash generation. Later in the year, we'll recommend that our Board approved another increase in our per share dividend. And finally, while we don't expect to repurchase any shares in Q1, we may be able to resume that activity later in the year within the limits of our Middle A ratings. As I get ready to close, I want to pause and thank the entire Target team with a particular call out to my colleagues in finance. It's been an honor to serve as your Chief Financial Officer for the last 4.5 years. Just as I have been, I'm confident my successor will be incredibly grateful for the leadership, integrity, passion and discipline you bring to your work every day. Until a successor is named, I'll continue to fully occupy the CFO role and partner with all of you on behalf of Target and our stakeholders. To my new team, I'm incredibly excited to be working with all of you. As I said earlier, our operations are already in great shape, and I'm fortunate to be working with a strong set of leaders. I can't wait to see what we can accomplish together as we build and sustain the foundation for another decade of profitable growth at Target. Thank you. Now I'll turn it over to Brian for some closing remarks.
Brian Cornell:
Michael, thank you. As we get ready to take your questions, I might get started with some of the questions I can imagine are on your mind this morning. First, are the updates we shared enough to get Target back to growth? The answer is absolutely. We're confident that the road map we've outlined today puts our core strengths, capabilities and points of difference to work in new ways with even greater value, relevance, ease for our current guests and U.S. consumers more broadly. This road map will help us meet consumers where they are to drive traffic, profitable sales growth, and long-term market share gains.
Another question might be, can Target keep building on the profit improvement you put up last year. You just heard it for Michael, nearly $2 billion in 2023 of operating income growth, far outpacing our guidance. More than $0.5 billion in cost savings from our ongoing efficiency efforts, giving us a fast start on our multiyear efficiency goals and realistic expectations for additional improvement in our operating margin rate this year as we move towards our 6% goal. Ultimately, I'm sure you're asking, what does this mean for shareholders over time? And that brings us back to our emphasis on long-term horizons and the durability of our business model. Again, you heard it from Michael. From 2013 to 2023, revenue grew by almost 50%, while earnings per share and the annual dividend more than doubled. The progress we made last year in shifting the momentum of our business, defining our road map for growth and improving our profit performance has set us up to resume share repurchase, potentially later this year. We know that's been an important source of shareholder returns over time. But since most of you know our capital priorities as well as we do at this point, I'm guessing you noticed that I'm ending with the priority that's been on top of the list for decades. Simply put, investing in the right strategies and capabilities for our consumers and our business is a surest way to deliver outstanding shareholder returns over decades. As you've seen in the last decade, there's a lot we can't control in the operating environment, but we are in charge of our financial decisions and the business plans and investments that drive our performance. We know that if we perform well for consumers, their market will reward investors who are fueling those efforts. That's why you've seen us highlight our road map this morning. It reflects our team's eagerness to grow, and more importantly, our plan to execute on that ambition. It's how we're putting the assets and capabilities we've built in the last decade to work in ways that are inspiring and in step with how consumers will be shopping in the next decade. Keep in mind strengths that are unique to us, a comprehensive competitive position, a position that's difficult to replicate because no one can put it all together like Target. We've said it before, it's the power of [ brand ], from our stores and digital experiences to our fulfillment options, our multi-category portfolio, our signature brand partnerships, our own brand [indiscernible] and above all, our global team. Our 400,000 Target team members and a talented and dedicated and determined leadership team, who have led and will keep leading our team through go time. But make no mistakes, everyone at Target from the check lane to the C-suite is committed to the next era of grow time. Now we look forward to hearing from you. I'll ask Christina, Cara and Michael to join me back on stage so we can take your questions.
Operator:
[Operator Instructions]
Brian Cornell:
Hands are going up, why don't we start right here?
Simeon Gutman:
Simeon Gutman from Morgan Stanley. My first question is on the buying discipline. So Target makes a lot of its profit on discretionary products. Do you think you've developed new muscle over the last year or so? Or you just reacted to the environment and we'll see some of this go back?
Brian Cornell:
Christina, I think that's a great place to start. And you can talk about the work we've done with our global sourcing teams to make sure we are evolving the way we buy goods across the country.
A. Hennington:
Yes. Thank you for the question. We have evolved significantly over the last 1.5 years plus. What we've been living through over the last couple of years really has been quite unprecedented. And the opportunity has been to infuse more agility and flexibility into our model. So in 2023, we bought with an intention of [ placing bets ] on the things that we were most excited about, innovation, newness, our own brands, where we saw the business trends were. But we also wanted to make sure that we created flexibility in the model. And so overall, we certainly bought less in those down-trending categories to manage the inventory. But by buying less led to swifter operations, ease and just clarity in how to operate within this environment. We were also able to introduce levers through dual sourcing capabilities, a country of production diversification having more domestic backup.
So in categories like apparel, where it's really important that we're on trend and we're able to get things that we need quickly based on what we're seeing in the market. We have increased our flexibility levers manyfold and are using reserve open to buy basically receipts that we haven't spend as well as other flexibility levers to buy into the things that are working. And it is really paying off. Not only did we manage our inventory levels significantly lower and led to significantly increase in stocks, the best we've had in 4 years as well as being able to chase into the things that matter. Our apparel business is perhaps the best example of that, where we've seen green shoots of acceleration quarter-by-quarter. And not totally visible when you look at the aggregate comp, our discretionary comps were the best in the fourth quarter. They were better than in the first quarter. So we've seen that discretionary comp acceleration through the year. That's what we plan to build on in 2024.
Brian Cornell:
I'd only add that even in 2023, as we took a more conservative approach in discretionary categories, Christina, Rick and Jill's teams certainly leaned into key seasonal moments to make sure that we had the right newness, the right affordability as guests continue to celebrate those key seasonal moments. We'll do more of that in 2024 as we continue to make sure we adjust our flexibility to meet the needs of guests as they continue to change their shopping patterns. Let's go over on the side. Michael.
Michael Lasser:
I have 2 questions. One, seems like if we were to characterize the strategy today, it would be remodel the stores, introduce new products, leverage some of the relationships that you have with your customers through a reintroduced Circle program. You have a lot of experience with those strategies. Is it right for us to think that each one of those could contribute 100 basis points to your comp, and that's how you build to getting low to mid-single-digit comp over the long term?
And then a more near-term question. You're guiding to 3% to 5% comp decline for the first quarter, flat to up 2%. How do you go from point A to point B? And how have you factored in some of the uncertainties like changes in credit card fees and the overall uncertain environment, given that there's an election year in the year ahead.
Brian Cornell:
I'm happy to start, Michael. And we're not going to provide you the waterfall today that breaks all those components apart, but everything you've talked about is baked into our plans. We certainly expect new stores to be a major contributor as we go forward. Michael talked about, over a decade, we expect those 300 new stores to generate about $15 billion of incremental revenue. We'll continue to invest in remodels. And we've got a long track record of seeing those remodels deliver really good returns.
We'll continue to lean into our own brands, our national brands and those great brand partnerships to make sure we're providing our guests with the newness and inspiration they're looking for. We're very excited. As you heard from Cara about the new Target Circle program, the benefits of that base program, circle card and the excitement around Target 360 and how that will extend our same-day offering to guests, bring it right to their home within an hour. So each one of those elements play a key role. We're very excited about the enhancements we've made from an overall digital standpoint to provide more ease and inspiration and discovery for our guests. And both Michael and Cara talked about the upward potential we see in Roundel. So they'll all play a key role as we go forward. But I think it fundamentally starts with us understanding consumer trends, how consumers are shopping today and we'll shop differently going forward and continue to meet their needs, no matter how they want to shop with Target. Either in a physical store, in a digital environment, whether it starts with social or they're just walking into a great neighborhood Target store. So each element is going to contribute to our road map for growth. And underneath all of that is that continued focus on retail fundamentals, the blocking and tackling that makes sure we provide our guests a great physical and digital experience, making sure we're always in stock that we leverage our crux, that we provide great affordability and we're there to provide a great guest experience no matter how you shop with our brand.
Michael Fiddelke:
Yes. And maybe just add on that by kind of reinforcing a point Brian made. I love the fact you can't decompose our strategy and to discrete things. It's how they work together, a guest engaging with circle that finds discretionary category discovery within that experience. And so it's never 1 plus 1 equals 2. We're hoping 1 plus 1 plus 1 equals 10. And it's how all of it comes together. You asked a question specifically on the cadence as we move through the year. I touched on it a little bit in my remarks, we anniversaried some of the strongest business last year in Q1, and so we would expect to see a build as we move through 2024.
Brian Cornell:
How about right back here.
Scot Ciccarelli:
Scot Ciccarelli with the Truist. Can you guys provide any more color on your most recent shrink results? And can you help us understand what happens with the sales velocity of products when you put them behind lock and key?
Brian Cornell:
Yes. Michael, I'm happy to start because I know it's a topic on everyone's mind. And when I think about shortage, when I think about shrink, I'll start with the word progress. I think we're seeing really solid progress and greater awareness at the national, state and local level. And certainly, our teams have been working to ensure we provide a great guest experience and provide an experience that's safe for our team and safe for our guests. And Michael, I think our teams have made significant progress, but a lot more to come.
Michael Fiddelke:
Yes. I mean I can't say enough about the hard work of the teams that have led to that ton of progress that Brian hit on. And the way that rolls into our [indiscernible] is we're expecting shrink to be flat year-over-year. We learned a lot in the first quarter. We inventory a lot of stores in Q1, and so it will be smarter a quarter from now. But that progress has us expecting for a lagging metric flat, and we'll see what we've learned as we go through the year.
Brian Cornell:
All right. Just roll it back here.
Michael Baker:
Mike Baker from D.A. Davidson. I wanted to talk about your efficiency efforts in the $500 million that you achieved this year. How do we think about that over the next few years? Is that linear? Does it sort of get sort of roll down hill and get better? What is assumed in your 2024 outlook.
Michael Fiddelke:
Yes. Well, I'm happy to start. The teams work against a tough top line to deliver that efficiency progress this year. It's a great start, and I can view that as a down payment toward that $2 billion to $3 billion that we expect to get over time. The things are a little closer in that were highlights of that this year. I'd call out the continued benefits of something like our sortation centers. We have a sortation center in a market ,we're faster and we're cheaper than other forms of delivery.
I also -- I mean we touched on a little bit in the conversation already, but it warrants another shout out. The benefit of exceptionally well-managed inventory just shows up everywhere. We're so much more productive in-store and in our DCs when inventory is well managed. And so I feel really good about the team's work there in 2023. I feel great about our inventory position as we step into 2024. And I would expect our teams to continue taking the growth we've seen and the growth we expect and to translate that more into more efficiencies over time.
Brian Cornell:
Yes. Michael, I'd only add that taking a very measured approach to setting priorities year-by-year. We see opportunities in stores, in supply chain, opportunities to better leverage technology to continue to build on that efficiency road map. So year after year, we'll reset priorities to make sure we're laser-focused on delivering those results, and they'll build over time. All right. Back over here.
Daniela Bretthauer:
Danny Bretthauer with HSBC. Question to Cara on the new Target Circle program. I mean, is $49, obviously, like an introductory price? How long are you willing to sustain at the price level? Because I think it's hard to make the math with same day 1 hour delivery at $49 and how do you plan to compete with the other programs, loyalty programs out there? What would be some of the key differentiators other than this entry $49 price point.
Brian Cornell:
Cara, I'll let you take it away.
Cara Sylvester:
Take it away. We're really excited to talk about it. And I think it's really important that we really anchor on the entire Target Circle ecosystem. That was really important to us. And the notion of accessibility and for all is really, really important. That's why we first are reimagining how we're thinking about delivering value. Our guests are really clear. They want value, affordability and they want ease and so we're making it even easier for our 100 million members to actually be able to get the deals and rewards that they want with automatic savings applied at checkout. I'll hit on your question around pricing in just a minute, but I think it's really important to talk about our cardholders as well. Today, the cardholders, that program doesn't work with Target Circle. And so what we're doing is we're actually bringing these 2 things together.
So that not only do you get 5% off every trip, and extended returns and free shipping, you also get all the benefits of the base Target Circle program, which are those deals that our guests love and those personalized rewards that are based specifically on your shopping behavior. The other thing that we're adding for our cardholders is an evergreen price of $49 for Target Circle 360. So if you are a cardholder for us, always on price will be $49, which is an amazing price, and it's less than $1 a week of the magic of Target delivered to your door. For Target Circle 360, we're really excited to build on our strength in same-day delivery since our acquisition of Shipt in 2017, you will get the magic of Target delivered to your door in less than an hour. You'll also have access to the Shipt marketplace of benefits. You will also have access to all of those deals and rewards and personalized perks as part of the base Circle program. It's just the beginning for us, that $49 is an introductory promotional price for Target Circle 360.
Brian Cornell:
I just want to take this moment and I hope many of our leaders back home are listening and just thank the Circle team, the teams have been working on this program for months and months. Our tech teams have been supporting them and the entire effort that the organization has put behind bringing this forward today. As you can doubt, we are really excited about the future Target Circle and think it's going to be a major growth driver and deepen guest relevance and bring new consumers into the target franchise. All right. Back up front.
Gregory Melich:
It's Greg Melich with Evercore ISI. I had 2 questions. One was, Michael, could you just -- you said Roundel will be up again. I think it was 20% last year. For guidance this year, are you thinking that offsets any pressure on credit and just tell us how credit is going?
And then my other question goes back to traffic, great to hear all the initiatives in the Target Circle. In the guidance, what are we thinking about with AUR and average ticket, given that it is a value-focused consumer. We heard all the products that are under $10 and all this. So in that 0 to 2 comp, how much would traffic be up 3 while AUR is down, something like that?
Michael Fiddelke:
So if I start with the questions on the credit side of things, we've seen -- I think we've characterized it throughout the year, kind of an expected return to normal in a lot of those underlying credit metrics. And so you've seen a little bit of softness year-over-year there. Then in 2023, was offset nicely and then some by the incredible growth we've seen in the Roundel business. And as a reminder, I think I said this twice in remarks, Roundel is both a little other revenue and a lot of gross margin. And so it benefits 2 places to get to that $1.5 billion of value in total. But we've seen outsized growth there, and we would expect that to continue this year. We're really confident about our prospects to continue growing our Roundel business to the benefit of the guest that get strong engagement with all of those offers.
Another example of how the strategy fits together, the more engagement we have with Circle, the better we know our guests. The better we know our guests, the better we can serve them through Roundel. And so we're excited about what growth looks like there. Your second question, Greg, refresh my memory?
Unknown Executive:
Traffic.
Michael Fiddelke:
Yes, we won't break out ticket versus traffic. But the theme I'll talk about that we've seen this year is a moderation of inflation, I think, but disinflation is the word of the quarter in retail. That's a good thing for the consumer. You've heard it for the consumer. You've heard us talk about that being one of the inputs, some share of wallet recovery on the discretionary side of things. And so we're pleased to see that ticket pressure because we think it's a good thing for the U.S. consumer.
Edward Yruma:
Ed Yruma, Piper Sandler. You spent much of the last decade kind of opening 8 typical stores, small boxes, urban locations, and it sounds like you're pivoting back to kind of traditional large boxes and ostensibly suburban areas. Would love to understand kind of what that small box portfolio looks like? Have you been pleased with the returns, given some of the changes in the urban dynamic? And then as you look to these larger stores, how should we think about the role of food in some of these bigger boxes?
Brian Cornell:
Ed, it's a great question. I'm happy to start. And actually, over the last couple of years, you've seen us move from a focus on small stores, and we can talk about the performance there to more larger-sized stores as we see new opportunities and catchments where we haven't competed in the past. And we've been very pleased with the performance of these new full-size stores as well as the continued performance in urban centers and on college campuses.
So as we look at our pipeline going forward, we recognize there's opportunities for more full-size stores, extend our proximity, bring the best of Target into some new trading areas. And as part of that, you will see us continue to expand our food and beverage offering. Rick talked about the progress we've seen in food and beverage and adding over $8 billion in the last couple of years and the strength of a brand like Good & Gather and for many of you who are tracking the consumer packaged goods industry, there aren't a lot of $4 billion brands out there. And we launched that brand just prior to the pandemic. And we just continue to see the steady growth and how our guests react to the quality and value we bring with Good & Gather. So we're excited about the pipeline. It will be more larger-sized stores. There will be a broader food offering. And we're going to be moving into trade areas where we can pick up incremental volume and market share because we, in many cases, just haven't competed in these trade areas in the past. Michael, do you want to talk about some of the returns we're seeing with some of our smaller stores.
Michael Fiddelke:
Yes, we feel really good about the returns of those small stores. And it's great to have that flexibility in kind of our toolbox of what's the right thing to build for the opportunity in a specific market. And to be clear, going forward, if the right opportunity can be fit with a 25,000 square foot box that brings us closer to a college campus or an urban center. We know how to do that. We like the returns, and we'll lean in there. But as we step back, and look at what that pipeline looks like in total. It's actually the big box stores where we're able to bring the best of Target that are bubbling to the top in terms of where we expect returns to be strongest. And so we'll lean in to that shift over time. And if our properties team was here on the stage with us, they could roll out a map of the U.S. and show a bunch of main and main locations where we'd love to bring Targets to new communities, and we feel good about what that pipeline looks like.
Brian Cornell:
And I'd add 3 more points as we think about small formats. And we're here in Manhattan. 10 years ago, we really didn't have a brand presence in Manhattan. Today, we have over a dozen locations, and we're in many of the different neighborhoods across the city. We've now been connecting with a consumer that we couldn't reach in the past. And we're going to build a long-term relationship there. We're on many college campuses across the country. We know the value of building a connection with college students while they're on campus and the lifelong benefits that's going to provide for our brand as they move into their first apartment or have their first child and start their families. And one of the other things like Christina build on it is the work we've done with smaller formats has allowed us to understand a lot more about segmentation and getting the assortment right geography by geography.
So as we move into new markets, we're going to get much better at segmentation, having the right assortment that reflects the demand in those local markets. So there have been 3 really important benefits of our small format journey. We're touching new cities where we didn't have our presence in the past. We'll build a lifelong connection with college students, and we've learned a lot more about segmenting our assortment.
A. Hennington:
Yes. The only thing I'd add, even the lifelong relationship with college students, you heard Jill be very intentional. We actually seek to make sure that we are really relevant at certain life stages, especially early on in our consumers' lives. Think about the strength that we have in a business like baby, then we migrate them to toys, then we migrate them into video games and/or into juniors. And then having then presence, we do very well at back-to-school and back-to-college time frames. It's very intentional in making sure that our brand stays in touch with families through every life stage. College is the natural next step in that phase and then, of course, back to childbirth. So afterwards. And so that's been very intentional, but then to build back on segmentation opportunities yes, we've learned a lot. I mean, these boxes are small. They're difficult to operate.
We certainly have to cut the SKU count intensively, and we have to study the macro -- or the micro environment of competitors. And so this ability to formulate the right assortment strategy for that community has taught us a lot about the potential to expand that further into our larger size boxes. And we see tons of upside and potential in more sophisticated segmentation and allocation strategies that allow us to optimize the local potential.
Brian Cornell:
Cara, one of the things you and I talked a lot is as we open up new stores, there's certainly a physical store component. We drive a lot of new revenue. But there's also benefits from a digital standpoint as we introduce the brand to new communities, you want to expand on some of the things we've learned.
Cara Sylvester:
Absolutely. We see -- we talk a lot about digital influence sales. We know how consumers are shopping today. And so many of us, right, are starting, even if you love shopping and only purchase in stores, you're using our app to check out what's new, to see if something is in stock, et cetera. So we understand the power of digitally influenced store sales. What we also see, though, is the power of store influenced digital sales because we know some guests are browsing in stores and actually are pulling up their app right while they're in the store and having impact digitally.
We certainly also see as we enter new markets, the power of our same-day services. That has been a shining star for us across the entire digital portfolio. I talked in my remarks about why that is in terms of the relationship that we have. And once guests try our same-day services, they love it. It is sticky in their lives. We are literally making their lives better. So we'll continue to build on that. But that's another great example.
Brian Cornell:
All right. We've got time for a couple more questions. Let's go up here.
Robert Drbul:
It's Bob Drbul, Guggenheim Securities. I just wondered if we could spend a few minutes on gross margin, maybe Q4 buckets and the performance detail around that, your assumptions in '24 for the full year. And then curious if you could share the financial implications, especially around gross margin on Target 360 your assumptions for the rollout for this year?
Brian Cornell:
Well, Michael, this is a surprise. We've made it all the way to the last few minutes of our conference today, and this is the first time we've had a question about gross margin.
Michael Fiddelke:
Excited to get the question as always. We'll, I can start by unpacking a little bit what we saw in Q4, and there's some consistent themes to what we saw in the broader part of the year because the theme of gross margin recovery this year. And I think Q4 and the year, we were just shy of 3 percentage points of improvement in gross margin. Better inventory management, we saved a lot of markdowns and costs that were associated with some of the inventory challenges that we had a couple of years ago.
So on a year-over-year basis, that's a big source of improvement. Within there too, freight and transportation is in a much better place today from a cost perspective, not all the way back to 2019 levels, but on a year-over-year basis, another significant source of improvement. In addition, we also see benefit from digital and supply chain to the tune of, I think, 50 basis points in the right direction for the quarter and the year. And that's a combination of being more productive as inventory levels have been better managed and a little bit of tailwind from fewer brown boxes shipped with our brown box business being down on a year-over-year basis. As we look ahead to next year, all of our best assumptions are wrapped into the EPS guidance we've given. And a little bit of deleveraging, given a cautious view on the top line with some continued improvement in gross margin, we think is going to be the right recipe going forward. When it comes to a Target Circle instead of speaking to any specific assumption within that business case, I think of Target Circle is about growth. When we meet our guests with the right value proposition in a free loyalty program and the right value proposition and Target delivered to your doorstep through Target 360 and if you're looking for 5% more every day, we've got to Target Circle card for you. All of that is about stronger relevancy in growth. And so the line of the P&L, I'm most excited about from a Target Circle standpoint is growth. And time and time again, if we think about the P&L through the lens of the guests, we get to the right decisions. It costs us a little bit more to serve a Drive Up order than it does an in-store trip. But when guests start using Drive Up, we've described it before, it continues to be true. They spend 20% to 30% more at Target thereafter. And so we're making decisions with what we think drives the most value and growth in total.
Brian Cornell:
Okay. Go back here.
Ivan Feinseth:
Ivan Feinseth, Tigress Financial Partners. Congratulations on the great results out this morning. I have 3 questions. First, Cara, in thinking about like store layout and remodel, like, for example, in my local Target, food is on like the left side, but yet cookware is all the way on the other side of the store. And sometimes when I'm purchasing food, I find the need, I may need some cookware to do the dish I'm looking to cook. As an example.
Second is information that you get from using Shipt where a Shipt customer will go outside to other retailers? How much do you take on that information to decide what you're going to carry in the stores? And then if they're using, let's say, buying premium brand, how high of a premium product point do you see yourself going because there are some of your competitors that are using value priced food to bring in customers, but those customers are buying premium priced products. And then third, on the partnership, what other areas do you see? And how far of a premium level would you go in adding partnerships within your store?
Cara Sylvester:
There's a lot there.
Brian Cornell:
So Cara, why don't you start with partnerships? And Christina, why don't you talk about some of the learning that we have around how we build assortments?
Cara Sylvester:
Absolutely. And so as I think about the introduction of Target Circle 360, we are absolutely looking at a wide range of what partnerships could look like to add benefits. Importantly, though, we are always going to be listening to our guests. That is how we actually struck up our conversation and partnership with Ulta Beauty as well as what we offer in our base program today with Apple. And so we'll be guests led, not Target led as we think about the types of partnerships that will add value to our guest lives. I do want to hit on specifically your question around Shipt. We do not leverage any data of Shipt on their marketplace internally at Target as we think about our assortment.
A. Hennington:
More specifically on how we build assortment and premium prices to answer some of your questions. Our goal is to make sure that we are meeting our guests' needs across a wide range of shopping occasions. And so we look at -- you heard us describe this especially when we talk about [ own brands ], right? We look for unmet need spaces and white spaces to innovate against.
Over the last year, we've spent a lot of time making sure that we have our value equation shored up. And the introduction of dealworthy is a big deal for us. It is an opening price point brand across the entirety of the portfolio outside of food and beverage, where we already have Market Pantry. So just make sure we really have value options for all consumers so that they can meet their budgets. On the flip side, we do really well with Ulta Beauty, which is premium beauty. And it's based on the insight that we've known for years in beauty, almost all beauty shoppers shop both. They shop mass and they start to shop premium. And for us to be able to service the guests and service all the trips in that category, we needed a solution [ for growth ], which allowed us to build this partnership with Ulta, which we're really, really happy about. And we do that across the -- we do that across the portfolio to say where is the opportunity for Target to serve a unique need and where are the unmet needs in the category. And our guest has given us a lot of freedom to say, I'll spend $600 on this item. And by the way, I don't want to spend more than $2 on my body wash. And that's fine, whatever works for them.
Brian Cornell:
I'll just finished up that discussion by saying, I think we've learned time and time again. We make really good decisions when we listen to the guests and listen to the broader consumer trends. Some of the things we rolled out recently. Starbucks for our Drive Up guest. We didn't come up with that. They was the guest saying, "Well, if Target could only provide me with my favorite Starbucks product, I'd enjoy this drive experience even more." If you could take my returns, I would really be pleased. So we respond to what the guests and the consumer tells us, and that's going to guide us for years to come. All right. We've got time for one final question. So I guess we're going right over here.
Christopher Horvers:
Chris Horvers, JPMorgan. So I have 2 questions. The first question, as you think about the performance in the fourth quarter, how do you think about share. Do you think it's more give back from the COVID pump? Do you think it's the consumers just so focused on food and value and you're just not getting the trip, so it's not resonating to the power of the target box. And how do you think about recapturing that share going forward?
And then my second question is for Michael, as you look at like just the seasonality of your business, it seemed to imply -- you're implying a step down in operating margin in the first quarter relative to the fourth quarter, was there anything unique either in the fourth quarter or the first quarter that making that the case?
Brian Cornell:
Michael, why don't you start with the second half, and I'll wrap up with Chris' first question.
Michael Fiddelke:
Yes. So as we look at the first quarter, I think the key thing there is our cautious approach on the top line, and there's some differences year-over-year in what we anniversary, but that's a source of pressure in the first quarter. As we get back to growth, deeper in the year, we'll see some of that pressure subsides. So that's the headline on that one, Chris.
Brian Cornell:
And Chris, from a market share standpoint, I can assure everyone here, we look at market share in a very granular way every single week across our entire portfolio. And we're going to be very focused on taking market share as we go forward. I'll step back, not just look at the last year, but the last several years. And if I go all the way back to the prepandemic, we've added billions and billions of dollars of revenue growth. I think, Michael, over $30 billion.
And we've deepened our relationship with guests along the way. We've added more capabilities and features. We've deepened partnerships. And those are going to guide us to be even a more relevant retailer and partner for consumers and guests for years to come. So we are very focused right now over not just the next year, but the next 10 years, to continue to drive even more traffic to our stores and visit store site to make sure we are a company that's driving top line growth because we know that's the best way to reward our shareholders. And we are absolutely going to be razor-focused on taking market share as we go forward. And sitting here today, we know there are significant opportunities across virtually every aspect of our portfolio, whether it's the work that Jill is leading and apparel and home or the work Rick is doing from a food and beverage standpoint and a beauty and essential standpoint, whether it's physical stores or digital, we see a pathway for continued market share growth, and we'll look at that every single week and talk about it every quarter because we know that's critically important to our road map for growth. So I appreciate everyone who joined us in person today. Those of you who have joined us through the video and the conference. Thanks so much. We look forward to seeing you and hearing from you during our first quarter earnings report. So thank you so much.
Operator:
Thank you for joining us.
Operator:
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.
John Hulbert:
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?
Brian Cornell:
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 down 4.9%, in line with our expectations. Consistent with prior quarters and overall industry trends, discretionary categories were the driver of this decline, partially offset by net sales growth in our frequency categories. Between sales channels, store comp trends were somewhat stronger than in the digital channel. Among our digital fulfillment capabilities, same-day services saw high single-digit comp growth led by Drive-Up, which expanded 12%. Strength in these services was offset by continued softness in brown box delivery, which is most affected by the pullback in discretionary categories. On the bottom line, our third quarter EPS of $2.10 was well above our expectations and more than 36% ahead of last year. This increase reflected the continued benefit of lower freight costs, disciplined inventory management by our team, favorable category and channel mix and the continued benefit of our work to enhance efficiency, which offset multiple pressures throughout our business. This is outstanding profit performance in the face of a very challenging environment, and I want to thank our entire team for their tireless efforts in support of our guests, our business and each other. As you know, one of our top priorities this year was to rebuild our profitability following the unique challenges we faced in 2022. And while there's lots more work ahead of us, I'm really pleased with the progress the team has delivered so far this year. At the same time, I want to make it clear. We are not satisfied with the top line trends we've been seeing. Our #1 priority is to get back to sustainable growth in both traffic and sales, and we're committed to investing in long-term initiatives to deliver this growth. As we assess the external environment, it's clear that consumers have been remarkably resilient. Yet at the same time, our research indicates that themes like uncertainty, caution, managing my time and budget and focusing on essentials while still finding ways to celebrate are all top of mind. Overall, consumers are still spending, but pressures like higher interest rates, the resumption of student loan repayments, increased credit card debt and reduced savings rates, have left them with less discretionary income, forcing them to make trade-offs in their family budgets. For example, this year, we've seen more and more consumers delaying their spending until the last moment. Guests who previously bought sweatshirts or denim in August or September are deciding to wait until the weather turns cold before making a purchase. This is a clear indication of the pressures they're facing as they work to stretch their budgets until the next paycheck. Consistent with these pressures, as we look at recent trends across the retail industry, dollar sales are being driven by higher prices with consumers buying fewer units per trip. In fact, overall unit demand across the industry has been down 2% to 4% in recent quarters. And the industry has experienced 7 consecutive quarters of declines in discretionary dollars and units. And while we're happy to see inflation rates moderating this year, if you compare industry pricing in key categories back to 2020, food at home pricing for families has increased 25% overall and in some areas, up to 30%. And if you're a parent raising a baby, you're facing increases of more than 30% on baby food and formula, too. And that's in addition to persistent increases in a variety of other categories. So when you layer on the impact of higher energy prices, it all puts pressure on discretionary spending. As a result, this holiday season, we're focusing on highlighting the amazing value we've always provided in our end caps, promotions and the price points we feature in our marketing. As we built our plans for this holiday season, we maintained our cautious inventory positioning in markdown-sensitive categories. This provides our team the necessary flexibility to quickly adjust to volatile trends, something that has served us well all year. But I want to be crystal clear. That does not mean we're backing off on newness. While we're cautious about the size of our inventory commitments, we're leaning into the amount of innovation featured in our assortment. And after several years in which our vendors were focused on raising production volumes in the face of unprecedented demand, we're encouraged by the focus on newness and innovation we're seeing from them. And as I've mentioned, throughout this holiday season, we'll be focused on highlighting value, helping families to celebrate the joy of the season in a way that fits their budget. Beyond our assortment, as we work to provide a great guest experience, we've enhanced our training of retail fundamentals to our teams. This is an important shift after years of operating in an environment that was anything but normal. After all, given the large number of team members we've hired over the last few years, a meaningful number of them have never experienced ordinary sales trends. As we've said many times, investments in our team are the most important ones we make. And today, we remain on our front foot, investing to ensure they can deliver a joyful industry-leading shopping experience. This holiday season, we'll be supplementing our existing team by hiring nearly 100,000 seasonal team members to meet expected demand and ensure we can deliver a joyful shopping experience. So now as I get ready to hand the call over to Christina, I think it would be useful to pause and assess how this year has progressed in comparison to our expectations. As a reminder, at the beginning of this year, we said we were expecting a challenging environment with the sales guidance range centered around flat comparable sales. In terms of profitability, we said we expected to grow our full year operating income by $1 billion or more with an expected EPS range of $7.75 to $8.75. So today, with 3 quarters of the year behind us, top line trends have obviously been tougher than expected, and we're firmly focused on getting back to growth. But the story on profitability has been very different. Through the first 3 quarters of this year, we've already grown operating income by more than $1 billion compared with last year despite unexpected headwinds from higher-than-expected shrink and softer-than-expected sales. We're encouraged with this performance against a challenging backdrop, which demonstrates the resilience of both our team and our business. I'm incredibly proud to be a member of this great team and excited about the growth we're positioned to deliver in the years ahead. Now I'll turn the call over to Christina.
A. Hennington:
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 Target offerings. We're excited to launch Fenty Beauty by Rihanna in the third quarter, and it has quickly become one of our top-selling beauty brands across the chain. In Food and Beverage, comp sales were down slightly to last year. Seasonal candy, snacks and hosting solutions performed particularly well. Comp sales in Essentials declined in the low single digits despite strength in health care and baby categories. Comp sales in our discretionary categories remained soft in the third quarter with declines ranging from the high single digits to low double digits. However, trends improved markedly compared with the second quarter, thanks to the agility of our team and their focus on listening and responding to our guests. Home saw a high single-digit comp decline, an improvement of more than 6 percentage points from the second quarter. Most notably, we saw strength in Back-to-School and college categories and a great response to our assortment of Stanley drinkware. Additionally, within kitchenware, we launched our most recent owned brand, Figmint, and received an enthusiastic response from our guests. Figmint offers more than 250 items, ranging from enameled cookware to ceramic mixing bowls to kitchen gadgets all at a quality, aesthetic and value that can't be topped. Apparel comparable sales also declined high single digits, an improvement of nearly 3 percentage points when compared with Q2. The business was strongest within new offerings, including our partnership with Kendra Scott jewelry, the latest All In Motion performance wear and new fall fashion sets within our women's categories. Hardlines comparable sales were down in the low teens. While we were encouraged by Back-to-School performance, demand for electronics remains particularly soft. This quarter's performance demonstrates that while the results are not immune to macro conditions, when we focus on retail fundamentals, offer exciting new products at incredible value and respond to our guests' wants and needs in a timely manner, we remain relevant with our guests, even against the challenging backdrop. By leaning into seasonal moments like Back-to-School, Back-to-College and Halloween, we not only drove sales in the current quarter, we helped to build lasting affinity with our guests. This focus on celebrating the season creates an engaging experience that keeps Target top of mind. And that's why we continue to offer events like our latest Target Circle week in early October, which added another 500,000 members to our loyalty platform, providing future opportunities to engage with these guests in deeper ways. Our goal this holiday season is to create the perfect combination of incredible value, inspiring and fresh products and a joyful shopping experience as you stroll the aisles in our stores or on the recently refreshed Target website and app. We aim to deepen the relationships with our guests as they look to deck the halls and celebrate the joys that the holidays bring. As we do year round, we are leaning into the power of and this holiday season by not focusing only on one aspect of our strategy, but celebrating how they all work together to create a unique offering in a crowded retail landscape. Our plans start with a celebratory experience that you feel the moment you walk into our stores or open the Target website or app, featuring on-trend and inspiring color pallets, imagery and in-store marketing that complements all the excitement and joy, we are creating with our national marketing campaigns. Guests will feel the holiday spirit before they even add their first item to the cart. The excitement builds with our assortment at unbeatable value only at Target-exclusive merchandise and our easy and convenient holiday solutions. And through it all, we'll remain diligent on executing the necessary retail fundamentals our guests want and expect from us, including being in-stock on the must-have items of the season, offering unmatched value and pricing, highlighting our inspiring and differentiated merchandise assortment and making each trip easy and convenient regardless of where, when and how guests chooses to shop. Whether a guest knows exactly what they're looking for or needs a bit of inspiration, we want to make the trip joyful, easy and welcoming. And we know families want to celebrate the holidays, but they're relying on us to help them do so affordably. With a combination of everyday low prices, compelling promotions and exciting savings events all season long, we aim to be the holiday destination for affordable joy. So with Thanksgiving right around the corner, guest shopping for food and beverage area will discover how we're helping families celebrate with a Thanksgiving meal that includes all the family favorites for under $25, featuring $0.99 per pound Good & Gather turkeys and the must-have sides for just $5. As they explore our assortment, guests will discover exciting gifting options for every loved one. In toys, guests will find the characters and items their kids want at prices designed to fit every budget, with over 2/3 of this season's toy assortment priced under $25. In addition, around 1 in 4 toy items is a Target exclusive, featuring everyone's favorite properties, including Barbie, Paw Patrol, Pokemon, Marvel, Teenage Mutant Ninja Turtles, LEGO and so much more. And so far, among the most popular toys in our assortment are All Things Target, including plush Bullseye dogs, Barbie First Job at Target Dolls and Target cash register and shopping cart toys, a nod to the Target brand love, even among our youngest guests. And back by popular demand, we have an exciting array of toys from FAO Schwarz, including only-at-Target exclusives with 50% of the assortment under $20. With so many options to choose from, we are making it easier than ever to help narrow in on what will bring the biggest smiles this holiday season through exciting in-store displays and experiences. And on target.com as well as the Target app, guests can immerse themselves in a digital 360-degree room filled with the hottest toys for kids of all ages to try before they buy. When the presents are taken care of, it will be time to deck the halls, and we're offering an array of holiday decor at even lower prices than ever before. Nearly 2/3 of the assortment will be priced under $20 with in-store and digital signing and displays, making it easy for guests to see how they can refresh their holiday decor affordably with $15 ornament sets, family baking solutions and Mondo Llama craft sets, $10 throw pillows and tree skirts and still much more. And of course, the season is all about gathering with loved ones. Guests will find all the best entertaining, gifting and gathering solutions in this year's assortment, and we're launching more than 100 new items in Good & Gather and Favorite Day, with over half of these priced under $5. Throughout the holiday season, guests can rest assured that they'll get the best price and quality, wherever and however they shop. We'll be offering incredible deals leading up to Black Friday, including 4 weeks of deals on tens of thousands of items with many up to 50% off. Target Circle members will receive exclusive promotions and offers to reward and deepen their love of All Things Target. Plus, we've added more personalization than ever before, giving them even more options to earn rewards. And of course, we'll offer our season-long price match guarantee, which assures guests that no matter when they shop, they'll get the best price of the season. The holidays are so special to so many families, and they are made even brighter by everything our team members do for our guests and for each other. I'm so inspired by how each of our teams from marketing to merchandising to stores to supply chain are bringing their best to create something truly magical and uniquely target this holiday season. I want to thank the entire Target team around the world for being the not-so-secret weapon that will help us to win the holiday season. As I get ready to end my remarks, John, I want to pause and thank you and acknowledge your countless contributions to the Target brand and team. I've greatly appreciated getting to work alongside you for so many years and know your legacy will be felt for many more. With that, I'll turn the call over to you.
John Mulligan:
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 enter the holiday season. In addition, even though we own a lot less inventory than a year ago, the team has delivered meaningfully improved reliability and in-stock metrics this year, and they made additional progress in Q3. More specifically, overall in-stocks in the third quarter improved nearly 1 percentage point compared with Q2 and more than 3 percentage points from a year ago. And notably, in-stocks in our highest volume stores saw an even greater year-over-year improvement. In terms of our top-selling items, while the in-stock rate remained consistent between Q2 and Q3, that was after we grew the size of that list by about 75%, meaning that today, our top item list accounts for more than 1/3 of our total sales. Beyond these broader metrics, we also saw meaningful improvements in our seasonal in-stocks and a more than 6 percentage point improvement in new item in-stocks. In our smaller stores, which on average have less shelf capacity and turn faster than the chain, in-stocks have improved by more than 2 percentage points between the first and third quarters. And today, our in-stock levels in those stores are slightly better than the overall chain. And finally, in the digital channel, the percent of items available for purchase has improved by more than 2 points compared with last year, reflecting an improvement of nearly 8 percentage points in Apparel. Beyond the work of our team to deliver these outstanding improvements, we're benefiting from a more than 2-week reduction of import lead times compared with last year and a nearly 10 percentage point improvement in purchase order fill rates compared with a year ago. And with the combined benefit of a faster supply chain and a simultaneous reduction in inventory levels, all of our supply chain facilities stayed at or below our desired capacity thresholds through all 13 weeks of the third quarter this year compared with only 3 of 13 weeks in Q3 of 2022. So while we'll continue to focus on ways to consistently deliver higher in-stocks and reliability, I'm incredibly proud of what our team has accomplished so far this year. So now before I turn the call over to Michael, I want to highlight how our team continues to deliver on their efforts to improve execution of everyday retail fundamentals as we prepare for the busiest shopping season of the year. One of the key areas of focus for our store teams this year was to ensure priority items remained available on our sales floors throughout the day. And this year, through these efforts, we've increased the amount of inventory available on our sales floors by more than $0.25 billion. In addition, we've seen improvements in metrics relating to backroom inventory accuracy and the percent of new assortments set on time. In the digital channel, the percentage of orders picked and shipped on time and the average Drive-Up wait time have all improved from last year. Also in support of the digital business, the percent of items ordered but not found has declined from a year ago, meaning that we are fulfilling more items per order and canceling fewer, a key factor in guest satisfaction. Since our goal is for Target to be the easiest place for our guests to shop, our teams have been focused on the front of store experience with the goal of providing consistently great service through the in-store checkout experience, along with drive-up and in-store pickup. And because our guests tell us they enjoy interacting with our team, since we've refocused on the front-end experience, we've seen more than a 6 percentage point increase in the usage of full service lanes across the chain. And we've seen sustained month-over-month improvement in the Net Promoter Score relating to interactions with our team at checkout. In addition, compared with last year, we've seen improvements in Net Promoter Scores for both Drive Up and in-store pickup on top of already high levels a year ago. Beyond the front of store, in support of our efforts to highlight value and affordability, our team has been working to increase the number of store end caps featuring 1 or 2 price points. As a result, going into this holiday season, nearly 2/3 of our end caps were meeting the standard and conveying a simple, compelling and easy-to-understand value message. Finally, I want to provide a quick update on our goal of hiring 100,000 seasonal team members to join our team and provide a great guest experience during the holiday season. I'm happy to report that our hiring stats this year have improved relative to last year. I'm confident our entire team will be energized and ready to support our guests throughout the busiest season of the year. So now as I get ready to turn the call over to Michael, I want to quickly thank all of you for your continued interest and engagement with Target. I've been fortunate to meet and interact with many of you over the years beginning with my time as CFO and continuing with my time leading operations. I also want to say to the entire Target team, thank you for everything I've learned from you, for your enduring passion for retail and for your love of this iconic brand. I'll continue to be a huge supporter of this company and this team when I'm no longer on these calls. Because of all of you, I know that the company and our guests are in very good hands, and I'll be cheering on your efforts from the sidelines. Now I'll turn the call over to Michael.
Michael Fiddelke:
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 shrink represented a 40 basis point headwind to our third quarter gross margin rate. While we're encouraged that this impact was smaller than expected and better than we faced earlier in the year, growth in shrink remains a significant financial headwind, and we're determined to continue making progress in the years ahead. While our Q3 guidance anticipated significant improvement in our gross margin rate, our actual performance was well above our expectations as the team delivered greater-than-expected progress on several fronts. At the top of that list is their continued agility in managing inventory, which delivered compelling benefits on both the gross margin and SG&A expense lines. In addition, our team's ongoing efforts to identify long-term efficiency opportunities is already contributing to this quarter's better-than-expected performance. Beyond those drivers, a couple of macro factors came in better than expected including freight costs and the impact of inventory shrink. On the SG&A line, our third quarter rate of 20.9% was just over 1 percentage point higher than last year. This growth reflected cost increases throughout our business, including continued investments in our team, along with the deleveraging impact of lower sales, partially offset by disciplined cost management throughout the organization. Our Q3 depreciation and amortization expense rate of 2.4% was about 10 basis points higher than a year ago, reflecting dollar growth of about 3%. Altogether, our third quarter operating margin rate of 5.2% was more than a percentage point higher than last year. And notably, this year's rate was only about 20 basis points lower than the 5.4% our business delivered prior to the pandemic in the third quarter of 2019 despite the cumulative 110 basis point drag from shrink we faced since then. Also important, given the growth in revenue that our team has delivered over that 4-year period, this year's Q3 operating margin dollars were more than 30% higher than in 2019. As a result, on the bottom line, both GAAP and adjusted earnings per share of $2.10 in this year's third quarter were more than 36% ahead of last year and more than 50% higher than in 2019. Important to note, while the backdrop today remains tough, because of the long-term investments we continue to make and the efforts of our team to identify efficiency opportunities throughout our business, we have a lot more opportunity to grow both our top line and increase our profitability in the years ahead. And our team is already delivering strong profit performance, both compared to a year ago and versus our longer-term history as well. Now I'll turn to capital deployment and reiterate our priorities, which have remained consistent for decades. We first look to fully invest in projects that meet our strategic and financial criteria. Then we look to support the dividend and build on our record of annual increases, which we've maintained for more than 50 years. And finally, we deploy any excess cash within the limits of our middle A credit ratings through share repurchase over time. Regarding the first priority, capital investment through the first 3 quarters of the year was just under $4 billion, and we expect full year CapEx will be near the high end of the $4 billion to $5 billion range we laid out for the year. While we're still in the early stages of developing next year's capital plan, our current expectation is that next year's CapEx will be somewhat lower than this year in the $3 billion to $4 billion range, reflecting our current view of the optimal timing for key investments we're planning over the next several years. Regarding our second capital priority, we paid dividends of just over $0.5 billion in Q3, $10 million higher than last year, reflecting a per share dividend increase of 1.9%. Regarding the last priority, we didn't repurchase any shares in the third quarter as we continue to focus on strengthening our balance sheet and restoring our debt metrics to levels that support our middle A credit ratings. And we continue to make meaningful progress on that journey as the combined benefits of higher profits and lower working capital have led to a meaningful improvement in operating cash flow. More specifically, our operations have generated more than $5.3 billion in cash through the first 3 quarters of the year, up dramatically from about $550 million through the first 3 quarters of 2022. As always, I'll conclude my review of the quarter with our trailing 12-month after-tax ROIC, which was 13.9% in the third quarter, down from 14.6% a year ago. While an after-tax return in the low teens is quite healthy in absolute terms, it's meaningfully lower than the returns we expect to deliver over time. Importantly, we've seen sequential improvement in this metric over the last couple of quarters, and we're focused on continuing that momentum in the years ahead. Now I'll turn to our guidance for the fourth quarter. On the top line, our expectations reflect our continued near-term caution, leading us to maintain our prior guidance for a mid-single-digit decline in Q4 comparable sales. On the bottom line, we're also maintaining a cautious posture, particularly because the fourth quarter is typically a very promotional season. As such, we're planning a wide range for our fourth quarter EPS of $1.90 to $2.60, which represents approximately flat growth to last year on the low end and growth of about 37% on the high end. I also want to note that 2023 is a 53-week year. So the fourth quarter will include an extra week of sales and profits. We estimate that extra week will add about $1.7 billion in sales and result in about 30 basis points of operating margin rate leverage on the quarter. Note that it will not affect our comparable sales as we base that calculation on periods of equal length. On top of the results, our team has already delivered through Q3, our fourth quarter guidance implies a full year EPS range that's very close to the original guidance range we provided at the beginning of the year, with a midpoint less than $0.05 from the center of the original range. That's an amazing outcome against the backdrop of a tougher-than-expected top line, and it's a testament to the tireless efforts of our team to stay nimble and successfully navigate through a volatile and unpredictable period. In fact, given how strong our profit rate performance has been so far this year, we've been getting some questions about whether we're only focused on increasing our profit rate, and I want to pause and address that question head on. As John mentioned earlier, coming into this year, we were confident our team would deliver a significant increase in our profit rate by achieving better alignment between our inventory and our sales. In addition, a year ago, we first talked about the significant long-term efficiency opportunities we're pursuing, given that we've grown our revenue to more than $100 billion per year. While that work is still in its early stages, the team has already delivered hundreds of millions of dollars of efficiency savings so far this year, significantly benefiting our profitability. But I want to make it clear, we are focused on growing profit dollars. And if we saw an opportunity to invest a portion of our current profit rate to gain sustainable long-term growth in dollars, we would gladly do that. Even more fundamentally, our first priority is to deliver long-term top line growth because the only way a retailer can sustainably deliver bottom line growth is by delivering top line growth as well. At the same time, we're not interested in making any investments that might boost the top line in the short term, but which wouldn't lead to any sustainable growth. In fact, our experience has shown that many times, those kinds of short-term decisions are actually harmful over time. So today, we remain focused on the long-term strategies that have been so successful in driving top line growth over the last half decade, including our work to enhance our assortment of both owned brands and national brands, our investments in our store assets and our team to deliver a reliable and differentiated shopping experience, investments in new stores and markets we've not previously served and in existing stores to keep them fresh and enhancing our digital experience, beginning with the website and Target app, all the way through to the fulfillment services we provide. As we pursue those long-term initiatives, we also have opportunity to further grow our operating margin rate in the years ahead, and we don't believe those efforts are incompatible with each other. But more directly, based on where we are today, we believe we can successfully deliver both top line growth and rate improvement over time. And as always, the basis for my confidence starts and ends with the Target team. They have delivered unprecedented growth over the last several years. And this year, they've made amazing progress in moving our profitability back toward the optimal level, all while focusing on building and maintaining long-term relationships with our guests. Our team is truly the best team in retail. Now I'll turn the call back over to Brian.
Brian Cornell:
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 and its impact on individual leaders that's been the most notable. John has served as both a formal and informal mentor to countless members of our team, and he's hired and developed an extraordinary group of leaders, including Mark Schindele in our stores and Gretchen McCarthy in our supply chain, both of whom are ready and well prepared to continue leading the work after John steps down. Perhaps the strongest compliment I can pay John is to say he will be missed as a colleague, and I will personally miss his partnership. But I know our operations will not miss a beat given how masterfully he's prepared everyone around him. And that goes for me, too. Since the day I arrived, John has been a trusted adviser, whose only goal was to do what was best for our guests, for this great company and for our team. I should also reiterate that John will remain in his role through the end of this fiscal year and has agreed to continue in advisory role until February of 2025. We'll share additional information on our succession plans for John early next year. I'm sure I speak for all of us when I sincerely thank John for all he's done for Target and wish him only the best in his retirement. With that, we'll turn to Q&A. Christina, John, Michael and I will be happy to take your questions.
Operator:
[Operator Instructions] Our first question comes from Robby Ohmes with Bank of America.
Robert Ohmes:
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.
Michael Fiddelke:
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.
Robert Ohmes:
And do you still expect shrink to be favorable year-over-year in the fourth quarter?
Michael Fiddelke:
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.
Brian Cornell:
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.
Operator:
Our next question comes from Rupesh Parikh with Oppenheimer.
Rupesh Parikh:
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.
Brian Cornell:
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.
Rupesh Parikh:
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.
Michael Fiddelke:
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.
Operator:
The next question comes from Michael Lasser with UBS.
Michael Lasser:
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?
Brian Cornell:
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?
A. Hennington:
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.
Brian Cornell:
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.
Michael Lasser:
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?
Brian Cornell:
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.
Operator:
Our next question is from Edward Yruma with Piper Sandler.
Edward Yruma:
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?
Michael Fiddelke:
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.
A. Hennington:
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.
Operator:
Our next question is from Kate McShane with Goldman Sachs.
Katharine McShane:
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.
Michael Fiddelke:
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.
Katharine McShane:
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?
A. Hennington:
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.
Michael Fiddelke:
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.
Katharine McShane:
And John Mulligan, congratulations.
Operator:
Our next question is from Joe Feldman with Telsey Advisory Group.
Joseph Feldman:
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.
A. Hennington:
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.
Brian Cornell:
Operator, we've got time for 2 more questions today.
Operator:
Our next question is from Simeon Gutman with Morgan Stanley.
Simeon Gutman:
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?
A. Hennington:
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.
Brian Cornell:
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.
Simeon Gutman:
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?
Brian Cornell:
Well, you've opened up the door for John Mulligan to answer your question today, and I'm really glad you did.
John Mulligan:
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.
Brian Cornell:
Operator, we've got time for our final question.
Operator:
Our final question comes from Chris Horvers with JPMorgan.
Christopher Horvers:
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.
Michael Fiddelke:
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.
Brian Cornell:
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.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation's Second Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, August 16, 2023.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our Second 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 second quarter performance, along with our outlook and priorities for the remainder of the year. 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 second quarter and his priorities for the remainder of the year. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. In the second quarter, our team and our business model showed remarkable resilience in the face of multiple headwinds in the external environment. While these headwinds have led to a temporary slowdown in the pace of our business, that doesn't mean our team is standing still. Throughout the company, our team remains focused on staying agile and flexible as we continue to serve our guests and to listen carefully to them in this very dynamic environment.
And we're fortunate to have a business model that's inherently flexible by design. We offer a balanced multi-category assortment that's focused on our guests' wants and needs, allowing us to stay relevant in any environment and to quickly pivot as our guest priorities change. And our unique stores as hubs model, a concept we pioneered in the retail industry, allows us to serve our guests quickly, flexibly and reliably on every shopping journey, whether it takes place in a store or on a digital device. By continuously listening to, learning from and engaging with our guests and then refining our playbook with their insights, we'll continue to achieve our purpose of delivering everyday joy for all the families we serve while reinforcing our strong culture of caring, growing and winning together. As you'll recall, in the first half of 2022, we were faced with excess inventory, driven by a rapid change in consumer spending patterns. In the face of that challenge, the team took important steps a year ago, allowing us to quickly adjust our inventory down to the proper level. Those critical decisions have allowed our team to operate efficiently while focusing on serving our guests. They've enabled the presentation of fresh, seasonally appropriate assortments throughout the year and provided the flexibility to lean into share opportunities in key seasons, like Back-to-School and Back-to-College. And importantly, last year's inventory actions laid the groundwork for the recovery in profitability we've achieved so far this year. Our team also played a critical role in our second quarter profit performance. As we began to see softening sales trends early in the quarter, the team in our stores and supply chain responded with speed and agility. Their discipline, along with ongoing efficiency efforts, allowed our profit performance to exceed our original expectations despite a meaningful shortfall on the top line. More specifically, for the quarter just ended, operating income expanded by more than $800 million compared with a year ago. And despite the fact we've experienced more than a percentage point of cumulative profit pressure from higher shrink since 2019, our EPS of $3.86 through the first half of the year is more than 50% higher than in 2019. While this is encouraging progress, we are confident we'll see further meaningful increases in our profitability over time. On the top line, Q2 results were below our expectations as comparable sales decreased 5.4%. Within the quarter, comp trends softened from the second half of May into June, before we saw a meaningful recovery in both traffic and comps in July. In the month, we were especially pleased with trends around Independence Day holiday, along with Circle Week, which also resulted in the addition of more than 0.5 million new Target Circle members. Consistent with recent industry trends, second quarter comps reflected continued growth in our frequency categories, offset by notable software results in our more discretionary categories. Across channels, sales were strongest in our stores, while results in our digital channel were led by continued growth in our Drive-Up service. Consistent with our stores as hubs strategy, more than 97% of our second quarter sales were fulfilled by our stores. As we've described for more than a year now, the divergence of sales trends between our frequency and discretionary categories is being driven by multiple cross currents that are affecting the U.S. consumer. These include the impact of inflation in frequency categories, like Food & Beverage and Essentials, causing these categories to absorb a much-higher portion of consumers' budgets. In addition, consumers are choosing to increase spending on services, like leisure travel, entertainment and food away from home, putting near-term pressure on discretionary products. And finally, the rollback of government efforts to support consumers during the pandemic, including stimulus payments, enhanced child care tax credits and the suspension of student loan payments, presents an ongoing headwind that consumers continue to manage. Beyond these factors in the second quarter, many of our store team members faced a negative guest reaction to our Pride assortment. As you know, we have featured a Pride assortment for more than a decade. However, after the launch of the assortment this year, members of our team began experiencing threats and aggressive actions that affected their sense of safety and well being while at work.
I want to make it clear:
We denounce violence and hate of all kinds, and the safety our team and our guests is our top priority. So to protect the team in the face of these threatening circumstances, we quickly made changes, including the removal of items that were at the center of the most significant confrontational behavior.
Pride is one of many heritage moments that are important to our guests and our team, and we'll continue to support these moments in the future. They are just one part of our commitment to support a diverse team, which helps us serve a diverse set of guests. And as we talk to these guests, they consistently tell us that Target is their happy place, somewhere they can go to escape and recharge. So as we navigate an ever-changing operating and social environment, we're committed to staying close to our guests and their expectations of Target. Specific to Pride and Heritage months, we're focused on building assortments that are celebratory and joyous with wide-ranging relevance, being mindful of timing, placement and presentation, leaning into segmentation and leveraging our digital experience and reconsidering the mix of owned brands, national brands and external partners within these assortments. Our goal is to ensure we continue to celebrate moments that are special to our guests while acknowledging that, every day, for millions of people, they want Target to serve as a refuge in their daily lives. In addition to these more recent challenges, our team continues to face an unacceptable amount of retail theft and organized retail crime. As you'll hear in more detail from Michael, shrink in the second quarter remained consistent with our expectations, but well above the sustainable level where we expect to operate over time. And unfortunately, safety incidents associated with theft are moving in the wrong direction. During the first 5 months of this year, our stores saw a 120% increase in theft incidents involving violence or threats of violence. As a result, we're continuing to work tirelessly with retail industry groups and community partners to find solutions to promote safety for our store teams and our guests. Looking ahead, as you'll hear from both Christina and John, our team is focused on moving forward and preparing for the biggest seasons of the year. And given the current consumer and economic backdrop, we've adjusted our guidance for the remainder of the year, consistent with a cautious planning approach that has served us so well during the first half of the year. Against this cautious backdrop, our team is laser-focused on delivering newness, quality and affordability, reinforced by a commitment to retail fundamentals.
Given the rapid growth and the volatility our business has experienced over the last several years, we have an opportunity to refocus our team on 4 key factors that determine where consumers choose to shop:
Being reliably in stock; highlighting affordability throughout our assortment, presentation and marketing; leveraging the proximity of our stores to the guests we serve; while ensuring a seamless differentiated, easy and inspiring guest experience on every trip, every day. These areas have always been a source of strength, and we want to ensure we continue to differentiate our experience from our competitors.
Within our merchandising, we'll continue to invest in our industry-leading owned brand portfolio, along with the expansion of key national brand partnerships like Ulta Beauty, Levis, Apple and Disney. We'll focus on deepening the relationship with over 100 million Target Circle members and leveraging the power of our Roundel ad business to integrate relevant offers and promotions throughout the fall. And we'll continue to drive awareness of our industry-leading Drive-Up service and highlight the recent addition of new guest-focused options, including Drive-Up returns and the ability to have a Starbuck beverage delivered with your order. Of course, we'll also continue to invest in our physical assets to position us for continued future growth. But the bulk of these investments are happening in our stores as we add new locations, complete full store remodels, enhance the efficiency of our same-day services and add new locations for our Ulta Beauty partnership, Disney store concept or enhanced Apple experience. In the supply chain, we're continuing to invest in upstream replenishment capabilities, along with the expansion of our network of sortation centers, which deliver meaningful savings while increasing the speed of our last-mile delivery. So now before I turn the call over to Christina, I want to pause and take stock of where our business is today. And I think it's helpful to pull back the lens because 2023 is the fourth year in a row in which the external backdrop has been far different from anything we've ever experienced. Yet today, as a result of our team's consistent efforts to listen, understand and serve our guests, Target is a much different company than it was 4 years ago. We have the right strategy, guest relevance and team to deliver sustainable long-term growth. Through the first half of 2023, our total revenue of just over $50 billion was about 39% higher than the $36 billion we delivered in 2019. This growth reflects significant increases across our entire business in all 5 merchandising categories in both our stores and digital channels and in our Roundel ad business. And this growth reflects an increase in guest engagement, as measured by the number of visits they're making to Target. And today, despite the challenges we faced in recent quarters, the number of guest trips through the first half of 2023 was more than 169 million higher or more than 21% higher than in 2019. Our team delivered this growth during a time of exceptional uncertainty and volatility. I want to end my remarks by acknowledging that accomplishment. And I also want to recognize the team members in our stores and distribution centers for the way they quickly responded to the recent and unexpected slowdown in our top line sales trends. It's because of their discipline and agility that we've continued to provide an outstanding shopping experience while delivering better-than-expected profitability so far this year. On behalf of all our stakeholders, I want to thank our entire team for their continued extraordinary efforts. Now I'll turn the call over to Christina.
A. Hennington:
Thanks, Brian, and good morning, everyone. Despite the multiple headwinds we were faced on the top line, there were a number of things to like in the second quarter. Of the many notable bright spots, our team's agile execution in service of our guests and each other rises to the top.
Consumers continue to face difficult choices with every purchase. Whether managing their budgets in the face of higher prices or planning for resuming student loan payments, our guests are facing multiple ongoing challenges. With inflation rates moderating, however, we've started to see consumer confidence begin to recover from recent lows. And while we're maintaining an appropriately cautious outlook today, we're hopeful that conditions can improve with time. In the meantime, even as consumers continue to spend with caution, our guests continue to embrace newness and seasonally relevant moments, all with an unwavering focus on affordability. In the second quarter, comparable sales were down 5.4%, softer than our expectations coming into the quarter. Frequency categories continue to grow, partially offsetting the softness we saw in discretionary categories. Essentials & Beauty grew in the mid-single digits, led by Beauty, which delivered comp growth in the low double digits. Within our Beauty offering, core Beauty delivered double-digit growth while sales from Ulta Beauty at Target more than doubled compared with a year ago, showing why we're so enthusiastic about this exclusive partnership. Food & Beverage sales were in the low single digits, and we saw particular strength in snacks, candy and beverages. Conversely, discretionary categories softened further from recent trends, with Apparel, Home and Hardlines all seeing comp declines in the low double digits to mid-teens in the second quarter, several percentage points softer than in the first quarter. Even as trends in these categories remain quite soft overall, there are pockets of newness that are working quite well, and we're doubling down on investments in those areas. For example, our Entertainment business within Hardlines continues to see healthy growth in the mid-single digits, driven by newness in books and renewed growth in vinyl records. With that in mind and knowing how our guests can't get enough of Taylor Swift, we proactively secured an exclusive vinyl offering that Swifties bought in droves. Additionally, in Home, we've seen incredible demand for Stanley tumblers and cups. So we worked in partnership with Chip and Joanna Gaines to add exclusive new colors to the line as part of our beloved owned brand, Hearth & Hand, found only at Target. As you heard from Brian, we anticipated some of the headwinds at play throughout the second quarter. including the continued pullback in discretionary spending. Other headwinds were incremental, including the strong reaction to this year's Pride assortment. Our goal is for our assortment to resonate broadly and deliver on the Target brand promise. In this case, the reaction is a signal for us to pause, adapt and learn so that our future approach to these moments balances celebration, inclusivity and broad-based appeal. As we move ahead, we're confident that if we stay close to our guests, consistently execute on our retail fundamentals and continue investing in our assortments, services and experiences, we will position Target for continued growth over the long term. After all, as a guest-led company, we have been listening to and learning from our guests for decades. As an example, last year, we heard loud and clear that Target Circle members love exclusive events. So we repurposed last year's Deal Days and made our Target Circle Week in July bigger than ever with incremental promotions and new ways to engage. In fact, we enrolled well over 0.5 million new guests during this event alone, more than 3.5x higher than in an average week. Additionally, Beauty guests told us for years how they would love the convenience of completing their beauty trip with access to prestige beauty products while shopping at Target. This led to the development of a unique partnership with Ulta Beauty to meet those needs. And today, based on the strong results we've seen so far, we continue to expand the footprint of these new shop-in-shops. When our guests, who already love our Drive-Up service, told us that they wanted us to add Starbucks and the ability to make returns, we quickly built, piloted and are now rolling out those capabilities across the chain, and we're seeing incredibly high Net Promoter Scores from our guests. And well before the recent release of the long-awaited Barbie Movie, we collaborated with our vendor partners to secure exclusive items across multiple categories while adding a splash of pink style for Barbie fans of all ages. Barbie, along with Disney's The Little Mermaid, are the most recent examples of our long record of success in securing timely, relevant product lines supporting key movie licenses across toys, apparel, home, beauty and food, which have allowed us to consistently capture between 30% and 60% market share with these properties. While we continue to take a conservative inventory position overall, these examples show that we are still leaning into key opportunities. We know our guests want to celebrate culturally and seasonally relevant moments, and we'll be leaning into those moments in a big way in the third quarter and the upcoming holiday season. And our guests have told us that affordability; availability; and easy, convenient and consistently joyful shopping experience are more important than ever.
While I've shared in prior calls that we're always focused on retail fundamentals, we're further sharpening our focus on 4 key aspects:
Comprehensive affordability, in-stock levels, leveraging our proximity to our guests and the overall shopping experience.
For a great example look no further than our Back-to-School and Back-to-College assortments. We know our guests are approaching Back-to-School with a value-conscious, deal-driven mindset, so we're leaning into savings for teachers and college students, including our 20% off Teachers Appreciation and Student Savings events. We're also featuring ultra low everyday prices all season long, with school supplies starting as low as $0.25, and key items such as lunch boxes and graphic tees at compelling $5 price points. And just in time for Back-to-School, we're launching new Good & Gather products, including an assortment of new lunchbox-sized items. Back-to-College is always a big season for Target. This year, we're leaning into affordability as well as proximity to college-bound students. This includes strategic inventory bets and allocations in key markets where there are the greatest market share opportunities to ensure we're in stock and ready to play offense during this critical season. Of course, affordability goes well beyond a single season like Back-to-School. In fact, with many consumers making their decisions on where to shop based on affordability, we're highlighting the comprehensive value we provide through our $30-plus billion owned brand portfolio. For example, Threshold, our flagship owned brand in Home, just received a major facelift. With new branding, stronger price points and a clarified aesthetic to help guests mix and match affordable styles for their homes, this beloved brand will be even easier to love. And just in time for the holidays, we'll be launching new owned brands while expanding others, including the launch of a new kitchenware line that will make everyday meal prep easier while offering incredible quality and durability. Look for lots of newness on store shelves and online later this Fall. As John will cover in more detail, we continue to invest heavily in our in-store experience, which starts with new stores and remodels that incorporate our latest and greatest offerings, including Apple, Levi's and Disney experiences, as well as the additional Ulta Beauty at Target locations. And just like we remodel our stores to reflect our latest thinking and guest feedback into the shopping experience, we'll begin rolling out a remodel of our digital experience this quarter. Based on guest feedback, we're investing to create a digital experience that enhances the love of discovery while balancing the ease of navigation. This will include different landing experiences, more personalized content, enhanced search functionality, ease of navigation and other updates to bring more joy and convenience to our digital guests. Through it all, our teams continue to exhibit a commitment to excellence in the pursuit of helping all families discover the joy of everyday life. Regardless of the external environment, our team consistently shows up and rises to the moment. I'm incredibly proud to work alongside such a talented team. Thank you for all you do to bring that Target magic to life day in and day out. With that, I'll turn the call over to John.
John Mulligan:
Thanks, Christina. Like Brian and Christina, I want to start by thanking our amazing team. This quarter's better-than-expected profitability was a testament to their agility and resilience as they successfully managed through multiple challenges.
And while the team deserves credit for this performance, they got an assist from this year's leaner inventory position which offered more room to maneuver than a year ago when the team was dealing with excess inventory. This year, with unclouded facilities, a renewed focus on retail fundamentals and our continued work to enhance efficiency, the team delivered an impressive increase in profitability in the face of a challenging top line. Across the entire supply chain, we're benefiting from much more favorable conditions than a year ago. Perhaps most notable is in global shipping, where second quarter import lead times were nearly 30 days shorter than last year and within a couple of days of pre-pandemic levels. In our domestic supply chain, because of strong partnership with our vendors, we're seeing improvement on multiple performance metrics, including fill rates and on-time arrivals. And at our regional distribution centers, inbound backlogs have been reduced by more than a day since last year. In the new flow centers we've opened over the last couple of years, we're also seeing improvements across multiple performance metrics as these new buildings continue to scale up towards capacity. In support of their primary role in replenishing store inventory, these facilities were designed and equipped to support our stores as hubs strategy with newly developed automation that can assemble customized, presorted and sequence shipments for every store they serve. With these shipments, stores see faster replenishment times, require less labor to unload a trailer and maintain lower levels of backroom inventory. More precisely, stores being serviced by these new facilities have seen a 20% reduction in lead times, enabling them to respond more quickly to changes in guest demand. Also notable, stores serviced by these new facilities are benefiting from improvements in in-stock levels while maintaining lower levels of backroom inventory. Beyond store replenishment, we're operating these new flow centers in a way that's unique within the industry. In the same way we pioneered ways to leverage the proximity, inventory and assets in our stores to quickly and efficiently fulfill digital orders, we're leveraging those same characteristics of our flow centers to fulfill certain digital orders beyond their primary role in replenishing store inventories. In light of our focus on retail fundamentals throughout the supply chain, our stores are seeing meaningful improvements in their in-stocks, even with 17% lower inventory on our balance sheet than a year ago. In the second quarter, overall in-stocks were a full percentage point better than first quarter and more than 2 points better than last year. We've seen even bigger improvements on our top items and in our top stores. And this year, we sat with meaningfully better in-stocks on key seasonal programs, including Back-to-School and Back-to-College, than we saw a year ago. Our new sortation centers are delivering outstanding results. These facilities operate downstream from our stores and help to increase the speed and efficiency of last-mile delivery. Up to 70% of the packages processed by these facilities stay in the local market, allowing us to partner with Shipt to handle the last mile. This integration with Shipt allows us to achieve meaningful efficiency and cost savings while offering much greater speed of delivery to our guests. More specifically, in markets where we operate a sortation center, the average click-to-deliver time is nearly 1.5 days shorter than the network average, with about 1/3 of the packages arriving in only 1 day. As we continue to open new buildings and test and iterate on their operating model, we expect these speed metrics will continue to improve in the future. Today, based on the proven success of this strategy, we have 10 sortation centers already operating and expect to open at least 6 more over the next few years. This current group of sortation centers is expected to process more than 35 million packages in 2023, representing a more than 20% increase from a year ago and a more than sixfold increase from 2021. As I described in our call 3 months ago, store teams this year have been focused on reinforcing best practices that support the retail fundamentals Christina highlighted earlier. In particular, this year, we've been investing to provide incremental training and reporting on several key factors that play a critical role in providing a great shopping experience, including staffing and scheduling; setting, filling and replenishing merchandise presentations; and protecting the safety of our guests and our team. Throughout this year, our store teams have been progressing through a strategically sequenced training program designed to reinforce these best practices at key moments, like Back-to-School and Back-to-College. The goal is to provide an elevated, consistent experience every day in every store across the country. Since we've rolled out this training, we've seen broad-based improvement on performance metrics tied to critical guest outcomes, including pricing accuracy, locating items for digital orders and setting key seasonal programs more quickly and completely. And in support of the goal of achieving greater consistency in the level of execution across our nearly 2,000 stores, we've implemented a new rapid response process to help individual locations recover more quickly when they begin to see a decline in key metrics. Also in stores, as Christina mentioned, we are really pleased with the early results from nationwide rollout of Drive-Up returns and the ability to add a Starbucks order to a Drive-Up trip. We've long said that Drive-Up receives the highest satisfaction rating of any service we provide. And as proud as we are of what we've already accomplished, we continually push ourselves to find new ways to further differentiate Drive-Up. And when we ask our guests how we could do that, they told us that adding Starbucks and taking returns were at the top of their list. To ensure that we could consistently execute on these new services while maintaining the high bar we've attained for satisfaction, we applied a disciplined test-and-iterate approach to the rollout, beginning with small-scale tests in the second half of 2022. Following a successful test of Drive-Up returns, we launched the service nationwide in April and May, and the results have been outstanding. Once a guest arrives at a Drive-Up lane, the average wait time for a team member to process their return is within 3 minutes, consistent with our standards for a traditional Drive-Up order. As we began testing the addition of Starbucks to Drive-Up, and given the complexities of making and promptly delivering a hot or cold beverage after our guest arrives, we wanted to put the process through an intensive period of testing and refinement. And today, based on what we've learned during the test period, we're confident we can scale up this service while consistently maintaining our service standards. As a result, we're currently in the process of rolling out Starbucks at Drive-Up nationwide and plan to complete the rollout by the end of October, just in time for pumpkin spice latte season. So now before I finish my remarks, I want to provide a brief update on this year's new store openings. As you know, we plan to open about 20 new locations this year, ranging in size from 20,000 to 137,000 square feet. In the second quarter, we completed and opened another 5 new stores, bringing our year-to-date total to 11. Highlight of our second quarter projects was the opening of our first new offshore location since 2021, a new store in the Oahu Windward Mall, bringing our store count in Hawaii up to 9. At 132,000 square feet and featuring a Starbucks, Ulta Beauty, CVS, Snack Bar and 18 Drive-Up stalls, this is one of the largest stores we'll open in 2023. And I'm happy to say that it had one of the strongest openings of the year, reflecting outstanding execution by our team. Like our other stores in Hawaii, this new location is expected to be one of the most productive in the chain. And during its first week, it generated the second-highest sales volume out of the most recent 175 stores we've opened. I also want to pause and acknowledge the devastating wildfires that hit Maui in Hawaii. Thankfully, members of our team there are safe, though some have lost homes, had to evacuate or are providing shelter for family and friends. Our nearby stores remain open, helping guests to get much-needed essentials while donating masks and other emergency supplies. In addition, Target has announced a $1 million donation to help national and local disaster partners, and our team member giving fund is collecting donations from team members across the country to help their colleagues impacted by these wildfires.
So as I turn the call over to Michael, I want to end with where I started and highlight the tireless efforts of the best team in retail. The last 4 years have been anything but business as usual, and through it all, our team has consistently maintained their focus on what matters most:
Taking care of our guests and taking care of each other. I couldn't be more proud to work alongside them and learn from them every day.
That, I'll turn it over to Michael.
Michael Fiddelke:
Thanks, John. As John just mentioned, our team and operating model continue to navigate through a host of challenges on the top line, but our business is showing its resilience.
More specifically, we're really pleased with the strength of our second quarter profit performance, which further validates the cautious planning approach and lean inventory position we've maintained throughout the year. This positioning, combined with our continued efficiency efforts, allowed us to make meaningful progress toward our profit recovery goals even in the face of softer-than-expected sales, giving us further confidence that our strategy is sound, we have the right team and our business is positioned for continued progress in the years ahead. Total revenue was down 4.9% in the second quarter. Total sales also decreased by that same amount while other revenue grew 1.3%. Within other revenue, we continue to see strong growth from our Roundel ad business, which offset declines in credit card profit sharing and other small income items compared with last year. Comparable sales were down 5.4% in Q2, reflecting a 4.8% decline in traffic. Among the factors affecting our top line performance, comps and discretionary categories continue to reflect challenging trends in the industry, which softened further in Q2. A second factor was lower inflation in food, beverages and essentials as we compare to over peak inflation a year ago. Furthermore, traffic and top line trends were affected by the reaction to our Pride assortment, which launched in the middle of May. And lastly, our results reflected the comparison over last year's clearance and promotional activity, which affected weekly comp trends in certain categories, particularly in the digital channel. While each of these factors played a role in the quarter, it's not possible to reliably quantify the separate impact of each one. In terms of the monthly cadence in Q2, comp sales in May were down a little more than 3%, moved down to a decline of just over 7% in June, then made an encouraging recovery to minus 5% in July. Monthly traffic followed a similar cadence and actually recovered a bit faster than sales in July. Even with unexpectedly soft sales, inventories remain very well controlled. At the end of the second quarter, balance sheet inventory was 17% lower than a year ago. This reflects our cautious planning approach, the agility of our team in responding to softer sales trends and the benefit of a faster global supply chain which enabled shorter lead times. Among our merchandising categories, discretionary inventory was down 25% at the end of Q2, partially offset by increases in our frequency categories and strategic investments and long-term share opportunities. Importantly, as John mentioned, even with much leaner inventories, we've seen meaningful in-stock improvements across our network. We were really pleased with our second quarter gross margin performance, which was enabled by our ongoing work to navigate this volatile environment. Our Q2 gross margin rate of 27% was 5.5 percentage points higher than a year ago. This increase reflects multiple benefits within merchandising, including lower markdowns and other inventory-related costs, along with the benefit of lower freight and transportation costs. Beyond merchandising, we also saw about 0.5 point of benefit in digital fulfillment and supply chain due to a lower mix of digital sales and a favorable mix of same-day services within the digital channel. Offsetting these benefits was a 90 basis point headwind from inventory shrink, in line with our expectations. One note. Consistent with the first quarter, category mix did not affect our gross margin rate compared with last year, and we saw a similar deceleration across all 5 of our core merchandising categories between Q1 and Q2 of this year. Our second quarter SG&A expense rate was 1.7 percentage points higher than last year. This increase reflects the deleveraging impact of lower sales, combined with the impact of higher costs, including continued investments in paying benefits for our team and inflationary pressures throughout our business. These pressures were partially offset by disciplined cost management across our team. On the D&A expense line. The Q2 rate was about 20 basis points higher than last year, reflecting the deleveraging impact of lower sales on a 3.9% increase in dollars. Altogether, our Q2 operating margin rate of 4.8% was about 4x higher than last year, reflecting a meaningful recovery from last year's inventory actions. On the bottom line, our second quarter GAAP and adjusted EPS of $1.80 was significantly higher than last year and above the high end of our guidance range. While we expected to see a big improvement in profitability this quarter, I can't emphasize enough the importance of our team's agility in delivering this performance, something that's even more notable given that shrink drove nearly a full point of profit pressure versus last year. Now I want to turn briefly to capital deployment and start with our priorities, which have served us well for decades. First, we fully invest in our business, in projects that meet our strategic and financial criteria. Then we look to support our dividend and build on more than 50 years of consecutive annual increases. And finally, we return any excess cash through share repurchase over time within the limits of our Middle A credit ratings. So far this year, we've made capital expenditures of $2.8 billion and continue to expect full year CapEx in the $4 billion to $5 billion range. In the second quarter, we paid $499 million in dividends compared with $417 million last year, reflecting a 20% increase in the per share dividend. And finally, we didn't repurchase any shares in Q2 as we continue to focus on strengthening our balance sheet and restoring our debt metrics to levels that support our Middle A credit ratings. And we're encouraged by the progress we've already made, as the combined benefit of a significant profit recovery and lean inventory position have driven a meaningful improvement in operating cash flow. More specifically, our operations have generated $3.4 billion in cash through the first half of this year compared with a slightly negative number through the first half of last year. I'll end my comments on the quarter with our after-tax return on invested capital, which measures our current profit performance in the context of our long-term investments. For the second quarter, our trailing 12-month after-tax ROIC was 13.7%. While still healthy in absolute terms and more than 2 percentage points higher than the first quarter, it remains well below the level where we expect to operate over time. Now I'll turn to our expectations for Q3 and the remainder of the year. And today, as we assess the economic and industry backdrop, we continue to see a mixed picture. On the positive side, GDP, employment and overall consumer spending have been resilient, and we're beginning to see a recovery in consumer confidence. On the other side of the ledger, while we're happy to see inflation rates begin to moderate, that's likely to cause some near-term pressure on dollar comps in our frequency categories. In addition, the upcoming resumption of student loan repayments will put additional pressure on the already strained budgets of tens of millions of households. Against this backdrop, we remain cautious in our planning, an approach that has served us really well so far this year. On the top line, we're now planning for comparable sales in a wide range centered around a mid-single-digit decline for the remainder of the year, consistent with what we experienced in July and the second quarter overall. This updated sales expectation is meaningfully softer than our expectation at the beginning of the year. With this change in the top line, we've also adjusted our bottom line guidance and now expect full year GAAP and adjusted EPS in the $7 to $8 range compared with our prior range of $7.75 to $8.75. While multiple factors will determine where our actual results wind up in comparison to this expected range, the single most important variable will be the pace of our sales as we're confident we'll continue to benefit from our efficiency efforts and lean inventory position. In the third quarter, we're expecting GAAP and adjusted EPS in a range from $1.20 to $1.60 on a wide range of comparable sales centered around a mid-single-digit decline. In terms of quarterly EPS cadence, I want to take note of a couple of unique circumstances this year. The first is shrink and how that is expected to play out over the next 2 quarters. As I mentioned earlier, based on the high loss rates we're continuing to see, second quarter shrink was consistent with our expectations, and our full year shrink expectations remain unchanged. However, we expect the year-over-year comparisons will look meaningfully different between Q3 and Q4. In Q3, we expect the dollar and rate pressure from shrink will be roughly consistent with the first half of the year at around 90 basis points. However, in Q4, we expect to see a small amount of year-over-year favorability from shrink. I want to stress that this anticipated change in quarterly comparisons does not reflect an expectation that underlying loss rates will begin to improve in Q4. As Brian mentioned, we're working hard, both inside our stores and with government and community partners, to achieve lower loss rates over time. And our long-run expectation is that shrink rates will moderate from today's unsustainable levels. But so far, we've only seen indications that loss rates might soon be reaching a plateau, but have not yet seen evidence that loss rates will begin to come down. So the only reason for the expected change in year-over-year comparisons is the cadence of how shrink was recognized by quarter in the back half of last year, a period when loss rates increased rapidly, resulting in higher shrink accruals at year-end. Because we've seen more consistent loss rates in 2023, quarterly accruals have been more consistent throughout this year. Another important consideration is that 2023 is a 53-week accounting year, so the fourth quarter will include an extra week of sales and profits. We estimate that the extra week will add about $1.7 billion in sales and results in about 30 basis points of operating margin leverage on the quarter. I'll note that the extra week will not affect our comparable sales as we base that calculation on periods of equal length. As I get ready to end my remarks, I want to add my thanks to the entire Target team. From the flexibility they built into our business plans, to their responsiveness in the face of this quarter's top line volatility, and their continued work to enhance our long-term efficiency, they're clearly demonstrating their amazing resilience and showing why we're confident that we work with the best team in retail. With that, I'll turn the call back over to Brian.
Brian Cornell:
Before we turn to your questions, I want to pause and reinforce why we're so confident in our long-term prospects, which position us for profitable growth in the years ahead.
Retail is an ongoing journey:
The continuous process of listening to consumers and rapidly evolving to meet their preferences. To do that well, you need to have the right assets in place which allow you to quickly evolve as your guests' wants, needs and preferences change. And we're proud of the way we have built and strengthened Target's assets over the last decade.
During this time, we pioneered and built a unique stores as hubs model and invested in new supply chain capabilities to support that model. We invested billions of dollars in our existing store base, modernizing their shopping experience while optimizing those facilities to support digital fulfillment. We opened new locations in markets that had never been served by a Target store, and we continue to evolve our new store design. We developed and launched industry-leading same-day services, which received some of the highest guest satisfaction ratings of anything we do. Within our assortment, we innovated to make our Food and Beauty businesses even stronger and gained huge amounts of market share along the way. We built an even stronger portfolio of industry-leading owned brands which today generate more than $30 billion in annual sales. We also strengthened our portfolio of national brand partners with Ulta Beauty as the most recent example. At the same time, we developed and launched our Roundel ad business, which leverages the power of our guest base and vendor relationships, to deepen the bond between our guests, our vendors at Target. We also built and launched Target Circle, which has quickly become one of the largest loyalty programs in the United States, providing us with even deeper insights about our guests and how we can serve them. And finally, we invested in our team, the best team in retail, by rapidly increasing their hourly wages and the benefits we provide while building stronger pathways to career development and advancement and designing operational processes to enhance their safety and job satisfaction. With all of these assets in place today, we're not standing still. We're uniquely prepared to navigate into the future, including any uncertainties we'll face. We're committed to carefully listening to our guests and to our team and continuing to invest in capabilities and assets that will best serve our guests, even as their wants and needs and expectations evolve from where they are today. Since no one knows what the future will bring and when new opportunities and challenges will arise, the company's best position to thrive over time are the ones with the tools to adapt. And with our stores, our brands, and our vendor partners, our capabilities and our great team, we have everything we need to deliver long-term growth and success. With that, we'll turn to Q&A. Christina, John, Michael and I will be happy to take your questions.
Operator:
[Operator Instructions] Our first question is from Rupesh Parikh with Oppenheimer.
Rupesh Parikh:
So I was hoping to get more color in terms of what you guys are seeing quarter-to-date. And then if you have any initial reads on what you're seeing with the Back-to-School season.
Brian Cornell:
Michael, I'm happy to start. Rupesh, obviously, it's very early in the season. But for the first 10 days of August, we're very pleased with the results we're seeing. They were very consistent with what we saw in the month of July as guests turn to Target for their Back-to-School and Back-to-College shopping.
Michael Fiddelke:
Yes. I don't have much to add to that. We knew the Back-to-School and Back-to-College seasons would be important for us. They always are. Second-biggest seasonal moment for us only next to the holiday season. And it was a season where we expected to have some share opportunities.
So like Brian said, 10 days in, so just getting started with the quarter, but we're pleased with what we see so far. And the exciting thing about the balance of the year is we've got a lot of those seasonal moments to come. And we know our business performs so well across all categories in those seasonal moments.
Brian Cornell:
Michael, the only thing I would add as we think about Back-to-School, and particularly Back-to-College, is we expect the shopping season to extend into September, in fact, throughout the month of September. So we're off to a solid start, it's still very early. But we think this will be a Back-to-School season that extends into September.
Rupesh Parikh:
Great. And then maybe one follow-up question. So at your Analyst Day, you indicated expectations for achieving a 6% operating margin rate as early as FY '24. Just given that weaker top line, is that still in the realm of possibility, of getting up to 6% in your next fiscal year?
Michael Fiddelke:
Fair question, Rupesh, and one I'm sure we'll come back to over time. Right now, we're laser-focused on delivering a strong back half of the year. We're pleased with the profit recovery we saw in the second quarter. When we headed into this year, the path to 6% was paved with meaningful profit rate improvement in 2023. And I couldn't be more thrilled with the progress the teams are making towards that, as evidenced by the strong profit performance in Q2. And we'll continue to plan cautiously and set the team up for as much agility as possible in the back half of the year. And I would expect that progression on profit to continue through the balance of this year, but more to come at the right time on what we think that long-term trajectory looks like.
Operator:
Our next question is from Kate McShane with Goldman Sachs.
Katharine McShane:
We wondered if you could talk through gross margins maybe a little bit more. We were curious about how much more markdowns were versus plan given the softness on the discretionary side and some of the merchandising challenges. And what was the offset -- the meaningful offset there?
Michael Fiddelke:
Yes. Kate, I'm happy to start and welcome, Christina, if you want to add any more color. But the biggest story on the markdown front. I mean, I think we described the promotional environment is rational and really as expected for the quarter. On a year-over-year basis, clearly, as you know, Kate, we saw meaningful improvement from last year's excess markdowns and cost to clear inventory. And so as you think about the 5-plus point improvement in margin rate year-over-year, the vast majority of that improvement comes from being cleaner from an inventory respective and saving those costs from last year.
And so again, just one more example of, by planning the business cautiously, by positioning with flexibility, and by the team reacting to some of the sales trends we saw in the quarter with urgency, we've been able to keep inventory really clean. If you look at the balance sheet, you'll see as clean of an inventory picture exiting the quarter as we started with, with inventories down 17% in total, down 25% in the discretionary categories. So we feel well managed on the inventory front, and that's showing up with markdowns playing out as expected.
A. Hennington:
Yes, Michael. I wouldn't have a lot to add. We're pleased with the team's agility and we believe that the environment is rational, and we're continuing to build back our profit in light of the circumstances.
Katharine McShane:
And a follow-up question comes on the heels, I think, of the first question that was asked. But wanted to get a little bit more detail about any changes in consumer behavior within the discretionary categories, especially as traffic got better into July? And just how you're thinking of the discretionary categories in the back half of the year.
Brian Cornell:
Yes. Kate, I think we've continued to see the same trends over really the last year now. Well, I think we see a very resilient U.S. consumer, and I think so much of that is fueled by the strength in the labor market. We continue to see a consumer who is facing high inflationary pressure in Food & Beverage and Essential categories that's absorbing a bigger portion of their wallet.
I think as they think about discretionary spending, we've seen a rotation in their wallet from goods into services. You're seeing the uptick in travel and leisure, what's happening in entertainment. So those trends, we expect to continue into the back half of the year. We'll watch it carefully. I think our inventory position allows us the ability to chase into demand, and we'll be ready when we see demand changing as we enter the holiday season. But I think the consumer is still taking a very cautious approach to discretionary spending in the goods sector.
Operator:
Our next question is from Oliver Chen with TD Cowen.
Oliver Chen:
Regarding traffic, what's your forecast for traffic that's embedded in guidance? Do you expect it to continue to be in the negative low or negative mid-single-digit range?
Also, as we dive a little deeper into the discretionary product assortment, what do you see as opportunities in apparel? And how are you thinking about your overall private label assortment in terms of rebalancing and/or the portfolio relative to non-private label?
Brian Cornell:
Christina, do you want to talk about some of the plans we have in place for the back half of the year, some of the newness we have in our assortment, and some of the exciting new changes we're going to make from an owned brand standpoint?
A. Hennington:
Yes, I'd be happy to. So Oliver, thanks for the question. On the discretionary portfolio, we continue to build our assortment strategy for the long term. We fully believe in our multi-category portfolio, that it offers us an ability to meet the guests' needs in a variety of different times.
At the moment, given where the consumer is spending, we're, of course, leading on the strength of our Food & Beverage portfolio and Essentials & Beauty, with Beauty really being a highlight with double-digit growth both in Ulta Beauty at Target as well as our core business. Within discretionary, what we're seeing is that there are things that are very much working around newness and innovation. And as you pointed out, our owned brand portfolio plays a huge role in delivering against those goals. We design, we create, we source, we build assortments that -- where we can control a lot of those elements. And we've introduced a lot of newness whether you think about, even in the last quarter, taking advantage of the hot trend with family tumblers and introducing that and embedding that in Hearth & Hand. We have just relaunched our own brand, Threshold, which is our signature Home brand, with updated aesthetics and great price points and new branding. We continue to lean on opportunities. You'll see us launch a kitchenware brand later this quarter, which we're really excited about for its value, but incredible quality and durability. But beyond those opportunities to introduce innovation, it's really taking advantage of the opportunities where guests can do more in one store at Target, and that happens during those seasonal times, where we can leverage both the strength of Food & Beverage as well as Home or Apparel to complete the trip. And Back-to-School, Back-to-College, as Michael mentioned, is a terrific time for us to showcase the strength of our portfolio. So we'll keep doing what we're doing. We're leaning into different categories, but we're planning appropriately so that we can be responsive in the market.
Michael Fiddelke:
And Oliver, on traffic, as you know, we don't break out a separate traffic forecast. And so kind of the build that goes into our top line guide is embedded in all the things that underlie it. But a couple of thoughts that, one, I'll just reiterate from my comments.
We were pleased with the sequential improvement in July in the quarter, and we saw traffic improve at a slightly faster rate than dollars did as we saw that improvement. And then if you zoom all the way back out, versus 2019, if you look at the first 6 months of this year compared to 2019, I mean, we've got almost well over 20% higher traffic coming to our business than we were pre-pandemic. That translates to 170 million or so more guests interactions with Target in store and online. And so the deeper guest engagement we've built is evidenced by our traffic growth over time, critically important to our prospects going forward.
Brian Cornell:
I'll try to tie those 2 questions together. During the balance of the year, you'll continue to see us lean into seasonal moments. We know those are very important moments for our guests, those are traffic-driving moments for Target. And to Christina's point, we'll combine great newness with affordability throughout those seasons.
If you're in our stores today or looking at target.com, you're seeing us lean into this Back-to-School season with great affordability. We'll continue to do that as we enter the Halloween season, get ready for the holidays, combining that great Target newness with great affordability that meet the needs of our guests. So we'll be cautious as we plan for the back half of the year, but we'll lean into those big seasonal moments where we know the guest expects Target to be there to meet their needs.
Oliver Chen:
Brian, one follow-up. Inclusivity has always been important to Target as well as thinking about stakeholders. What are your thoughts in terms of appealing to the broad array of customers going forward and strategies there, particularly around LGBTQIA+?
Brian Cornell:
Oliver, at the heart of our purpose is our commitment to bring joy to all the families we serve. And that really is all families. So we want to make sure Target is that happy place for all of our guests, a place where they can recharge and enjoy those shopping experiences, and you should expect to see us continue to do that over the years to come.
Operator:
Our next question is from Michael Lasser with UBS.
Michael Lasser:
The perception is that Target gained a lot of share over the last few years. And now as its traffic is under pressure, guests are either going elsewhere or Target is losing market share. So what levers can Target pull in order to recapture those who would become disenfranchised or are seeking out value or discretionary goods at other retailers? And how much might it cost to regain those guests that are now shopping elsewhere?
Brian Cornell:
Michael, I might start by zooming out a bit and kind of looking at our performance over several years. Since the start of the pandemic, we've added over $30 billion of top line growth, a significant increase since 2019. And importantly, that's been driven by an increase in trips and transactions, guests spending more time shopping in our stores.
I think the strategy we have in place and have had in place for years will serve us well going forward. We'll continue to make sure we're investing in a great in-store experience. Making sure that we are recommitting to retail fundamentals, which means being in stock every time you shop, providing great affordability, making sure we're leveraging our proximity, providing a great guest experience. That extends into the work we'll do from a fulfillment standpoint. We continue to see our guests turn to Target for same-day services, whether it's Drive-Up or Pick-Up or having something delivered to their home through Shipt. Our owned brand portfolio is now a $30 billion brand portfolio. It's a trusted portfolio of brands that provides great quality and style and affordability. So we'll continue to invest in the strategy that served us so well over the last few years and I believe will continue to serve us well going forward.
Michael Lasser:
Understood. Our follow-up question is on the operating expense outlook. In light of the traffic declines, presumably, you're adjusting your labor. And on top of that, you're in the midst of harvesting $2 billion to $3 billion of savings over the next couple of years. So can you give us a sense for how your operating dollar growth is going to look in the back half of the year? And are there any onetime factors that are going to benefit your operating expense dollar growth that would not be sustainable moving forward?
Michael Fiddelke:
Yes, I'm happy to take that one, Michael. I mean, obviously, on the SG&A line, leverage matters. And so the softness we saw in the second quarter showed up in some deleverage on some of those more fixed expenses, especially in an inflationary environment. We still got a fair amount of inflation. And importantly, investments in our team, in wage and benefits on that line as well.
But I'll say the team's flexibility in the quarter, not just in SG&A, but across the P&L, was really remarkable. And that starts with well-managed inventories. And we talked about the implications for markdowns on the gross margin line there. But managing inventory well flows across the whole system. I mean, we were heavy last year. That makes us more efficient -- more inefficient in stores when the back rooms are full. It makes us more inefficient in our distribution centers when we're managing a lot of inventory. And so we're seeing the benefits of that cleaner inventories position across the system, and I would expect those benefits to continue. And we've got a team that's really focused on managing costs and expense well in the current environment. And that work on efficiency, to translate the scale gains we've seen over the last few years into a more efficient operation, I would expect that to continue to be fuel in the quarters and years to come on the efficiency front.
Brian Cornell:
Operator, we have time for one last question today.
Operator:
Our last question is from Simeon Gutman with Morgan Stanley.
Simeon Gutman:
I wanted to ask, I don't know the way in which you look at the consumer, whether it's in quintiles or deciles. Can you give us a sense, if you look at the comp that the business is performing, how that spreads across your best customer, your middle customer and then maybe your most occasional customer? And if there's anything we could glean from that and think about how it recovers.
Brian Cornell:
Christina, do you want to share some of the insights we have about the different guests that are shopping our stores today?
A. Hennington:
Yes. I think, obviously, we've seen the -- as Brian talked about, we've seen a rotation in their wallet. And so the guests that are more engaged with our discretionary businesses are now leaning more on into our frequency businesses.
But I would tell you a very compelling proof point that came out of the second quarter is how we performed during Target Circle Week. Target Circle Week was Target's opportunity to demonstrate value and give back value to our most loyal customers. This was a shift from prior years, where we did Target Deal Days, and the guests really responded to our actions. In fact, it was our single-largest Target Circle Week ever. We acquired an incremental 500,000-plus guests, which is more than 3.5x the average weeks' acquisition rate, into that loyalty program. A loyalty program, by the way, that already has 100 million members. And so the depth to which we're relating to our guests is going to continue to be fueled by our ability to understand them and serve them uniquely, and Target Circle is one way that we're going to do that.
Simeon Gutman:
And then the follow-up, maybe for Michael. If you look at the margin recovery of the business that could happen over, call it, the next year or so, is there anything that stands in the way of it? Meaning if we see comps recover and bounce back, especially that means your signature categories recover, is there any reason why we shouldn't see margins continue along that path? I know you said we'll answer it when we get back to the back half of the year. But is there anything that stands in the way of that margin recovery?
Michael Fiddelke:
I think it's the factors we've been talking about for a while now, Simeon. And to see a return to positive comp growth in some of those higher-margin discretionary categories, that would be a welcome benefit to margin, for sure.
One of the things we'll need to continue to watch is the pressure we've seen from shortage. If You go back to where we were pre-pandemic, I mean, that is one of the single biggest margin headwinds in the business. And so the path of stabilization, we were pleased to see shortage come in as we forecasted in Q2, but that's still a material headwind on a year-over-year basis, on a 2-year basis. And so I think that will be an important variable to watch going forward as well.
Brian Cornell:
Michael, on that note, as we wrap up the call today, I certainly want to thank our entire team for their efforts throughout the quarter.
I particularly want to recognize our asset protection teams. We've talked a lot over the last couple of quarters about the pressures we've been facing with organized retail crime, and I really appreciate the work that our asset protection teams do each and every day to keep our guests safe, our team safe and allow us to operate safely each and every day. So thank you all for joining us. We look forward to talking to you later this year. That wraps up our second quarter call.
Operator:
Goodbye.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation First Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, May 17, 2023.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our first 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 minutes, Brian, Christina, John and Michael will provide their perspective on our first quarter performance, along with our outlook and priorities for the second 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 press release and 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 first quarter and his priorities for the second quarter and remainder of the year. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. In the first quarter, our team's discipline and dedication to staying in step with our guests, drove results that met or exceeded the expectations we set at our financial community meeting back in February. Q1 total sales increased 0.5%, reflecting flat comparable sales at the midpoint of our guidance range, combined with the benefit of sales in new locations.
Profitability for the quarter was ahead of expectations. We came into the year clear-eyed about what consumers are facing with persistent inflation and rising interest rates. And we were determined to build on the trust our guests have had in target by unifying as a team to deliver affordable joy each and every day as consumers and businesses navigate, a third straight year of dynamic challenges. We knew this year would demand agility and teamwork and the ability to flex across our multi-category portfolio as we emphasize the categories our guests need most now. Well, our team did all of that in Q1, taking other step forward on our long-term growth trajectory. I might point to 3 unbroken years of traffic growth as a proof point. In the first quarter, comparable traffic grew 0.9%, even as consumers were becoming more cautious in their overall shopping behavior. That's a healthy indication of the trust, loyalty and strategic relevance we've created, especially given how much and how frequently consumers and the world circumstances have changed over those 12 straight quarters of traffic growth. Very few others can point to anything like that. This growth in guest engagement is the product of deliberate investments we've been making for many years. In all we do, we put the guests at the center, listening carefully to them and finding innovative ways to make their lives easier, more convenient and more joyful. And here again, both the balance of our multi-category portfolio and the flexibility of our stores as hub model are helping us stay in step with our guests. The mix of in-store shopping has been growing for well over a year now as consumers have become increasingly comfortable in public places. This has led them to choose more in-store visits causing in-store sales growth to outpace digital in the first quarter, both this year and a year ago. Notably, even within the digital channel, our same-day services, which rely entirely on our stores expanded more than 5% during the quarter. As usual, this increase was led by our Drive-Up service. We saw growth in the high single digits as more and more of our guests embrace the speed, convenience and reliability it provides. In total for the quarter, more than 97% of our sales were fulfilled by our stores. As it did throughout last year, pressure from inflation and rising interest rates affected the mix of retail spending in Q1, with a further softening in discretionary categories in the March and April time frame. This coincided with the deterioration in consumer confidence, reflecting recent events such as the banking crisis that emerged in March. These continued signs of caution among consumers have reinforced why we entered this year with a conservative inventory position. And as Michael will cover in more detail, we maintain that cautious stance throughout the first quarter and feel good about our current positioning in light of the trends we've been seeing. But as Christina will highlight in a few minutes, our cautious posture has not reduced our commitment to offering fresh, on-trend merchandise throughout the year. We know that newness is a critical element of what our guests expect when they shop with us. And even if they manage their household budgets and make disciplined buying choices, our guests continue to respond when we offer the right combination of newness, trend right fashion and affordability. That's what we mean when we talk about affordable joy. It's something that's core to our brand and a key differentiator in the marketplace. Beyond macroeconomic challenges, we continue to contend with significant headwinds caused by inventory shrink, building on a worsening trend that emerged last year. While shrink can be driven by multiple factors, theft and organized retail crime are increasingly urgent issues, impacting the team and our guests and other retailers. The problem affects all of us, limiting product availability, creating a less convenient shopping experience and putting our team and guests in harm's way. The unfortunate fact is violent incidents are increasing at our stores and across the entire retail industry. And when products are stolen, simply put, they're no longer available for our guests who depend on them and left unchecked, theft and organized retail crime to grade the communities we call home. As we work to address the problem, the safety of our guests and our team members will always be our primary concern. As a result, we are engaged in a variety of mitigation efforts, which began with significant resource investments to protect our team and our guests. In addition, we're installing pictures to protect merchandise and adjusting our assortment in affected stores. Beyond safety concerns, worsening shrink rates are putting significant pressure on our financial results. More specifically, based on the results we've seen so far this year, we expect that shrink will reduce our profitability by more than $0.5 billion compared with last year. And while we're doing all we can to address the problem, it's an industry and community issue that can't be solved by a single retailer. That's why we're actively collaborating with legislators, law enforcement and retail industry partners to advocate for public policy solutions to combat organized retail crime. As we communicate with those partners, we emphasize that we're focused on keeping our stores open in the markets where problems are occurring. Our stores create jobs, serve local shoppers and act as critical hubs in communities across the country and we'll continue to do everything in our power to keep our doors open. At the same time, we'll be closely monitoring the safety of our team and guests as well as the financial impact to our business as we determine the right path forward at Target. Even as we navigate through multiple short-term challenges, we remain focused on making Target stronger and better for all our stakeholders over the long term. Right now, our team is rallying around of focus on retail fundamentals to ensure we're staying reliable and affordable for our guests and that we're translating key points of difference like our physical proximity to the vast majority of U.S. shoppers and our emphasis on a joyful guest experience into unmatched ease and inspiration for our guests as we continue to grow and scale. We're also intently focused on creating easier and more efficient ways for our team to deliver on our strategy and fuel our ongoing growth ambitions. Underpinning all of this is our continued commitment to disciplined, return-based investments that will benefit stakeholders both today and well into the future. This goes well beyond our physical capital. As John will outline, we'll continue to make important investments in our team. This begins, of course, by building on the robust investments in wages and benefits we've made in recent years. Because of those past investments, today, we offer starting a wage range of $15 to $24 across the country. We significantly enhanced the health and wellness benefits we provide and tens of thousands of our team members are enrolled in our industry-leading debt-free college educational program. But our efforts extend well beyond the wages we pay and the benefits we offer. We are committed to building a culture of growth, providing our team with strong foundational learning, enhancing their skills and providing them to excel not just at their current role, but their next role on the Target team. as they continue to build a rewarding career with us. I want to close my remarks by thanking our team. Nothing is more energizing than the time I spend with them, from visits to our stores and distribution centers across the country to the time I recently spent with our headquarter team in Bangalore, India. Our team is proud to work at Target, and they show that pride through their actions every day, all in support of our guests. I'm proud to work alongside them, and it's a privilege to represent their efforts in venues like these. With that, I'll turn the call over to Christina.
A. Hennington:
Thanks, Brian, and good morning, everyone. In many ways, the themes of the first quarter operating environment were very similar to what we've outlined in recent quarters. So it likely comes as no surprise that we continue to face elevated volatility and see a reprioritization of spending away from discretionary categories in the face of persistent inflation in groceries and essentials. Despite the near-term challenges facing the retail industry and our business, we remain confident in our ability to generate long-term results, largely driven by the unwavering commitment displayed by the Target team, to our guests, each other and the communities where we operate. Guests continue to place their trust in Target, choosing to shop with us more and more often, at a time when consumers are hyper-focused on managing their budget.
As Brian mentioned, American consumers continue to face difficult trade-off decisions as they juggle the wants and needs of their families. Consumer saving rates are down, and while inflation rates are finally declining, so is consumer confidence. The fear of a looming recession weighs heavily on many American families and though discretionary spending remains soft, our guests are still looking to sprinkle some affordable joy into their regular shopping at Target. In the first quarter, comparable sales were flat to last year, which was squarely at the center of our expectations. As you heard from Brian, we continue to benefit from traffic and sales growth in our frequency categories; Food & Beverage, Household Essentials and Beauty, which helped to offset softer year-on-year sales in our more discretionary home, apparel and hardlines categories. Within the quarter, total sales were strongest in February, began decelerating in March and softened further near the end of April. Q1 performance was led by Beauty, which delivered comp growth in the mid-teens in light of continued strength in both Core Beauty and Ulta Beauty at Target assortment. Food & Beverage grew in the high single digits, reflecting broad-based strength across the category. Household Essentials delivered low single-digit growth, reflecting notable strength in both the health and pet care categories. Apparel, home and hard lines all experienced sales declines from the mid-single digits to low double digits as guests continue to pull back on discretionary purchases. Notably, guests are shifting to shop more just in time in these categories as they wait until the last moment before key events to invest in new decor or wardrobe refreshes. As we've been noting for some time, despite overall softness in discretionary categories, seasonal moments and newness in apparel, home and hard lines continue to be bright spots, prompting great responses from our guests. Within the first quarter, we had strong Valentine season and Easter holiday across multiple assortments, ranging from food and hosting solutions to decor and giftables. New offerings in apparel, including the latest wave of our designer dress collection and new sets in women's athleisure have seen incredible responses from guests. And this year's major theatrical releases such as Super Mario Brothers and the upcoming Disney film, The Little Mermaid, are driving outsized share gains and sales momentum. These examples demonstrate that when our assortments are fresh, seasonally relevant and affordable, that's a winning formula to engage and delight our guests. Given that consumers are cautious when buying discretionary items, we are being more declarative than ever about affordable joy and leaning into value messaging across all our media channels, in-store signing, merchandise displays and through our digital platforms. With a balance of strong opening price points, timely and relevant promotions, as well as a mix of competitively priced national brands and high-quality and affordable owned brand offerings, we have an opportunity to boldly demonstrate the power of Target's value proposition to our guests. As I've shared in prior calls, this is where the power of Roundel and Target Circle really shine through, creating collective value for our guests and for Target. With consumers more price conscious and focused on promotions right now, we know they're willing to search for a deal, but appreciate when we make the hunt easy for them. By utilizing our rich guest insights, we are best able to match the right product to the right guests with the right promotion. This is why we take such a differentiated approach with Roundel, thoughtfully and selectively connecting vendors and their products to our guests. Roundel's interconnection with the broader Target digital ecosystem means we are uniquely positioned to inspire the millions of users of our website, the Target app and other diverse media platforms. This helps vendors find consumers that are most likely to be interested in our products, creates awareness and conversion to new products for our guests through compelling deals and ads and drives top line and bottom line benefit to Target, all with an eye to enhancing the guest experience. Similarly, we know this personalized touch is why active Target Circle users make 2.5x the trips in Q1 compared to non-Circle guests and spent 3x more. Whether through everyday offers or member exclusive events like Target Circle week in March, we see incredible guest response to Target Circle promotions. Roundel and Target Circle provide opportunities for us to connect with guests in both the short and long term, offering instantly gratifying promotions in the now and a tailored and elevated experience that builds lasting affinity tomorrow and beyond. And beyond promotions and product placements, we know that when guests try our own brand offerings, they love the value and quality they receive, and this leads to repeat purchases. We also know that simplified, easy to understand, pricing promotion removes friction from the shopping experience, both in stores and online. This explains why our guests are responding to affordable home decor selections where we are expanding our assortment of items priced under $10. It's why we recently launched new swim assortments starting at just $12 and to help our guests get ready for summer celebrations of all kinds are only a Target Sun Squad brand, offers everything needed to be outside this summer with more than 60% of the entire assortment priced under $10 and nearly 90% of the assortment priced under $20. But our comprehensive view of affordability extends beyond compelling price points. In particular, our own brand portfolio offers an unmatched combination of quality and price. For an example, look no further than our $3 billion owned brand, Cat & Jack, featuring on-trend durable and affordable kids clothing. With everyday essentials like $4 T-shirts, $5 leggings, and $8 dresses and jeans, Cat & Jack offers both affordability and style. And because we stand behind not just the price but the quality of these items as well, we guarantee all Cat & Jack apparel for 1 full year with free returns should anything not meet our guest expectations. This is just another example of how we offer comprehensive value for our guests giving them affordable options without skipping on quality. As we look to the second quarter and beyond, we will continue the steady drumbeat of newness and value all while maintaining a cautious inventory ownership position in our discretionary categories. In terms of seasonal moments and holidays, Target teams are focused on helping our guests celebrate all summer long. Starting last weekend, we kicked things off by celebrating Mother's Day with affordable and inspiring ways to thank the moms in our lives, and we have plans to continue celebrating key summer moments [indiscernible] long wrapping up with everything needed to host the perfect Fourth of July Barbecue. With new summer Food & Beverage offerings, including more than 100 new Good & Gather items to target exclusive pickup offsets for amateurs and pros alike, we are listening closely to our guests and providing the hottest trends across our entire assortment. In apparel, guests will find vibrant color pallets across our offerings, helping all families celebrate summer and style. Best of all, these apparel items provide amazing value with clear, compelling opening price points. For kids and kids at heart, the summer's roster of exciting movie blockbusters will find their way into multiple assortments ranging from apparel to toys to collectibles, featuring familiar characters from Disney, Marvel, Teenage Mutant Ninja Turtles and more. And because you can never have too much of a good thing, the latest assortment drop from Tabitha Brown just launched a few days ago. Already off to a fabulous start. This collection celebrates the joy that comes from gathering alongside friends and family, recharging in the summer sun and pausing for fun and games. The assortment includes over 60 items ranging from backyard entertaining essentials, games, tableware, outdoor furniture as well as guest favorite food items backed by popular demand. As we navigate this challenging environment, we will continue to lean into flexibility and focus on retail fundamentals while remaining vigilant in monitoring changing trends with the consumer and the economy. It's only because of our incredible team that we are able to stay nimble, listening for and quickly applying guest feedback into our operations. So our teams in stores, supply chain and headquarters locations around the world. Thank you for sharing your talent and passion and support of our guests. You are truly the best team in retail, and you bring Target's values to life each and every day. With that, I'll turn the call over to John.
John Mulligan:
Thanks, Christina. Through all of the rapid and unexpected changes we've experienced over the last 3 years, teams throughout our operations have done an amazing job, maintaining their energy, staying agile and doing everything in their power to serve our guests' ever-changing needs. And today, with 2 years of unusually rapid growth behind us and last year's excess inventory in the rearview mirror, we are focusing this year on training and development for our team with an emphasis firmly centered on retail fundamentals. Our goal is to reinforce the reliability and consistency of our shopping experience as we help our team members to succeed in their current job and build the right skills to prepare for the next one.
More specifically, every store this year is engaging in assessments to reinforce consistently strong execution throughout the country and every day of the year. These assessments are centered on the factors most essential to operating great stores and delivering a consistent experience, ranging from staffing and scheduling to inventory management, in-store signing, digital fulfillment, guest and team member safety and the checkout experience. In support of these efforts, we're investing in training and development across every level of our team from entry-level team members to the store leaders. Beyond the reinforcement of everyday best practices, we're preparing our team to support new services including the upcoming rollout of Drive-Up returns and the opening of additional Ulta Beauty at Target locations. In addition, to develop our store supervisors and leaders, we're investing in a cohort-based peer learning model, in which participants engage in classroom experiences, one-on-one coaching and on the job practice. All of this training is designed to help our teams succeed today and build our pipeline of future leaders. Of course, a foundational element of our team development effort is our education assistance program called Dream 2B, which enables our U.S.-based part-time and full-time team members to pursue tuition-free undergraduate and associate degrees, certificates and boot camps. This industry-leading program features tuition-free options in more than 250 business aligned programs across more than 40 schools, colleges and universities. Since the rollout of Dream to Be in 2021, tens of thousands of our team members have successfully participated in this program. As you saw in today's release, we ended the first quarter with a 16% less inventory than a year ago. This decrease reflects our current cautious position in discretionary categories, combined with the impact of excess inventory on last year's balance sheet. Those factors are being partially offset by some purposeful inventory investments. These include investments in support of our frequency categories, in light of the rapid growth we've been seeing and to ensure we're in stock. And I'm happy to say that these investments have been paying off. In the first quarter, out of stocks of our most important Food & Beverage and Essentials items, we're running at 3-year lows and trending in a favorable direction. In addition to support of our frequency businesses, we're also making strategic inventory investments where we believe we have a long-term market share opportunity, most notably in the upcoming Back-to-School and Back-to-College seasons. As you know, in our supply chain, we're engaged in a multiyear journey to modernize how we replenish inventory in our stores. When I moved into this position 8 years ago, store inventory replenishment was a standardized inflexible process. That placed a heavy burden on our store team members. With this modernization effort, our primary goal is to reduce those labor demands on our stores. We achieved that result by moving work upstream to a distribution center, where we can apply the appropriate processes, technology, tools and automation to accomplish the work at scale. This results in higher labor efficiency for the company overall while allowing our store team members to spend more time in the front of our stores with our guests. In the upstream distribution centers we've opened over the last 2 years, we've implemented technology and capabilities that improve how product is sorted and loaded on to trailers headed for our stores. These improvements reduce the necessary time for the store team to unload the trailer and for them to move the inventory to where it's needed in the store. In these new buildings, we've also invested to automate the sortation and packing of break pack items, facilitating the shipment of quantities smaller than a full case pack. This automated process makes the shipment easier to unload, reduces sorting time for the store team and lowers the amount of inventory in our store backrooms. Outside of our new facilities, we're working to roll out similar capabilities to our legacy distribution centers. In addition, throughout our legacy network, we continue to focus on reducing the overall cost of store replenishment by implementing automation, along with other improvements. For example, we've been testing ways to improve the lead time and accuracy of our deliveries from several of our existing buildings and have seen an increase in speed and lower out-of-stocks in stores service from these facilities. But I want to stress, automation is only 1 way to deliver value to our business. Consider our sortation centers, which are positioned downstream from our stores to provide speed and efficiency in support of last mile delivery. Our sort centers are not highly automated. Instead, they use technology and sophisticated process logic to sort packages and provide a faster and better guest experience at a significantly lower cost. In fact, it's because of the relative simplicity in the design of these buildings and the efforts of an incredibly innovative and energetic team that we've been able to scale the number of these buildings so quickly from 3 a year ago to 9 today. And an expected total of 15 or more in 2026. Beyond rapidly scaling the number of sort centers, our team continues to innovate around the existing processes in those buildings, finding ways to deliver additional value to the business. One example is a new facility that we opened earlier this month in Smyrna, Georgia. This new facility, which costs very little to open, serves as an extension of the existing sortation center in the Atlanta market extending the reach of our next-day delivery capability. With this new facility, online orders that have been packed by Atlanta area stores continue to flow to the sortation center, where they're sorted and delivered via our national carrier partners or a ship driver. However, a portion of local orders falling outside the sortation centers last mile delivery area can now be transferred to Smyrna extension, where ship drivers can pick them up and serve additional neighborhoods. With the opening of this extension facility, our next-day delivery capability is now reaching more than 3 million guests in the Atlanta market. As we mentioned at our recent financial community meeting in our Dallas and Minneapolis sortation centers, Target and Shipt have been testing the development of high-capacity van routes that enable us to bring last-mile delivery to a larger number of guests. In addition, over the past year, across all of our markets served by our sortation centers, we have shifted more routes to larger passenger vehicles and early results have been positive. Compared with routes previously served by sedans, SUVs and minivans can deliver more than double the number of packages per route while high-capacity vans can service nearly 5x as many packages. And beyond capacity, the use of larger vehicles enables further route optimization, increasing the number of packages that can be delivered per hour. With these changes, in the first quarter, approximately 65% of our last mile deliveries serviced by Shipt were made with larger vehicles compared with 0 a year ago. This resulted in meaningful cost savings for our last mile delivery program overall. Based on the success of these efforts, we're developing plans to begin testing high-capacity vans at a larger scale. In addition, we're developing a standardized faster way to load those vans, enabling package containerization and easy identification of the correct packages at delivery. In addition to simplifying the load process for the drivers, this new process will enable us to safely move a larger number of ship drivers in and out of our sort centers in a given amount of time, expanding our last mile delivery capacity in these markets. While there are many different ways our team is working to gain efficiencies and deliver value to the business, all of our projects have some things in common. First and foremost, they're all designed and implemented with a focus on our guests and continuing to build their engagement with Target. In keeping with that guest focus, we design processes and deploy technology and automation as a way to highlight the human element in our business rather than minimizing it. It's an essential element of our purpose to help all families discover the joy of everyday life. As I get ready to close, I want to pause and thank our team for bringing that purpose to life every day for both our guests and for your fellow team members. Here are the reason that guests trust and love our brand and why they choose to shop at Target. With that, I'll turn it over to Michael.
Michael Fiddelke:
Thanks, John. In many ways, the environment today feels completely different than 3 years ago when the pandemic was just beginning and no one knew what to expect, but today even as the pandemic feels further and further behind us, we continue to face elevated macro uncertainty and volatility as the world continues to transition toward a new normal. From a macro perspective, inflation remains high and stubbornly persistent, having recently peaked at decades high levels. To control this inflation, the Federal Reserve has been raising interest rates at an unprecedented pace. But for now, despite the building economic pressure from both inflation and higher interest rates, the U.S. unemployment rate is lower today than it's been in 50 years. And as Christina mentioned, consumer spending patterns continue to evolve, putting significant pressure on our discretionary categories.
While I'm guessing we're all looking forward to the day when economic conditions begin to stabilize and normalize, I'm pleased that today, even in the face of all these challenges, we're continuing to see deeper engagement from our guests. That's most visible on our traffic, which grew just under 1% in Q1 and has now grown for 12 consecutive quarters. In fact, since 2019, prior to the pandemic, first quarter total sales have increased more than 43%. The vast majority of that growth is the result of an increase in sales per square foot over that time of which a significant portion has been driven by traffic. Total sales grew 0.5% in the first quarter, reflecting flat comparable sales, combined with the contribution from new locations. Total revenue growth of 0.6% reflected sales growth, combined with double-digit growth on the other revenue line, led by our Roundel ad business. As Brian mentioned, sales trends softened over the course of the first quarter. More specifically, we began the quarter with positive comp growth in the month of February and then saw the trends soften into low single-digit declines by the end of April and so far into May. Our first quarter gross margin rate of 26.3% was about 60 basis points higher than a year ago. Among the drivers, we saw more than a percentage point of favorability in merchandising, driven primarily by a reduction in freight and transportation costs, along with the benefit of retail pricing and a lower clearance markdown rate as we compared over last year's inventory actions. We also saw a small gross margin rate benefit from lower digital volume and a more favorable mix of lower cost same-day fulfillment. Offsetting those 2 sources of benefit, shrink reduced our gross margin rate by a full percentage point compared with a year ago. As Brian highlighted, pressure from shrink has continued to increase, and we now expect that if current trends continue, shrink will reduce our full year profitability by more than $500 million compared with last year. One note, the impact of merchandise mix on our first quarter gross margin rate was approximately neutral as the rate impact of sales declines in our highest-margin categories was offset by sales declines in lower-margin rate categories. Consistent with the guidance we provided for the quarter, our first quarter SG&A expense rate was 19.8%, up about 90 basis points from a year ago. This increase reflects our continued purposeful investments and paying benefits for our team, combined with inflationary cost pressures throughout our business against a backdrop of flat comparable sales, partially offset by the benefit of productivity increases and strong expense discipline across the company. Our first quarter D&A expense rate was down about 10 basis points, reflecting lower accelerated depreciation related to our remodel program compared with last year. Altogether, our first quarter operating income rate to 5.2% was higher than expected, due primarily to upside in our gross margin rate as the benefits from lower freight and transportation costs and our efficiency efforts offset a higher-than-expected impact from shrink. As John mentioned, Q1 ending inventory was about 16% lower than a year ago. Within that inventory number was a decline of more than 25% in discretionary categories, reflecting the excess inventory we were carrying last year and the cautious approach we are taking this year. Partially offsetting the decline in discretionary inventory are the purposeful inventory investments we're making in our frequency categories, along with some strategic bets in support of long-term share opportunities. We believe our cautious inventory approach has served us well so far this year and will continue to be the right approach going forward. As I turn now to capital deployment, I'll start where I always do, by reiterating our long-standing priorities. First, we fully invest in our business in projects that meet our strategic and financial criteria. Second, we support the dividend and look to build on our record of annual increases, which we've maintained since 1971. And third, only after we've supported those first 2 priorities, we deploy any excess cash to repurchase shares over time within the limits of our middle A credit ratings. Regarding the first priority, we made capital investments of $1.6 billion in the first quarter as we continue to remodel stores, open up new locations, build upstream inventory replenishment capacity and ramp up our sortation center strategy. With 1 quarter of the year behind us, we continue to expect our full year CapEx will be in the $4 billion to $5 billion range. Regarding the second priority, we paid dividends of $497 million in the first quarter, up from $424 million last year, driven by a 20% increase in the per share dividend, partially offset by a decline in average share count. And finally, given the impact of the current environment on our financial performance, we didn't repurchase any shares in the first quarter. In the near term, we'll maintain that approach and don't intend to resume repurchase activity until it's compatible with our long-term credit rating goals. On that note, I'm pleased with our progress in strengthening our balance sheet. Even as profitability remains well below our long-term potential, we've already seen an encouraging improvement in our operating cash flows. More specifically, our operations generated $1.3 billion of cash in Q1 in stark comparison to a year ago when our operations absorbed $1.4 billion. This dramatic year-over-year improvement was driven almost entirely by changes in our inventory investment compared with last year. And finally, I want to end my review of the quarter with our after-tax returned on invested capital. For the trailing 12 months through the first quarter of this year, our after-tax ROIC was 11.4% compared with 25.3% a year ago, reflecting both the change in profitability and the increase in working capital we began to see a year ago. As we move further into the year, we expect to see higher profitability than a year ago and continue to benefit from the inventory efficiency reflected in this quarter's cash flow. Based on these expectations, we anticipate a recovery in the ROIC metric this year and expect to continue building back toward our longer-term potential in 2024 and beyond. So now let me turn to our expectations for Q2 and the full year. As I mentioned, on the sales line, we experienced notably softer comp trends as we exited the first quarter and moved into May. As a result, we're anticipating second quarter sales in a wide range centered around a low single-digit decline, consistent with those recent trends. In terms of profitability, we're expecting a range of possibilities as well. On the gross margin line, we believe that many of the same trends that emerged in Q1 will continue in the second quarter, including a meaningful tailwind from freight and transportation costs, and a significant headwind resulting from inventory shrink. Similarly, on the SG&A expense line, we'll continue to face broad-based inflationary pressures and expect to benefit from efficiency efforts and cost discipline across our team. However, if our second quarter comp sales end up declining in the low single digits, which is where they are trending currently, we'll see greater SG&A rate pressure related to cost deleverage than we experienced in Q1. In light of all of these expectations, we believe our Q2 operating margin rate will be much higher than the very low rate we earned a year ago, but lower than the 5.2% we saw in Q1. Altogether, our expectations translate to a second quarter GAAP and adjusted EPS range of $1.30 to $1.70. As we look beyond Q2, we continue to believe that we entered this year with the appropriate level of caution planning conservatively in light of a tough macro environment and rapidly changing consumer trends. While we're facing some clear headwinds in the short term, we also have multiple actions underway to mitigate them, including ongoing efficiency work and cost saving efforts that we expect to flow into the P&L in the second half of the year. While we feel good about these efforts, we also remain cautious on the overall environment in light of the macro industry pressures we've outlined today. Taking this all into account, we are maintaining the full year guidance we provided at our Financial Community Meeting in February. Namely, we're planning for full year comparable sales in a wide range centered around flat. We expect to grow our full year operating income by $1 billion or more, and we expect our business to generate full year GAAP and adjusted EPS of $7.75 to $8.75. As I get ready to turn the call back over to Brian, I want to reiterate my confidence in our longer-term prospects for profitable growth. Even today against a very challenging backdrop, we're starting to assemble the building blocks for a recovery in our operating margin rate back towards its longer-term potential. And while spending pressures in discretionary categories are currently outweighing the continued strong growth we've seen in our frequency categories, we're confident that the economy and the consumer will stabilize over time and will once again benefit from growth in the more discretionary portion of our assortment. In the meantime, we have the capacity to navigate this environment with a strong balance sheet and a resilient business model. We have the right long-term strategy, and we're privileged to work with the best team in retail. I want to express my sincere thanks to our entire team. You are, by far, our most valuable long-term asset. With that, I'll turn it over to Brian.
Brian Cornell:
As Michael just mentioned, we don't build our strategy based on a single moment, but focus on the best way to serve our guests over time. We take that approach when we invest in our stores, in our supply chain, in digital fulfillment and our team. And as we've said many times, we also build our assortment to serve the long-term needs of our guests and the benefit of this flexible assortment strategy has been clearly evident over the last few years. Following the onset of the pandemic, we saw unprecedented traffic and sales growth in our discretionary categories.
And now this year, even as guests are pulling back on discretionary purchases, we still grew traffic just under 1% in the first quarter as guests increase their spending in Beauty, Food & Beverage and Household Essentials. But a short-term pullback in discretionary purchases doesn't mean we'll turn away from our apparel, home and hardline categories. Instead, we'll continue to invest in them and deliver fresh new items throughout the year. That's because our guests continue to love these categories, and we're focused on building our guest engagement with them. Think about it this way. When I arrived at Target just under 9 years ago, our Food & Beverage category was underperforming and losing market share. But rather than turning away from that part of our business, we decided to lean in. We committed to the long term and engage in the hard work that we needed to improve our performance, ranging from our relationship with vendors to our French food supply chain, store labor model, assortment strategy and our own brands. Much of that work happened behind the scenes, and it took time before business trends in Food & Beverage started to change, but the work paid off over time. We entered 2023 following 3 straight years of unprecedented growth and market share gains in Food & Beverage, having grown that category by more than 61% between Q1 2019 and this year's first quarter. Beauty is another category where past investments are paying off. It's been performing well for years because we continually invested in the store experience, in passionate, talented and well-trained team members, in our digital experience and our assortment. Our growing partnership with Ulta Beauty is the latest example of how we're finding innovative ways to further enhance our beauty assortment and experience. And our business results clearly demonstrate that our investments are paying off. We've experienced double-digit growth in Beauty sales for the last 3 years in a row and just saw mid-teen growth in the first quarter. These examples demonstrate why we're investing and maintaining our long-term focus across the board on every 1 of our merchandising categories, fulfillment options, stores, services and our team, all in service to bringing affordable joy to our guests. If we do that right, we'll always be ready to serve our guests as their needs change, further deepening our long-term relationship with them. With that, we'll move to Q&A. Christina, John, Michael and I will be happy to take your questions.
Operator:
[Operator Instructions] Our first question comes from Ed Kelly with Wells Fargo.
Edward Kelly:
I wanted to start with the guidance. I mean, clearly, you're beginning to see increased consumer pressure now in Q2. And I think those signs of weakening are broad out there. But the midpoint of your guidance implies a pretty good back half improvement. I'm just kind of curious how you thought about Q2 with the reaffirmation of the full year? And is it realistic for us to think that the back half would be in the low $2 range, given what Q2 guidance is?
Brian Cornell:
I'll let Michael start by talking about Q2, and then I'll talk about our focus on the balance of the year.
Michael Fiddelke:
Yes, thanks for the question. You said part of the answer right in your question. We continue to take a cautious approach to the top line. We think that served us really well in the first quarter. 1 of the reasons we got the profit outcome we did in the first quarter is that with inventory position conservatively, that gives us flexibility and agility. And so you'll continue to see us take that posture for the balance of the year. And that comes with an impact on the top line and the bottom line. Our leverage looks different at a slightly negative comp than it does when we're running a positive comp.
A couple of other things that I dimensionalize kind of in how they'll paginate over the year, though. When the shrink with the current trends continuing, that year-over-year pressure from shrink is certainly front half loaded in the year. And so you see that impact in Q2 as well. And then we're excited about the continued work on our efficiency initiatives, and you'll see some of that come to bear in the back half of the year, too. So taking that all together, we feel good about the full year positioning, and we're appropriately cautious for the second quarter.
Brian Cornell:
You heard Christina talk about the changes we've taken from an inventory standpoint, the benefits that it's going to provide over the balance of the year, that gives us optimism as we think about the full year guidance. The combination of reduced inventory allows us to bring newness into our assortment, make sure we're on trend with the items we know our guests are shopping for, continue to leverage the traffic gains we've seen now for 12 consecutive quarters and balance the strength we're seeing in Food & Beverage, Household Essentials and Beauty with the seasonal moments where Target shines. So as we sit here today, we're excited about Back-to-School and Back-to-College. We've got great plans for the holiday season. And Christina and her team have done a fabulous job of making sure we've got new on-trend items that are going to delight our guests and provide that affordable joy we're looking for each and every day.
Edward Kelly:
Just a follow-up. At the Investor Day, you mentioned that 6% is, I guess, potential for '24. And the backdrop is shifting though. Can you just sort of update us on your thoughts around that building blocks considering the macro?
Michael Fiddelke:
Yes, nothing new to share on that front today. I mean, as we sit here 1 quarter into the year with a comp that played out kind of exactly as we expected and a full year guidance that we think is still appropriate. I think we're -- the underlying work in front of us to build back profitability, a meaningful piece of which is part of our plan here in 2023. It will be the first step along that path.
Operator:
Our next question is from Chris Horvers with JPMorgan.
Christopher Horvers:
So a follow-up to the first question there. So on the comp side, is it your expectation that despite disinflation in consumables that clean inventory, some new newness and easier compares, you're expecting general merchandise performance to, I guess, maybe get less worse as we get into the back half of the year?
A. Hennington:
Chris, maybe I can start this one. We acknowledge that there's a lot of volatility and that we cannot predict the future, but our expectation is that some of the strengths of Target really amplified during the back half of the year. And it starts with what Brian said, Back-to-School, Back-to-College, where the full value proposition of Target is really put on display. You can leverage all 5 categories in our multi-category portfolio to achieve what you need for your families, buying backpacks and lunches and new outfits for school. And that really then sets up into a cadence of the fall with -- we start new fashion trends in September. We go into October with Halloween, followed by Thanksgiving and Christmas, and those are big moments for Target.
On top of that, we do believe that there's some market share upside in key categories, especially in home, where we believe Back-to-College will benefit strongly from market disruptions in categories like domestic and kitchen appliances. So we're betting on some of those things as well as the newness and the agility that both Michael and Brian have spoken to that having the right fresh assortment and continuing to lead into the affordable side of that will give us momentum in the back half.
Michael Fiddelke:
Chris, the only thing that I might add to that is, that's all underpinned by a clean inventory position. I mean 1 of the benefits of planning inventory cautiously as we've got the flexibility to lean in to all the good stuff Christina just talked about. And so the end of the quarter, down 16% on a year-over-year basis, that's over 25% in the discretionary categories gives us a lot of room to maneuver as we get into the back part of the year.
Christopher Horvers:
Got it. Then as a follow-up, just thinking about the puts and takes as you move through in the back half of the year on the margin, particularly on the gross margin front. So it sounds like the shrink kind of wait and it sort of dissipates as you hopefully catch up on an accrual here. Does freight also improve? And then as you think about the benefit of freight rise into the back half? And then as you think about the efficiency efforts, can you talk about how they're proceeding and where you expect those efficiency efforts to play out in the P&L?
Michael Fiddelke:
Yes. You're hitting on some of the 3 key big factors as we get into the back part of the year. We're pleased to see headwind on a year-over-year basis. From freight, we're in a better place now than we were a year ago certainly on that front, and that will continue as we get into the back part of the year based on how we currently have things projected.
On the efficiency side of things, I mean, there's a lot within that. Some of that will come to bear this year. As we've shared before, importantly, some of that will come to bear over the next few years. But as an example of something that we'll see more benefit from in the back half of this year, sortation centers are a perfect example. We've got many more facilities open this year. They'll do a lot of business in the back half of the year. And so that's -- it's more sort centers helping deliver goods faster in a sort center market and save us some last mile shipping costs with our Shipt and drivers delivering those brown boxes. And so that's 1 of many initiatives that will start to bear fruit as we get into the back part of this year and the years to come.
Operator:
The next question is from Michael Lasser with UBS.
Michael Lasser:
One of the key debates right now on Target is what's the sustainable gross margin rate moving forward? And the first quarter performance is going to help inform the various perspectives on that. So with that being said, can you help bridge the gap in your first quarter 2023 gross margin performance versus 2020 -- excuse me, 2019? I know you said that 100 basis points of the gross margin decline versus last year was shrink. I think you previously said that heading back to last year, there was a 150 basis point drag. So is it right to think that the -- more than 2/3 of the decline from this quarter to 2019 was just shrink related?
Michael Fiddelke:
So I'll take a swing at that, Michael. The -- as I said in my remarks, the big drivers, speaking on a year-over-year basis of margin in the first quarter, we had a tailwind from freight. We already talked a little bit about the benefit we're seeing there on a year-over-year basis versus 2019, freight is still a headwind, to be clear. But on a year-over-year basis, we're seeing some benefit. We also saw some benefit on a year-over-year basis on the markdown and think salvage front as we recover from some of the inventory actions that we started to take last year. And then we saw the headwind from shrink, a full percentage point in the first quarter on a year-over-year basis. Like I said, if the current trends were to continue, we'd see that drag from shrink to be front half of the year loaded and kind of how it shows up throughout the year. But you're hitting on the key -- 3 key drivers on a year-over-year basis.
Michael Lasser:
Okay. And my follow-up question is, the other area of discussion is going to be how do you get this flattish comp for the full year in light of what proceeds to be deteriorating macro situation. So perhaps you're going to make some purposeful choices trading off some margin in order to drive traffic? And if that's the case, how much are you willing to sacrifice the profitability in order to maintain the top line performance as we move into the second half of the year and beyond?
Michael Fiddelke:
I'm happy to start. Christina, feel free to chime in. We think about it a little differently than that, Michael, in that as we think about the last back half of the year, I mean, we're going to drive traffic in a lot of ways, but it's not a simple trade margin for traffic play. It's about being relevant for our guests in the moments that matter. And is evidenced by the strength in traffic we saw in Q1. With the balance we have across categories, we can appeal to whatever is at the top of the guest shopping list. And first and foremost, that's how we think about staying relevant and driving traffic. So our guide for the year unchanged at the end of Q1 versus what we said 90 days ago, incorporates our best view of how we see all of those puts and takes playing out. And it's a wide range on the top line and the bottom line, but we believe is appropriate from the variables as we digest them sitting 1 quarter into the year. Christina, feel free to -- is there anything you'd add?
A. Hennington:
Yes. I agree with Michael, 100% that we aren't looking to make those 2 trade-offs. What we do instead is we look at where is there potential for us to take share because our unique proposition in the market might play really well under these circumstances. But in the discretionary categories, we're going in with a very conservative posture. And so it's the strength of our multi-category portfolio and the guests choosing Food, Beverage, Household Essentials and Beauty that's creating the majority of the traffic gains that we're seeing right now.
And I'm very confident about what that means in terms of what the guests are saying in the categories where there's the most price inflation and the most price sensitivity. They're choosing us disproportionately often, which I think is a very good sign of the relevance that we created. Now we will lean into newness, we will lean into affordable joy. We will lean into areas where the guests also are telling us that they're finding our value proposition to be relevant. That showed up in the first quarter in key seasonal moments and is why I'm excited about the back half because we have more of them and there's more disruption in key categories like home.
Brian Cornell:
Michael, the only other thing I would add is as we think about leveraging our multi-category portfolio in this environment, we have the advantage of a nice balance between national brands and the continued strength we see in own brands, particularly at a time when our guests are looking for that affordable joy from Target. So we do think we're uniquely positioned to continue to maneuver through a challenging 2023 through the strength of our multi-category portfolio, the great national brand partnerships we have, complemented by our own brands and the flexibility we built into our system by reducing inventory and giving us the ability to flow fresh new items that are trend right for our guests.
Operator:
Our next question is from Karen Short with Credit Suisse.
Karen Short:
I just wanted to ask a little bit about your -- you had a lot of discussion in terms of price points that are going to be lower in discretionary. So I guess my question is, how much of there -- how much of your weakness in discretionary is just a misperception on your actual price point and your value proposition? That's my first question.
And then my second question is when you obviously have more of an extreme issue on shrink than some other retailers, how much are you losing sales based on some of the measures that you're taking?
Brian Cornell:
Karen, why don't I start and address the last point because as we sit here today, we think about what's happening from a theft and organized retail crime standpoint. It's an urgent issue, not just for Target, but across the entire retail industry. It is a problem that impacts availability of product, the shopping conditions are less convenient. And unfortunately, what I'm most concerned with is it puts our team and our guests in harm's way. So we are working right now with NRF, our partners at [indiscernible], other retailers across the country to make sure that we can talk to legislators that we can work with law enforcement to make some industry-wide changes and we're advocating for public policy changes to address the growing issues that surround all of us in retail today with theft and organized retail crime.
Christina, if we talk about our approach to discretionary categories, I think we've been very clear about the fact that we've been trying to bring fresh new items and at a great price point and value that our guests are looking for. And Karen, I think that's been really consistent throughout the last couple of years as we've seen an overall decline in apparel sales in the industry, in home and hardline-related categories. But Christina can talk to the fact, in many cases, we're holding or growing share in categories that have been soft. But where we've continued to see strength in our ability to hold share and bring newness that's relevant to the guest.
A. Hennington:
Yes, that's absolutely right. We have been talking about unit share for many, many, many quarters in a row because in many cases, we didn't actually raise our prices as much as the market. And we maintained that affordability. And so that has continued to help contribute the traffic gains that we've seen and the performance that we've seen in aggregate. Our value proposition is always a balance between expect more and pay less, and we're always going to play up that. And so the opportunity for us is to make sure that we are cutting through in our -- with the clarity of our promotions that we continue to put those great items in front of the guests and our merchandise displays and that our website reflects the incredible value that we do offer.
I would tell you though that something that we're leaning into that has the potential to continue to create relevance for our guests is Target Circle. Target Circle is our loyalty program. It's free, and it offers personalized promotions and it is -- we've seen that, that is generating better returns than mass promotions. And so our ability to not only create relevance for our guests, but deliver better returns for the business is a big priority for us. And that is part of the ecosystem the way we deliver value. The last part that I'd offer up, though, is because of the way we deliver value and our value proposition is about balance, it comes through a lot in the assortment and own brands play a particular role here. Not only are they great quality products that have been designed with specific guest needs in mind, they're also incredibly accessible from a price point perspective. And that's why you hear us talking a lot about that, particularly in this environment.
Operator:
Our next question is from Rupesh Parikh with Oppenheimer.
Rupesh Parikh:
I just want to get your perspective in terms of what you're seeing right now in the promotional backdrop. And then for Q2, just curious if you guys have assumed a more promotional backdrop in Q2?
A. Hennington:
Right now, there's no question that guests are seeking deals. The opportunity to balance their budget by finding deals is very visible. As I just talked about, the way that we're continuing to evolve our proposition is make sure that the deals that we do offer are certainly competitive with the market, but that they're increasingly more personalized. And as has been said a couple of times now, the inventory position that we're in right now gives us the ability to compete with the market but not chase the market down. And so that's what we're really excited about. We have an agile playbook that will allow us to continue to go after creating relevance for our guests and offering value but keep it rational.
Rupesh Parikh:
Great. And then my follow-up question, just on the shrink, I think per estimates, I think shrink is now $1 billion-plus headwind over a 2-year basis. Does your team feel that you can fully recover that headwind over time? And then with some of the efforts that you already have in place, are you starting to see traction with any of those efforts, even if they're maybe in the early stages?
Brian Cornell:
John, why don't you talk about some of the mitigation efforts we put in place?
John Mulligan:
Yes, I think -- as we think about mitigation efforts, I would go back to, first, what Brian said, it starts, first and foremost, with creating a safe environment for our team and for our guests. And there are multiple approaches to that, that also have a financial impact. So clearly, there is what we do with merchandise and how we display it and how we make that available to a guest. There is assortment changes that we can make to improve that performance as well.
And then finally, there's security changes in the store that we can make. You put all 3 of those together and as you said, we introduced some of those last year. And over time, we do see the impact of that. We see improvement in the safeness of the store. We see improvement in sales and we see a reduction in out-of-stocks, all of which to us are positive indicators that we can make progress. And we'll continue to implement those. Now some of those create additional friction for our guests. It's on us to create the right environment with our team so that we reduce that friction as much as possible. But we do see, overall, again, through time, we see those things improve.
Operator:
Our next question is from Simeon Gutman with Morgan Stanley.
Simeon Gutman:
Brian, and it's been said a few times, the consumer is becoming more cautious. Can you talk about the competitive backdrop? I think it's natural that it's gotten more competitive. It sounded like that in Christina's remarks. Can you maybe give perspective on how it compares maybe to last year or even pre-COVID?
Brian Cornell:
I think we've seen pretty consistent trends year-on-year. One of the things, as we think about discretionary categories, Simeon, and we talked about this in February at our financial community meeting. While we have seen some softness, last year, we generated almost $55 billion of revenue in those discretionary categories. And if we go back to pre-pandemic, we've seen sizable gains across all 3 of our major discretionary categories; apparel, home and hard lines. So there's still a consumer who's shopping those categories.
There's certainly a competitive activity that we're watching carefully. But to Christina's point, we're trying to make sure that we're not leading the market down. We're using the benefits of Target Circle that personalized offers to those guests that we know are looking for those items at Target and blending the balance of our national brands with our own brands to provide great value each and every day. So those categories are still relevant to the consumer. As Christina mentioned, we see certainly dislocation in the retail market that's going to open up market share opportunities for us. I think we're going to start realizing some of that during the Back-to-College season. But we'll also see opportunities over the balance of the year and as we go into the holiday season, they continue to make sure guests are turning to Target for those discretionary purchases they're looking to make.
Simeon Gutman:
And then a quick follow-up maybe for Michael. The negative flow-through in Q2 looks like it's higher than that of Q1. And there is some movement in math given the comparisons here. Curious, why shouldn't there be more margin recovery in Q2 even on the negative comp or potentially negative comp?
Michael Fiddelke:
Yes. I think I've hit most of the key themes there already. Just to repeat a couple, we're positioned in the top line conservatively and that means what leverage looks like in an inflationary cost environment throughout the P&L looks different planning for a slightly negative comp in our guide for Q2. So you see some deleverage there. And then we've talked a few times, the headwind of shrink will be present again in Q2, and that's more of a front half of the year thing than a back half of the year thing. But those would be some of the key things that we'll watch as the quarter plays out.
Brian Cornell:
Operator, we have time for 1 final question today.
Operator:
Our final question is from Dean Rosenblum with Bernstein.
Dean Rosenblum:
I want to just follow up on the gross margin questions first. So you mentioned that relative to 2019, rate is a headwind, shrink is a headwind, et cetera. When we talked back in the fourth quarter event, we've asked about the notion of permanent sort of impairment to gross margins. We're looking at gross margin historically. In the second quarter with gross margin above 30%, can you give us some idea of where you might expect gross margins to come in for the second quarter? What might you consider middle slice and may be ambitious for gross margins for the second quarter?
Michael Fiddelke:
Yes. Our expectations for both margin and SG&A and the rest of those are all baked into that EPS guide. And so as you guys know, we don't break out the specific components in our guidance. And the other thing I'd note, you probably heard me say this before, quarterly margins have more noise in them than I think sometimes the group here might appreciate. And so stepping back and seeing the margin trajectory over a longer period of time, I think, is going to be important. And we've got some work to do on that front. It's baked into our guide for the year to recover some of the margin pressure that we saw last year.
Brian Cornell:
All right. So that concludes our first quarter call. And we appreciate all of you joining us and look forward to talking to you later this year. So thank you.
John Hulbert:
Well, good morning, everyone, and welcome to our 2023 Financial Community Meeting. I'd like to start by welcoming the investors and others who are attending this meeting remotely. And of course, we're happy that so many of you have joined us here in person today.
Before I turn it over to Brian to start the meeting, I have a couple of important disclosures. First, 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. And second, in today's remarks, we refer to non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP measures to the most directly comparable GAAP measure are included in our financial press releases, financial presentations and SEC filings, which are posted on our Investor Relations website. With that, I'll turn it over to Brian to begin the meeting. [Presentation]
Brian Cornell:
Well, good morning, and thank you for joining us. Looking forward to spending this time with you. We're eager to share our plans, including how we'll continue to grow, how we'll continue to rebuild profitability on that growth and how we'll strengthen our business in conditions that have changed a lot since we gathered here at the Time Center last year.
At that time, we just passed a crucial milestone. We had just become a $106 billion company. For the full year 2022, which we're reporting today, we placed another $3.1 billion of revenue growth on top of that growth. We grew traffic by 2.1%. We gained unit share across our core merchandising categories, which means that consumers were constrained by inflation and have to be very selective about where they shop and what they buy, continue shopping and buying at Target. And despite difficulties throughout the year, we closed the books on 2022 with our 23rd straight quarter of comp sales growth. However, the path between last year's Time Center meeting and this one was anything but predictable. When we last gathered here, New York was still under a mask mandate. And though -- although consumers had started moving towards postpandemic behaviors, with families returning to travel and restaurants and shifting some dollars at a retail, we are just beginning to see how volatile and uncertain 2022 would become as spiraling inflation forced families to put discretionary purchases on hold and focus most of their spending on necessities. And there was a rapid escalation to the most expensive operating environment we've seen in decades, all of which was made worse by the spike in fuel prices caused by Russia's war on Ukraine. Those variables and many others continue to have a profound effect on the retail landscape. So this morning, we want to take stock of that situation. We want to speak clearly of how Target is planning to stay on our growth path for the years ahead. We're keeping this morning's agenda very focused on our strategy, operations, growth investments and financial expectations. We see this as a time to combine steady leadership with our long-term strategy and a continued focus on agility and strong focus on retail fundamentals. Our goals this morning are to show you how we're navigating near-term challenges. How the durability of our business model lies in its flexibility. We'll share what we're prioritizing to stay in step with our guests, and how we'll flex across our multi-category portfolio, which means, in the near term, leaning into growth in nondiscretionary categories. We'll also reinforce how the trust and loyalty we've built with our guests shows in our traffic and share gains. Given value is absolutely top of mind right now, being able to deliver affordable joy, differentiates us in the marketplace. And that's a clear advantage in the near term and remains our focus over the long term. With those factors in mind, we also want to use this time to set clear and realistic expectations so shareholders and stakeholders can track what progress looks like in 2023. Taking a step back, I might start by recognizing that our growth in '22 didn't come easily. It wasn't nearly as profitable as we expect it to be over time. In 2020 and 2021, our team put in the effort and the hustle to keep pace with the most turbulent business environment many of us have ever seen. They brought the expertise and excellence to take the company to a new level. But while we gained incredible scale by continuing to prioritize our guests, I acknowledge we're still developing some of the tools to marshal that scale efficiently. Yet, as we think about what growth looks like from here, it's helpful to anchor back to what we were saying at year-end 2019. At that time, we were putting up proof points on a strategy that was and still is unique in retail, when we built to reliably deliver low single-digit increases in sales year after year. It started by investing in our team, in part because we believe human interaction is the key to growth in a digital age. As we move into 2023, we'll continue to support our team and lean into our culture, knowing they're at the heart of our overall success. The 2019 strategy put stores at the center of everything. Because when we remodeled or added a store and improve the guest experience, comps grew. At the same time, turning stores into fulfillment hubs was and still is the most efficient and least costly way to grow omnichannel sales. As you'll hear today, we're not standing still on our store remodel and expansion plans or investments in a bigger supply chain or ongoing improvements in digital. It's no surprise that 100% of our store sales are fulfilled by stores. But in our case, more than 95% of all sales, including digital, are, too. Since 2019, our store base has only grown slightly, but total sales grew nearly 40% in that time frame. Our digital business nearly tripled in size, and our sales per square foot increased by 37%. And fulfilling substantially all that growth through essentially the same asset base was nothing short of incredible on the part of our team. So as we hold on to those gains and look to put growth on top of them, we'll continue to invest in stores, in supply chain, in digital through our stores as hubs model. Our 2019 strategy prioritize the differentiation and profit performance of an owned brand portfolio that is simply unmatched in retail. At the same time, we're curating national brands our guests love. And in 2019, we had just started our premier partnerships with Levi's and Disney. Since then, both those partnerships have expanded, as of partnerships, with Apple and Starbucks. And as you know, we're in the middle of building on an incredibly exciting partnership with Ulta Beauty. Meanwhile, our team has built on our position of strength in owned brands, adding 17 of them since 2019. That includes 2 more $1 billion-plus brands in Good & Gather and All In Motion. But we're not slowing down with owned brands. In fact, just the opposite. As you'll hear from Christina, we're planning a steady cadence of newness in owned brands and national brands across our multi-category portfolio in the year ahead. What else was in the 2019 strategy? Well, that was a year we introduced Target Circle. At that time, it was a powerful new asset for guest engagement, personalization, loyalty and sales that quickly attracted 50 million users. Since 2019, the user base has doubled and is still growing meaningfully. And Circle has become the heart of our increasingly connected loyalty ecosystem. Since 2019, our media company, Roundel, has grown significantly with great additional growth and profit potential on the horizon. It's sought after by advertisers for its relevance and reach, and it's growing each year because our guests appreciate the engagement and the value it delivers. Roundel makes for a more deeply engaged guests and partners. And because it gives us better understanding of our guest preferences, it makes us an even better and more profitable retailer. So we intend to place additional emphasis and investment towards Circle and Roundel in 2023, given the growth potential they'll unlock. So let's pause here, and I'll start to put all this together. While I'm deliberately drawing a connection between 2019 and the year ahead, there's one giant difference, we're starting 2023 on a revenue base of $109 billion, not the $78 billion we had back then. There are other big differences, too. Today, we're reporting a full year comp increase in the low single digits, similar to 2019, and unit share gains across all 5 of our core merchandising categories. But unlike 2019, our 3-year revenue growth is $30-plus billion, not just $8 billion. And our digital penetration now stands at nearly 19%. During the pandemic, guests became more attached to Target. And as we deepened engagement with guests, more moved into the ranks of our most engaged, measured by spend, trips and cross-category purchases. Guest engagement is also reflected in a significant increase in transactions since 2019. In fact, those increases started as far back as 2017. And we're positioned to keep growing engagement levels across our guest base even as we focus on expanding that base overall. So standing here today, my sense is that if a new normal is on the horizon, it will be much more like 2019 than the last 3 years. And as we plan prudently to invest in 2023, we see a return over time to solid and consistent growth with operating income margin rate that should move towards and then begin to move beyond our prepandemic rate of 6% in the next few years. Today, we'll show you our work for how we arrived at that conclusion. But a spoiler alert, it starts with the strategy. You've seen it many times before, and while the facets on this slide haven't changed, we're prioritizing to accelerate key growth drivers and making changes that will help us respond to the short-term environment, while continuing to advance all elements of our strategy. They all work together to keep our growth trajectory rolling. Christina will cover that in greater detail, including the focus this year were placing on the magic of Tar-zhay, on affordable joy and on digital growth, Target Circle, Roundel and our enterprise sustainability strategy, Target Forward. Then John will cover what we're learning from an ongoing operational evolution, what we're testing, what we're in the process of optimizing, what benefits we see from the standpoint of efficiency as we continue to scale. Michael will describe how we're planning cautiously, and we believe appropriately, given the economic challenges we anticipate this year. But caution doesn't mean cut off from continued growth and progress. In fact, some of the most exciting progress we anticipate will be translating our newfound scale into simpler, more efficient ways to run Target. The difference between an enterprise-wide efficiency mindset and a cost-cutting program starts with what questions you ask yourself. For us, the question isn't, what can we cut? It's how do we make things easier for our team to more efficiently deliver a guest experience, that continues to live up to our brand promise. So we'll invite Mike O’Neil, the leader we tapped to coordinate these efforts across Target, to offer his perspective on efficiency, what it is, what it isn't, how we can drive continuous improvement and what we can unlock with this focus. We're looking forward to the next hour or so. We recognize that the landscape is unpredictable, and there are plenty of near-term challenges on the horizon. We believe 2023 will be a year in which the durability of our model allows us to flex up the categories and the value proposition that are most relevant to our guests today. We'll double down on execution, so our guests get all they've been promised every time they turn to Target. And we'll stay focused on gaining share across our portfolio, underpinning all the work we're doing around efficiency, to provide fuel for longer-term growth. We're optimistic about what this team can deliver and realistic about how 2023 will keep challenging us to be agile, resilient and responsive for our guests, our communities, for each other and for our shareholders. Before we leave here today, our goal is to take you along. So you can see exactly what we're seeing. And with that, let's get going.
A. Hennington:
Thanks, Brian. Despite the challenges of the past year, Target's differentiated position in retail has never been stronger. With a great assortment, compelling value, an unmatched suite of fulfillment options and a joyful shopping experience, Target continues to drive preference with American shoppers in the face of a turbulent economic and consumer backdrop.
We have continually adapted to the environment around us, delivering ease, value and inspiration to our guests, all at a time when daily doses of joy are needed more than ever. And amidst this volatility, we continue to hone the foundational elements that it takes to be a long-term winner in retail. Fourth quarter comparable sales grew 0.7% on top of nearly 9% last year. And for the full year, comparable sales grew 2.2% on top of nearly 13% in 2021. While our business has been generating growth on top of growth for years now, the mix of last year's sales looked vastly different than what we had expected. Throughout 2022, changing attitude towards COVID, followed by the pressure from persistent inflation, caused demand for discretionary categories to slow meaningfully. With this in mind, we've taken a cautious approach to this year's inventory commitments in many of these categories. And we're focusing on the agility of our operating model to adjust should sales trends exceed our expectations. In light of the volatility we've experienced, I often get the question, what did Target learn from the past year? What I'll share with you today are some of the lessons learned. In short, we've learned that our strategy is working. At the same time, we've come to further appreciate the importance of strong day-to-day execution, combined with the agility required to react even quicker to changing consumer trends. And of course, last year, reinforced the importance of providing every guest with a great shopping experience. Most of what I'll share today likely won't sound all that different from the playbook we've used for the past few years. That is intentional. For example, our multicategory assortment continues to resonate with our guests, even as consumer demand continuously evolves. The unique balance we've achieved across all five of our core merchandising categories continues to be a key differentiator in the market, with each category serving at times as a trip driver, at other times as a basket builder, and oftentimes as both. Throughout 2022, we saw and continue to see incredible growth in our Food & Beverage and Essentials & Beauty businesses, offsetting a meaningful pullback in discretionary categories like Home, Apparel and Hardlines. But despite this pullback, these discretionary categories still delivered around $55 billion in sales last year. In both our Food & Beverage and Beauty categories, 2022 delivered the third consecutive year of double-digit sales growth, stemming from increases in both traffic and average ticket. And while we're thrilled to have driven unit share gains across all of our major categories last year, we saw the strongest gains in these rapidly growing frequency categories, a proof point of the relevance and value found in these assortments. In Beauty, we continue to be a market leader, delivering the highest growth rates of any category we sell. We've been seeing outsized growth across the entire portfolio from everyday beauty assortments to new and exciting offerings like those we've added through our partnership with Ulta Beauty. In fact, last year's sales from Ulta Beauty at Target were more than 4x higher than in 2021, and this growth was almost entirely incremental. As such, we remain excited to continue opening additional Ulta Beauty at Target locations this year and beyond. Of course, we don't build an assortment for a given snapshot in time. Rather, we flex across our categories as consumer demand shifts. And even in tough times, our discretionary assortment provides a unique opportunity to connect with guests in key moments, from major life changes, to seasonal celebrations and everyday moments in between. Now I want to be clear that despite our cautious inventory position in discretionary categories, we're still focused on delivering newness throughout the portfolio and placing select bets in businesses where we believe market share opportunities are strongest. That's because despite continued volatility the path that Target guests are attracted to all things trendy and new. We believe our commitment to newness is a key reason why we continue to generate traffic growth, and why we drove broad unit share gains last year. Our focus on balance can be found within each category as well, where we continue to offer both industry-leading national brands and high-quality affordable owned brands that are unmatched by our competitors. Our owned brands have long been a source of pride and differentiation for Target, offering great style and quality, all at incredible value. So it's no surprise that our owned brands have continued to outpace total enterprise growth and why we have plans to launch new or extend assortments in more than 10 owned brands this year. Recently, a study listing the 10 fastest-growing private label brands in 2022 included three found exclusively at Target. Target was the only retailer to have more than one brand on the list, and two of them were the only nonfood brands to make the cut. Many retailers were not focused on newness in 2022, but the opposite was true at Target, where we continue to excite our guests with innovative and trendy products. For example, we launched Future Collective, a first-of-its-kind apparel owned brand, featuring collections in partnership with a rotating roster of diverse influencers. This innovative approach blending the strength of Target's owned brands with the excitement of our limited-time partnerships and collaborations has been a huge success, particularly with Black guests, furthering our commitment to ensure all guests see themselves reflected in our assortments. Most recently, we launched a new line with actor and influencer, Tabitha Brown. Tabitha's energy and passion absolutely shines in this new line, and our guests are loving it. Tabitha serves as the latest example of the endless possibilities that comes from bringing together the incredible talents of diverse designers and the power of Target's multi-category portfolio. Take a look and see what I mean. [Presentation]
A. Hennington:
The passion of these designers is so inspiring, the emotion and pride is palpable, and we love the way the Tar-zhay magic of these partnerships cut across categories, including last quarter's launch of Marks & Spencer and Tabitha's recent extension into food.
And while these collaborations offer joy for our guests, recent history has reinforced that focusing on the basics of retail is just as important as the latest innovation or new offering. In fact, nailing the fundamentals is the bedrock of a successful retailer, from the overall shopping experience to ease and convenience, relevance, everyday value and more. Of these fundamentals, we know that a strong and reliable shopping experience is the surest way to build trust and affinity. So we aim to provide a consistent, joyous and easy experience, both in stores and online, making Target a shopping destination, not just a means to an end. To do this, we've invested heavily in new stores, our remodel program and our same-day fulfillment services, as John will highlight shortly. We led the way in comprehensive pay and benefits, attracting and retaining the best team in retail, allowing us to provide a level of service unmatched by our competitors. We've invested in one-of-a-kind brand partnership experiences like those with Levi's, Apple, Disney and Ulta Beauty. And while some of these partnerships are newer, we featured Starbucks in our stores for decades, proof that when we work with iconic brands, we build lasting relationships. With a Starbucks in nearly all of our stores, they have become part of the shopping ritual for many of our guests. In fact, we've served up more than 170 million Starbucks beverages last year alone. A strong digital shopping experience is every bit as important as the one we create in our stores. So we've been investing to ensure that the experience is seamless across every channel, regardless of how our guests shop. Whether searching for an item or browsing for inspiration, we continue to elevate their experience, providing personalized and relevant content using our incredible data and guest insights. This will include more customized homepages, improved search functionality and even more personalized offers from Target Circle. It will also include more relevant content from our digital advertising business, Roundel. Our digital success won't be driven by a single service or offering, but through a comprehensive set of experiences designed to be greater than the sum of the parts. Target Circle is one of the nation's leading loyalty programs with over 100 million members and growing. Through continuous learning and application of guest insights, Target Circle served up 3x more personalized offers in 2022 and Target Circle members spend 3x more on average this past holiday season. We also continue to invest in the tools, team and capabilities of Roundel. To us, Roundel is more than a digital advertising platform or another revenue source in the P&L. The goal is for our guests to have a tailored, relevant experience, while helping our vendors reach the guests who are most likely to be interested in their products. Said simply, Roundel makes us better merchants, more consistently serving our guests with the products they want. This is why our approach to digital advertising looks different than others. We put our guests at the center of this strategy, just as we do in every other aspect of our business. It's no wonder we continue to see such explosive digital growth, why Roundel grew by more than 60% over the past 2 years, and why we'll continue to leverage the risk -- rich guest insights. And regardless of whether our guests are shopping online or in-store, they are looking for comprehensive value now more than ever. That means offering great everyday prices and promotions and offering quality and inspiration. After all, Target invented affordable joy decades ago and is still a key differentiator in a crowded retail market. Our guests see value in countless ways, from our competitively priced and high-quality owned brand offerings to multiple RedCard benefits, including 5% off on every trip and free shipping for all online orders, all with no annual fee. We offer compelling value at every turn, and we are continuously listening to our guests to understand what value means to them. And beyond these retail basics, we continue to hear from our guests that they prefer shopping with companies who prioritize people and planet. That's why we're so focused on our Target Forward strategy. This isn't a standalone strategy, but rather Target Forward is fully integrated throughout our business, fueling our growth potential, while bettering the world. As part of this strategy, we'll continue to elevate Black voices and brands and are on track to spend $2 billion on Black-owned businesses by 2025. We'll also continue to focus on designing products for a circular future like in our owned brand, Universal Thread, where we are using materials such as recycled cotton and polyester. These are just a few of the countless examples of how we push ourselves and industry partners to grow sustainably. Our purpose to help all families discover the joy of everyday life requires a balance of quality, value and innovation that sets us apart from competitors. We are relentless in ensuring every decision supports this delicate balance. It's easy to say, but takes incredible diligence to execute. And while you've heard me say it before, it bears repeating now. We truly have the best team in retail. I'm so grateful for the many efforts of our team to serve our guests and each other, day in and day out. With that, I'll turn things over to John.
John Mulligan:
Thanks, Christina, and good morning, everyone. So Brian talked about the last few years being unpredictable. To put a finer point on that, if you had told me in late 2020, during the height of the pandemic, that 2022 would be the most challenging operating environment in my career, well, I would have assumed you were joking. Yet shifting consumer preferences, supply chain volatility and rising inflation created a set of conditions that called for flexibility, responsiveness and resilience. Our environment remains volatile, and we expect 2023 will have its own unique set of challenges. But if I've learned anything over the past 3 years, it's never underestimate the power of a purpose-driven team and the culture they create.
2022 offered more examples of Target teamwork than I can count, but two will stick with me for quite a while. 5 months ago when Hurricane Ian devastated communities across Florida, our team sprang into action. They didn't wait for me or Brian or anyone else on the leadership team to tell them what to do. Instead, they gathered input from those on the ground and told us what they needed. Pop-up resource centers that provided laundry, food, gas, restroom, showers and Wi-Fi-enabled laptops to 700 team members and their families. Extra inventory to stock local stores with essentials guests would need to weather the storm, and financial support, $5 million to fund local relief efforts and up to $3 million in matching donations to our team member giving fund, which provides assistance to team members affected by natural disasters. It was about the same time that our inventory action plan was in full swing. You'll remember, we announced bold measures last summer to quickly take action to rightsize our inventory in response to shifting consumer demands. It was a big ask of our team, one that required them to move quickly and aggressively to reduce existing inventory and cut back on receipts for the back half of 2022. And the team responded as they always do with heart and hustle. They worked through 8 distribution centers worth of inventory in a matter of months, putting us in a strong position heading into the critical holiday season. That's our culture in action, bottom-up ingenuity centered on caring for our team and our guests. And it's that culture that fuels our strategy and growth. For years now, we've shared our vision of using our stores as fulfillment hubs to get closer to our guests. It was an idea that was novel when we first introduced it, but it's been widely adopted as others expand their view of what stores can do. Now I'm an engineer to my core. So it gives me great satisfaction to see the way Target built our stores as hub strategy from the ground up and how our operating model gets stronger with each passing year. We don't have a rigid road map. Instead, we use a highly repeatable process to test concepts, refine them, test them again, until we can replicate them with confidence, efficiency and scale. And then and only then do we ask ourselves what's next? And how can we make this even better? And the whole process begins again. Let's take Drive-Up. You can trace the origins of Drive-Up to the launch of our Store Pickup service a decade ago. It took a few years to get Store Pickup where we wanted and when we did, we were able to take it one step further with Drive-Up. We launched Drive-Up as a test in our Minneapolis market in 2017. By the following year, the service was available in more than 1,000 stores around the country, and it reached all 50 states in 2019. With the foundation in place and operating at scale, we started to explore new capabilities. In 2020, we made fresh and frozen groceries available. In 2021, we added adult beverage and expanded our app to give guests a more customized experience. Last year, we began testing Starbucks at Drive-Up. And today, we're announcing the next phase of our Drive-Up services with Drive-Up Returns, which started as a pilot last year and will be available across the chain by the end of the summer. Not only is this a huge win for our guests who can now do even more at Drive-Up, but it brings more efficiency to our returns process, with more resale opportunities and fewer expenses for mail-in returns. We're combining the strength of our digital self-service returns process with our industry-leading Drive-Up experience to meet our guests where they are. This is what it means to be a truly omnichannel retailer, giving our guests the flexibility, ease and convenience to shop the way that works best for them and scaling capabilities across every facet of our business. Online, in-store, Drive-Up, it doesn't matter how they choose to shop with us. We're here to make their Target run better than ever. Looking back, the evolution of Drive-Up may seem like it was a natural progression, easy to predict and implement. When you're bringing to market new ideas in an environment that is anything but stable, you have to be ready to adjust course and explore alternatives. Our team has gotten really good at moving in step with the needs of our guests. That flexibility and a commitment to the fundamentals that make or break a retailer, things like hiring the right people, offering the right products and delivering the right experiences to our guests, underpin our stores as hub strategy and contribute to our larger story of growth. Same-day services like Drive-Up are a great example. They grew nearly 7% last year as more shoppers appreciate the convenience and speed with which they can check off everything on their list. And because we own our same-day capabilities, pickup and Drive-Up are much more economical and flexible than other forms of digital fulfillment. In fact, our average fulfillment cost per unit has come down 40% over the past 4 years as our same-day services have grown to account for over half of our digital sales. Again, these results don't happen overnight, and they aren't achieved in a vacuum. They are the product of steady investment and listening to our guests. Take our stores, which sit at the heart of our stores as hub strategy and play a dual role of shopping destination and fulfillment hub. Our stores are not only beautiful, with open floor design, plenty of natural light and design elements that reflect the communities they serve, they're built to keep inventory moving through our system and support Target's trajectory of growth. Late last year, we introduced a new store prototype in Katy, Texas. From the front entrance to the back room, this 150,000 square foot store is a stunner. Beautiful design elements reflect the local environment and community. Features like natural refrigerants, electric vehicle charging stations and rooftop solar empower our Target Forward sustainability ambitions and get us closer to our goal of net zero emissions by 2040. And a backroom 5x bigger than our average store allows us to ramp up same-day fulfillment, while preserving a seamless experience for our guests and our team. We plan to open about 20 stores this year in a mix of sizes, from the shores of the outer banks in North Carolina, to the heart of Inglewood, California. We're also planning to invest in about 175 stores throughout the year, ranging from full remodels to the addition of shop-in-shop experiences like Ulta Beauty and retrofitted fulfillment spaces to support our same-day services. Our ongoing investment in our suite of stores is just one way we're building for the future. What might be less evident to our guests is how we're building facilities behind the scenes to make their experience even better. We've built upstream capacity by opening flow centers in Chicago and New Jersey, with several more slated to open over the next few years. And a new food distribution center that opened in Maryland this past October expand support for our growing food and beverage business. This additional capacity gives us more flexibility to manage inventory and keep our stores stocked with the items guests want when they want them. We're also making investments downstream. Earlier this month, we announced the expansion of our sortation center network to more than 15 facilities by the end of 2026. These facilities have transformed how we move inventory with speed and precision to guests' doorsteps. We started with a prototype less than 2 years ago to see how we might bring more efficiency to how we sort, batch and route packages. Today, we have 9 sortation centers open across the country, allowing us to deliver packages to guests within 2 days. Up to 40% are delivered 1 day when using our last-mile delivery capabilities with Shipt. And because Shipt is fully integrated into our last-mile operations, we benefit from significantly lower delivery costs. To give you a closer look at how these sortation centers have become core to our business, we ask leaders from Target and Shipt to give you a brief tour and talk about how our test and learn approach applies to last-mile delivery. Let's take a look. [Presentation]
John Mulligan:
As you heard from [ Dory ], [ Saad ] and [ Kamau ], we've learned a lot over the past few years, using every opportunity to improve speed, cost and quality. And in regards, our sortation centers are just hitting their stride. We delivered more than 25 million packages through sortation centers last year, and we expect to double that amount in 2023 with the help of our local and national carriers.
Together, the investments we're making create a more nimble sourcing, inventory management and fulfillment capability at Target, and they continue to help us navigate tough times, prepare for the unpredictable and fuel steady growth, all thanks to our incredible team. We've made huge strides in recent years to connect with our guests through our stores. The momentum continues to build, and I look forward to sharing progress with you and our guests in the quarters to come. Michael, I'll turn it over to you.
Michael Fiddelke:
Thanks, John. As Brian mentioned, it was exactly a year ago that we were on this stage, talking about our 2021 financial results, a year in which our business generated double-digit growth in comparable sales and even faster growth in EPS. And as Christina discussed, we knew on that day that the environment was likely to change, but we didn't yet know how dramatic those changes would be. The rapid pace of this transition led to multiple profit pressures on our business, including markdowns and other costs related to last year's inventory actions, significantly higher shipping and domestic transportation costs and higher inventory shrink.
So as we focus on our business plans, both for 2023 and the longer term, it's important to consider how the environment will continue to evolve. On the one hand, many things about life and consumer behavior already look a lot like they did before the pandemic. Students are back in school, sports arenas are full, people are eating out again and consumers are embracing in-store shopping. At the other extreme, certain aspects of life appear to have changed forever. Many office jobs are now hybrid, with remote work and virtual meetings playing a much more significant role. That means many of us are spending a lot more time working at home, which has implications for long-term buying patterns in multiple categories, most notably our Food business. Fulfillment mix has also seen a permanent shift. Our same-day services have seen explosive growth. They now account for more than half of our digital sales and more than 10% of our total sales. And that trend shows no signs of reversing. Even as people have remixed their trips in favor of in-store shopping, guest engagement with these digital services has continued to grow on top of the huge expansion that's occurred over the last few years. Most importantly, our guests' overall engagement with Target has increased significantly over the last few years, and it continues to grow. Think about it this way. In 2021, guests made about 2 billion trips to Target, which was about 300 million higher than in 2019. And last year, even as consumer spending moved away from products into services, traffic grew again. The deeper relationship we've established with our guests and our proven ability to deepen it further are some of the many reasons we're so well positioned to deliver profitable growth in the years ahead. Beyond the factors that have changed permanently, there are several others that are clearly still in transition. These include transportation and the global supply chain, where we've already seen remarkable improvement, but we're still facing elevated costs and variability compared to the prepandemic period. Another factor is inventory shrink, which has increased broadly across U.S. retail over the past 2 years. And finally, the most significant and important driver of uncertainty today is the fact that the broad macro economy is still in transition, leading to an inflationary period, more pronounced than we've seen in decades. As Christina mentioned, rapidly rising prices have put pressure on discretionary spending as consumers make room for higher prices on necessities. In addition, higher interest rates have further pressured budgets by increasing the cost of mortgages and car loans. So where does that leave us today? Despite all of the recent turmoil and the pressures facing our business, we remain in a very strong position to drive healthy growth in the coming years. Our guests are more engaged than ever, and that engagement continued to grow even during a tumultuous year. And even after a year in which we experienced unique and unexpected headwinds to both our profitability and cash flow, our business is sound, it remains strong and we're laser-focused on the path forward. In 2023, we'll focus first on agility and strong execution. Most notably, we'll take a cautious stance on our inventory commitments and markdown-sensitive categories, with the flexibility to sell into our base inventory and expand receipts over time. At the same time, we'll continue investing in our long-term strategic initiatives that propel our market share and profit growth, including our remodel program, our new store pipeline and projects to add replenishment capacity and increased efficiency in our supply chain. We'll also focus on strengthening our balance sheet. In 2022, our business was a net user of cash for the first time in many years. This was driven by a host of unique factors, including unexpectedly low profitability, higher-than-expected CapEx driven by inflation and project costs and a rapid slowdown in inventory turns due to excess inventory and longer lead times in global shipping. This year, we expect each of those factors to become more favorable. More specifically, we're expecting an increase in profit dollars and a somewhat slower pace of CapEx. And given our cautious inventory positioning and rapidly improving lead times in global shipping, we're planning for faster inventory turns in 2023, driving higher payables leverage and recovery in working capital as we move through the year. In the near term, until those expectations play out and our cash generation increases, we're not planning to repurchase any shares, consistent with our goal to maintain our middle A credit ratings. Over time, as our cash flow recovers and our debt metrics improve, we expect share repurchases will play a meaningful role within our broader, long-term capital deployment priorities. But as always, those repurchases will only occur after we fully invested in our business and supported our team, after we've supported our dividend goals and within the limits of our middle A ratings. Now I want to share some thoughts on our 2023 outlook, and I'll start with our expectations for the first quarter. Given the current conditions we're facing, we expect our business to generate first quarter comparable sales in a wide range, from a low single-digit decline to a low single-digit increase. This reflects our expectation for continued strength in our frequency businesses, offset by softness in discretionary categories. On the operating income line, we're expecting a first quarter rate in the 4% to 5% range, higher than what we saw in the fourth quarter, but down somewhat from the 5.3% our business generated in last year's first quarter. While there are a number of factors driving this expectation, I'd note that our first quarter SG&A expense rate is expected to be about 1 percentage point higher than a year ago, reflecting continued investments in our team and guest experience, without an expected leverage benefit from higher sales. Altogether, on the bottom line, we expect our business to generate first quarter GAAP and adjusted EPS in a range from $1.50 to $1.90. Now I'll turn to our full year expectations, and I'll first note that the range of potential outcomes gets wider as the year goes on, given the high degree of uncertainty regarding the strength of the economy and the consumer. Given this uncertainty, we firmly believe caution is the appropriate posture, especially when planning sales and inventory in discretionary categories. On the frequency side of the business, our full year plans envision continued share gains and strong sales growth. But we're mindful that inflation in these categories may begin to moderate, pressuring dollar comps across the industry. In light of those considerations, along with our outlook for discretionary categories, we're planning for the same wide range on the top line that we're planning for the first quarter, from a low single-digit decline to a low single-digit increase in our comparable sales. In terms of profitability, the range of potential outcomes is similarly wide. As I mentioned earlier, we're positioned to benefit from a number of significant tailwinds on the gross margin line, most notably as we cycle over last year's inventory actions. In addition, we're expecting hundreds of millions of dollars of additional opportunity from lapping last year's unusually high freight and transportation costs. At the same time, we're also preparing for some notable headwinds on the gross margin line. These include inventory shrink, which may continue to rise before we see rates begin to moderate over time. We're also expecting some pressure from soft sales in our highest-margin discretionary categories. And finally, we see the potential for increased promotional intensity across the industry this year, given that we're competing in a constrained environment for consumer spending. On the SG&A line this year, we expect continued strong discipline in managing costs across the enterprise, but we're also not backing away from investments in our team and guest experience, and we'll face potential rate deleverage given our outlook for comparable sales. In light of these considerations, we're planning for a wide range of potential outcomes for our full year operating income. But even at the low end of those expectations, we expect to grow our operating income by more than $1 billion this year. Altogether, our expectations translate to a full year GAAP and adjusted EPS range of $7.75 to $8.75, which represents growth of about $1.75 per share at the low end of the range. On the CapEx line this year, we're expecting to invest between $4 billion and $5 billion. While this range is somewhat lower than last year's CapEx, it's quite strong relative to our history. This year's plan reflects the optimal level to invest in the current environment and our expectation that we'll continue to earn high returns on our long-term growth investments, including our remodel program and new store pipeline and our continued work to build capacity and capabilities in our supply chain. As we think about the longer-term trajectory of our business, we expect that as external conditions normalize in the next several years, our operating income margin rate should reach and begin to move beyond our prepandemic rate of 6%. This return to prepandemic levels could happen as early as 2024, depending on the speed of recovery for the economy and consumer demand. I want to pause and emphasize that this year's guidance does not reflect how we expect our business to perform over the longer term. Once we see a normalization of consumer demand and a resumption of growth in discretionary categories, you'll see that reflected in a stronger top line performance and a meaningful increase in our operating margin rate beyond what we're planning for this year. I also want to reiterate something we've said many times. While we often talk about rates because it's helpful for analytical purposes, our goal is to find the optimal rate that maximizes profit dollar growth over time. In other words, we'll continue to focus simultaneously on top line growth and the rate we earn on it without focusing on either metric and isolation. So now before I invite Brian and Mike O'Neil to join me on stage, I want to pause and thank our team for their continued optimism and resilience through a turbulent year. Last year presented a host of unexpected and unprecedented challenges that all seemed to arrive at once. Through it all, our team maintained a long-term focus, serving our guests and taking care of each other. As a result, we saw continued expansion in guest traffic and engagement throughout the year and historically strong hiring and retention metrics across our team. Those are some of the most important factors in determining our long-term success and why I feel so confident about Target's potential in the years ahead. Now I'd like to invite Brian and Mike O'Neil to join me on stage so we can have a brief conversation about the enterprise efficiency work we've asked Mike to lead.
Brian Cornell:
Well, Michael, thank you, and Mike, thanks for joining us today. I know everyone would like to get into the work, but I think it would be really helpful to just pause for a second and talk about your background and why we selected you to lead this very important initiative.
Michael O’Neil:
Yes. Thanks, Brian. Really happy to be here and excited about the opportunity to lead this work for Target. I've been at Target now for 15-plus years, started in finance, worked in various roles with our merchandising operation partners to help deliver on their strategic priorities and their financial growth. Through that experience, I got to see the business model through the lens of the P&L.
A couple of years ago, I went over then to human resources and led our pay and benefits and strategic workforce planning teams. And that was a great opportunity to see the business through the lens of our team members. I had a chance to lead that team during the early days of the pandemic and saw quickly the work our team does to take -- the importance of taking care of them to take care of our guests. From there, I've been back now in finance for a couple of years, and was leading the financial planning and analysis teams where we work with every business function to deliver on both our finance and strategic priorities. And coming back to finance and seeing the growth we've seen over the last couple of years, it was pretty apparent to me the opportunity to step back and think about how do we run this business model now at the larger scale. And so I think with those experiences, plus the relationships I've built over these 15 years, I think, position me well to lead this work forward.
Michael Fiddelke:
Mike, when you took on this role, we spent a lot of time talking about what this work's about and what it isn't. Can you share a bit about the reasons we've initiated the work and what we're looking to accomplish?
Michael O’Neil:
Yes. I think I'll start maybe with what it isn't. This isn't about sacrificing long-term growth for short-term profits. A typical tactic here is to look to shrink your cost base in the face of declining revenues. Well, that's not Target, right? We are growing, continue to grow. In fact, this work has come out from the growth we've seen over the last 3 years. We've grown $30 billion -- over $30 billion since 2019. That's more than 14 years prior. And that creates a tremendous opportunity to step back and reimagine how do we operate this business at a larger scale, but more importantly, how do we position Target for future growth.
And so as we're looking for efficiencies, we'll look for ways to simplify the work, to streamline processes, to reduce redundancy, all with the mind of how do we make it easier for our team members to deliver a great guest experience. In doing so, our initial scoping says, we'll deliver $2 billion to $3 billion of cost savings over the next 3 years.
Michael Fiddelke:
Mike, I want to clarify one thing briefly. After Brian and I mentioned this effort in our last earnings call, we got some questions about whether that $2 billion to $3 billion number includes the natural recovery from the headwinds we experienced in 2022. Can you help clarify that?
Michael O’Neil:
Sure. I've got a couple of those questions as well. And I would say, I reiterate that this is not about the work over -- or what's happened to us over the last 12 months. It's about the growth that we've seen over the last 3 years. And so no, what's not included is anything that will come, the natural recovery from the headwinds of last year. This work is the designed to deliver fuel beyond that, both to deliver on our -- both our top line and our bottom line goals.
Brian Cornell:
Mike, when we asked you to lead this project, we spent a lot of time thinking about the guardrails. Now obviously, there's big opportunities that we want to capture. But there's also things we never want to compromise. Do you want to talk about the opportunities versus the guardrail of let's say, "We'll never head in this direction?"
Michael O’Neil:
Yes, I think that's a really important question. And the things we're not willing to sacrifice start with a team member and the guest experience. We're not going to take away anything given the investments we've made in our team over the last couple of years, and spending that time in human resources during those early days of the pandemic had an appreciation for all our team did to run our business and to serve our guests. And so I look at our team members and the investments we make as an investment in the best team in retail.
Similarly, on the guest side, our shopping experience is a key differentiator for Target, and we're not looking at anything to take away from that. In fact, our guiding principle around this work is, how do you make it easier for our team members to run our business and in doing so, deliver a great guest experience? And so we do that, we think we'll see benefits to both the team and our guests.
Michael Fiddelke:
Mike, since we first announced this work, I've had a bunch of investors ask me where they should expect to see the results of this work show up in the P&L? Can you share your initial thoughts?
Michael O’Neil:
Sure. I think it's -- you're going to see it across the full P&L. So I'm not sure you're going to be isolating it to one single component. What excites me about this work, though, as we think about running the different scale, I think there's top line opportunity. And so it's going to start with sales. Now we're not going to do anything against the -- we're going to continue to invest in our team, but any efficiency work will have SG&A impact on the SG&A line. And product costs continue to be our biggest line item on the P&L, so we'll see it there as well. But I also will say it'll expand beyond the P&L as we look to be more efficient in our CapEx.
Brian Cornell:
So Mike, I know you're still in the early stages of scoping the work, but there's also things that we've been working on for quite some time now that we can build on. Do you want to highlight some of those?
Michael O’Neil:
Sure. We touched base on a lot this morning that work around digital fulfillment, I think, is a great example. We've been -- that work in several years underway, when you think about our stores as hub model, has significantly decreased our fulfillment cost. John mentioned 40% over 3 years.
We've also been able to increase speed of delivery and improved the guest experience across all those different nodes, whether that's ship-to-home, Drive-Up, Order Pick up or Shipt delivery, and it's extremely capital efficient. If you look forward now, we think there's hundreds of million dollars to continue to unlock with our investment in sortation centers. That's a business -- that's a capability that's been on our road map for a few years now, but requires scale and density at the market level to unlock. And given the growth over the last 3 years, we now have that. And so we think there's opportunity in a dozen of metro markets. We already have 9 facilities out there and plan to have a total of 15 by 2026. And so we'll open those up, but also we'll make those centers more efficient as well as we think about streamlining processes in them and looking to introduce automation and technology.
Michael Fiddelke:
Thanks, Mike. Can you also provide an example of a newer effort you're excited about?
Michael O’Neil:
Yes. I think the best example is the work that's underway now in Apparel. This one is near and dear to my heart. My first role at Target was the finance partner for our women's apparel business. I also think it serves as a really great example of what is possible with this work. Apparel, just like the rest of our business, has seen explosive growth. We've grown over $3 billion and now a over $17 billion business in Apparel business. It also has its unique complexities, right, from the fact that we partner with vendors to source raw materials, to the fact that we have unique fixtures in store for presentation. So all the geographical and weather and demographic considerations that go into assortment planning and allocation.
And so that growth, combined with that complexity, makes a tremendous opportunity to step back and say, how do we run this business at a larger scale and how do we position it for future growth? And so we're focused right now on driving simplicity, speed and consistency across the entire pair of value chain. And in doing so, we expect to see benefits from assortment planning, to supply chain, all the way down to guest fulfillment. And the benefits will be across the P&L. We'll see it in lower markdowns, we'll see it in increased productivity -- labor productivity, and we'll see it in top line sales. And so I love that example because it gives you a chance to step back and say, look, we've seen this growth over the last 3 years. How do we look end-to-end across the value chain to position it differently? How do we simplify for the work for our guests? And in doing so, we believe we'll see benefits across the P&L with the most important one being top line sales.
Brian Cornell:
So Mike, I love the way you framed this up. This is all about fueling future growth, driving simplicity, reducing complexity, never compromising the guest experience and the role our teams play. Are there any other components as you think about this, that you want to touch upon?
Michael O’Neil:
Well, I'd say thanks for letting me come up to share just a couple of examples. I would say -- I'd reiterate is this starts with growth. It starts about how do we make it simple and easier for our team members to deliver a great experience. And that work is going to be a multiyear journey, and this will require end-to-end problem solving across the value chain. But when we do that, we focus on making a better team member experience. We'll see a better impact to our team, our guests and our P&L.
Brian Cornell:
Well, Mike, I want to thank you for joining us on stage here today. We're really excited about the opportunities that are in front of us. You've heard a few examples today, and we'll continue to provide updates along the way.
So Mike, thank you for joining us.
Michael O’Neil:
Thanks, Brian.
Brian Cornell:
Michael, I'll have you back here in a second.
Michael Fiddelke:
Great.
Brian Cornell:
So as we get ready to hear from you and take your questions, I thought I'd briefly recap some of the themes you've heard today. First, our commitment to our guests is as strong as ever. Second, our strategy, our multi-category portfolio, our stores as hub model will provide the flexibility we need to keep growing because we're going to stay closely connected to our guests. Finally, there have been some fundamental changes at Target over the last 3 years. We're more than $30 billion bigger. We set the omnichannel standard with stores as hubs. We'll continue to build and innovate in that realm. We'll set the pace in supporting and developing the very best team in retail.
Perhaps the most important takeaway is something that hasn't changed, and that's our ability to shift our business and our categories in step with our guests. If they need to prioritize food and essentials, we'll lean into those categories. But as you heard from Christina, in a year when discretionary spending was down, our discretionary categories generated $55 billion in sales. Our guests today are responding to newness. They're celebrating seasons as we just saw with Valentine's Day. They're eager to be out in our stores and enjoying that guest experience, and we're seeing it in our traffic growth. And we know they really value affordable joy. So we remain fully committed to our multi-category portfolio, to essentials and to our discretionary categories. And as our guests lean back in discretionary categories over time, we'll be ready to flex into those trends, building substantially on the near-term plans we share today. We know that will happen. But in the meantime, we're moving forward thoughtfully. We're doubling down on retail fundamentals. We're finding fuel for further growth through efficiency. And while we're emphasizing prudence in our near-term performance, I am incredibly positive about the long-term potential and our ability to translate both into positive outcomes for all stakeholders, including shareholder returns over time. So I want to close by thanking our team as they tune in from around the globe, and thanking all of you for staying with us on this journey. And with that, I'll ask Christina, John and Michael to come back, and we'll open it up for your questions.
Brian Cornell:
All right. I see hands already going up. We've got paddle runners around the room. As I call on you, I might ask you just to pause, introduce yourself and ask your question. So why don't we start right here. Michael?
Michael Lasser:
It's Michael Lasser from UBS. A few questions. Number one, last year at this meeting, you had talked about an 8% operating margin. So what has changed this year to -- last year to this year structurally with the business to make it a lower operating margin business?
Two, what is it going to take to get to the 6% operating margin by next year? And third, Brian, sorry, did you look at the experience over the last few quarters and say, hey, we missed what we expected it to do. So let's take a more conservative, cautious view on how we're planning this year, leaving potential room for upside?
Brian Cornell:
Michael, why don't I ask you to start, and then I'll come back and answer the back half of that question.
Michael Fiddelke:
Yes. So we've got a journey in front of us on the profit front, and 2023 plays an important role in stepping back to where we expect to get over time. When we guided to a wide range today, even at the low end, we expect over $1 billion in net income growth year-over-year. And we want to execute that plan, that's first and foremost. Under the right set of conditions, we think we can get to 6% in 2024. And then we'll take it from there. But we've got the next couple of years squarely in focus because we've got work to do to recover our performance from last year.
As we think about what's optimal over time, I'll go back to what I said in remarks, we want the optimal rate that maximizes profit dollar growth over time. And I think there's still a few variables that will click into place between now and when we have that conversation in the quarters and months to come. But we want to be focused on dollars, in dollar growth, philosophically, that's the thing that we'd leave the group with today.
Brian Cornell:
And Michael, back to lessons learned from last year. We've used the term uncertainty quite a bit today. We recognized last year that the consumer trends move very quickly. And one of the things I'm most proud of is the way this leadership team embraced the challenge, took it head on, made the adjustments in our inventory and protected the guest experience. That's why we continue to see traffic growth and unit share gains across our portfolio and why we're so well positioned today for 2023 with overall inventory down 3%, but importantly, discretionary inventory down 13%.
So lessons learned for us, but I'm incredibly proud of the way this team dealt with that issue upfront, protected our team, protected our guests and position us for the long term. Why don't we go over on this side.
Paul Lejuez:
Paul Lejuez, Citigroup. A couple of questions on Drive-Up returns. Curious what percent of your returns are done at store? Also what is your typical attach rate? When you get somebody in a store that would return an item, do you also convert them to sales? Is there a risk that you might give up that opportunity? And then second, just high level, free cash flow. Once you get through all the working capital changes in F '23, what does free cash flow look like in your view for this upcoming year?
Brian Cornell:
All right. So several questions to answer there. John, I might ask you to start and explain why we're so excited about the changes we're making with returns through Drive-Up. And then Michael, we can talk about the second part of the question.
John Mulligan:
Yes. The majority of returns come back to store, but a meaningful portion are still shipped back to us. So that's not insignificant. As it relates to your -- the second part of your question around attach rate, and this is the question when we started Order Pick Up and when we started Drive-Up. And to us, that's respectfully not an important consideration.
What is important is allow the guests to interact with us how they choose. And at every step when they see us -- when we see them jump into Drive-Up, when we see them use Shipt, when they -- we see them use Pick Up, their engagement with Target increases, not just digitally, but also in-store, and that becomes a better guest for Target. The best guest set for Target are the ones that interact with all of our various ways of interacting with them. And so this provides them another opportunity to create ease. You've got your kid in the back. I need some milk and I got to return this, whatever, at Target. I put that in my trunk. I show up. They bring the milk, they take that away and I'm off on my day again. And then on Saturday, we'll come in and do the stock-up trip and that will be great. So our approach is just to continue to lean into where they want us to go. Top two feedback things on Drive-Up, why can't I get my coffee? Why can't I get a Starbucks? And why can't I return something? And so we're still working on the Starbucks, but we're ready for returns. And again, if we listen to the guests, they'll engage with us.
Brian Cornell:
Yes. John, I think one of the things we've learned over the last 3 years, and we watched it carefully as we expanded Drive-Up and Pick Up and started delivering right to your home with Shipt, we said, all right, is this going to impact the guest engagement in store? It's quite the opposite. As guests use all of our capabilities, they actually spend more dollars in-store and just reward us with more trips. So it's been an important learning that we'll build on. And I think we'll just deepen that engagement as we give them another easy solution for returns.
Michael Fiddelke:
Yes. Just -- at risk of piling on. We care about economics at the transaction level. We care about the economics at the category level. We care about the economics at the fulfillment path. But the thing that we thought differently about over time is cutting the economics by guests. When we take friction out of the process and make it easier for guests to just fall more and more in love with Target, that's the most powerful economic relationship to be focused on. I think we've learned that time and time again, and Drive-Up is a perfect example.
On the free cash flow question, we're not guiding to free cash flow specifically, but we expect material improvement from a free cash flow basis. And I touched on some of the drivers. The first is better profitability. The second is we expect working capital recovery. I mean our turns slowed, our supply chain times were longer this year and that came with working capital investments to make sure we're getting product here early enough with a volatile supply chain. And so we were running at suboptimal working capital levels through the bulk of 2022. As we move through 2023, I would expect that to improve.
Brian Cornell:
I think I see a hand up right in this first row. In fact, quite a few. We'll start right in the middle.
Simeon Gutman:
Simeon Gutman, Morgan Stanley. You mentioned that fulfillment costs, I think, on digital are down 40% since 2019. Is there any merit to the fact that you're a $110 billion sales organization and that you've suddenly become less efficient such that this path back to 6% requires investments? And so the ultimate question is how much of getting back is the pure recapture of lapping markdowns, freight costs, shrink versus how much you have to invest to get back to that level?
Brian Cornell:
Yes, I'm happy to start. It's a piece of both. We've seen some structural changes in the business. We talked about shrink as being one, and that's not one that we expect to turn in a different direction quickly. But the efficiency we've been able to drive, given how efficient stores are as a fulfillment hub is a huge advantage to us when it comes to digital fulfillment. It's fast for the guest, the economics of it work for us and we build engagement like we talked about before.
Separately, we continue to be focused, as Mike shared, on the efficiency work. And that's important work. We want fuel from efficiency, to keep investing in growth of the business. And that will also play a role in getting us to the right profit outcome that we should have as a $100-plus billion retailer. Go ahead, Mike.
Michael Fiddelke:
Sorry, Brian. I'd add on as it relates to capacity, particularly because you brought up fulfillment, we've seen our sales productivity in the store increase by 37% over the last 3 years, Brian mentioned that. We still have -- so an average store has gone, call it from $40 million to $55 million over the last 3 years. We still have stores that do over $100 million and do well over $100 million. The top quartile does significantly more than the median store.
So we have tons of capacity sitting out there unused in our stores and the ability to turn faster, again, back to we need to improve how we move inventory and how quickly we move inventory, which we're on the journey on, but our stores have significant capacity to continue to drive both in-store sales and our digital business.
Brian Cornell:
Why don't we go in the back?
Unknown Analyst:
Brian, I'd like to talk a little bit about the trade down impacts you're seeing. Are you a net gainer or donor on the trade down? And to the extent you are losing some share there, do you have -- does your customer database allow you to adopt win-back strategies targeted to those people who may have traded out?
Brian Cornell:
Okay. Christina, do you want to talk about what we're seeing as far as guest shopping behavior?
A. Hennington:
Yes, happy to. First of all, over the last couple of years, we've gained a tremendous amount of new guests into the Target ecosystem. And so our focus right now has been to deepen our engagement with the guests. Of course, we always want more guests, but the opportunity in front of us is much more to convert them into using the suite of capabilities because they become much more loyal. They understand the Target value proposition more deeply once they experience the ease and convenience of Drive-Up or once they recognized what an incredible food and beverage offering we have. And so that's our primary focus right now.
When we talk about trade down, those are words that are used in many different facets. Sometimes it's used internally in talking about private label. For us, we talk about owned brands rather than private label because these are brands we've invested in for years. We build them, design them, create the packaging, the marketing materials, and they're hugely important to our strategy. And so in that sense, we never think about it as trade down. We think about it as trade in. It creates more options for people to use and engage with our portfolio because it tends to be the same great quality at incredible price points. And so the growth of our owned brand strategy would reflect significant potential in the future based on the success we've had in the past. So right now, our focus is to make sure our guests are aware of what we have and create a better, less frictionless experience, make sure that we deepen the loyalty with the consumer.
Brian Cornell:
Right. Moving right here.
Gregory Melich:
Right. Maybe I'll just -- I'll jump in. Greg Melich. I got the mic. I'll just do it.
Brian Cornell:
You got the mic. The power of the mic, Greg.
Gregory Melich:
Really two questions. John, maybe -- well, maybe, Michael, if you could help us on some of the other margin drivers that you see, particularly shrink, you called out is still a headwind. What do you do to actually fix that? I'm also thinking credit profitability now that some of the delinquency rates and other charges are changing.
And then maybe bigger picture, Brian, how important is keeping traffic? You've gained so much traffic and customer engagement. How do you think about pulling that lever versus promotion and margin and expect more, pay less? Is it critical that traffic keeps growing no matter what? Or could it slip 1% or 2% just given your mix? How do you think about pulling those levers as we go through this uncertain year or 2?
Brian Cornell:
Michael, why don't I start with the focus on traffic. And as we sit here today, and you've heard me talk about this for years and years now, we think one of the most important indicator of a retailer's health is the traffic indicator. And that's why we feel so good about the fact that we've had 23 consecutive quarters where we've seen comp store sales growth, and it's all on the back of traffic. We're getting more footsteps into our stores, more visits to our site, greater engagement. Our guests are spending more with us. They are rewarding us with more trips and they're shopping more categories. And we think that's critically important.
To John's point, while we've seen a significant lift over the last few years in our sales per square foot, we know there's still potential to go further. And as we think about capabilities like Target Circle, our ability to connect with those guests and deepen their relationship, introduce them to newness in our assortment in other categories, we think we have a tremendous opportunity in front of us. But sitting here today, I continue to believe looking at trips is critically important. And in an inflationary environment that we're working in today, it's why we're so laser-focused on unit share improvement because those things are going to be really important as we move to a more normalized environment, because the guest is turning to us more frequently for all of their needs, both frequency and discretionary. They're shopping more categories. So making sure we're looking at units carefully, looking at trips to me is a key indicator of the health of our business today and why we're so excited about the potential in front of us.
John Mulligan:
And maybe for the second part of your question, Greg, when it comes to margin and profitability in general, it starts with what Brian did. The strength of the top line is going to matter a lot and we feel encouraged by the traffic trends that we've seen.
In terms of the other structural buckets, you hit on a few of them. We talked about shrink. We've seen a normalization in some of the credit metrics we watch, I think consistent with what you'd see in the industry. I wouldn't put that highest on the list of factors for next year, but it's one we'll stay close to and monitor. We've also talked and some of what we covered earlier today, we expect a promotional environment next year. We see guests responding to promotion in the fourth quarter, and we expect that, that's something that could continue. We'll also have some tailwinds on the margin side though. I mean we're anniversary-ing a level of markdowns in salvage that was extremely typical for us, and we want to make sure we recover that. We've seen some improvement in supply chain and freight. And so as we anniversary some of the peaks from last year, that should be a good guy on the margin line. And so it's all of those variables that we factored into the guidance we gave today.
Brian Cornell:
Okay. Why don't we go back there.
Ivan Feinseth:
Ivan Feinseth, Tigress Financial Partners. I have two questions. Could you go into some detail on how Roundel contributes to revenue growth? What percentage of your vendors are on it? And how you demonstrate your value proposition to them?
And then my second question, this morning on your interview on CNBC, you spoke about your strength in toys and your growth in home goods. What other category opportunities do you see that, going forward, you could lever and become a retailer of choice in those categories?
Brian Cornell:
Right. Well, Christina, I'll let you talk a bit about Roundel and just how important it's been for our vendor partners and deepening engagement. But the second question is something we talk about all the time. And sitting here today, you and I both know, while we have built great momentum and added over $30 billion of growth, we know we still have category opportunities all around us.
A. Hennington:
Yes. So first, Roundel, like I mentioned in my prepared remarks, is an incredibly important part of our ecosystem. It gives our vendors an opportunity to target the guests that they see as most likely to be intrigued by their new products and the quality of merchandise that they're bringing to market. It allows us to highlight those products and give them real-time insights about how it's selling because of the closed loop reporting that we can offer.
And so this has been a huge part of the demand generation for a lot of our businesses. We are very engaged with a broad spectrum of vendors across the entirety of the portfolio, and believe that Roundel is going to be an important part of the future, partly because of that guest-centricity that we bring to the model, but also because our guests want to know what's new and relevant, both across owned brands and national brands and how it fits into their lives. So maybe I can pivot to that second question and really talk about what opportunities we have. Well, we have a broad portfolio. And we think the strength of our multi-category portfolio is a differentiator in the market. We don't build an assortment for a snapshot in time. So having a healthy business across every dimension, allows us to flex as market conditions change. Right now, we're flexing into Essentials & Beauty and Food & Beverage. But a couple of years ago, it was Home and Hardlines that took the center stage. So having the ability to connect with consumers and having relevance and strong market share positions in many businesses is important to us. The way that we continue to build relevance is by staying super guest-centric, working to make sure that we are a destination for seasonal businesses. Seasonal businesses are kind of in our core DNA because it's a great way for guests to do more in one store at one time. Everything you need for back-to-school. You can get your backpack. You can get your calculator. You can get your pens and paper. You can get your new outfit. So those are really important to us, but the other is the importance of newness. And you heard me talk a lot about that. They're in an environment where consumers are making trade-offs. More of the same is not going to get it done. And so really investing in innovation and something that excites them, like our Apparel floor pad right now, if you haven't been in our stores or on our site lately, go check it out. The colors, the styles, the aesthetics are right on and it's absolutely grabbing the attention of our guests.
Brian Cornell:
Yes. I want to go back to the heart of your question. Do we have opportunities to continue to grow share? And it's something that Michael and I talked to many of you about all the time. Despite the growth we've seen over the last few years, adding well over $30 billion of top line growth, sitting here today, we represent 3% of the retail market. So as a leadership team, we see opportunities to grow across our entire multi-category portfolio, continue to leverage growth in store and from a digital standpoint.
So while we've seen tremendous progress and we're proud of the way we've transformed the business, we still see a significant runway to take share across every one of our major categories going forward, leveraging that great in-store guest experience and the digital experience we offer, that great combination of inspiration and ease that makes Target such a great destination for guests across the country. So we see tremendous opportunities for years to come to continue to bolster our share position. Let's come back to the front row. I know your hands have been up for a while.
Edward Yruma:
Ed Yruma from Piper Sandler. It sounds like Beauty has been a real strong category for you. Can you click down a little bit more on Ulta, maybe the difference in performance there versus non-Ulta stores? And maybe why not move faster? And then just as a quick follow-up on the $2 billion to $3 billion in efficiency gains, do you have any of that baked into '23?
Brian Cornell:
Christina, you want to start and talk about Beauty? And then Michael, we can talk about '23.
A. Hennington:
Yes. First and foremost, Beauty at Target has been a success story for a number of years. We have an incredible assortment that's been relevant for a while. But adding Ulta Beauty has completed our assortment. Our ability to offer prestige products in our store with a servicing experience and expertise that Ulta has brought to the table has been the missing link. And so we've completed that picture.
And so really excited about the performance, really excited about our partnership and we're looking to accelerate. We're already at 350 stores, and we'll add more, as John talked about, as part of our remodel program. So really bullish about the future there.
Brian Cornell:
Yes. Ed, you and I actually walked a store recently. And I think you heard from our local team, the fact that very excited about the results we're seeing with Ulta Beauty and it's clearly driving even more traffic to Target. But at the same time, that team talked to you about the fact that our core beauty assortment continues to grow. So they're complementing each other, and we're just becoming more and more destination for that beauty shopper.
Michael Fiddelke:
On the $2 billion to $3 billion, there's a piece of that, that shows up in 2023. But a large chunk of that is multiyear in nature. And you think about the apparel example that Mike shared, I think that's just a perfect example. That's a business that grew so fast over the last few years and our teams did an amazing job to protect the good guest experience as we grew.
But when we step back and look end-to-end across a business like apparel, we just see how much opportunity to simplify. Make things easier for the guests. Make things easier for our team. And changing some of those core processes won't happen overnight. That's why the multiyear nature is important. But we expect those benefits to be significant.
Brian Cornell:
Great. Let's go to this paddle right here.
Christopher Horvers:
Chris Horvers, JPMorgan. So my first question is you sit at these apex of different general merchandise categories that were major COVID winners. So as you peel away and look at the unit trends that you saw in the fourth quarter, are there signs of any stability, whether it's TVs or computing or decorative home or athleisure? Is there anything that has given you some encouragement to say like maybe we're getting to the bottom of the curve?
And then my second question is around the first quarter operating margin guide versus what's implied for the fiscal year. It doesn't look like the implied is maybe like 4.5 to 5 on the fiscal year. It's not much better than the midpoint of the first quarter but yet, they're bigger quarters. You're going to lap all these headwinds from the freight side, which should be coming down, the markdowns, the salvaging. So why isn't -- and presumably consumables inflation comes down so that relative performance improves, why wouldn't you see better operating margin performance over the year relative to 1Q?
Brian Cornell:
Christina, you want to unpack some of the trends we're seeing in discretionary categories?
A. Hennington:
Yes. The most consistent theme is where there's innovation, there's still relevance. And so consumers are finding them. Social media, of course, is a great way for consumers to become connected to new products and new ideas, and you'll be surprised things will spike quickly.
And sometimes we don't see them coming. In other times, we're well prepared. But I would tell you that there are pockets of those in every business. And so right now, we're planning the discretionary categories at an aggregate level more cautiously, but we're certainly leaning into market share opportunities where we see them. We believe that there's opportunity in the Home business, and we'll be launching more brands in the back half of this year, both on the national and owned brand side that have the potential to grow share in that category. We're seeing it definitely in Apparel, where you get the right fashion moment and the right fashion trend. It doesn't matter that they bought a lot of performance wear over the last couple of years, they're still interested in buying new. And so that's been the most consistent correlation. With that said, we're also introducing that level of newness and interest in categories like Food & Beverage and Essentials. Our favorite day brand that we've launched over the last couple of years, was a -- which is a sweets brand, has been -- has seen explosive growth over the last year or 2. And this is a place where we've taken the liberty to innovate in basic categories, whether it's cookies or ice cream and so forth, and the flavor profiles, the way that they brought the items to market have really shown that the guests will engage across the board if we give them a reason to.
Brian Cornell:
Chris, if we go back to discretionary categories. You heard us talk today, Christina highlighted the fact that in 2022, despite some of the softening trends, we still generated $55 billion of revenue in discretionary categories. One of the things I highlighted this morning during my CNBC interview is I go back to 2019. We've grown our discretionary portfolio by almost $14 billion.
So we're going to move forward from a much bigger base and much more relevance in those categories. And to Christina's point, we know they are going to return to growth over time It's going to be led by newness and innovation in the near term. But we're in a much different position going forward than we were prepandemic. And I think we have much more relevance and credibility in the space than ever before.
John Mulligan:
Yes. I think we're both at, what, 20 years or so at Target, Christina? We've seen ebbs and flows across the categories in our assortment over that time. And to us, the long-term winners will be the ones that build engagement in the moment now. That's why we're so focused on traffic. Apparel and Home will have their time in the sun again, and we'll be well positioned when they do.
On the first quarter versus the balance of the year, I think I'd go back to just some of the broader themes. I think the biggest variable, that's a tough one for any of us to predict right now, it's just what's the path of the consumer during the year. We planned the first quarter reflective and mindful of the discretionary trends that we saw in the fourth quarter. And we'll learn a lot, I think, together as we move through the year, and that will inform what the balance of the year plays out at. But we think an appropriately cautious approach based on the trends we've seen is the right place to start and we'll unpack it as the year progresses.
Brian Cornell:
I'm trying to scan through the room to see hands that have been up for a while that we haven't gotten to. Let's come back over here.
Karen Short:
Karen Short from Credit Suisse. So a couple of questions I wanted to ask. We know what your tail -- or headwinds were for '22 in terms of dollars. You're at kind of the $1 billion-plus mark. And obviously, we know what you're guiding to on operating profit dollars for this year.
But I guess the question that I would have is, it seems like maybe you've set a low bar. And so the real question is, if there's upside to the top line. Is that something you would choose to flow down to the bottom line? Or would you be more inclined to lean into continuing to, I guess, invest to maintain that kind of 5-plus percent operating margin for '23? And then the second question I would have is just on the $2 billion to $3 billion, if you could just give a little bit more on the buckets of where those are coming from? And then it sounds like there's some capture in '23, but most of it is '24 and beyond?
Michael Fiddelke:
Yes. It's a good question, Karen. And I guess I'd go back to just kind of philosophically how we think about the business. We're in the maximizing dollars business. And so we'd read and react through this year to make the right choices that we think maximize profit dollars both for 2023 and position us well for beyond.
I'd love nothing more than in the quarters to come and to say, gosh, some trends played out stronger. The consumer was stronger in the back half of the year than maybe we thought. And if that's the case, then we'd happily have that conversation and be thrilled to outperform. But I think the reality is, as we sit at the start of the year, it's an uncertain environment. And we want to plan cautiously in that. And that isn't just kind of on paper caution, that's making sure that we're positioning the business right. It was important to start the year clean from an inventory perspective. We feel like we've accomplished that goal. And we'd like to lean appropriately cautiously in our inventory buys in the discretionary categories with a ton of flexibility to react if things would turn out better, but we think that's prudent for the volatility that we see right now.
Brian Cornell:
All right. Looks like we've got time for one more question. I see a paddle up in the back.
Peter Benedict:
Great. Pressure is on here. Peter Benedict at Baird. I guess first question would be on gross margin, down a little more than 500 basis points since 2019. Assuming mix doesn't get any better the next couple of years, just curious, Michael, how you think about the recapture of a portion of that? Where are the opportunities there? What would you think? Again, without mix getting dramatically better.
And then my second question would just be, in the event that sales this year end up tougher than expected, your confidence in your ability to deliver still that $1 billion of improvement in EBIT, how much flexibility are you thinking on that front?
Michael Fiddelke:
Yes. Maybe I'll do those in reverse. The wide range of guidance that we gave today is reflective of the scenarios that we envision right now. And so we feel good about the line we've drawn in the sand with that guidance now and we'll get a lot smarter together as the year plays out.
When it comes to margin opportunities, we've talked about a lot of them already, but maybe one I would add to the list, just as a for example, is to link some of what Christina talked about with Target Circle and how valuable it is for us to be able to interact with our guests in a more individualized way. And that translates to good news on the top line, and we can make the right offer or the right message show up for the right guest at the right time. It should also translate to efficiency on our markdowns as we get more efficient with personalized promotions. We've learned over time that a personalized promotion has a higher return than a mass promotion. And so Circle gives us the opportunity to do even more of that better in the years to come. And so there's a lot of macro puts and takes, no doubt, as we unpack margin in the years to come, but there's also some important things that we're driving within the business that you know.
Brian Cornell:
Right. So with that, I want to thank all of you for joining us today. I know we'll see many of you throughout the year, and I hope to see all of you back here at the Time Center next year. So thanks for joining us. Get home safe.
Operator:
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.
John Hulbert:
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?
Brian Cornell:
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 fresh inventory and a reliable, uncluttered shopping experience for our guests, setting up our business to deliver strong growth in Q3. Among the drivers of our comparable sales, third quarter traffic expanded 1.4% on top of 12.9% growth a year ago. In addition to traffic growth, we saw a 1.3% increase in average ticket as guests continue to rely on Target for convenient, reliable one-stop shop. Across our merchandise categories and similar to the second quarter, we saw a very strong growth in our frequency businesses, led by double-digit growth in both Beauty and Food & Beverage. That strength offset persistent softness in our discretionary categories, which worsened at the end of the quarter. Christina will provide more detail in a few minutes. While overall Q3 comp growth was nearly identical to our second quarter performance, we experienced dramatically different trends within the quarter. More specifically, through the first 2 months of the quarter, we had seen comp growth of well over 3%, and then saw a deceleration to just under 1% in October. Even within the month of October results in the back half of the month were much softer than in the first half and the mix of our sales tilted much more heavily towards promotions. This rapid change in trend is consistent with what we're seeing in syndicated data on broader industry trends and the feedback we're hearing from our guests. More specifically, consumers are feeling increasing levels of stress, driven by persistently high inflation, rapidly rising interest rates and an elevated sense of uncertainty about their economic prospects. With high rates of inflation contouring the road, their purchasing power, many consumers this year have relied on borrowing or dipping into their savings to manage their weekly budgets. But for many consumers, those options are starting to run out. As a result, our guests are exhibiting increasing price sensitivity, becoming more focused on and responsive to promotions and more hesitant to purchase at full price. On the profit line, we saw an expected improvement in the third quarter as we move beyond the bulk of those costs from our second quarter inventory actions. However, Q3 profitability came in well below our expectations, driven by several factors. First and foremost, we faced an unexpected gross margin rate headwind from a higher-than-expected mix of promotional sales as guests moved away from full price purchases. In addition, like the rest of the industry, we're facing a growing financial headwind from shortage, which is running hundreds of millions of dollars higher than a year ago. Along with other retailers, we've seen a significant increase in theft and organized retail crime across our business. As a result, we're making significant investments in training and technology that can deter that and keep our guests and store team members safe. Looking ahead and taking recent trends into account, our team is making adjustments in real time with agility and flexibility in light of the revised expectations for both the top and bottom lines in the fourth quarter. It's in tough environments like these that we're most fortunate to have a durable business model and a strong balance sheet, allowing us to maintain our focus on long-term investments and market share opportunities at a time when many others will be forced to pull back. And to create additional capacity for us to continue investing in long-term growth and market share while also delivering strong bottom line performance, we are undertaking an enterprise-wide effort to identify opportunities to simplify and enhance the efficiencies of our business. I want to make it clear. This effort is not about slashing resources. Instead, it's about optimizing our operations to match the scale of our business. This effort is particularly important today because of the rapid and unanticipated level of scale our business is added since 2019 as total revenues have grown from less than $80 billion in 2019 to a projection of well over $100 billion this year. While our team has done an excellent job of staying agile and quickly accommodating all that growth. We now have an opportunity to look from top to bottom across all of our operations to ensure they are fully optimized for the size of our business. We're still in the process of fully scoping out this effort, but we believe it presents an opportunity to save a total of $2 billion to $3 billion over the next 3 years in support of our investments in long-term growth, along with our profit goals. In the near term, our team is energized and laser-focused on bringing the best of Target to our guests throughout the holiday season, knowing it's critically important for Target to be there for them during the busiest time of the year. Our team is committed to offering value across our entire assortment through great everyday prices, unbeatable value on our owned brands and accessible opening price points in every category. In addition, we'll highlight our compelling and simple promotions, free services like Drive-Up and in-store pickup and new accessible payment options. And of course, we'll provide additional savings opportunities through our RedCard and Target Circle programs, neither of which has a membership fee. So as I get ready to turn the call over to Christina, I want to thank the entire Target team for your energy, your spirit, your care for each other and your passion for our guests and our brand. You're the reason that Target has such a positive impact on the communities where we live and work and the reason we're known as a welcoming and inclusive brand. Thank you, and happy holidays to all of you. With that, I'll turn the call over to Christina.
A. Hennington:
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 to promotions, even as they celebrated key seasonal moments like back-to-school, college and Halloween. Among our frequency categories, Beauty continues to drive strong performance, delivering sales growth in the mid-teens. Skin care, hair care and cosmetics, all performed very well and our Ulta Beauty at Target offerings nearly tripled their total sales volume when compared to this period a year ago. Food & Beverage continues to outperform the market with low double-digit growth and strength across the portfolio, gaining both dollar and unit share every week throughout the quarter. Comparable sales in Essentials categories grew in the low single digits, reflecting particular strength in pets and health. While already soft, sales trends in our discretionary categories softened even more in the last few weeks of the quarter, a trend that's persisted into the first few weeks of November. But importantly, despite this challenging environment, we still saw unit share gains in all 5 of our core merchandising categories in the quarter, a sign that when guests are looking for convenience and value on both wants and needs, they're increasingly turning to Target. Apparel comps were down only slightly in Q3, driven by growth in kids, men's, seasonal and new fashion forward assortments, offset by softness in swim, women's accessories and basics. In Home, sales declined in the mid-single digits despite strong performance in seasonal areas. Hardlines sales were also down mid-single digits reflecting continued softness in home electronics and sporting goods. Additionally, we saw a meaningful deceleration in toys this quarter, most notably in October. This is a trend we will continue to monitor closely as we move throughout the holiday season. Across the portfolio, owned brands continue to outperform their national brand counterparts, growing at double the rate of the total enterprise in the third quarter. Because of our unique industry-leading, in-house design and sourcing capabilities, Target's exclusive owned brands provide tremendous quality at incredibly competitive prices, a great combination anytime but never more so than in an inflationary environment. So as we turn our focus to Q4, we'll do what we always do, work tirelessly to deliver value and solutions to our guests while also delivering affordable joy at a time when they need it most. As we've outlined this morning, we're taking a prudent approach to our inventory planning and sales expectations for the fourth quarter in light of the concerning industry trends we've seen over the past several weeks. But even with this cautious stance, we're focused on providing our guests with affordability and ease at every interaction with the Target brand. One of the signature ways we plan to stand out this holiday season is through our focus on the combination of newness and value, which cut across all our core categories. Given that the gift-giving season is underway and our guests are turning to Target more and more for their Food & Beverage needs, it's an ideal time for our recently announced partnership with British retailer, Marks & Spencer, who has collaborated with us to offer a limited time assortment of gourmet, premium food and chocolates, that's sure to be a perfect gifting solution this holiday season.
Despite recent trends in toys, we know they will play a critical role for our guests over the holiday season, and we have all the top toys and exclusives this year at incredible prices. Back by popular demand, our exclusive assortment from FAO Schwartz features more than 120 toys. And for all the Marvel fans out there, the first of its kind collaboration between Target and Disney will feature exclusive Black Panther merchandise and experiences, including the only-at-Target, Black Panther:
Wakanda Forever War on the Water LEGO set.
And the power of these partnerships doesn't stop there. We've added nearly 50 Disney shop-in-shop experiences this year, bringing the total to well over 200 of these shops across the country. In partnership with Apple, we've more than tripled the number of shop-in-shops since last year, and our Target Circle members have access to free trials of some incredible Apple services, including a free 4-month trial of Apple Fitness+. And with Ulta Beauty at Target, we'll have opened another 250 locations this year and now have more than 350 locations open across the chain. Through all our new tried-and-true and exclusive holiday offerings, we'll remain laser-focused on supporting our value proposition with key deals starting earlier than ever. Week-long Black Friday deals and our guest-favorite Deal of the Day offers are available now and feature our best plan prices for the season, with prices up to 50% off across toys and games, electronics, kitchen appliances and more. Besides industry-leading promotions, we are offering compelling, easy to shop, everyday price points on key items like $3 Christmas ornaments, $5 holiday Wondershop and candle assortments, and $10 gifting assortments across categories like Beauty, Apparel and Home. And to reinforce our commitment to value, we'll be offering free and easy payment and fulfillment options, including our recently launched reloadable RedCard, which provides all the benefits of our RedCard debit and credit programs, including free shipping and 5% off every purchase, all without the need for a credit check or an existing bank account. Combine this with our easy, convenient and free same-day service options like Drive-Up and order pickup, all with no membership fees and our free-to-join loyalty program, Target Circle, we have an unmatched combination of value-added and affordable shopping experiences to help our guests celebrate and amplify the joy of the holidays. Throughout the season, we will remain nimble and respond to changes in consumer promotional and macro trends, always in service of optimizing current and long-term performance. And despite the challenges facing our business and our guests, we have a not-so-secret-weapon to help us provide joy and value for our guests, a world-class team. Like Brian, I want to pause and add my sincere gratitude for the Target team. No matter what is thrown your way, you execute with grace compassion and consistency, a combination that leads our guests to return to our stores and website time and time again. With that, I'll turn the call over to John.
John Mulligan:
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 to our experience with lead times, we saw improvement across multiple dimensions of our transportation costs in the quarter, even as those costs remain above pre-pandemic levels. Container rates in global shipping have come down by about 1/3 in recent months, and we'll realize that benefit in 2023 as we renegotiate our staggered contracts with shipping partners. And importantly, we expect to see further reductions in those rates going forward as they remain about 3x higher than we were paying in 2019. Similarly, domestic transportation rates have come down since the beginning of the year, but remain higher than a year ago and double the rates we were facing in 2019. And of course, fuel costs, which are a major driver of our domestic transportation expense are still running more than double the amount we were paying in 2019 despite having moderated in recent months. Now I'll turn to the work of our properties team, where we're still wrapping up some projects but close to completing our supply chain and store projects for the year. On the distribution side, we're continuing our work to build replenishment capacity across the country, given the amount of growth we've delivered over the last few years. The other big addition to our distribution infrastructure is the build-out of our sortation center strategy. A year ago, we were operating a single sort center here in the Minneapolis market. And this year, we've opened 5 more with several more on track to open in 2023. These centers, which are typically a little bigger than a single store, increase our speed and meaningfully reduce our last-mile delivery costs in the markets where they operate. They also create backroom fulfillment capacity in the stores they serve, as they eliminate the need for each individual store to sort the boxes they've packed for delivery. On the store side, we are on track to complete about 200 full remodel projects this year in which we update every part of the store to reflect our latest thinking and offer a modern and inspirational shopping experience for our guests. Beyond full remodels, we're also on track to complete about 200 fulfillment retrofits this year in which we optimize their capacity and efficiency in supporting our same-day services. And finally, the team is on track to complete our new store program for 2022, in which we plan to add 23 new locations to the chain. The size of these new stores ranges widely from 19,000 to 145,000 square feet as we continue to open the right size store for the neighborhood we're serving. And as we've mentioned in recent calls, based on evolving conditions in the commercial real estate market, we've been finding more and more opportunities to open larger locations that can offer the full range of our assortment, along with a full suite of fulfillment options to serve our guests. In light of that opportunity, just over a week ago, we opened the first example of a new larger store prototype in the Houston, Texas market. At nearly 150,000 square feet, this new format incorporates our latest thinking in store design, featuring a more open layout, localized elements to inspire and serve our guests, 5x more space to support our digital fulfillment services and sustainable features in support of our Target-forward goals. While we'll continue to open new stores of all sizes in the next few years, we plan to lean into this new layout when appropriate and incorporate its features into other projects, including remodels. Among the many innovations we've incorporated into this new location in Houston, we've added 2 new Drive-Up services. The first is the ability for a guest to order a beverage from Starbucks on their way to pick up their Drive-Up order. We started testing this new service in the second quarter with a limited menu in a small number of stores, allowing us to collect feedback and fine-tune operations before expanding it more broadly. Based on the success of that pilot, earlier this month, we rolled it out to more than 200 additional stores across the country, just in time for the holidays. The other emerging capability is the ability for a guest to return a purchase through our Drive-Up service. We began testing this service only a month ago with our team members in a small number of stores, consistent with our test-and-iterate approach. Based on the operational success of that initial test, in early November, we expanded the service to our guests in that same small set of stores, and we'll look to apply any learnings from that guest-facing test before rolling out the service more broadly next year. So now before I turn the call over to Michael, I want to pause and thank our teams across the country who have worked tirelessly to ensure we are staffed and ready to serve our guests during the upcoming holiday season, our busiest time of the year. Consistent with prior years, before determining our seasonal hiring goals, we focused first on providing opportunities to our existing team to support their desired hours and backup training interests. And today, based on all that hard work in preparation, I'm happy to report that we're entering the holiday season in a very healthy staffing position, reflecting our success in hiring throughout the year, the significant wage investments we've made throughout the country, an increase in the number of team members who are looking to pick up extra hours and an 18% increase in applicants for seasonal positions compared with a year ago. As Brian mentioned, it's in times like these that we feel most fortunate to have a durable business model, which can sustain us through an ever more challenging economic and consumer backdrop and allow us to emerge with additional profitable growth and market share opportunities over time. That's why we're ensuring our teams are staying focused on our guests and taking the right actions to continue deepening our relationship with them. If we maintain that guest focus, I'm confident we'll find ourselves in an even stronger competitive position over time. With that, I'll turn the call over to Michael.
Michael Fiddelke:
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 year ago when the bulk of our global shipments were arriving late. The second factor is the unexpectedly rapid acceleration in the global supply chain that we saw in Q3, which caused us to receive shipments even earlier than scheduled. It's also important to note that the composition of our inventory continues to evolve as we've leaned into frequency categories where we're seeing robust growth and taken an increasingly cautious position in discretionary categories. More specifically, the percent of our inventory units in discretionary categories was 8 percentage points lower than at the end of Q2 and lower than in 2019 as well. With that context, I'll turn to our third quarter financial performance, beginning with the top line. Total sales grew 3.3% in the third quarter, the same as in Q2, driven by a 2.7% increase in comparable sales, combined with the benefit of new stores. Total revenue grew 3.4% in Q3, reflecting a 9.5% increase in other revenue, which was driven by the growth in our Roundel ad business. Traffic continues to be an important driver of our growth, having expanded 1.4% in Q3 on top of nearly 13% growth a year ago. In addition, this quarter, we benefited from a 1.3% increase in average ticket. Among our sales channels, stores continue to drive our growth as we saw a 3.2% increase in store comparable sales in Q3 on top of nearly 10% growth a year ago. Comparable sales in our digital channel grew 0.3% in the quarter on top of nearly 30% last year. Same-day services led our digital growth, most notably through our Drive-Up service, which delivered high single-digit growth on top of more than 80% growth last year. As Brian mentioned, while our overall Q3 comp increase was consistent with Q2, we saw a dramatic change in the pace and composition of our business toward the end of the third quarter. More specifically, within the quarter, comparable sales grew 2.8% in August, rose to 4% in September and decelerated to 0.9% in October. Also notable, even within the October period, there was a dramatic change in the pace of our sales. As you'll recall, the month began with an initial round of holiday promotions from Target and some of our competitors, and in that week, we saw a high single-digit increase in comp sales compared with last year. However, for the remainder of the month, we saw a low single-digit decline in comp sales over those last 3 weeks. Nearly all of the slowdown was driven by our discretionary categories, Apparel, Home and Hardlines, as our guests became increasingly cautious in their spending in those categories at both Target and throughout the industry more broadly. So far in the month of November, trends have been largely consistent with what we were seeing at the end of October, in terms of our comp trends, the mix of sales between frequency and discretionary businesses and the focus on promotions by our guests. While our Q3 gross margin rate of 24.7% was more than 3 percentage points higher than in Q2, it came in far short of our expectations, driven by 3 factors. The primary driver was a higher-than-expected markdown impact from promotions as our guests became increasingly price-sensitive and concentrated their discretionary spending on items on promotion, most notably in the latter weeks of the quarter. While we anticipated a highly promotional environment this fall, given the excess inventory we had been seeing across retail, this enhanced focus on promotions reflects an increasing level of stress on consumers as they navigate through multiple headwinds, including persistent inflation and rapidly rising interest rates. A second factor that's impacting our gross margin is inventory shortage, or shrink, which is a growing problem facing all retailers. At Target year-to-date, incremental shortage has already reduced our gross margin by more than $400 million versus last year, and we expect it will reduce our gross margin by more than $600 million for the full year. As Brian mentioned, this is an industry-wide problem that is often driven by criminal networks, and we are collaborating with multiple stakeholders to find industry-wide solutions. For example, because stolen goods are often sold online, Target strongly supports the passage of legislation to increase accountability and prevent criminals from selling stolen goods through online marketplaces. A third factor that affected our Q3 gross margin was the incremental cost of managing early inventory. In the near term, these pressures should begin to recede as we move through the fourth quarter and into next year as receipt flow naturally moderates following the holiday season and we'll begin to benefit from the reduction in order lead times John mentioned earlier. And finally, regarding gross margin, category mix moved from being a slight headwind in Q2 to a small tailwind in Q3, contributing about 20 basis points of gross margin benefit in the quarter. This change in mix impact might seem counterintuitive given some of the category trends I highlighted earlier. However, underneath the surface of discretionary comps when compared to our second quarter results, comp sales in Apparel, a high-margin discretionary category got stronger in Q3, while comps in Hardlines, a lower-margin discretionary category saw a deceleration in the third quarter. Moving down to the SG&A expense line. We saw a small amount of deleverage in Q3, even as we continue to benefit from disciplined cost management across the organization. In spite of that discipline, we're facing inflationary cost pressures across multiple expense lines in the P&L. Within compensation, expenses reflect ongoing investments in hourly team member pay and benefits, partially offset by a year-over-year rate benefit from lower incentive compensation expense. Altogether, on the operating income line, on both a dollar and rate basis, we saw a year-over-year decline of about 50% in the third quarter. I want to emphasize that we're not happy with this performance and expect to deliver much stronger dollar and rate performance over time. Now I want to turn to capital deployment. And as always, I'll start by reiterating our priorities, which have been consistent for decades. We first look to fully invest in our business in projects that meet our strategic and financial criteria. Then we look to support our dividend and build on our 50-year record of annual dividend increases. And finally, we devote any excess cash beyond these first 2 uses to repurchase our shares over time within the limits of our middle A credit ratings. Beginning with our first priority, capital expenditures have come in at about $4.3 billion through the first 3 quarters of the year, and we're now expecting our full year CapEx will come in around $5.5 billion in light of continued inflationary pressures affecting the cost of this year's projects. We paid just under $500 million in dividends in the third quarter, up from $440 million a year ago, reflecting a 20% increase in the per share dividend, partially offset by a decline in our average share count. And finally, we didn't repurchase any shares in the third quarter, given current financial performance and the working capital investments we've made to support in-stocks and early receipts. In the near term, we will continue to take a very cautious approach to share repurchase in light of the volatility of the environment and our commitment to maintaining our middle A credit ratings. So now I want to close my Q3 review with a discussion of our after-tax return on invested capital. For the trailing 12 months of the third quarter of this year, our after-tax ROIC was 14.6% compared with 31.3% a year ago. While this is a disappointing decline, a mid-teens after-tax return on capital is still very healthy in absolute terms and a testament to the durability of our business. Importantly, we expect to see a significant recovery from this number over time as we move beyond the unusual headwinds that have been affecting our business this year. Now let me turn briefly to our expectations for the fourth quarter. In the current environment, we're facing an even higher degree of uncertainty than a quarter ago given the volatility we've been seeing recently. And in light of the dramatic changes in shopping patterns we've seen both at Target and across the industry, we believe it's prudent to plan for a wide range of comparable sales outcomes in the fourth quarter that's centered around a low single-digit comp decline, consistent with recent trends. Underlying the sales expectation, we're planning for softer discretionary category comps than we've seen in the last 2 quarters, partially offset by the benefit of continued strong growth in our frequency businesses. If these sales trends persist, we'd see far less of a benefit from leverage on fixed expenses than we've seen so far this year. In addition, we'd expect greater markdown pressure from Q4 promotions given the increase in price sensitivity our guests have shown recently and our commitments to end the year with a clean inventory position, especially in those categories where trends have softened. And as I mentioned, we're planning for additional pressure from inventory shrink, given the worsening trends that have emerged so far this year. Altogether, these expectations lead to a wide range for our expected Q4 operating margin rate centered around 3%. The single-most sensitive input to this profit projection is the level of demand for our discretionary businesses. If that demand improves from recent trends, we would expect fewer markdowns and would likely outperform our updated profit expectations; while if demand softened further, profit could see additional pressure. As we look beyond the holiday season, we're planning for a continued challenging environment as we move into next year. And as John and Brian already pointed out, we are fortunate to have a durable model that is well positioned to continue serving our guests even in the toughest of times. In addition, we have a significant opportunity to harness efficiencies in support of our long-term growth and profit goals. At the end of 2019, our operations had been built to support a business that delivered $77 billion in sales that year. And our long-term algorithm at the time was anticipating low single-digit top line growth in the years ahead. If things had played out that way, we might be looking at a total sales number in the low to mid-$80 billion range this year. Instead, even in the midst of a very challenging environment, we're positioned to deliver total sales of well over $100 million this year. So today, we have a compelling opportunity to look across our operations with an eye to simplifying and optimizing those operations for a more than $100 billion business. And today, as we look at the operations we have and where we think they can be, we believe there's a $2 billion to $3 billion savings opportunity over the next 3 years. To be clear, this isn't about slashing resources. And in particular, we're focused on continuing to invest in our team, which is our most valuable asset. As Brian said, we are in the initial stages of scoping this opportunity, and we expect to share detail on our progress at our 2023 Financial Community Meeting. In the meantime, I want to join Brian and wishing all of you a happy holiday season, and I want to pause and thank the entire Target team for making Target a great place to work and a store that's ready to bring joy to millions of our guests throughout this season and beyond. With that, I'll turn the call back over to Brian.
Brian Cornell:
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:
[Operator Instructions] Our first question is from Christopher Horvers with JPMorgan.
Christopher Horvers:
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.
Michael Fiddelke:
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.
Brian Cornell:
Chris, did you have a second question?
Christopher Horvers:
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?
Michael Fiddelke:
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.
Operator:
The next question is from Michael Lasser with UBS.
Michael Lasser:
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.
Brian Cornell:
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.
John Mulligan:
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.
A. Hennington:
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.
Brian Cornell:
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.
Michael Lasser:
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.
Brian Cornell:
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.
Operator:
Our next question is from Ed Yruma with Piper Sandler.
Edward Yruma:
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?
John Mulligan:
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.
A. Hennington:
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.
Operator:
The next question is from Scott Mushkin with R5 Capital.
Scott Mushkin:
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?
Brian Cornell:
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.
Scott Mushkin:
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?
Brian Cornell:
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.
Operator:
The next question is from Robby Ohmes with Bank of America.
Robert Ohmes:
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?
A. Hennington:
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.
Robert Ohmes:
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?
John Mulligan:
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.
Operator:
The next question is from Simeon Gutman with Morgan Stanley.
Simeon Gutman:
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.
Brian Cornell:
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.
Simeon Gutman:
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?
Michael Fiddelke:
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.
Brian Cornell:
Operator, we got time for one last question today.
Operator:
Our last question comes from Kate McShane with Goldman Sachs.
Katharine McShane:
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?
Michael Fiddelke:
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.
Brian Cornell:
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.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to Target Corporation's second quarter earnings release conference call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, August 17, 2022.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our second 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 minutes, Brian Christina, John and Michael will provide their perspective on our second quarter performance and our outlook and priorities for the remainder of the year. 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, the most important of which are described 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 quarter and his perspective on the back half of the year. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. Back in June, we announced that our team would be undertaking a bold effort to rightsize our inventory position in the categories through which demand patterns have rapidly changed.
While this decision had a meaningful short-term impact on our financial results, we strongly believe it was the best path forward. Consider the alternative:
we could have held on to excess inventory and attempted to deal with it slowly, over multiple quarters or even years. While that might have reduced the near-term financial impact, it would have held back our business over time. Of course, this decision would have driven incremental costs to store and manage the excess inventory over a longer period. But much more importantly, it would have degraded the guest experience. It would have cluttered our sales force and hampered our ability to present new, fresh and fashionable items, the ones our guests expect from Target.
Just as importantly, the extra inventory would have presented an ongoing burden to our supply chain and store teams, as they face the distraction of working around it day after day. Instead of taking that passive position, our team chose a more decisive path, aggressively reducing the inventory we already owned and cutting back on receipts for the back half of the year. And today, with those decisions behind us, we're in a much better position as we head into the fall season. As you'll hear in more detail, we've meaningfully reduced our ownership and commitments in categories where we've seen softening demand. This has allowed us to strengthen our inventory position and in-stock position in the categories that are driving our growth, most notably in Food & Beverage, Beauty and Essentials.
Regarding the financial impact of those decisions, Michael will provide more details in a few minutes. But the high-level story is, the vast majority of the financial impact of these inventory actions is now behind us. This positions our business to deliver a meaningful improvement in operating margin rates in the fall season. However, beyond financial and operational outcomes, I'm focused on how our inventory actions will benefit our guests and our team. Regarding our guests, we're now positioned to continue driving engagement and growing traffic with a clean, safe and uncluttered store experience and an assortment that highlights newness and supports growth. For our team, this quarter's inventory actions will enable them to focus on doing what they do best:
providing a great guest experience while reducing the strengths and distraction from overly crowded store backrooms and distribution facilities.
After we announced the rightsizing effort at the beginning of June, I have heard from countless leaders across the company, who wanted to relay their gratitude for the decision to move quickly and face the issue head-on. In the same spirit, I want to pause and acknowledge the incredible effort of the entire Target team during a very challenging time for the economy, for our industry and our business. Our success in reducing inventory was a result of unprecedented effort, coordination and collaboration across multiple teams, from our U.S. headquarters to our Target India headquarters, to our stores, distribution centers, transportation team and sourcing offices around the world. And today, in the face of a very challenging backdrop, I'm proud of how our team and business model continue to serve our guests' evolving needs. Everything we do, from the design of our operating model to the way we train our team, is done with a focus on better serving our guests. It's reflected in how we choose our assortment, where we curate a broad range of items, both in-store and online, from the stylish to the functional, incorporating quality and value throughout. It's also evident in how we design our store and the digital shopping experience that make them easy, convenient and inspirational, inviting guests to choose the right option every time they shop. All of these decisions make our business model more durable, allowing us to drive deeper guest engagement and grow traffic in every environment. Consistent with the shopping trends we've seen for more than a year, our second quarter comp increase of 2.6% was driven entirely by traffic, which expanded 2.7% this year, on top of double-digit growth a year ago. With this increase, second quarter traffic has expanded by well over 20% since 2019. In raw numbers, that means in the second quarter alone, we've added more than 90 million guest visits over the last 3 years. These visits are a vivid demonstration of a deepening level of guest engagement resulting from multiple investments throughout our business. These investments include dozens of new stores and hundreds of remodels every year. They also include investments in our industry-leading same-day services, which have transformed our business in a short time. More specifically, 3 years ago, in the second quarter of 2019, digital fulfillment accounted for just over 7% of total sales. In contrast, by the second quarter of this year, the same-day portion of our digital sales accounted for more than 10% of our total sales. This drove our total digital penetration up to almost 18%, more than doubling in only 3 years. Beyond our stores and fulfillment services, guests continue to respond to our investments in our own brand portfolio. This portfolio delivers more than $30 billion in annual sales, and includes 12 brands that generate more than $1 billion each. At the same time, we're investing in new spaces and presentation for key national brand partners like Apple, Disney and Levi's. And of course, we've been rapidly expanding the number of stores that feature an Ulta Beauty at Target given the incremental traffic and sales they deliver. But nothing has been more important than the investments we made in our team. These investments include the move to a starting hourly wage range of $15 to $24 across the country, enhanced health care and wellness benefits for a larger percentage of our team, the rollout of an industry-leading debt-free college educational plan and our work to enhance the growth and development opportunities available to all of our team members, and the team members of color in particular. As we look ahead to the back half of the year, the team is laser-focused on delivering convenience, value and joy at a time when our guests are facing multiple challenges. And while we've taken a cautious stance on our inventory commitments, we'll continue to lean into frequency categories where guest demand has been strong and where the markdown risks are very low. In addition, given the ongoing pressure our guests are facing from inflation, we're leaning into value. This means we're focused on providing great everyday pricing and strong opening price points across every category, including in our own brands. At the same time, we hear from our guests that they're focused on celebrating the seasonal moments they missed over the last 2 years. As a result, we'll lean into those seasonal moments, helping our guests find ways to come together and celebrate with family and friends. So we still have a lot of business ahead of us. We've seen an encouraging start to the back-to-school and back-to-college season, and our teams are already deep into their planning for the upcoming Halloween season, a time when we expect our guests will fully embrace trick-or-treating and scheduling parties to celebrate with family, friends and neighbors. Given continued volatility in the external environment, we built our fall plans with a priority on flexibility and agility, and that's where our business model shines. More specifically, our multi-category portfolio stays relevant and drive strips across a wide range of wants and needs. In today's environment, that means our Food & Beverage category is front and center, having grown more than 50%, or $1.8 billion since the second quarter of 2019. But regardless of whether a Target Run begins with a need for an item in food and beverage or household essentials, to see what's new in our beauty assortment, the pick of a toy for a birthday party or a piece of luggage for an upcoming trip, our safe one-stop shopping experience provides an opportunity to sell items in every one of our categories on every guest visit. Beyond our assortment, our unique stores-as-hubs operating model offers unmatched flexibility in how we can fulfill guest demand. Whether a guest wants to make a conventional in-store shopping trip, place a drive-up order, arrange a Shipt delivery or simply have a box delivered to their front door, stores can fulfill every one of those needs quickly and reliably, allowing our guests to choose what works best for them in that moment. And as Michael will outline in more detail, our strong balance sheet and robust cash generation support continued investments during tough times like these, investments in our long-term growth and market share. At a time when many others will be struggling just to survive, the ability to play offense and focus on the long term makes us well positioned to emerge from the current downturn even stronger than before. So as I get ready to turn the call over to Christina, I want to thank our team for their continued passion for serving our guests and each other. While the environment remains challenging, I'm inspired by the new and unique merchandise, seasonal offerings and partnerships our team has planned for the back half of the year. And as I've traveled across the country to visit our stores and distribution centers, I've been inspired to hear how our team is energized and eager to serve our guests with energy, empathy and care, bringing some daily joy at a time when our guests are dealing with multiple headwinds. This unshakable guest focus is one of the many reasons our unique team makes Target a great company, and I am privileged and grateful to serve with them. With that, I'll turn the call over to Christina.
A. Hennington:
Thanks, Brian, and good morning, everyone. Despite the tough environment we are facing today, I continue to be pleased with both our top line performance and the underlying market share we're seeing across our business
As Brian mentioned earlier, the inventory actions we announced in June involved incredible collaboration across teams at headquarters, stores and throughout our supply chain network. And I'm proud to say that together as one team, we accomplished what we set out to do. By moving through excess units, we were able to realign our broader inventory portfolio to those categories our guests are most focused on, including frequency categories like Food & Beverage, Everyday Essentials and Beauty as well as all things new, seasonal and fashion-forward. To accomplish that goal, teams analyzed and built action plans to aggressively work through excess inventory at every point along the product journey, from vendor to guests. This included rigorously reforecasting expectations for the balance of the year and beyond and determining where to reduce future receipts and orders. In some cases, they meant working with vendor partners to reduce our fall receipts in light of our updated expectations. It also meant quickly building compelling promotional plans to drive unit velocity for product we already owned, all with a focus on providing great value and generating excitement for our guests. And throughout the execution of these action plans, our teams remain steadfast in their guests-first focus, refusing to compromise the shopping experience in our stores or online. As you heard from Brian, the short-term profit implications of these decisions were meaningful, but we're confident they're the right long-term decisions for our business, for our teams and for our guests. As we formed and revisited our plans for the third quarter and beyond, we spent a lot of time listening to the wants, needs, hopes and concerns of our guests. What we're seeing in our results and hearing from our guests is that they still have spending power, but they're increasingly feeling the impact of inflation. And while the recent reduction in prices at the gas pump has been encouraging, guest confidence in their personal finances continues to wane. Against that backdrop, we've seen our guests shop our owned brands in bigger ways and more frequently, knowing they are choosing great quality products with incredible value. We've also seen guest behavior evolve as they focus on optimizing their personal budgets through a heightened response to promotions as well as greater trip consolidation. At the same time, guests continue to experience difficult news headlines, COVID surges and continued political volatility, leading them to seek more ways to celebrate, connect and find opportunities to bring joy to their families. This is one of the reasons we continue to see such strength in our seasonal categories, which we expect will continue in the back half of the year. Now let me turn to some of the category highlights from the second quarter, in which overall comparable sales grew 2.6%, on top of 8.9% a year ago, reflecting continued strength in Food & Beverage, Beauty and Household Essentials. Food & Beverage led the way in the quarter with growth in the low double digits, reflecting broad strength across multiple subcategories. Beauty grew in the high single digits, reflecting notable strength in Ulta Beauty at Target, along with the skincare and bath categories. Essentials grew in the mid-single digits with performance led by pets and health care. Overall, across our discretionary categories, sales were softer than a year ago, but remained nearly $3.5 billion or more than 35% higher than the second quarter of 2019. In Hardlines, overall comp sales were down slightly to last year. Within Hardlines, softness in electronics was partially offset by strength in entertainment, which grew in the high single digits, along with high single-digit comp growth in toys, an encouraging sign as we plan for the fourth quarter holiday season. Overall, the Home category saw a low single-digit decline compared to last year despite affinity for our seasonal assortments and encouraging early results in back-to-school and back-to-college. Apparel also saw a low single-digit decline in the second quarter but saw meaningful growth in women's fashion-forward categories, along with performance apparel, on top of strong sales growth in the category over the past 2 years. As I mentioned earlier, while overall sales growth is one key indicator of the health of our business, market share is an equally important measure that we use to understand how we're performing. And notably, during inflationary times like these, we heavily focus on unit share, specifically to better understand our relevance as compared to our competitive set, given that growth in both traffic and units is a strong proxy for the guests' overall engagement with Target. Time and time again, these metrics have proven to be a better barometer for lasting success as compared to growth solely through average retail prices. That's why I'm so encouraged that across all 5 of our core merchandising categories, we grew unit share in the second quarter. So now let's turn our sights to all that is to come for the balance of the fiscal year. Having celebrated holidays in a big way in the second quarter, guests already have their sights set on upcoming holidays and seasonal moments in Q3 and beyond. Preparing for the upcoming school year is top of mind for families right now. And to help with the transition, we're providing budget-friendly options for students, parents and teachers alike. Beyond our assortment of value-priced owned brands and leading national brands, we're offering a onetime 20% off Target Circle deal for college students to get those dorm rooms prepped and ready. And we've also extended our teacher prep event to nearly 8 weeks of discounts on supplies and more. And today, while we still have several weeks of the season left to go, we've been encouraged by early results in both our back-to-school and back-to-college programs. Shortly after school begins, we'll turn our attention to celebrating Latino Heritage Month, which begins in the middle of September. We're excited to help celebrate this important cultural moment with our guests through the presentation of a compelling assortment, 99% of which was created by members of the Hispanic/Latino community. Then before we know it, Halloween celebrations will be underway, with all the tricks and treats the season has to offer. Our guest research indicates that more families plan to participate in Halloween festivities compared with last year, and we're ready with a wide array of gender and size inclusive costumes, new owned brand trick-or-treating candy and accessories, haunted house cookie building sets and so much more. And for those that want to celebrate the broader fall and harvest season in general, rest assured that there will be no shortage of new offerings from Good & Gather to create perfect meal, snacking and entertaining solutions, including delicious new flavors of the season like maple, cinnamon, apple and, of course, all things pumpkin spice.
Outside of specific holidays, we are focused on helping our guests experience Everyday Joy, and our ability to cut across brands and categories is part of what makes us uniquely Target. For an example, look no further than our upcoming collaboration this fall with Marvel to bring a unique assortment to our guests across the Avengers and Spider-Man franchises. One standout will be lots of Marvel Studios' Black Panther:
Wakanda Forever and Black Panther Legacy exclusives within toys, Apparel, Home and more. We'll have more details to share in the coming months.
And in an exciting collaboration with long-time partner, The LEGO Group, we are bringing their popular LEGO Ideas contest to Target, in which LEGO superfans submit ideas for a themed LEGO building set. After a public submission phase, a handful of finalists will be selected for guests and fans to choose their favorite idea to be produced as an exclusive set at Target and LEGO brand retail stores. But Target Joy goes well beyond key holidays or exclusive launches. It's about how we continue to iterate and improve upon what our guests already know and love from their regular Target Run. This next quarter, you'll see us elevate our fashion assortment with several new collections and updated brands. We'll introduce new well-known national brands in cookware and kitchen. We'll also continue to expand our leading national brand partnerships, including opening more Disney stores and, of course, Ulta Beauty at Target. In fact, we're only a year into this new partnership, and there's plenty of room to grow ahead. With the introduction of new designer fragrance brands, including Coach, Clinique, Kate Spade and more as well as additional skin and hair care products, we continue to evolve the assortment to bring more joy to our Beauty guests. We remain on track to open at least 250 of these unique spaces this year. Plus, we've already seen more than 1.5 million guests link their Target Circle and Ultamate Rewards accounts, a number that's sure to continue to grow in the months and years ahead. So now before I pass things over to John, I'd like to take a moment and echo Brian's gratitude for the team. While we have demonstrated time and time again that our durable, flexible model can quickly pivot with changing consumer demands and a host of retail and economic conditions, none of that can happen without an incredible team. Their talent, dedication, passion and expertise allows us to continue putting the Target guests at the center of every decision we make. As a result, we continue to benefit from deeper guest loyalty and preference for our brand. I have been at Target 19 years, and I continue to be inspired every day by the talent around me. Thank you for your commitment and care to all our stakeholders. With that, I'll pass things over to John.
John Mulligan:
Thanks, Christina. In past calls, I've described how our operations team is always focused on two things at the same time. Of course, they're always focused on short-term execution and problem-solving to ensure we provide a convenient, consistent and inspiring experience for our guests. In addition, our team works every day to deliver on our long-term vision and aspirations, ensuring our operations are ready to support our future plans. While this dual focus on both near-term and long-term priorities has always been present, it's been especially notable this year, given that we've been operating in a very unique environment.
In terms of the short term, and as Brian and Christina mentioned earlier, our work to quickly rightsize inventory require determination, commitment and coordination between multiple teams across the company. And given the need to protect the guest experience, there was no higher priority than delivering against this near-term plan. At the same time, our team remains passionately focused on the long-term investments we're making in our future. These investments include our work to modernize and expand our store footprint, increase upstream capacity in our supply chain, automate distribution center processes to reduce store workload and enhance our last-mile fulfillment capabilities by opening sortation centers and integrating them into our Shipt network. And fortunately, as Brian highlighted, the strength of our business allows us to continue funding these long-term investments even in the face of the challenging external backdrop we're facing today. I want to first turn to our work on inventory. And I'm happy to report that our team has made remarkable progress over the last few months, causing conditions in our supply chain to improve significantly. More specifically, and to provide some helpful context, over time, we want to keep our DC network operating at or below 85% of its maximum capacity, given that operational difficulties and costs rise significantly when we move beyond that level. So it's important to note that back in June, inventory in our DC network peaked at well over 90% of our capacity. Also notable, by the end of the second quarter, less than 2 months later, our team had quickly reduced DC capacity utilization to below 80%. Put another way, by the end of the second quarter, the physical space occupied by our distribution center inventory was more than 20% lower than the peak we reached in June. So today, while we still have some individual sites where we need to make more progress, the team has accomplished a remarkable improvement in a very short time, which will allow our end-to-end operations to function more efficiently and effectively in the back half of the year. As Christina mentioned, beyond addressing the inventory we already owned, the team also took a hard look at sales trends and determined ideal inventory levels across every category for the remainder of the year. As a result, we've meaningfully reduced our fall season receipt commitments in many discretionary categories. With these reductions, we're projecting our DCs will remain at or below 85% capacity through the remainder of the year, even after the seasonal increase in holiday inventory that is set to occur over the next 2 months. In other words, for the first time I am aware of, our fall season inventory is projected to peak at a lower level than in spring, providing another vivid illustration of the unique dynamics we've encountered so far this year. While this inventory rightsizing process hasn't been easy and our teams have devoted an amazing amount of effort in a small amount of time, this work has allowed our teams to strengthen ongoing communication mechanisms and build new processes. Going forward, these improvements will enable our merchandising and supply chain teams to maintain enhanced real-time communication, particularly with respect to categories where we face the highest inventory risk, allowing us to respond to changes with more speed and agility. While pressure from excess inventory has presented the biggest challenge to our team this year, dealing with high costs and volatility in the external supply chain has run a close second. And today, while conditions remain far from what we would have considered normal in the years before the pandemic, there are early signs that both costs and volatility may have peaked. More specifically, lead times in global shipping have begun to decline. Spot rates to move shipping containers have fallen somewhat. And in light of the reduction in petroleum prices we've all seen recently, fuel surcharges have been easing somewhat compared with the peak rates we saw earlier in the second quarter. That said, conditions remain highly unfavorable when compared to the years before the pandemic, and we're mindful of the continued risks in the months ahead, including potential slowdowns at the West Coast ports, a reversal of the recent decline in energy costs and the possibility of additional COVID lockdowns in China. In addition, we continue to encounter far too many delays affecting overseas shipping which require us to pay spot rates to move containers, rates that are well above our prenegotiated shipping rates. As such, we're maintaining our practice of moving receipt dates earlier than we would have in the past, which allows us to mitigate the business risk from receiving shipments later than expected. You'll recall that at this time a year ago, when the external supply chain began slowing down and shipments were arriving late, we began relying on air freight much more than usual to ensure we receive key seasonal merchandise on time for the holiday season. While that was the right decision at the time given the circumstances we were facing, this year, we expect to meaningfully reduce our reliance on air freight by moving to early receipt dates for seasonal inventory. To accommodate these early receipts without adding further color to our supply chain in stores, we secured temporary capacity to store and stage shipping containers near the ports where we receive them. When needed, this allows us to quickly clear the containers from the port area and hold them until the ideal time to begin moving inventory into our supply chain network. While we don't expect to need this additional capacity over the long term, we believe it's clearly the most efficient approach in today's environment, given the volatility we continue to face. I also want to highlight the critical role that our stores have played in our work to improve conditions in our supply chain. During the second quarter, our store teams engaged in a host of activities to support the effort, including the execution of countless promotions and markdown programs to move the excess merchandise quickly and the development of innovative presentation strategies to highlight the deals we were offering our guests. This included repurposing the seasonal presentation space in our stores to highlight deals and create meaningful statements, including key item promotions. It also included the early wind down of our outdoor living assortment, which allowed us to bring in our back-to-school set earlier than usual, ensuring we are back in stock and reliable on key items parents needed to fill their back-to-school shopping list. More specifically, at the end of the second quarter, about 3/4 of our back-to-school and back-to-college receipts were already downstream in our stores, a number that was closer to 50% at the end of Q2 a year ago. So now before I turn the call over to Michael, I want to turn my focus to our longer-term priorities and the multiple ways we're investing in our future growth. As you know, the majority of our CapEx is going into our store network, both to extend our footprint and invest in existing locations. These store investments fall into 3 major buckets. The first and largest investment is in our store remodel program, where we completely transform the space in an existing location, modernizing the shopping experience while enhancing the productivity of our team. At this point in the year, well over 100 remodels are currently in flight across the country, keeping us on track to complete nearly 200 remodels this year. In addition to these complete transformations, we're also making smaller investments in hundreds of other locations. This includes the hundreds of fulfillment remodels we'll accomplish this year, in which we reconfigure portions of the store to enhance the efficiency, safety and capacity of our drive-up, in-store pickup and ship-from-store services. In addition, this year, we're investing in several hundred locations to add an Ulta Beauty at Target, a co-branded Apple shopping space or a Disney store presentation to the sales floor. And finally, we're on track to add about 24 new store locations in 2022. So far this year, we've opened 12 new locations across the country, in neighborhoods as diverse as SoHo in New York and Jackson Hole in Wyoming. Beyond this work in stores, we're also making significant investments in our supply chain focused on 3 main priorities. The first is to build additional upstream capacity to our network, given that we continue to grow sales on top of the $27 billion we added in 2020 and 2021. In support of this goal, we opened 2 upstream DCs near the end of 2021 and plan to open 6 new upstream facilities over the next several years, including 2 on track to open in 2023. In addition to the space we're adding to the network, we're continuing to modernize how our existing distribution centers serve our stores by developing and automating processes that reduce the amount of store workload devoted to receiving inventory and restocking store sales floors. And finally, we're rapidly expanding the number of sortation centers operating around the country. We have 6 of these facilities operating today, including 3 that have opened in the last few months, and we have plans to add 5 more by early next year. These small facilities expand ship-from-store capacity in the locations they serve while significantly reducing last-mile delivery costs, particularly as we integrate our Shipt drivers into the process. Given the package delivery density we've achieved across many markets over the last few years, we see continued opportunities to add more sortation centers over the next few years, which adds speed and significantly reduce last-mile costs in markets where they operate. As I mentioned last quarter, this year's capital projects are being impacted by the cost increases, material shortages and supply chain pressures that are affecting other parts of our business. And I'm really proud of how our construction team is managing through these headwinds. More specifically, while cost increases are raising the cost of many of these projects, the team has done an excellent job in keeping the vast majority of projects on track and on time despite the significant headwinds they are facing. So as I conclude my remarks, I have to pause and add my thanks to the entire team for their resilience and perseverance during a period of incredibly rapid change, which caused this quarter to be as challenging as any I've seen in my career. In the face of that challenge, what's been amazing is how our team members have stayed positive, how they've worked to find collaborative solutions across multiple teams and never strayed from their commitment to our guests and our company purpose. With the progress they have made, our operations are now in much better shape, and the team is energized and ready to play offense in the back half of the year. While we are all mindful of the near-term volatility in the environment, it's times like these that often present the biggest opportunity to gain long-term market share as others face the distraction of trying to stay afloat while we continue to invest and improve our operations. That's one of many reasons that I've never been more optimistic about our prospects in the years ahead. With that, I'll turn the call over to Michael.
Michael Fiddelke:
Thanks, John. As John mentioned, we often ask our team to be mindful of both short-term and long-term considerations when making decisions. And given the unique circumstances we've been facing, this quarter, we faced a decision with meaningful implications for both. As Brian outlined earlier, if we had decided not to deal with our excess inventory head-on, we could have avoided some short-term pain on the profit line, but that would have hampered our longer-term potential. Instead, because of the path we took, our quarterly profit took a meaningful step-down, but our future path is brighter. Our operations are healthy, our store and DC teams have more flexibility to maneuver and we're ready to feature both the fresh assortment and uncluttered shopping experience our guests expect and deserve. That passionate commitment to the guest experience is one of the many reasons we've now seen 21 consecutive quarters of comparable sales growth.
While normally our income statement gets the most attention, I want to start my remarks today with the balance sheet and specifically, our inventory position. And as I dig into the detail, I want to acknowledge upfront that this kind of analysis is a relatively complex exercise because of the growth and volatility we've experienced over the last couple of years, because of the broad and diverse assortment that we sell and the fact that our business is seasonal from quarter-to-quarter. More specifically, given that our inventory position throughout the pandemic was far from optimal, focusing on year-over-year growth numbers isn't very helpful right now. As a result, we often base our inventory analysis on growth trends compared with 2019, a pre-pandemic year when our inventory and sales trends were much more in sync. With that as context, I want to zero in on one of the questions I'm sure you have, which is why our inventory on the balance sheet remained roughly constant at around $15 billion between the first and second quarters. The simple answer is that while that single number didn't change much, we accomplished exactly what we intended to do during the quarter, which helped change conditions significantly below the surface. More specifically, because of the inventory actions we executed, unit growth compared with 2019 in our discretionary categories decelerated by more than 15 percentage points between the first and second quarter, a change we estimate would have reduced our inventory position by more than $1 billion if taken in isolation. However, a couple of offsetting changes moved our quarter-end inventory in the other direction. First among them, we leaned into our frequency categories during the quarter, accelerating 3-year unit growth versus Q1 at a double-digit rate, resulting in stronger in-stock metrics compared with 90 days ago. Another factor that drove inventory dollars higher is the continued increase in unit costs we've been seeing across all of our categories, which caused the dollar value of our inventory to grow faster than unit growth in the second quarter. So where do we stand today? At the end of the second quarter, inventory on the balance sheet was about $6 billion higher than we reported 3 years ago. Of that dollar growth, about $3 billion or approximately half of that total growth is the result of higher unit costs across our assortment. Of the remaining $3 billion, our analysis indicates another $1 billion to $2 billion is related to our decision to move receipt timing earlier, given the volatility we continue to expect in the supply chain. And also importantly, beyond reshaping the inventory we already have, our Q2 inventory actions also included the removal of more than $1.5 billion of fall receipts in our discretionary categories, reflecting our continued focus on reducing risk in the current environment. That's why we feel good about our inventory position as we head into the back half of the year. So now I'll turn to a review of our second quarter financial results. Total sales increased 3.3% in the quarter, driven by a 2.6% increase in comparable sales, combined with the impact of new stores. Total revenue increased 3.5%, reflecting sales growth along with the benefit of nearly 15% growth on the other revenue line, driven by continued strength in our Roundel ad business. Just as Christina pointed out, that unit share is a key measure of Target's relevance versus competitors, traffic growth is another important indicator of the relevance of our brand. Our continued traffic growth in the second quarter clearly demonstrates the ability of our balanced multi-category assortment to deliver continued relevance in a rapidly changing environment like we're seeing today. So that even as our guests' preference for individual categories has been changing dramatically so far this year, that hasn't affected their preference for Target. As a result, traffic accounted for 100% of our comparable sales growth in the second quarter, increasing 2.7%, on top of 12.7% a year ago. Average ticket remained essentially flat in the quarter, as low single-digit increase in average retail was offset by a similar reduction in the number of items per transaction. Across our sales channels, store comps grew 1.3%, on top of 8.7% a year ago, while digital comps grew 9%, on top of 9.9% last year. Digital growth continues to be led by our same-day services, which saw double-digit growth overall and mid-teens growth in drive-up. On the gross margin line, we saw a nearly 9 percentage point decline compared with last year. Merchandising accounted for more than 7 points of this pressure, driven primarily by our inventory reduction efforts, along with the impact of higher fuel and transportation costs, product cost increases and higher shrink, partially offset by the benefit of retail price increases. In addition, digital fulfillment and supply chain drove about 1.5 points of pressure, reflecting increased compensation and headcount in our distribution centers, combined with the cost of managing excess inventory and higher last-mile shipping costs. Consistent with the first quarter, mix accounted for approximately 10 basis points of pressure. The softness in higher-margin categories like Apparel and Home was largely offset by softness in lower-margin discretionary categories, most notably electronics. On the SG&A line, we continue to benefit from fixed cost leverage and efficiency gains across our operations, which helped to offset the impact of cost inflation across multiple expense lines. Within overall compensation, lower incentive compensation more than offset continued investments in pay and benefits for our hourly team members. Altogether, our second quarter operating margin rate was 1.2%, down from an unusually high 9.8% a year ago, driven entirely by the decline in our gross margin rate. This operating margin performance was below the midpoint of our most recent guidance, as the cost of our inventory actions was somewhat higher than expected. While an operating margin rate of just over 1% is well below anything I've seen in my career and something I never expect to see again, I have no doubt that it was the right outcome given the unusual circumstances we've been facing this year. Our focus throughout the second quarter was to ensure that we took care of the excess inventory of our network and adjust future receipts to reflect the rapid change in sales trends we've seen so far this year. We accomplished this goal to the benefit of our operations, our team and our guests. Finally, one note on our tax rate. In a period like this year, when our operating profit is unusually low, tax benefits have a larger-than-normal impact on our tax rate, which helps to explain why our year-to-date tax rate has been lower than expected. Looking forward, given that we anticipate a meaningful improvement in our operating performance in the back half of the year, we continue to expect our full year effective tax rate will be in a range around 21%. Now I'm going to turn to capital deployment and begin where I always do by articulating our priorities, which we've supported consistently for decades. Our first priority is always to invest fully in our business, in projects that support our strategic and financial criteria. Once we've met this first priority, we support our dividend and look to extend our 50-year record of annual increases. And finally, once we've supported the first 2 priorities, we return any remaining excess cash by repurchasing our shares over time, within the limits of our middle A credit ratings. Regarding the first priority, second quarter CapEx was approximately $1.5 billion, bringing our year-to-date total to just over $2.5 billion. As you'll recall, at the beginning of the year, we guided to an expected full year CapEx range of $4 billion to $5 billion. And at the time, I indicated my hope that we'd reach the high end of that range, with the outcome depending on how many capital projects could stay on schedule. So I'm happy that, as John mentioned, the team is doing a great job of keeping projects on track despite facing multiple headwinds, all while inflation in the cost of equipment, materials and labor is driving project spending above initial projections. As such, we now expect our full year CapEx will be $5 billion or more for the year, reflecting both the number of projects that remain on track and the expected impact of cost inflation. Of course, while we prefer not to face the cost pressure on these projects, I'm encouraged that so many value-creating projects remain on track to be completed this year, projects that will benefit our operations and our P&L for years to come. Turning to our second capital deployment priority. We returned $417 million in dividends to our shareholders in the second quarter, up from $336 million a year ago, driven by a 32% increase in the per share dividend, partially offset by a decline in average share count. And finally, in June, we reached the final settlement for the accelerated share repurchase agreement we initiated last March. Under this ASR, we invested $2.6 billion to retire 12.5 million shares of our stock. Looking forward, just as our inventory commitments reflect continued caution for the remainder of the year, we're taking a similar cautious stance in terms of our share repurchase activity. And of course, any repurchase activity will be consistent with our long-term goal to maintain our middle A credit ratings. So now I want to close my commentary on the quarter by covering our after-tax return on invested capital, which measures both our near-term profitability and the efficiency of our CapEx decisions over time. In the second quarter, our trailing 12-month after-tax ROIC was 18.4% compared with 31.7% a year ago. And it's notable, while the current number is well below where we expect to operate over time, an after-tax number in the high teens would have been considered aspirational for our business only a few years ago. So for us to temporarily move down to this level in an environment as challenging as we're facing is a vivid confirmation of the underlying strength and resilience of our business model, and the reason we continue to be incredibly optimistic about our future prospects. And that confidence starts and ends with our team, so I want to pause and express my gratitude to the best team in retail. Without your efforts, we couldn't have achieved the remarkable growth in traffic and sales that we've seen over the last few years and why even in a tough year, our business remains strong. Now let's turn to our guidance. And based on the hard work of our team in the second quarter, we feel really good about how we're positioned going into the back half of the year. At the same time, given that we've been experiencing volatile economic conditions so far this year and that volatility appears likely to continue in the months ahead, we're maintaining a cautious stance as we plan our business given the potential macro and consumer risks that might emerge. That's why, as you've heard throughout our remarks today, our second quarter inventory actions were specifically designed to reduce our level of risk in discretionary categories. And in terms of our operations, the team has focused on building flexibility into our plans, placing a premium on staying nimble and adjusting quickly in the face of any potential change in macro trends. Regarding the top line, our expectations have remained consistent so far this year, with guidance for full year total revenue growth in the low to mid-single-digit range. With the front half of the year behind us, both our Q1 and Q2 results have put us squarely in the middle of that range. And today, based on our current performance and plans for the back half of the year, we remain positioned to deliver full year revenue growth in the low to mid-single-digit range. On the operating margin line, our most recent guidance anticipated a fall season operating margin rate and a range centered around 6%. This expectation is nearly double our spring result. And notably, if we hit that rate in the fall, it would exceed the fall season rates we were delivering prior to the pandemic. And today, similar to my commentary on the top line, based on the success of our Q2 inventory actions and our current performance, we remain positioned to deliver an operating margin rate in a range around 6% in the fall season. Between the last 2 quarters of the year, we expect our third quarter rate will be well below our Q3 performance over the last couple of years, while our fourth quarter rate should be much more in line with our recent Q4 experience. Most notably, in the third quarter, we'll continue to experience some spillover impact from our inventory actions in the range of $200 million. In contrast, in Q4, we'll be annualizing meaningful cost headwinds that surfaced a year ago, which will make the year-over-year comparison more favorable despite the current headwinds we're facing. All that said, while we typically anticipate something closer to a balance of upside and downside potential when we make any forecast, the macro and consumer risks in the back half of this year feel skewed to the downside. That's why even in the face of consistent business trends in recent months, we've undertaken the significant cost and effort to remove risk from our inventory commitments. It's why we're stubbornly focused on real-time monitoring and communication of evolving conditions, and why we've asked our team to build flexibility and agility into their plans. With that mindset, if trends move away from what we're seeing today, we're ready to quickly adjust. So now before I turn the call back over to Brian, I want to emphasize why we're so confident in our long-term potential, even as we navigate a very challenging environment in a year of multiple challenges, including rapidly changing consumer preferences, inflation at 40-year highs, volatile supply chain conditions and rising fuel and transportation rates that are expected to add well over $1 billion of cost this year. Our business continues to generate historically strong traffic increases, low to mid-single-digit revenue growth and unit share gains across all of our core merchandising categories. And even in the face of unprecedented profit rate pressure driven by the host of factors I just listed, we remain profitable with an after-tax ROIC in the mid-teens. In fact, if our performance in the fall is consistent with the revenue growth and operating margin rates I outlined earlier, we remain positioned in 2022 to generate higher operating margin dollars than we did in 2019. That's what we mean when we say we have built a durable model. And today, while we expect conditions to remain challenging in the near term, the operating margin rate improvement we're projecting in the back half of the year should serve as an early indicator of the continued rate improvement we should deliver in the years ahead. With the potential for additional rate expansion and continued growth in traffic and revenue in the years ahead, we're facing a compelling financial picture as the economy and consumer eventually recover. That's why I've never been more confident in our long-term prospects than I am today. With that, I'll turn the call back over to Brian.
Brian Cornell:
Thanks, Michael. I often tell my team that leadership and performance are tightly linked over time, but that leadership often appears first. That's why I'm extremely proud of the leadership our team showed in the second quarter. After they took a hard look at our owned inventory position and the amount that was building up across our industry, they opted to make the hard choice
They made that decision with the full knowledge it would have a profound impact on our near-term profitability. They also knew there was another path. We could have avoided attacking the problem and avoid some of the pain in the short run. But instead, our team chose to lead. They knew the best path for our guests and for our teams in our stores and distribution centers was to take action and improve the condition of our inventory and operations quickly. That path would allow the entire Target team to move ahead without facing the ongoing burden of excess inventory holding us back. So the team quickly developed the [ bolder ] plan, which we announced in early June, just over 2 months ago. And in the intervening weeks, teams across the company worked tirelessly to take the plan and make it a reality. That's the reason we're positioned to deliver a strong improvement in our profitability this fall despite an environment that's far from ideal. Because of our team's leadership, our business today is much better positioned to perform, and I couldn't be more proud and grateful for the courage they have shown. So with that, I want to thank you for listening into our call today. And now Christina, John, Michael and I will be happy to take your questions.
Operator:
[Operator Instructions] We're now ready with our first question from Christopher Horvers with JPMorgan.
Christopher Horvers:
You talked about an encouraging start to back-to-school. Can you talk about what you've seen in July and August? A lot of retailers like you have talked about improving trends. So what does that mean for how you're thinking about the back half comps? And does that reflect the current trend in the business, as you said in the guidance? Because I guess the question we have is, is the risk -- how did you incorporate the risk that the bounce in trend that you're seeing now is just that episodic event-type spending that you've been highlighting all year?
Brian Cornell:
Chris, thanks for joining us this morning. I'll let Christina talk about some of the back-to-school and back-to-college trends and Michael to build on guidance. But before we start, based on the length of our prepared comments, we are going to ask for some additional time for Q&A. So operator, we're going to extend the time for this call to make sure we cover as many questions as possible.
Christina, do you want to start by talking about some of the back-to-school and back-to-college trends we're seeing?
A. Hennington:
Yes. As I shared earlier in my prepared remarks, we're optimistic about what back-to-school and back-to-college mean. This -- during seasonal times is when Target really shines, the reason being that our multi-category portfolio makes us even more relevant, the opportunity to buy kids uniform, backpacks, the school -- the lunch kit and everything that goes in it and, of course, all the supplies. And so they've always -- seasonal moments have always been a good proxy for the strength of the total portfolio. And so as we're seeing good early trends, albeit there's a lot of business left to be done, we believe that, that is a good indicator of the strength of the potential for the fall. The other thing to look at, of course, is how we have performed to date, and our traffic and unit share growth that we've seen across the portfolio holistically gives us confidence in the guest choice of Target as their retailer of preference.
Brian Cornell:
Chris, I'll let Michael talk about guidance. But one of the things that really stands out for me as I look at our position today, is that continued strength in traffic and the growth we're seeing in units across our entire portfolio. I'd also recognize, based on the actions we've taken with our inventory position, if you walk our stores today, it is clear that we are prepared for back-to-school and back-to-college, and we're really standing tall in those categories.
Mike, do we want to talk about the guidance?
Michael Fiddelke:
Yes. And I'll build off the comment you just made, Brian. When we look at the quarter, Chris, a lot of the trends we see in Q2 are informing our view of the back half of the year. And I think Q2 is a pretty good proxy for some of those top line assumptions that we have in the back part of the year. The consistency of traffic for the year across the months of the quarter, I think that's the thing that we look at really closely that gives us a lot of evidence that even as shopping habits have changed and category trends have changed, we've seen a consistent draw to more and more shoppers shop in our stores and shopping us online. And that consistency of traffic is the thing that gives me lot of optimism as I look to the back half of the year even if we can't sit here today and predict every twist and turn.
Brian Cornell:
Chris, I'll add one final point. As we talk to our guests, when we talk to consumers, while there's certainly a cautionary environment in front of us, but one thing that seems to be very consistent is a guest and consumer who says they want to celebrate the holiday seasons. So we certainly expect that they are going to be celebrating Halloween this year and actively trick-or-treating and hosting parties with friends and family. We know they're looking forward to Thanksgiving, and they're going to look forward to celebrating the Christmas holidays. And that comes out each and every week as we survey consumers and talk to our guests. So that gives us great optimism for our ability to perform during these key holiday seasons.
Christopher Horvers:
Got it. And so my follow-up is just, Michael, you talked about the phasing of the operating margin. So the interpretation is that the fourth quarter is going to look a lot more consistent with what you did last year, maybe a little bit below. So the third quarter comes in well below that 6% -- around 6%.
Michael Fiddelke:
Yes. You -- as I said in my remarks, I expect to -- we sit here today, expecting a fourth quarter, it looks more like the fourth quarter we've seen in the last couple of years. And so I think that's a 6.8% last year and a 6.5% the year before that. That's the right range around which we set our expectations for the fourth quarter. And obviously, to get to a 6% in total, that implies a lower number in the third quarter. And the driver there is, like I talked about in remarks, some of the costs of our inventory actions do spill over into the third quarter. And we'll continue to manage the elevated fuel and freight costs and kind of how those net against pricing action and things like that over the balance of the year. But we feel good about that range, around 6%, and we'll continue to watch the macro environment really closely.
Operator:
The next question is from Edward Yruma with Piper Sandler.
Edward Yruma:
Two from me. I guess first, on the variance relative to your previous expectations in terms of the inventory actions, were there specific areas where you had to cut deeper or cost more to get out of inventory positions? And then as a broader question, one of your peers talked about some changes they're seeing in their customer base. I guess are there any noteworthy changes that you're seeing? Are there customers trading down or trading into Target?
Brian Cornell:
And I'll start, and then I'll turn it over to John to talk about some of the inventory actions, but I really want to start by recognizing our team. I think as we sit here today, over the last few weeks since our announcement in June, this has been a collaborative effort, and the team has accomplished so much to put us in the right place as we get ready for the back half of the year. So based on the work that the teams have done across our supply chain system, in merchandising, in finance and supply chain, in stores, the team has accomplished more than we expected in a short period of time and put us in a better position from an inventory standpoint than we might have expected back in June.
John Mulligan:
Yes. Ed, I'll just add on it. I think largely, we're on track with what we thought at the -- when we came out with the announcement earlier in Q2. A little bit of it cost us a little bit more in promos or clearance to move some inventory. But I think the work the team did in a very short amount of time to size what we needed to take care of is largely in line with where we are today, and we feel really good about where we're at.
As Michael said, a little bit spilled over into Q3, and that's really just timing more than anything else. We just didn't get to it. But the work that's been done, we're really proud of. And I would say, from my position, we did exactly what we set out to do. We got rid of the inventory we needed to, the operations are in a much better place. There's a little bit more to do here in Q3 that will clean up. And I think the one thing I'd add on that I don't want to get lost is the amount of receipts that were cut from discretionary categories in Q3 and Q4, and that is just huge for us, again, because of the uncertainty in those particular categories. And if sales end up a little bit higher, we'll have a little bit higher sell-through, and that will be a great day. But that really derisks those categories going forward. So we feel great about the work that's been done over the past few months.
A. Hennington:
And Ed, maybe I can add a little bit to the question about the customer. As I shared in my prepared remarks, our guest is still demonstrating that they have spending power. The choices that they're making to balance their budget is what we're watching. And so obviously, we're moderating our investment in some of those discretionary businesses, and we're leaning very much into Food & Beverage, Essentials, Beauty, but also select portions of the portfolio and discretionary that have stayed resilient, whether it's toys, luggage, seasonal moments, fashion-forward apparel. And so it's really about reading the guests listening to them and continuing to support a level of agility in the business model. And in terms of other choices that they're making, I think traffic and unit share are the best barometer for their investment in Target. We're still growing traffic, and we're growing unit share in every major category, which to me says that our relevance is high with the guests right now and they're managing their budgets as best fit and they're finding options at Target.
Operator:
Our next question is from Steph Wissink with Jefferies.
Stephanie Schiller Wissink:
Just wanted to ask a follow-up question on pricing for the back half. Just give us some sense of how you're thinking about promotionality. I think you've mentioned in your prepared remarks that consumers were responding to some of the promotions you were putting out. So just give us a sense of what you factored into the guidance in terms of heightened levels of promotions.
Michael Fiddelke:
Thanks for the question, Steph. I mean we always know as we get to the back half of the year, it's a promotional environment. The holidays always are, and so we factored that in accordingly. And we see a consumer in the current inflationary environment that's focused on value. And like we've said many times in these calls, we think about pricing first through the lens of our guests. We want to make sure the guests can find great value on shelf, online and the way that we're priced and we feel good about where we've struck that value equation. And I think the traffic we're seeing speaks to the fact that guests see it, too.
Brian Cornell:
And Steph, I'd only add that Christina and her team have done a wonderful job as we plan for the back half of the year, of ensuring that we have great value for our guests but also that we have exciting newness. And I think that combination is a winning formula for us as we think about the back half of the year.
Operator:
Our next question is from Michael Lasser with UBS.
Michael Lasser:
My first question is how much did the clearance and promotional activity contribute to the C-store sales growth in the first -- in the second quarter? And if you do see more downside than upside risk to the guidance for the back half of the year, why didn't you just moderate the guidance a little lower for the back half?
Michael Fiddelke:
Sure, Michael. Thanks for the question. While the kind of counterfactual with every elasticity of where Q2 would have landed, it is a little bit of more art than science. We think that the net dollar impact of our markdowns is probably negligible all in, in the second quarter. And of course, we took some markdowns to move through some product, but we think that probably net-net, that didn't move our top line comp a lot.
As we think about the back half of the year, we're informing the back half based on the trends that we're seeing now in the business. And as we've talked about, some of those trends that we saw change at the end of Q1, we've seen persist into Q2, and we factored that in to our thinking for the back half of the year. We'll continue to be mindful of what's clearly in an uncertain environment for the economy and the consumer. And to the point Christina made earlier in Q&A, we'll stay close to those trends, and we'll adjust accordingly. And that's why taking the inventory actions we did to give us some room to operate and to give us some flexibility in the system will be important in an uncertain environment.
Michael Lasser:
Okay. My follow-up question is there's obviously a lot of moving pieces with what's happening at Target right now. But isn't a lot of this just transitional and setting the set stage to grow better 2023 really somewhat independent of the macro environment? So with that being said, could you size the impact to your margins from all the inventory actions that you're taking this quarter, next quarter that are temporary and will be isolated to this year and won't repeat next year? Can you give us a better sense of what the ongoing profitability of the business is?
Brian Cornell:
Michael, I'll start by saying, I think your summary really captures the actions we've been taking today really to make sure that we continue to build on the traffic we're seeing in our stores and the visits to our site, the strength we're seeing in unit market share gains; but importantly, the investments we made to ensure we have a great guest experience in the back half of the year and going into 2023. So the bold, decisive actions were really to make sure we continue to build on our current momentum, the great relationship we have with our guests, the momentum we're building from a market share standpoint and providing our guests with a great Target experience every time they shop. That will continue and set us up well for 2023.
As far as sizing it, we'll certainly come back to all of you as we think about guidance for next year, but we certainly expect to see a more normalized environment from an operating profit standpoint as we move into 2023 and continue to build on the momentum and the investments we've been making in our business for years.
Operator:
The next question is from Simeon Gutman with Morgan Stanley.
Simeon Gutman:
Following up on actually Michael's question, is there any way you can quantify some of the structurally higher costs in labor in the DC? Just as a way to back out, that might be the one driver that stays in gross margin. But then in theory, you should recapture most of what's happened this year.
Michael Fiddelke:
Yes. I mean there's probably a piece in each bucket, Simeon. As we've grown the business, obviously, we invest more labor in moving the product to support that growth, and that's a piece of some of that growth there. And then it also costs us more when we're full. And our supply chain was full in the second quarter. And so there's a piece of that, that will result in improved productivity over time as we get some of that inventory out of the system. To Brian's point, we'll come back and unpack next year when the time is right to do that. But I expect to see both of those drivers present as we do so.
Simeon Gutman:
And maybe just a quick follow-up. You mentioned Q4 profitability should look more Target-esque. Does that mean -- like what's the assumption for mix in that fourth quarter relative to where we are today?
Michael Fiddelke:
Yes. We aren't breaking out a specific assumption for mix. But I think if you look over the last couple of quarters, you see mix isn't a big driver of our margin results. And so I wouldn't think about it markedly any differently as we project ahead.
Operator:
Our next question is from Kelly Bania with BMO Capital.
Kelly Bania:
Curious if you could just help us dissect the gross margin a little bit between the promotional activity, the inventory impairment versus the cost of storing and moving this excess inventory. Because I think it would just be a little helpful for investors to interpret that comp and traffic number and just how you're thinking about that traffic and comp as the promotions moderate into Q3. And it sounds like Q4, you're planning for very little promotional activity. So I was just wondering if you could kind of parse some of that out to help us think about that.
Michael Fiddelke:
I'll maybe start at the end of your question. We expect Q4 to be promotional. It always is. And our plans plan for promotions that will provide great value to our guests and those seasonal moments that matter. That's been true in every Q4 in my 18 years here, and I expect it not to be any different this time around.
With respect to unpacking the margin, I'll go back to some of what I said in my comments. And we were, year-over-year, 9 percentage points down, 7 of that is mostly driven by inventory actions and you see incremental markdowns as a piece of that. You also see the cost of some of those receipt cancellations that John talked about earlier. And then you see about 1.5 points of pressure from supply chain and digital. And a piece of that is related to us being heavier in the system and that drives some costs. A piece of that is the elevated freight and transportation rates that we've talked about previously, that will continue to kind of maybe move up and move down based on the day, are definitely elevated versus any historical measure. And you can see over that -- see that is a piece of that year-over-year pressure, too.
Operator:
Our next question is from Robby Ohmes with Bank of America.
Robert Ohmes:
My question was on inflation in food and consumables. And can you give us any number on how much inflation you guys saw in the second quarter, but also the 2 half guide you guys have given us. What's the inflation tailwind you guys are expecting in food and consumables? And also related to that, you guys talked about the focus on everyday pricing. Is there any incremental margin pressure from the frequency items or the focus on everyday pricing being sharp?
Michael Fiddelke:
Yes. I mean we've seen persistent cost inflation in food. And I think across the industry, you've seen price move with that. That's been no different here at Target. We are really mindful of making sure that we feel good about our price gaps, definitely do today in food.
And if you zoom out from the food-specific piece of that, again, I'll come back to traffic. If you look at what drove our growth in the second quarter, there were some puts and takes within basket between ASP and units. But the story was traffic. And so again, that gives us evidence that we're getting that value equation right for our guests.
Robert Ohmes:
And is the inflation component within same-store sales in food and consumables? Is that similar to sort of the numbers we're seeing in the CPI for food at home?
Michael Fiddelke:
I think that's generally in the right ballpark. Obviously, there's some mix implications there if you're comparing retailer to retailer. But we've seen persistently high inflation in food. And I think that's a trend that's been with us for a while, and we don't expect it to change anytime soon.
Robert Ohmes:
And sorry, just to clarify, the pricing, folks, are you -- would you say you guys are investing in price in food and consumables? So maybe taking a lower margin in the grocery part of your business than maybe historically you would have.
A. Hennington:
No. Maybe I'll add a little context here. We're consistently evaluating our complete value proposition to the consumer. And so part of that is price. And in the consumables categories, we've had a little bit more flexibility to move with the market because it's domestically replenished and bought every single day. And so we have absolutely moved up in some retail. But the way we counterbalance total value proposition is by looking at, of course, what else produces value, compelling promotion, an incredible owned brand portfolio that allows the guests to opt-in to whatever price point is right for them and a maniacal focus on balancing our good, better, best and opening price point options. And that, the combination of those things, are yielding more unit share growth at Target, which means the guest is actively engaged in the offering that we're providing and, of course, that traffic that Michael pointed to.
Brian Cornell:
And Robby, as Christina noted, the strength of our owned brand portfolio in this environment is a really important element of how we deliver value to our guests each and every day. And in Food & Beverage, our Good & Gather brand now is a $2 billion brand that continues to see very strong growth. So that's just one way we deliver value to our guests each and every day at Target.
Operator:
Our final question is from Oliver Chen with Cowen.
Oliver Chen:
On the topic of back-to-school, what would you speak to as factors that are most different this year versus last year as you get ready for that? And secondly, on the inventory actions, as they relate to third quarter, what's left to do there? And might you have to take deeper promotions than you thought previously? The consumer is requiring a lot of discounts to respond to promotions more than other retailers thought in many cases. Would love any thoughts there.
Brian Cornell:
Oliver, I'll start, and I'll let Michael finish up, but I think the one big difference today, as we sit here today and think about back-to-school and back-to-college is certainty. I think we know across the country, children are going back to school. They'll be in classrooms. They're going to be back on campus. So I think that element of certainty is very different from what we've faced over the last couple of years. And again, we expect to see a very solid back-to-school and back-to-college season because we know children are going to be in classrooms and will be back in campus, and Target's a place they go during this important back-to-school and back-to-college season.
Michael Fiddelke:
And then, Oliver, kind of what's in some of the Q4 actions we still have to take, just to provide kind of an example there. If there's seasonal product, it's a natural time to leave our store within Q3, and we'll continue to work through some of that inventory then. And so that's an example of some of the work still to be done. But kind of in where we started, we feel really good about our inventory position as we exit the second quarter. And we accomplished what we set out to do from an inventory perspective.
John Hulbert:
So operator, that concludes our second quarter call. We look forward to talking to many of you over the next few weeks and seeing you later this year, so thank you.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation First Quarter Earnings Release Conference Call. [Operator Instructions]
As a reminder, this conference is being recorded, Wednesday, May 18, 2022. I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our first 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 first quarter performance and our outlook and priorities for the second quarter and beyond. Following the 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, the most important of which are described 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 quarter and his perspective on our outlook. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. Our first quarter results demonstrate the underlying strength of the relationship we've built with our guests at a time when our team is working through multiple cost pressures affecting our business. As expected, our business continued to grow in the first quarter, on top of huge gains a year ago, underlying the resilience of both the consumer and the ability of our team to serve them. However, due to a host of factors, this growth was challenged by unusually high costs, resulting in profitability well below what we expected to be and where we expect to operate over time.
First quarter comparable sales grew by 3.3%, on top of 23% growth a year ago. This marked our 20th consecutive quarter of comparable sales increases. 11 of those quarters were before the pandemic, followed by the rapid acceleration we saw in 2020. We're also encouraged that traffic continues to fuel our growth, increasing nearly 4% in the quarter, on top of 17% growth a year ago. Our first quarter gross margin rate was well below our expectations, reflecting a combination of factors that prove to be very different than expected, driven by a rapidly shifting macro backdrop and changing consumer behavior. More specifically, we saw much higher-than-expected rate and transportation costs and a more dramatic change in our sales mix than we anticipated. This resulted in excess inventory, much of it in bulky categories, which put additional strain on an already stretched supply chain. Christina, John and Michael will share more details shortly. And while we have a lot of work ahead of us to restore profitability to the level where we expect to operate over time, I want to thank the team for maintaining their laser focus on the guest experience. We've spent years growing Target's relationship with our guests, which is fueling the traffic and sales growth we're seeing today. In sustaining that guest focus, we're confident we'll see deeper loyalty and profitable sales growth in the years ahead. On our sales channels, first quarter comps were balanced between store and digital as each increased a little more than 3%. Within our digital channel, growth continues to be led by our same-day services and Drive-Up in particular which delivered growth in the mid-teens this year on top of more than 100% growth a year ago. Since Q1 of 2019, prior to the pandemic, first quarter sales have grown more than 40% or just over $7.4 billion. Broken down by channel, store sales accounted for about $4.1 billion of this increase, while digital sales grew another $3.3 billion, having expanded by more than 250% over that time. From a category perspective, we continue to benefit from our balanced multi-category portfolio, which allows us to flexibly serve our guests as their wants and needs change. More specifically, in the first quarter, we continue to see strong growth and market share gains in food and beverage and essential categories. We also benefited from double-digit comp growth in Beauty, reflecting our ongoing work to enhance presentation, assortment and service, including our new and expanding partnership with Ulta Beauty. The result of this partnership have exceeded our initial expectations, driving higher productivity and sales in both Beauty [ area ], and adjacent categories in the store, where we've added an Ulta Beauty experience.
In our other 3 core merchandise categories:
Apparel, Home and Hardlines, we saw a rapid slowdown in the year-over-year sales trend beginning of March, when we began to annualize the impact of last year's stimulus payments. While we anticipated a post-stimulus slowdown in these categories and we expect the consumer to continue refocusing their spending away from goods and into services, we didn't anticipate the magnitude of that shift.
As I mentioned earlier, this led us to carry too much inventory, particularly in bulky categories, including kitchen appliances, TVs and outdoor furniture. And with very little slack capacity after 2 years of unprecedented growth, we faced elevated cost to store and had begun rightsizing our inventory position. Nevertheless, we're still seeing healthy overall spending by our guests, even as their spending continues to evolve. Notably, we continue to see meaningful spending surges around holidays, including Easter in April and Mother's Day a couple of weeks ago. Also notable, in comparing this year's weekly sales of pre-pandemic levels at the beginning of 2019, we're actually seeing stronger 3-year growth trends in recent weeks compared with the beginning of the first quarter, even in categories where we saw a rapid slowdown on a 1-year basis. These encouraging longer-term growth trends demonstrate the continued resilience of the American consumer and the trust they place in Target even if they face multiple challenges. Not surprising, when we talk to our guests, they often express their concerns about a host of rapidly changing conditions, ranging from geopolitics to the high and persistent inflation they've been experiencing, particularly in food and energy. At the same time, guests are focused on getting back to many of the habits and behaviors they suspended during the heart of the pandemic, including travel, out-of-home activities and social gatherings. And importantly, even as the mix of what they're buying continues to evolve, their spending capacity continues to benefit from elevated saving rates, high employment and healthy wage growth. So as we continually adapt our offering to best serve our guests in a rapidly changing environment, today, we're focused more than ever on providing value across our multi-category assortment, presenting options that are affordable and accessible to a broad and diverse base of guests across a wide range of household incomes. And even as we face multiple cost pressures, our team is working tirelessly to maintain prices wherever possible. But of course, while it's always the last lever we pull, external conditions led us to raise prices across a broad set of items in multiple categories. But as you've clearly seen in recent quarters, overall costs have been rising much faster than retail prices, resulting in year-over-year declines in our gross margin rates. While we're not happy about the near-term pressure this causes on the profit line, we strongly believe these decisions will benefit our business over time. And as we currently monitor our prices and quality stack up versus the competition, our guests are telling us they appreciate the value and experience we're providing. More importantly, our guests are showing appreciation, with more footsteps in our stores and more clicks on our site, resulting in continued traffic and sales growth on top of record growth a year ago. As we look ahead, we'll maintain this focus on value, helping them to save time and money in a rapidly evolving environment. For those who are focused on driving pure miles in response to record high gas prices, our broadened unit merchandise assortment, combined with our low prices, offers a smart way to save time and miles by consolidating shopping trips. Of course, for guests who are looking for money-saving options when they're shopping for their families, our $30 billion portfolio of home brands offer outstanding quality and savings across every one of our merchandising categories. And because saving time is valuable in any environment, we're continuing to invest in expanding the scope of our reliable and convenient same-day services, including our Drive-Up and in-store pickup services, which we offer our guests at no charge. Just as we designed our merchandise portfolio to flexibly serve our guests, our operations have managed through extreme volatility over the last few years. Rapid growth amounting to tens of billions of dollars, combined with unprecedented shift in demand across categories, channels and services, has created a host of challenges for our team, which they've handled with incredible energy and focus. And while we entered this year hopeful that volatility will begin to moderate, we've experienced the extreme opposite in Q1, and we don't see current conditions improving right away. In the face of this volatility, our team continues to focus on the guest experience, working to ensure that anything our team is handling behind the scenes doesn't what our guests see and feel. So as we look ahead, it is clear that many of these pressures will persist in future quarters, but that hasn't affected our long-term plans and expectations, including our confidence in the ability of our business to grow mid-single digits and maintain an operating margin of 8% or higher over time. In the meantime, even as we navigate to restore profitability from the impact of these short-term challenges, we're continuing to invest in project design to deliver continued profitable long-term growth. Our business model and team have proven their ability to successfully navigate through extreme volatility. And we're confident our business will emerge even stronger from these challenges we're facing today. Just as our investments in early 2017 were followed by profitable growth in later years, we're confident the decisions we're making today, combined with our investments in future growth, will pay off handsomely over time. With that, I'll turn it over to Christina.
A. Hennington:
Thanks, Brian, and good morning, everyone.
Just a few months ago, at our Financial Community Meeting, my presentation outlined our strategic vision as a company. While I covered many facets of our strategy that day, where I started then is where I want to start again today, with our guests. We frequently get questions about how our guests are feeling given the current economic environment, how their shopping habits are evolving and what's top of mind for them. Our guest base encompasses every slice of the American population given that we serve nearly 20 million guests on average each and every week. And the breadth of their individual decisions as they navigate a rapidly changing macro environment is just as broad, making the answers to those questions that much more complex. A guest might be telling us that they're worried about inflation and rising gas prices. But they're also looking to splurge on new shoes or some accent pillows for their home. Another guest remains worried about COVID, but they're still planning to resume travel and looking forward to summer outings like Little League games and barbecues with friends. Many guests are sharing their uncertainty of the overall state of the economy, but are feeling more positive about their personal finances. With so much on their minds and a wide array of wants and needs, it has never been more important for Target to be flexible and provide ease, safety, inspiration and solutions for all of our guests. In the first quarter, we invested in delivering a great guest experience to build and maintain the trust and love for the Target brand. And those decisions came with substantial costs. I'll share more on this shortly. Our first quarter results reinforce the power of our multi-category portfolio, which allows us to lean into those ever-changing wants and needs. More and more, we are seeing our guests increasing mobility and love of newness play out in their Target purchases as baskets shift more toward experiences and going-out categories. This includes notable strength in fashion forward apparel, prepaid cards, toys and travel. While apparel basics moderated in the quarter, trend-based apparel accelerated meaningfully as increasingly, people are returning to the office or dining out with friends. We're also seeing robust growth in Beauty, driven by particular strength in going-out categories like sunscreen, color cosmetics and fragrance. Luggage grew more than 50% as the world continues to reopen, and we reunite with the places and people we have missed visiting. And our owned brand portfolio continues to grow faster than total sales, as it has quarter-after-quarter for years now. We continuously benefit from the growing guest affinity for our owned brands, which are designed to drive trips to Target, not simply to provide another option when guests are already in a store. Our guests appreciate the value, quality and great design they have come to expect and love from Target owned brands, even as they continue to appreciate our national brand options and partnerships as well. As Brian outlined, our team delivered just over 3% in comparable sales growth in the first quarter, in line with expectations, reflecting strong traffic and unit share gains. First quarter growth was strongest in frequently purchased categories, including Food & Beverage, Beauty and Essentials. Food & Beverage, which delivered low double-digit growth this quarter was strong across the entire assortment. Over the last 3 years, first quarter Food & Beverage sales have increased by nearly $1.8 billion, accounting for nearly 1/4 of our total sales growth over that time. Market share gains in this category are being driven by unit share growth, most notably in our owned brand offerings, as more of our guests turn to Good & Gather and Favorite Day for their meal solutions. Beauty has been one of our fastest-growing categories for years now and grew again in the low double digits in Q1 as guests spend more time outside of the home and want to look and feel their best. Since the first quarter of 2019, Beauty sales have expanded by more than 45%, the mass majority of which occurred before our rollout of the Ulta Beauty at Target experience, evidence that there is still plenty of room for growth in this category. Essentials grew in the high single digits in Q1, having added well over $1 billion in first quarter sales over the last 3 years. Notably, nearly $0.5 billion of that growth happened after 2020, when we saw explosive demand for categories like household paper, over-the-counter and cleaning supplies.
Across our other core categories:
Apparel, Home and Hardlines, we saw small declines in comparable sales this quarter. In Apparel, despite unfavorable weather across most of the country, comp sales remained nearly flat to last year, having grown more than 60% in the first quarter a year ago and nearly $1 billion since the first quarter of 2019.
In Home, even after a small pullback in Q1 comps, sales remain more than 40% higher than the first quarter of 2019, equating to more than $1.2 billion in growth over that time. Our seasonal categories continue to excel as our guests turn to Target for all of their holiday and celebratory solutions, leading to all-time records in the recent Valentine's Day and Easter seasons. And notably, guests are finding new ways to enjoy and celebrate the spaces they've invested in over the past few years. Having already renovated their homes with purchases in categories like furniture and small appliances, guests are now refreshing their homes with smaller touches, driving demand in categories like decor, candles and seasonal assortments; further evidence, not just of the strength in our multi-category portfolio, but the breadth of what we offer within categories as well. Hardlines saw a slight pullback in Q1, but has grown more than $1.3 billion since the first quarter of 2019. Within Hardlines, guests have been refocusing their spending away from electronics like TVs and into experiences for both kids and adults, which led to strength in our toys, travel and prepaid card categories. As Brian mentioned, first quarter gross margin performance was well below our expectations. This was driven by a number of factors, the most impactful of which was softer than expected sales in several categories, resulting in too much inventory in those areas. As we developed our plans for the quarter, our task was to anticipate how spending would change under circumstances no one had ever seen before given that we were about to compare over 2 years of historically high federal stimulus payments. As such, we relied on numerous forecasts and estimate, both internal and external, to help determine our view for the quarter. Despite this careful approach, the mix of actual demand materialized differently than we had anticipated. In addition, as supply grew and demand shifted away from bigger, bulkier products like furniture, TVs and more, we needed to make difficult trade-off decisions. We could keep this product knowing it would sell over time or we can make room for fast-growing categories like Food & Beverage, Beauty, and personal care and Household Essentials. To preserve the quality of on-shelf presentations and support the guest experience, we chose the latter, leading to incremental markdowns that reduced our gross margin. While these were difficult decisions, we believe they'll pay off in the long term, given that building long-term loyalty remains our top priority. As we look ahead, we'll continue to do all we can to support our guests, providing them great value, an unbeatable selection of necessities and affordable luxuries and a shopping experience that sparks a smile and provides a temporary escape. The second quarter offers many opportunities for our team to help all families discover the joy of everyday life. And this summer's assortment features some of our most inclusive offerings yet. First, in May, we are celebrating Asian American and Pacific Islander Heritage Month by highlighting Asian founders and creators, amplifying their voices with stories of how their unique cultures influence the creation of their products and businesses. With June right around the corner, we're excited to honor our LGBTQ+ community as we celebrate Pride Month. This uplifting and always relevant assortment offers bold product, inclusive marketing and everyday affirmation that authentically represents and celebrates community and culture. And of course, we just finished celebrating mom in May and have plenty of options to honor dads in June, along with many other opportunities to celebrate the joys of summer. And speaking of joy, we're ecstatic about our recently announced expanded partnership with actress, author and social media phenomenon, Tabitha Brown, a beacon of positivity, inspiration and joy. Having collaborated with her on social media for years, we're excited to grow our partnership with Tabitha and feature 4 limited time-only collections set to launch over the next year, starting with an exclusive apparel and accessories line of more than 75 items this June that are sure to lift both style and spirit. Before I pass things over to John, I want to thank our teams across stores, distribution centers and headquarters locations all around the globe for their unwavering leadership and service to our guests and to each other. Without them, we would not be able to continue growing our business and serving our guests each and every day. Despite the volatility and rapid shifts in consumer demand, the macro environment and the global supply chain, our business remains strong, and we're confident in both our long-term strategy and our team's ability to navigate through this dynamic period. We continue to focus on serving our guests in all that we do through our ability to provide relevance and joy in our assortment, the delivery of a positive one-of-a-kind inspiring guest experience and by building lasting, deepened affinity over time. We're lucky to have the best team in retail to make all of this come to life, and I look forward to all we will do together in the second quarter and beyond. With that, I'll pass things over to John.
John Mulligan:
Thanks, Christina. Over the last couple of years, our team has been focused on 2 separate and related issues, namely, beginning with the acceleration in sales in early 2020, our inventory wasn't growing fast enough to keep up with the expansion of our sales volume. And as a result, we weren't maintaining in-stock levels consistent with our standards.
Following 2 years of effort to catch up, by the time we entered 2022, we had made considerable progress. Overall inventory levels were aligned with both the level of sales we had already achieved and our near-term growth expectations. As a result, we began to see improvements in both in-stocks and product availability. However, conditions have remained far from perfect. Some items and categories remained spotty, typically driven by vendors who are facing multiple constraints in their businesses. A separate challenge our team has been facing, which became more acute in the back half of 2021, is driven by capacity constraints in both the global and domestic freight markets. These issues continue to make it more difficult and more expensive to move inventory where we need it to be. Our team has done a great job managing through these challenges. And as you've seen from our recent gross margin results, our P&L has reflected those higher freight costs. Coming into this year, we anticipated we'd see continued tight conditions and elevated costs in freight markets. But the actual conditions and costs have been much more challenging than expected. More specifically, first quarter freight and transportation costs came in hundreds of millions of dollars higher than our already elevated expectations. And for the full year, we're now expecting about $1 billion of incremental freight costs, even compared to our expectations only 3 months ago. Among the reasons for this incremental pressure, record high fuel costs are a meaningful driver as well as the global shipping market, where costs have stayed unusually high and where we sometimes need to rely on the spot market to secure adequate capacity. Compounding these near-term pressures on our gross margin rate, volatility in both consumer demand and delivery times placed additional stress on our supply chain in Q1, one that was already running lean on capacity in light of the growth we've seen over the last 2 years. As Brian and Christina mentioned, this quarter, we ended up carrying too much inventory in several categories where the slowdown in sales was more pronounced than expected, including home, electronics, sporting goods and apparel. In addition, capacity pressures were compounded by the fact that in several of these categories, including kitchen appliances, furniture and outdoor living, items are bulkier than average and require higher-than-average amounts of storage capacity. As our team collaborated with Christina's team to work through this excess inventory, we made decisions with an eye on preserving the guest experience. Rather than jamming store sales floors with excess product, which would have made them more difficult to shop, our team secured temporary storage capacity instead. And as Christina mentioned, rather than carrying items beyond their relevant season, her team made the tougher call and marked items down to clear them and keep our presentations fresh and inspiring. While these were difficult decisions in the moment, we have no doubt they are the right long-term choices. However, they involved higher costs, resulting directly from the actions we chose to take and indirectly in terms of team member hours required to manage the extra volume. As Michael will discuss in more detail, while we don't expect these conditions to persist over time, they'll continue to impact our Q2 results before conditions begin improving later in the year. More specifically, as we move beyond the front half of the year, we'll have had enough time to adjust inventory levels and receipt volumes to match the pace of sales, even in longer lead time categories. In addition, capacity in our supply chain will continue to build throughout the year as the new buildings we opened last fall continue to ramp up their productivity while we work to open additional buildings in the years ahead. Beyond this ongoing work to expand the upstream supply chain, we continue to add downstream capacity in our sortation centers, which increased speed and reduced the unit cost of last mile delivery. Following our successful test of the concept in the Minneapolis market, we now have 6 sortation centers open and operating, with plans to open 3 more by the end of the year. While the newly opened centers are still ramping up their capacity, in total, our 6 sortation centers handled 4.5 million packages in Q1, a number that's expected to grow significantly throughout the year. Each of these facilities already has volume flowing to our national carrier partners, including the ability to sort USPS packages individually by post office, creating a high-speed, low-cost delivery option in the metro areas surrounding each center. In addition, we've begun rolling out our lowest cost delivery option, Target last-mile delivery, at our Atlanta sortation center and will soon expand that capability to the other 4 recently opened facilities. For this capability, we collaborate with our partners at Shipt, whose drivers sign up to deliver batches of orders that have been sorted hyperlocally down to the neighborhood level. This provides a fast, efficient, reliable and low-cost delivery option for our business, benefiting both our guests and the P&L. While we're excited about the results these centers are already delivering, this initiative is in the very early stages, and we have plans to continue opening centers and ramping up this new capability for years to come. Beyond investments in the supply chain, we're also excited about the investments we're making in our stores, allowing them to become more productive, more fun and more inspiring to shop. For the year, we have plans to complete remodel projects in nearly 400 stores. And through the first quarter, we had already mobilized on just under half of those projects, keeping us on pace for the year. Just under 200 of this year's projects will be traditional full remodels in which we transform every part of the store, from wall to wall and floor to ceiling, updating the shopping experience to make it more inspiring for our guests and more efficient for our team to operate. Beyond those full remodels, we're planning to complete just over 200 fulfillment remodels in 2022 as well. These projects are focused on the operations of the store and their ability to support our same-day services. More specifically, these projects make changes within the 4 walls of the store to add capacity for same-day orders and incorporate features to enhance our pickup and Drive-Up capabilities. When warranted, these remodels include the addition of walk-in coolers and freezers near the front of the store, adding reliable capacity for our team to fulfill fresh, refrigerated and frozen items through our pickup and Drive-Up services. In addition, with many of these projects, we had a dedicated door for our team members to use when delivering Drive-Up orders to the parking lot. We're also adding canopies, more prominent signing and more Drive-Up spaces in our parking lots, making the Drive-Up process safer and easier for both our team members and our guests. Beyond these existing store investments, we continue to open new stores around the country. In the first quarter, we opened 7 locations, all smaller formats, in markets ranging from Jackson Hole in Wyoming to Times Square in New York. We continue to be pleased with the performance of our new stores and our ability to flexibly serve guests in new neighborhoods. And for our stores and markets that were temporarily affected by COVID, including college locations, tourist destinations and dense urban areas, we've seen continued rapid recovery in sales volumes as activity ramps up in those markets following periods of lockdown over the last 2 years. Similar to the pressures we've been experiencing in our merchandise costs, our construction team has been dealing with volatility in the price of raw materials and labor in our new store and remodel projects. And like our merchandising partners, they've done a great job working around those costs and constraints, keeping projects on track while maintaining their focus on delivering a great guest experience. So as I get ready to hand the call over to Michael, I want to pause and thank the entire operations team, from our stores, to supply chain, and our properties team to our partners at Shipt. The growth we've seen in our business and the expansion of our capabilities over the last 2 years has been both energizing and inspiring, but it certainly hasn't been easy for our team. They've handled growth well beyond what any of us would have expected 2 years ago, even as they worked around new challenges and unexpected obstacles. One of the joys of the last year has been the ability for me to once again get out in the field, traveling to our stores and distribution facilities around the country, and experiencing firsthand the energy and positive attitude our team brings to work. They're united in their support of our guests, for our brand and for each other. Every day, they bring our company purpose to life. And every day, I am inspired by what they accomplish. Now I'll turn the call over to Michael.
Michael Fiddelke:
Thanks, John. I want to start my remarks today where John just ended and add my thanks to our entire team. Even with all of the challenges they've been facing, they refused to get distracted. Instead, they maintained their focus on our company purpose, to help all families discover the joy of everyday life. Our team shows up to work every day with a passion for serving all families and for serving each other.
As John mentioned, it's been a joy in recent months to be able to travel once again, meet with teams across the country and hear what's on their minds. And the optimism and energy of our team is infectious. I can feel that whenever I meet with the team, and obviously, our guests can feel it when they shop, which explains why our first quarter traffic has increased more than 20% over the last 2 years. In the first quarter, our comp increase of 3.3% was supported by a traffic increase of 3.9%, partially offset by a small decrease in average ticket. Among our fulfillment channels, store sales grew slightly faster than digital in the quarter. Within digital, same-day services continue to drive our growth, and accounted for well over half of our first quarter digital sales; within our same-day services, Drive-Up accounts for the majority of sales, and it continues to grow the fastest. In fact, of the $3.3 billion in first quarter digital sales that we've added since 2019, Drive-Up accounts for nearly half of that growth. On the first quarter gross margin line, we saw a rate decline of about 4.3 percentage points compared with last year. Among the causal factors, merchandising actions drove about 3 percentage points of the decline, driven by the combined impact of impairments, markdowns and other actions taken to rightsize our inventory position in categories that were too heavy, along with the impact of higher freight costs. Among other drivers, higher supply chain costs accounted for a little over one percentage point of this year's rate decline, reflecting the impact of higher headcount and compensation in our distribution centers. Sales mix accounted for the remainder of the decline, worth about 10 basis points of pressure. On the SG&A expense line, we benefited from fixed cost leverage and strong expense control throughout the quarter, which helped to offset the impact of inflation-driven cost increases in multiple expense lines. Within compensation, the continued impact of team investments was offset by lower incentive compensation compared with last year. On the D&A expense line, we saw about 10 basis points of benefit in Q1, reflecting leverage on strong revenue growth. Altogether, our first quarter operating margin rate of 5.3% was about 4.5 percentage points lower than last year. While we expected this year's rate would be well below last year, our actual performance in the quarter was far lower than we anticipated, driven by the unexpectedly high costs we incurred on the gross margin line. Turning now to capital deployment, I'll start where I always do, by reiterating our priorities, which have remained consistent for decades. First, we fully invest in our business and projects that support our strategic and financial criteria. Second, we support the dividend and look to build on our 50-year record of annual dividend growth. And finally, we return any remaining excess cash within the limits of our middle A credit ratings through share repurchases over time. Beginning with the top priority, first quarter CapEx was just under $1 billion, keeping us on track to spend $4 billion to $5 billion for the year. While our teams continue to face multiple challenges, including supply shortages, shipping delays and permitting and inspection delays in some communities, they're doing a great job of working around these obstacles and keeping projects moving. In addition, as John mentioned, unexpected inflationary pressures are affecting some of our capital projects, which will impact our total spending for the year. As I mentioned at our recent Financial Community Meeting, we're excited to make progress on our capital projects, which continue to move our business forward. And today, given the team's efforts to advance this year's projects, I believe we'll reach the high end of our $4 billion to $5 billion plan for the year. Moving to our second priority. We paid dividends of $424 million in the first quarter, up about 25% from last year. reflecting a 32% increase in the per share dividend, partially offset by a decline in share count. We plan to recommend that our Board approve a healthy increase in the quarterly dividend, in the mid-teens to low 20% range later this year, keeping 2022 on track to be our 51st consecutive year of annual dividend increases. And finally, regarding share repurchases. Given our strong leverage metrics coming into the year, we entered into an accelerated repurchase plan in the first quarter, which will result in the retirement of up to $2.75 billion of our stock by the time the plan settles in June. In addition to this ASR, we repurchased another $10 million in shares in the first quarter. While we anticipate having continued ample capacity to return capital through share repurchases this year, given the current supply chain challenges we're facing and their impact on working capital, we now expect our total repurchases this year will be lower than the $7 billion we returned in 2021. As always, we'll adjust our pace, up or down, based on external conditions, business performance and cash flow, with a goal of maintaining our middle A credit ratings. So now I want to turn to our after-tax return on invested capital, which measures both our profitability and the efficiency of our CapEx decisions over time. In the first quarter, we reported a trailing 12-month after-tax ROIC of 25.3%. While this is a very strong number, indicative of the underlying health of our business, it was much lower than expected, near the very low end of where we expect to operate over time. Now let's turn to our guidance. In terms of the top line, based on our first quarter results and the trends we've seen so far in May, we continue to expect full year revenue growth in the low to mid-single-digit range. In terms of our profitability, given the unexpected cost headwinds that we're currently facing, we now believe our full year operating margin rate will be well below our prior guidance of 8% or higher. More specifically, given the elevated level of volatility we're currently facing and multiple sources of uncertainty going forward, we see a range of potential outcomes, centered around a 6% operating margin rate for the full year. As John mentioned, in the second quarter, we expect the challenges we faced in the first quarter will continue to impact our near-term profit performance. And our team is focused on doing everything necessary to ensure we enter the fall season with an appropriate level of inventory by category. As such, we expect a Q2 operating margin rate in a wide range, centered around our first quarter rate to 5.3%, well below where we'd expect to operate under normal conditions. As we move into the back half of the year, we continue to expect our profit performance will begin to improve. In particular, as John mentioned, we expect to have worked through the excess inventory positions that hampered our Q1 performance and which we expect to impact our gross margin in Q2. That said, we don't expect the external environment will be anything close to normal in the back half of the year. In particular, we don't expect to see any meaningful reduction in global supply chain pressures until 2023 at the earliest. So the elevated costs we've been facing will continue to affect our profitability for the remainder of the year. But let me be clear about a couple of things. First, we are not happy with our current profit performance, and our team is laser-focused on helping to quickly restore our business performance to where it should be operating over time. That said, nothing that is happening today has changed our long-run expectations regarding the ability of our business to grow nor has it changed our view of the long-run potential of our business to deliver an operating margin rate of 8% or higher over time. And today, as we navigate these near-term challenges, we are fortunate to have an incredibly healthy underlying business, one that can stand up to the significant headwinds we're facing and come out stronger on the other side. We have ample financial capacity to continue making long-term investments, in new stores, remodels, supply chain, and of course, in our team, all with a focus on serving and delighting our guests, driving deeper loyalty, and building on the top line growth we've seen in recent years and which continues today. After all, even after a significant pullback from last year, first quarter earnings per share were more than 40% higher than in the first quarter of 2019 prior to the beginning of the pandemic. While that doesn't mean we're where we want to be operating today, it shows we have a strong foundation from which we can recover from today's challenging environment and restore our operating margins to 8% or higher over time, consistent with our long-term financial algorithm. And given the loyalty and momentum we've established with our guests and the power of the investments we continue to make, we expect to continue growing the top line, even as we regain the level of profitability we expect our business will generate over time. Now I'll turn it back over to Brian for some closing remarks.
Brian Cornell:
Thanks, Michael. Before we move to your questions, I want to take a few minutes to reinforce why we're confident in the ability of our team and our durable business model to successfully navigate today's volatile environment and deliver continued profitable market share growth in the years ahead.
As Michael covered, even as elevated costs put meaningful pressure on our near-term financial performance, our business today remains profitable and very healthy, and it continues to grow. Since the first quarter of 2019, both our revenue on the top line and our EPS on the bottom line have each grown by more than 40%. Underlying that growth, we benefited from strong increases in both guest traffic and average ticket over the last 3 years, meaning the guests have found more reasons to visit our stores and our site and purchase more when they shop. This is the definition of a durable business model, one that can stand up to the unexpected pressures and remain healthy and growing.
When I think about the critical drivers of our long-term success, there are 2 things that rise to the top of that list:
our team; and the relationship we've developed with our guests. And when I think about the quality of our team, I don't believe that it's ever been better.
Over the last 5 years, we've made significant, purposeful investments to ensure we're hiring, elevating and retaining the best team in retail. These investments begin with paying benefits. But we've also found new ways to enhance the work experience and provide pathways for advancements, all in keeping with our Target forward goals to create an equitable and inclusive workforce and workplace. So even as we work tirelessly to restore our business to its long-term profitability, you should expect us to continue investing in our team, because we'll never achieve our longer potential without them. We have the same perspective regarding relationships with our guests. Over the last 5 years, we've made a number of deliberate decisions that were designed to deepen the relationship between Target and our guests. These decisions have resulted in ever-increasing traffic, translating to growth on both the top line and the bottom. So in the quarter just ended, when our team was facing potential trade-offs between a guest experience and incurring short-term costs, I am proud to say that they maintained their focus on the guest experience. That's because our team is laser-focused on our long-term financial performance, which depends on building and maintaining an ever-deepening relationships with our guests. So with that, I want to thank you for listening into our call today. And now Christina, John, Michael and I will be happy to take your questions.
Operator:
[Operator Instructions] Our first question comes from Chris Horvers with JPMorgan.
Christopher Horvers:
I have a question and as well as a follow-up. So first question is, in the first quarter of 2020, you took a large inventory impairment that you were able to get back in the second quarter. Now understanding it's a different environment that we face in this quarter, but the question is, how much lingering markdown risk could there be in 2Q? Maybe how large was the impairment? And why wouldn't this capture the risk in the first quarter? And how are you framing out the potential gross margin decline in 2Q?
Michael Fiddelke:
Yes. Thanks for the question, Chris. We still got some inventory to work through. And so you saw some of that pain in Q1. And our gross margin guidance of Q2 of operating -- or sorry, our operating margin guidance of a 5.3%, give or take, a wide range around that, contemplates the work we still think we have to do on the inventory side in the second quarter. Importantly, we believe taking those actions in Q1 and Q2 set us up well for the balance of the year. We've got some big important seasons in front of us
Christopher Horvers:
Okay. And then as a follow-up, can you expand a little bit more on what changed in your implied operating margin outlook for the back half? You mentioned supply chain costs. Are these now about $1 billion for the year? Are these now big enough to offset the air freight pressures in the back half, particularly 3Q? And then did you also change your mix assumption? And to what extent are you baking in more promotions and clearance relative to a few months ago?
Michael Fiddelke:
Yes. You hit on 2 of the bigger factors that will be at play in the back half of the year. As we've discussed, we see about $1 billion of freight and transportation pressure, outside of what we would describe even at the start of Q1. But we do expect, and we continue to take product in early intentionally to protect against supply chain disruption. We expect to see some offset as we don't anniversary the same level of air freight that we saw in the back half of the year.
When it comes to mix, I mentioned in my remarks about a 10 basis point drag from margin rate mix. The biggest shift from a category perspective is just the change in some of the categories at the top of the guest shopping list. And some of those categories where we've got some inventory to work through are the ones we'll work through in the first half of the year, and will be better positioned heading into the second half.
Operator:
The next question comes from Karen Short with Barclays.
Karen Short:
I had 2 questions. So the first is, I'm just curious on your philosophy with respect to the fact that you had an Analyst Day on March 1 and had some insight into the trends that you were seeing. So can you maybe just update us on your philosophy on maybe giving a pre-announcement? Because, I mean, I think it did come up with Walmart yesterday as well. So you're in good camp on things changing very quickly with the consumer and with the cost side of the equation. So that's my first question. And then I just had a quick follow-up.
Brian Cornell:
Karen, as we stand in front of you and others in March, we did not anticipate the rapid shifts we've seen over the last 60 days. We did not anticipate that transportation and freight costs would soar the way they have as fuel prices have risen to all-time highs. While we were certainly anticipating the impact of overlapping stimulus and consumer and guest returning to more normal activities, we did not expect to see the dramatic shift in many categories that we've talked about, the shift from categories like TVs to luggage, from small appliances to toys, and guests celebrating, being out with friends. That certainly impacted our business in the first quarter, and we expect that to continue in Q2. And we certainly didn't anticipate the impact that would have on our supply chain costs.
So things changed rapidly after we stood on stage in New York. We own that. It's what we're adjusting as we build our plans for the balance of the year. And we're committed to improving our operating performance over the second, third and fourth quarter and getting ourselves back on track for a more normalized environment in 2023.
Karen Short:
Okay. And then my second question is, obviously, we -- you have the higher sales productivity. That should be sustainable. So that should also translate into a sustainably higher operating margin structure, right, longer term, which is what you guided to. But that's the biggest question, obviously, that investors are asking today given what you just reported and what your guide reflects. So maybe if you could just give a little more color on why -- and the puts -- not the puts and takes, but the -- I guess, a stair step function to get back to your algorithm on the 8% operating margin.
Michael Fiddelke:
You hit the nail on the head in your question. The sustainability of scale benefits, especially as you've seen in SG&A leverage, that should be sticky, and we would expect it to be sticky. We've got some work to do on the margin line, and Q1 and Q2 outlook reflects that. But as we work through some of that inventory liability, as we let the levers we have to pull react to the current environment, to Brian's note, some of that snuck up on us in the first quarter, and we'll work through some of that over time. But we continue to have a lot of confidence that the long-term run rate of profitability for the business is in the 8% range, give or take. And it's our work to do the hard work to get back to that path.
Brian Cornell:
Karen, just finished my -- one of the things that hasn't changed since we were together in March and gives us great confidence as we go forward is the relationship we have with the guest. While we've certainly seen significant cost pressures since the start of this quarter, the guest continues to reward us with footsteps in our stores and growing traffic, more visits to our site. We feel very good about putting over 3% comps on top of 23% last year. The fact that traffic grew by almost 4% on top of 17% last year gives us great confidence that while we're facing some operating challenges, we've made that invisible for the guests. And we protected the guest experience as they shop our stores and visit our site.
That gives us tremendous confidence that, that guest will continue to reward us, particularly as we provide great value and affordability during a time of need. So that continues to give us confidence, not in just this year, but in our out-year forecast.
Operator:
The next question is from Kate McShane with Goldman Sachs.
Katharine McShane:
I wondered if you could help us understand a little bit more the slightly down average ticket during the quarter. Just given the level of inflation that we did see on the cost side and the prices that you may have passed through, are there any pricing actions here that can help offset some of these margin pressures further? Or can we expect higher prices than what we saw in Q1?
Michael Fiddelke:
Sure. Thanks for the question, Kate. As we shared in remarks, the headline story for us is traffic growth. But if you -- as you decompose ticket, we did see a low single digit increase in ASPs, offset by a reduction in units per basket. As you've heard us probably say many times before, a lot goes into that ASP number. It's a little bit product mix, it's a little bit how much inflation is in the environment. And so a little trickier to decompose there, but that's just a little more color on what we saw in the basket.
We continue to be laser-focused on that traffic number. That's a great indicator for us of how -- what we're doing is resonating with the guests and to continue growing the top line by growing and deepening engagement with Target. That positions us well for the back part of the year, and that positions us to have the top line that we want as we rightsize the profit picture over time.
Katharine McShane:
Okay. And with regards to the operating margin guidance, and granted that I know you've kind of anchored it to the 5.8% and it being a wide range around that, is there any way you can dimensionalize how much lower do you think the margin can go or what the bottom of that range might be in your scenario analysis?
Michael Fiddelke:
Yes. There's -- I mean, obviously, there's a lot of factors at play as we look at Q2 and the balance of the year. I think we used the language, we wouldn't expect it to be normal for the balance of this year. So our best view of those factors is in our Q2 guide of 5.3%, plus or minus, a wide range around that, and in our guide of 6% for the year.
Operator:
The next question is from Scott Mushkin with R5 Capital.
Scott Mushkin:
So I guess the first thing I wanted to talk about a little bit is the inflation that consumers are seeing, particularly in those everyday items like utilities, food. How do you think the consumer is going to react over time? I know people talk about peak inflation, but from our vantage, it probably doesn't occur till maybe late summer. And how concerned are you that consumer demand holds up?
Brian Cornell:
Well, Scott, obviously, we're watching this on almost a daily basis. And while we can't project into the future, I wish I had that crystal ball in front of me, we can tell you what we saw during the quarter and the start of May, where we just continue to see a resilient consumer. Our traffic numbers are up to start the second quarter. They're shopping multiple categories. And they're appreciating both the newness that we're providing, the seasonal relevance in our stores and in our assortment and the value we're providing. And we think that's critically important to our success over time.
So I'd love to give you an outlook on what's going to happen with the consumer and how do they respond to ongoing inflationary pressure. But I can tell you, the traffic we saw in our stores and the visits in our site in the first quarter, the way that's continuing in May 1 tells us that we've built extraordinary trust over the last couple of years. And we're continuing to be rewarded by a guest and the consumer as we work into the second quarter.
Scott Mushkin:
So as a follow-up to that, Brian. I guess when you guys look at your business and the volatility that we're seeing and the potential the consumer could weaken, I know you're not seeing it yet, when do you start getting more aggressive on your costs to take action to maybe bring things down if you see things? How quickly can you move? And when do you start to do that?
Brian Cornell:
Well, Scott, we work each and every day to make sure we're finding efficiency throughout our operation. And certainly, coming out of the first quarter, we are doubling down on finding operating efficiencies and greater effectiveness in the organization. We know we've got to be really agile. And I think it's been one of our strengths over the last few years and certainly pronounced during the pandemic, that we have to be able to respond to a changing environment, whether it's the consumer changes, the economic changes around us.
And we'll continue to make sure we're focusing on agility, maintaining that relationship with the guests, growing market share even in a volatile environment and making sure we just deepen that relationship with our guests, which we think, long term, along with investing in our team, is the most successful way for us to create value for our shareholders.
Operator:
The next question is from Joe Feldman with Telsey Advisory Group.
Joseph Feldman:
I think earlier in the scripted remarks, Christina had made a comment that consumers seem more positive about their finances. And I was just curious if you could share a little more color behind that, like what you're seeing or hearing in your survey work.
A. Hennington:
Yes. I'd be happy to, Joe. We have been -- the last couple of years, we have been highly engaged in trying to understand the consumer. We've been through a series of chapters of consumer behavior shifts almost every 2 months for 2-plus years, honestly. And what we're seeing is that the consumer has taken control of their environment more so because the macro environment feels out of control.
And so despite the fact that they might have worries about inflation, they're in charge. And they're making decisions based on their preferences and what they value, which means going back out, if that's what they want to do, traveling because they've missed it, seeing their friends and family again. And it's about moderating those behavior shifts and accommodating our assortment and our messaging and our relevance based on how those shifts happen. And so it's really important to stay close to the consumer and not expect that past behavior as an indicator of the future.
Joseph Feldman:
Got it. And then just a follow-up again on the gross margin pressure you guys are seeing. Should we assume things gradually improve as the year progresses? Because presumably, you'll be lapping some of that pressure from last year. Prior to this quarter, I mean, historically, you guys have always had a pretty steady gross margin on an annual basis anyway, around 28%. And so is there any reason to think we won't kind of naturally come right back to that as we cycle through these pressures?
Michael Fiddelke:
Yes. You're certainly pointing in the right direction there, Joe. We've given the kind of explicit expectations for Q2, but implied in the full year is an improving profitability picture that will come through margin in the balance of the year. To focus on the annual in the long run there is a theme that I've come back to over and over. Quarterly margin is going to have more volatility than one might think. But in the long run, we're pleased with what we see as the potential of the profitability of the business. And we'll be on a path in the back half of this year to take steps in that direction for sure.
Operator:
The next question is from Edward Kelly with Wells Fargo.
Edward Kelly:
Yes. Brian, I wanted to ask you about pricing. Beyond the inventory issue, much of the pressure seems cost related in areas like supply chain. Can you talk about the potential to pass these costs through to consumers and the time frame this may occur? I mean we are hearing from probably your biggest competitor, I guess, plans to do this. If there's any hesitation, maybe talk about why.
Brian Cornell:
Yes. Joe, we absolutely are looking at this very carefully. And you should expect us to surgically pass along cost where appropriate. But we're also laser-focused on protecting our value position in this environment and making sure we provide great affordability to the guests in a time of need.
So we'll take a very balanced perspective on that. But I think we've got to start with doing the right thing for our guests and making sure we continue to provide the value that they look for from Target each and every day while we manage the cost environment and determine where and when we can pass along costs selectively.
Edward Kelly:
Okay. And then just a follow-up. Inventory per store is up a lot over 2019 before, pre-pandemic. And a lot has obviously changed, and your sales are a lot higher. But can you talk about where this should be? Maybe quantify the amount of excess that's still sitting in inventory today and where the most work needs to be done. And then what are you doing going forward to adjust things like cancellations? Or is it just really sort of adjusting ordering going forward?
Michael Fiddelke:
Yes, Ed. The -- it's a good question. There's a few things going on if you look at the level of inventory on our balance sheet. One is we've got some categories where we need to work through some inventories. We've already talked about that piece. There's a little bit of product cost inflation sitting in that number, too. But I will say, given our desire to make sure we're landing some product earlier and protect against supply chain volatility, for the near term here, you should expect kind of that new normal of sales growth to inventory growth to include some working capital investments as we land some of that product sooner to make sure we've got it for the guest.
And so those are the 3 big factors that we're watching. Obviously, the first of those factors, we'll work to make some progress on here in the second quarter to get us in line with what we expect sales trends to look like for the back part of the year. But old normal might not be the current run rate in the near term as we work to secure product, land it early and avoid some of the disruptions that have caused out of stocks over the last year.
John Mulligan:
Yes. And just to pile on a little bit, I think all things being equal, we would say, given how much larger we are, we turn -- everything would turn faster. But I think Michael hit on it, I don't think 2019 is a reasonable compare. Given the, frankly, slowness in the supply chain, lead times are longer. And that means we carry more inventory at any given time because of those lead times.
And so we aren't where we want to be right now, for sure. Like Michael said, we're lumpy, and we need to work through that, we will. But in general, the increase in turns that we would naturally see being a larger business with more sales is going to be offset by lead times that have increased virtually across every part of the supply chain.
Brian Cornell:
Operator, we have time for one more question today.
Operator:
Our last question comes from Robbie Ohmes with Bank of America.
Robert Ohmes:
Two quick follow-ups. The first is, if you guys isolate groceries, so Household Essentials and Food & Beverage, how was gross margin in that area of your business versus expectations? Is that seeing similar kind of pressure?
Michael Fiddelke:
We feel good about the gross margin performance in grocery. And just Food & Beverage in general has been such a steady top line grower, share gainer quarter after quarter. And so the strength that we've built in that category, I think, makes the economics in Food & Beverage work in the right direction. We've talked a lot, and I think it's important as we think about consumer looking for value, the strength of the owned brands in Food & Beverage, Good & Gather and Favorite Day and the guest response we've seen to those 2 owned brands has just been incredible. And that's great from a guest preference perspective. It's also good for margin.
Robert Ohmes:
And the ability to cover the cost increases coming through on the national brands has been healthy?
Michael Fiddelke:
Yes. We're obviously looking at that across all categories and making sure that we're providing great value to our guests in spite of those inflationary cost pressures. No different approach in food and beverage, where we're looking to get that balance right there, too.
Robert Ohmes:
And then just quickly, on the traffic, which is -- was really healthy against -- I think it was plus 17 last year, any sense of new customers versus frequency?
Michael Fiddelke:
So it's always a little bit of a mix of both when we're doing our job, right? But the thing that we come back to when it comes to driving traffic is just driving deeper and deeper engagement. And you've heard us talk in the past with over 100 million Target Circle guests. That's just one more way that we can continue to drive preference in a personalized way and build deeper and deeper engagement with Target over time.
And you can see that coming through in the traffic results we see, not just in this quarter, but over the past couple of years. And that gives us a lot of optimism that what we're doing is resonating with the guests, and that should bode well for the balance of the year and beyond.
A. Hennington:
Yes, Robbie, and if I could just add 2 cents to that. The breadth of our growth across our guest base was very broad. All income levels, demographic levels, it was broad. And that's because of our commitment to continue to be more and more relevant over time using the tools that Michael talked about, but really our commitment to being consumer-centric.
Brian Cornell:
All right. Operator, with that, we're going to conclude our call today. I really appreciate everyone participating. And we look forward to talking to you soon. So thank you.
John Hulbert:
Well, good morning, everyone, and welcome to Target's 2022 Financial Community Meeting. I'd like to start by welcoming the investors and others who are attending this meeting remotely this morning. And for the first time in 3 years, it's great to welcome everyone who's here with us in person in New York.
Before I turn it over to Brian, I have a couple of important disclosures. First, 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. And second, in today's remarks, we refer to non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP measures to the most comparable -- directly comparable GAAP measure are included in our financial press releases and SEC filings, which are posted on our Investor Relations website. With that, I'll turn it over to Brian to begin the meeting. [Presentation]
Brian Cornell:
Good morning. It's great to be back here in New York for our first live event since the start of the pandemic. I can tell you, our entire team has been looking forward to seeing you in person. It's been a long couple of years.
But I also have to acknowledge the continued uncertainty that surrounds our world, which is only being magnified by the growing conflict between Russia and the citizens of Ukraine. It serves as another reminder of our continued need to support our teams, our guests, our communities as we all navigate these very challenging times. It's been 5 years since I stood in front of many of you, the head of then a $70 billion company. I was a little nervous as I laid out a bold new company strategy. Today, I stand in front of you as the head of a $106 billion growth company with a long list of proof points that our strategy is working.
We've delivered 19 consecutive quarters of comp growth:
11 quarters of comp growth before the pandemic, 8 quarters of comp growth since the pandemic. We've grown because we've accelerated our investments in our team and in our strategy. We've accelerated our growth because our team stepped up in heroic ways, meeting the explosive demands that materialized with the pandemic.
5 years ago, we had 1,800 stores. I announced the plan to add stores and upgrade the stores we had. And I saw jaws drop and our stock price dive for a while. At that time, retail was about closing stores, not opening them. Many of you questioned our approach. Now 5 years later, we have almost 2,000 stores, and we're still remodeling and building new stores. We also know the way we run our stores is the secret to growing digital sales. Yes, the way we run our stores is the secret to why digital is now 19% of sales. So as we look at the next 5 years, we're going to continue to build on our strengths. We have a culture, we have the connections, and we care. We care about delighting our guests. We care about delivering value to our stakeholders. And as you see in our fourth quarter results, we're accelerating our investment in what's next as we continue to deliver what's now. For Q4, our comp sales were up nearly 9%. We achieved standout results relative to the market. We achieved growth on top of last year's all-time record growth. Our full year comp was up a remarkable 12.7%. In the last 2 years, we've grown by more than 35%. That's more than $27 billion. That figure alone would place the company in the top quarter of the Fortune 500. And we're seeing the benefits of stores as hubs. Growth was split nearly 50-50 between stores and digital dollars. Over this time frame, we grew 2021 traffic by more than 12% on top of nearly 4% in 2020. And we posted 2021 after-tax return on invested capital of 33%. We achieved all this growth while protecting consumers from dramatic cost of good inflation, delivering adjusted EPS that is 44% higher than last year and more than double where it was in 2019, and funding all of our ambitious strategic investments completely. Our Q4 results show we're taking our strategy forward to the next level with speed, with efficiency and with relevance, with care. Over the next 75 minutes, we'll show you how we're investing in opportunities for big wins. We've added Ulta Beauty to our stores. So far, our sales per square foot are strong. Guest engagement is impressive. We see the scale of opportunities as being even more impressive. We'll show you how we translated a massive influx of insights from new guests and loyal guests who are engaging even more. You'll see how we're accelerating our capabilities in personalization, creating an always-on, inspiring guest experience and driving unparalleled value to our partners with a fast-growing revenue stream for our business through Roundel. We'll show you how we're adding capacity, efficiency and innovation across stores and supply chain operations, driving the next phase of stores as hubs. We'll show you how we're growing by increasing our multi-category assortment. We'll show you how we're making incredible progress in a category like Food & Beverage. And above all, we'll show you how we're growing by keeping investments in our team constant. We believe our constant investment creates that critical connection between social and environmental sustainability. ESG is a critical part of our Target Forward strategy. So yes, we're going to keep growing in 2022. And knowing this, we've upgraded our long-term financial algorithm. Michael will lay that out later this morning. We are a bigger, stronger company now. We're growing on a bigger base than ever, and we recognize the power of 'and'. We have a slate of focused initiatives, and they work together in unison. We have a connection to our guests, and we have relevance to their lives. We have physical/digital experiences and the only at Target touches. We have a multi-category portfolio and a differentiated approach to curating owned and national brands. We have scale in same-day services and the pathway for more digital growth, thanks to the synchronized operation of stores, fulfillment centers, flow centers, sortation centers and Shipt. We have the commitment for Target forward, and we can use our size and scale to benefit people and the planet. We'll serve our guests through challenging times, and we'll find terrific opportunities for growth. We definitely have the power of 'and'. We know today's consumers are facing a series of follow hardships from the pandemic. We see higher prices across the country. We see supply chain constraints that are steadily working themselves out but will likely take more time, both of which are made more uncertain by the crisis in Ukraine. And we see people reevaluating how they think about work. Millions of people are searching for careers that have meaning and purpose, and they are turning to companies like Target for opportunities. As you'll hear today, we're walking our stakeholders through these challenges. We have the global scale to keep the products people want and need moving through our pipeline. We have the value levers, multi-category assortment and multichannel shopping experience. And we allow our guests to consolidate trips, get more done in one store and experience a little bit of affordable luxury for their families, especially in this inflationary economy. Above all, we built a culture that cares. Our teams understand the way to grow and win together is to care. They care about each other. They care about our guests. They care about our communities. They care about the millions of families we touch each and every day. As I look at the future of Target, I increasingly see care separating us from the industry. So before we dive in a corporate strategy and operational details, I want to tie some of these things together. I want to show you how our potential, our culture, our connection and caring tie into a business model that will deliver even more personalized, even more equitable, even more sustainable growth in the future. For a concrete example, look no further than the announcement we made yesterday to invest up to $300 million to set a new starting wage and to expand access to health care benefits to more team members and their families. 2 years ago, we raised our starting minimum wage to an industry-leading $15 per hour. Now we're setting new starting wage ranges of $15 to $24 per hour, positioning Target as a wage leader in every market where we operate. We'll also provide broader, faster access to health care for hourly team members, making nearly 20% of our team newly eligible for benefits and reducing the waiting period for all hourly store team members to enroll in Target medical plans. You can count on us to keep leading with investments like these. But to really appreciate where we're headed as a company, I want you to know not just what we're investing in, but whom. I'm thinking of Jen Mayer, Store Director of T1235 in Hudson, Wisconsin. Jen started as an intern 26 years ago. Since then, she's gone on to lead stores for Target in Iowa, Missouri, Indiana and Minnesota. In the 2 years since she moved to Hudson, store sales have increased by 30%. You'll hear about chain-wide figures like that from John, and Jen's store is a proof point to that trend. Shortly after she started in Hudson, Jen oversaw the introduction of Drive Up right at the start of the pandemic. And in 2 short years, our stores rocketed up to the top 75 for Drive Up. So the store performance is strong, but that's not what caught my attention. Instead, it was a speech by one of Jen's team members, a 27-year-old named Lindsay, one of the thousands of team members who joined Target in the pandemic. In front of a Black Tie Gala last fall, Lindsay related how she was devastated after losing her previous job during the COVID lockdowns of 2020. Here's what she had to say.
Unknown Attendee:
It is a privilege and honor to tell you how I became a Target team member. My Target story is one of inclusion and acceptances. As we know, when the pandemic happened and businesses and people were affected everywhere, I sat home crying about being laid off from my job and needing a schedule. I wanted it and needed to work. I like to shop by Target, so I thought, you know, that would be a good place to work.
That's when all on my own, I updated my resume and sent my application in. I didn't need my mom's help this time. She wasn't in my interview either like she was in the past. 45 minutes into the interview and telling them that I had to be honest, I have autism. They said, "Thank you for sharing. Welcome to Target."
Brian Cornell:
No one who knows Jen or her team would be the least bit surprise that they hired Lindsay on the spot or that Lindsay has had a great developmental experience in the store, is doing well and appreciates her extended Target family. Jen speaks for the company when she says, it's important to give everyone opportunities. In her 20 years as a store director, she's moved hundreds of team members from part-time to full-time. She's developed and promoted dozens of team members to leadership positions. She's helped them cope with trauma, overcome disparities, build skills and save for the future.
She speaks boldly for our culture when she says, "I ask myself, what would I want someone to do for me? And then I tried to do that times 10." This is the kind of question we ask ourselves to the company all the time:
what can we do with our resources, with our strategy and plans, with our team and culture to serve the world around us in a bigger or beneficial way?
So as I hand off to our team, I'll ask you to keep that story in mind. Jen Meyer will be the first to tell you, we're just getting started, that you can't equate accelerated returns with exhausted ones. Her store with those strong results hasn't even been touched by a remodel. Starting in April, T1235 will get an Ulta Beauty and a Disney store, will significantly increase the size of her grocery footprint and add a dedicated entrance for Drive Up and Order Pick Up given the volume of same-day services. And the growth from this remodel will spur Jen's store even higher. It will combine with thousands of comparable examples countrywide to bring more joy, more equity and opportunity and even more growth in both financial and societal terms to our stakeholders here and around the world. Christina?
A. Hennington:
Thanks, Brian. This morning, I'm eager to give you a peek behind the curtain to answer the question, what's next for Target? And the short answer is a lot. I'd like to share with you a deeper look into the growth framework we use to drive our strategies forward. With a fortified foundation and the deepening level of trust we've established with our guests, we're continuing to build what's working strategically while making smart choices to launch new initiatives.
While I plan to spend most of my time today sharing our specific strategies and the lens through which we view them. Let's first acknowledge what enables the execution of these strategies in the first place:
our team, our operations and technology. The investments we've made in these areas will empower everything we'll share today. In fact, they're increasingly becoming differentiated growth drivers in their own rights, and they propel our purpose
Our culture to care, grow and win together, coupled with our core values of inclusivity, connection and drive, support our purpose. Without them, our purpose statement is just words on the page. It's only when we're aligned in who we are, what we care about and how we drive forward together that our purpose comes to life. Here's a recent example. One of our guests, Nicholas, recently lost his sister to cancer. One of his family's most prized possessions was a photo his sister in an opal-housed picture frame that she gave to him before she passed. One day, the frame fell and shattered. Unable to find a replacement, Nicholas reached out to us with a plea for help. The frame, unfortunately, was no longer in production. But the owned brand team tracked down 2 remaining frames, which they sent to Nicholas and his wife, complete with handwritten notes of sympathy and care from the Target team. Nicholas shared with the team, "I know it's just a frame, but there's a lot of meaning behind it. What you did may seem small, but it represents so much more." This is just one example of how our team continuously shows up, living out our values and putting care first. I am so grateful for their unwavering commitment to our guests, the communities they serve and each other, all in service of our purpose. So now let's go deeper into each of our 6 strategic pillars, distinct but interwoven aspects of how we intend to grow. They represent core ideas to create forward motion for our business and help define the sum of the parts that is uniquely Target. Let's begin with one of the most iconic differentiators at Target, our brands. Through our careful balance of exclusive owned brands and industry-leading national brands, Target differentiates by curating a unique assortment, driving preference in a crowded retail landscape. We built guest affinity through our flagship brands like Good & Gather, All in Motion, Cat & Jack and Threshold. We've also continued to innovate with new brands such as Brightroom, Target's first dedicated storage and home organization owned brand; and Kindful, our first pet food brand with premium ingredients and no artificial colors, flavors or preservatives. Through our world-class design and sourcing functions, we are able to develop and produce products adding incredible quality and value, always a focus for our guests, but never more so than in an inflationary environment. To illustrate the scale of our owned brands, in 2021 alone, Target sold more than 330 million units in Cat & Jack, equating to nearly 7 items for every child in the United States under the age of 11. And even though these brands are already big, they're still growing. In fact, Target's owned brands grew 18% in 2021. And at more than $30 billion, our owned brand sales alone now rival the size of some Fortune 100 companies. But as we've said before, it isn't about owned or national brands. The harmony created between them is part of what makes Target unique. Our recent progress in denim serves as a perfect example. Years ago, we recognized a vast opportunity to elevate denim's role at Target, stemming from considerable guests and market research. So when Universal Thread and Goodfellow launched, both featured extensive new denim offerings, including a variety of styles and inclusive sizing, all at sharp price points. The guest reaction was to the quality and value was fantastic. We further rounded out the assortment by deepening our partnership with Levi's, which continues to grow. All told, the interplay between our owned and national brands has reinvigorated this category, bringing us from a retailer that sold denim to a denim destination, having grown sales in this category by more than $150 million since 2019. And Levi's isn't the only growing partnership at Target. We're also deepening our relationship with leading national brand partners like Disney, Apple and Ulta Beauty. Brian touched on the strong results we're seeing with our first 100 Ulta Beauty at Target stores. We entered this partnership knowing our guests were looking for prestige beauty brands and industry-leading expertise, and that's exactly what these new shops are delivering. In stores where we've added an Ulta Beauty experience, guests are buying incremental items from the Ulta Beauty assortment while continuing to shop the beauty brands they loved at Target for years. In fact, these new spaces average more than 2x the productivity of the rest of the store, and the growth is proving to be incremental. Specifically, in stores that have added an Ulta Beauty section, we're seeing a mid-teens lift across total Beauty and productivity lifts in complementary categories as well. With these incredible results, we remain committed to operating at least 800 Ulta Beauty at Target locations over time with plans to add more than 250 new locations in 2022. At Target, we pride ourselves on the level of service and shopping experience we provide. As John and Mark will share in more detail, we made meaningful investments and progress in the store shopping experience over the past several years. So I'll focus on our opportunity to grow our in-store services. Target has long been a destination and escape, largely because of the differentiated experience we provide. In-store services are one more way we can make life easier for our guests, helping them to accomplish more in a single trip to their local store. Years ago, we began our partnership with CVS Health to provide pharmacy services in our stores, and they continue to deliver exceptional care and expertise today. This not only benefits our guests who fulfill their prescriptions in our stores but also consolidates another trip, simplifying their lives. Similarly, we provide convenient, well-established optical services, which we have at more than 500 of our stores and growing. Yet we still have an opportunity to do more. Let me share an example of a recent pilot we plan to scale. In 2021, Target began testing ear piercing at several Minneapolis-based stores. Our research found that guests were looking for a reliable, safe and convenient place to get their families' ears pierced. So we created a joyful and differentiated experience, making us the first-and-only national retailer to offer ear piercings performed by a licensed nurse. This service helps us connect and celebrate a major milestone with often younger guests, creating lasting affinity for our brand. Given the success of the pilot, we recently expanded the rollout to nearly 200 stores with plans to meaningfully increase that number by the end of 2022. This is a fantastic example of what happens when we listen to our guests, deeply research the market opportunities and create a differentiated solution. Another growth pillar is our focus on affordability as value remains among the biggest loyalty builders in retail. Our goal is to deliver unbeatable value by providing affordability across every category every day. After all, we established our Expect More, Pay Less promise decades ago, and we're continuously evolving what it means to deliver great value. Given that the U.S. economy is experiencing the highest inflation rate in decades, the American consumer is becoming increasingly price-conscious. This is why we believe our comprehensive view of affordability, which focuses on price but encompasses so much more, sets Target apart from our competitors, driving deepened engagement and growing loyalty. Our guests tell us that affordability begins with price, but also includes proximity, accessibility and assortment choices that satisfy any budget. It also means receiving valuable benefits like those we offer through Target Circle, including exclusive promotions and deals, 1% earnings to redeem on future purchases and the ability to help direct Target's charitable-giving to the causes our guests care most about; and the industry-leading benefits we offer with our RedCard holders, including 5% of every transaction, free shipping on Target.com and no annual membership fees. Over the years, RedCard guests have saved more than $9 billion on their purchases, including more than $1 billion in 2021 alone. Now I'd like to share a bit more about 2 emerging growth pillars in our framework. While they represent more nascent opportunities, they are positioned to spur incremental growth on top of our existing strategies. The first is our focus on relevance, something we've long worked to maintain and grow with every guest interaction. Brian shared the compelling opportunity we have to better harness and apply the power of guest insights. Through this opportunity, we can optimize our assortment, more effectively make offers to our guests and, most importantly, personalize our interactions with them. We've long known the joint value we can create for our vendors, our guests and Target by connecting guests to the products they want and need. But as we continue to deepen our relationship with the guests, our ability to refine and elevate this value is extraordinary and will continue to drive outsized growth over the next several years through the likes of Target Circle, Roundel and Target Plus. Carol will provide more detail on these rapidly growing platforms in a moment. Finally, I want to highlight Target Forward, the newest chapter in a long history of strong corporate responsibility at our company. At a time when the American consumer is becoming increasingly focused on not just what they buy but also where and how the product was made, how its production impacts the world and those who produced it, and how companies function as citizens of a global community, we are proud of our bold commitments to better people in the planet with every choice we make. As we grow and continue to develop our new owned brands, our Target Forward commitment is to design and elevate circular, sustainable brands. Of course, these brands will begin with a focus on our guests but also consider the impact to the world. We aspire for 100% of our owned brand products to be designed for a circular future by 2040. Additionally, our teams will continue designing to eliminate waste, using materials that are regenerative, recycled or sourced sustainably to create products that are more durable, easily repaired or recyclable as well. Beyond our sustainability efforts, our aspirations to accelerate opportunity equity are equally pivotal. While we still have far to go, Target's Reach Committee is encouraged to be leading the industry with progress against virtually every goal we have set forth. We'll continue to share specific progress over time, but I want to highlight a few examples with you today. The first is in our Beauty business, where we have increased our black-owned or founded brands by 65% since 2020, and are now leading the industry with more than 70 black-owned and founded brands. Some of these entrepreneurs launched through Target's accelerator programs designed to quickly scale brands at Target. Entrepreneur Cora Miller of the Black-owned Hair Care business, Young King Hair Care, went through our 2020 Target Takeout program and subsequently launched in 365 Target stores. Given the immediate success and reaction from our guests, we now have plans to expand this line into significantly more stores in 2022. Cora is among a group of fewer than 100 Black female entrepreneurs to raise more than $1 million in venture funds ever. We want Cora's story to become the rule, not the exception. We'll continue to elevate entrepreneurs like her through Accelerator programs, including the recently launched Forward Founders program, which equips historically under-resourced entrepreneurs to build their businesses and gain access to industry-leading retail resources and partnerships. When more than half of our first cohort comprised of Black entrepreneurs, we aim to provide a launching point for many new and emerging Black-owned businesses. If we've proven anything over the last few years, it's that Target's a growth company. Even though we're now more than a $100 billion business, the opportunities for growth are immense. We have created momentum through unique and innovative strategies, many of which began long before the onset of the pandemic. And because of our durable, flexible business model, we have proven we can adapt to any environment. We'll continue to play offense and accelerate these strategies while listening to the ever-changing wants and needs of our guests to ensure our playbook is a direct reflection of what they have come to expect from Target. With that, I'll turn it over to Cara, who will provide more color on some of our powerful growth strategies.
Cara Sylvester:
Hello, everyone. I'm excited to be here to share a view of Target's growth through our guest' eyes, because as Christina shared, everything we do should be rooted in a deep understanding of what our guests want, along with the empathy to understand what they need and how those needs continue to evolve. In the next few minutes, I want to show you how our commitment to relevance has positioned Target to deliver the most personalized omnichannel experience in retail.
In my first year as Chief Marketing and Digital Officer, I've had the privilege of sharing Target's story in many virtual firesides, roundtables and interviews. And the common thread, when I think about all of those times, is that people always ask me how Target stays 3 steps ahead with our guests in these rapidly changing times. And while I am not a huge fan of giving away all the keys to success, I always point to our culture of care and our core value of inclusivity that have us listening and learning from our guests deeply and continuously. When our insights team talks with guests, we don't just ask them questions about Target and their experiences shopping with us. Guests share their hopes with us, their fears and their dreams. They share simply what's going on in their lives. Through these ongoing check-ins, every area of our enterprise has a view of the holistic human experience lived by our guests during the pandemic and what that might mean for Target in the future.
We also know from brand research what matters most to guests when they shop and connect with us. Ease and affordability are essential, but our guests are looking for more, too:
quality and value, community and connection, inclusivity and feeling seen, what Brian calls the power of 'and'. And what gets me really excited is how we're delivering loud and proud on these personal guest values at scale.
Target's digital experience, which we have been investing in for years, plays a key role here as a gateway to our guests and a huge growth driver for us. Our digital business has nearly tripled in the last 2 years and in 2021 delivered a 20% comp on top of a 145% comp the year prior. Then there's 45% comp growth in digitally enabled same-day services on top of 235% last year. And our flagship Target app has moved from 30% of digital demand a little over 2 years ago to closing in on 70% today. But the biggest differentiator when you look at Target's digital experience, it is designed with guests at the center. We take the friction out so that guests can experience Target on their own terms, which means we are guest-obsessing at every touch point to stay a step ahead of evolving guest behaviors. For example, we're leaning into the love our guests have for our digitally led same-day services because that's sticking. Routines developed early in the pandemic are now part of their lives, things they cannot live without. But they look a little bit different today. So here's a guest who had a Drive Up border, our highest NPS service, but then she was drawn inside to discover something new. Then there's this guest who said, "Can we just talk about the fact that you can go through Target with Starbucks at hand and then go through Ulta?" These new kinds of Target runs and stock-ups reflect our guests' evolving needs and wants and a seamless omnichannel experience that delivers on them. Today, Target has 40 million guests in counting shopping across channels. And as you've heard us share before, omnichannel guests spend 4x as much as stores-only guests and even more compared to digital-only guests. Target can bring together insights across an omnichannel journey, from RedCard and registry, to digital and in-store, to our call centers and every step in between, which means we're getting a 360-degree view of the kind of guests that are driving so much growth. With these meaningful insights, we can make sure that Target Magic they love is even more relevant in their lives and the experience even more personalized. So you can imagine what this looks like. For one guest scrolling through the app, what she sees is curated especially for her. There's her favorite items and great deals on her go-to essentials for weeknight dinners. And because she told us she's a teacher, it really means something to her when she sees a Target Circle offer that makes her classroom supplies more affordable. She's getting ideas for what to pack in lunchboxes for her kids this week, too, maybe a little something from Good & Gather. And what's more, her app experience helps make life easier as someone who might need a shopping partner once in a while. That's our name for a new service that allows her husband to do the Target run while she's working, a service that is near and dear to my family's heart. So she checks out and later that afternoon, he picks up what's for dinner. Here's another kind of personalized guest journey that we're obsessing over. A guest is shopping for essentials when he sees a message from a banner ad about Clorox' Glad bags. He's purchased them before, but other brands, too. The headline benefits really resonate with him. So this time, he adds Glad to his cart. He checks out and drives up. Purchases like this one contributed to a 40% higher return on ad spend for Clorox and a 25% increase in customer retention over the duration of the campaign. Let me share the back story on this type of Target run. At the start of the pandemic, Clorox saw growth in guests buying their products for the first time, and they wanted to retain them. So they turn to our media company, Roundel, to measure guest values and behaviors. Using that research, Roundel developed a series of A/B tests, and Clorox used those key insights to optimize messaging and audience targeting. How we're leveraging media to know our guests better and create a more relevant and personalized experience for them is incredibly exciting, and so is this. From its humble beginnings in 2007 with just 5 team members and known as online vendor marketing, Roundel is now a 500-plus person strong fully integrated Target team, already delivering more than $1 billion in value for Target, and we expect that to grow to $2 billion over the next several years. To sum up Roundel, it's positioned for continued success because it's delivering on relevance and value. That's a win-win-win for Target, for our partners and for our guests. Now I'd say the same thing about Target Plus. Target Plus is different than other marketplaces. It's invite-only with vetted partners we have relationships with who are extending our aisles digitally. And because of our trusted and curated assortment, our guests aren't sifting through thousands of pages of results for the one thing that's going to bring them joy. In fact, Target Plus is so seamless on the things that matter, the ease of the experience, a relevant assortment and the benefits of RedCard and in-store returns, the majority of guests don't know they're shopping with marketplace. It feels like Target. It feels personal, and the love for marketplace is only growing. In 2021, Target Plus grew 75%. So let's take a look through our guests' eyes. In Target stores, our assortment of sunglasses features a curated set of options designed to meet the wants and needs of a broad set of families. For this guest, though, who's purchased Goodfellow shades to keep at home, at work, in his car, he's thinking about splurging for his upcoming vacation. The RayBan aviator he's looking for our online, and he's over the moon about the RedCard savings as he makes the purchase from our partner, Luxottica. And when he decides on a pair -- different pair that will frame his face even better, it's easy enough to stop by the store and let us handle the returns. With rich insights from omnichannel experiences, we're able to serve up even more deals that guests want, more suggestions of services they've never thought of, more ways to support brands and nonprofits close to their hearts. And that brings me to Target Circle, which I'm really excited to talk about. So here's a lesser engaged guests who joined Circle through our partnership with Ulta Beauty. She's able to seamlessly link her Ultimate Rewards account for Circle for all of the benefits. She's thrilled that she can now find her favorite skin care brand and her go-to mascara at her local Target store. And I want to pause here for just a second. Christina told us about how we're off to a great start with the Ulta Beauty shop-in-shops. But let's recognize how that partnership is translating to digital and loyalty with our guests. We're getting to know these guests in Circle, leading to more personalized experiences that are serving up the things they crave. And back to this guest, other things she may love, like Wild Fable. So in such a short time, someone who only shopped occasionally is now on the path to super fandom. Circle is a way for us to deeply understand our guests and have a 2-way connection with them. And in addition to the fact that in less than 3 years, it's become one of the biggest retail loyalty programs in the United States with 100 million members and growing. It's also one of the new ways we're creating relevance at scale with a strategic shift from mass promotional offers to personalized. During holiday, personalized offers showed an $8 to $10 lift in promotional basket size compared to mass offers and a conversion rate of 70% versus 40%. In addition to the personalized deals curated for them and the fact that they can vote and support local nonprofits important to them, I have to call out our guests' love for Target Circle Bonus. Our new gamification platform personalizes missions and rewards members. And it's already delivering big for our business, resulting in nearly $200 million in incremental sales in 2021. And as you're hearing repeatedly today, we're just getting started. So I've shared lots of examples about how we're meeting our guests' needs and wants throughout their omnichannel journey, but this one stands out as a point of pride. In the past, we've run a Black History Month campaign for the month of February. But now through our digital platforms, we've grown towards an always-on, deeply relevant approach. So Target guests can shop and support Black-owned founders and entrepreneurs all year round through Black Beyond Measure and Latino-owned brands, and women-owned brands, and Asian-owned brands, and so many more personalized and inclusive experiences where guests feel seen and heard every day. Here's one more. Let's take a look at a new spot from our brand campaign, What We Value Most Shouldn't Cost More. [Presentation]
Cara Sylvester:
There's a lot of good to see here. But it's not just what the guest sees, it's also about what's happening behind the scenes that makes all guests feel seen. We're partnering with diverse content creators in new ways from production crews to on-site catering in front of and behind the camera. Every part of the marketing ecosystem reflects our forward values. And this is so important. We are walking the walk in terms of our investments. By the end of the year, we're committing 5% of our annual media spend to Black-owned media partners and another 5% to Hispanic-owned media partners. Because equity, opportunity and inclusivity are core to who we are, they show up authentically in our omnichannel experience, and our guests are responding to that.
This guest feels seen. In stationery, she feels a sense of belonging and inclusion when she holds a heartfelt message in Braille. And we brought him joy. Let's close with his journey. [Presentation]
Cara Sylvester:
So no matter where you look in our omnichannel experience up at the Cat & Jack sign in store or online, the relevant connections we have with our guests are making a positive difference in their lives within our communities and for our business, and we're never going to stop.
Now I'm delighted to introduce my friend and team member, John Mulligan.
John Mulligan:
Well, good morning, everybody. So I'm often asked how Target continues to operate within a challenging and volatile environment, putting growth on top of growth and building trust with our guests quarter after quarter. I could point to our agile supply chain, our hundreds of omnichannel stores, our industry-leading fulfillment capabilities and the operational algorithms that make it all work. But the real key to our continued growth is our global team and all the ways they're using our resources and operations to take care of our guests.
In just the last 2 years, they've picked and packed 4x more items for same-day fulfillment, supported double-digit store traffic gains with a safe inspiring environment, opened over 60 new stores, remodeled hundreds more, and moved record levels of inventory to support our growing needs of our guests. Brian touched on how our Target team is showing up for each other and how that spirit of care starts here with our team and then extends to our guests and our communities. Our team is the connection across our business and the pulse of our operation, and I want to acknowledge their impact on how target shows up today and how we'll continue to deliver in the future. The power of our team is always visible in our stores, nearly 2,000 of them in neighborhoods across the country, serving as inspiring shopping destinations and local fulfillment hubs. Although the idea of leveraging stores to fulfill online orders is widely embraced across retail today, we are on our own when we introduced the concept 5 years ago. As a result, we're years ahead of others who just started using physical stores to meet digital demand. We know using stores as hubs would give guests more choice and convenience while giving our operation more flexibility and capacity for future growth. That was true prior to 2020 and could have not have been more essential since that time.
Today, when our guests turn to Target, no matter how they choose to stop, those stores answer the call. Located just miles from most American homes, our stores handled more than 95% of the $100 billion plus in sales we did in 2021, including 12% more in-store traffic and most of our digital demand. Notably, more than half of those online sales were filled through our same-day services:
Drive Up; Order Pick Up; and same-day delivery with Shipt.
Our Chief Stores Officer, Mark Schindele, will share more shortly about how we'll keep investing in those services. They not only offer the quickest fulfillment at the lowest cost, their trip drivers that actually deepen guest engagement with Target. And on top of it all, they are the fastest-growing part of our business. This past year, they grew 45%, building on 235% growth in 2020, showing the continued guest appetite for fast and easy shopping. With digital fulfillment growing exponentially and in-store traffic continuing to rise, our stores are supporting more and more volume. In the last 5 years, the average store has added $15 million in sales, which means $40 million stores have become $55 million to $60 million stores and growing. And as our stores become more productive, they naturally gain efficiencies, including significant cost leverage and lower clearance markdown rates. So as they contribute more to our top line, they further protect the bottom line. We've said from the beginning that our stores have the capacity to support higher growth. That remains true today, even as average sales per store have risen 30% in just the last 2 years. But that enormous growth also means our operation is years ahead of where we had planned. So we're continuing to build upstream capacity we'll need over time. As we do, we're investing in ways that enable growth and move us toward our Target Forward sustainability commitments, from how we build and run our stores to the standards we hold for our vendor partners as well as how we will keep taking care of our team. We're continually strengthening an operation that supports a long future for Target and the world around us. Our investments in capacity start upstream and how we innovate within our supply chain to deliver on the growing need for inventory in our stores. Before last year, we hadn't added a new regional distribution center in over a decade, even as our total sales grew 40% over that same time period. Rather than add buildings, we grew by investing in automation, robotics and process design to improve the efficiency of our existing sites. Of course, we'll always keep investing to make our buildings more efficient. But with an additional $27 billion in sales over the last 2 years, we can't rely on that alone. It's time to expand our network.
Last summer, we opened 2 new distribution facilities:
1 in New Jersey and 1 in Chicago. Today, we have 4 more currently in development that will open over the next few years with plans for several more to follow. Lighting up new buildings adds tremendous capacity to our supply chain network in support of our stores and will position Target to handle many more years of growth.
As we continue investing upstream from our stores, we're also innovating downstream with sortation centers to accelerate our last-mile capabilities. These centers help us further scale our stores as hub strategy and create room for future growth. The first of these facilities, located not far from our headquarters in Minneapolis, has been up and running for just over a year. Before it opened, our store teams would fulfill online orders and palletize the packages in the backroom, waiting for 1 daily pickup from our carrier partners. Now Target trucks collect those packages at our 40-plus Twin City stores throughout the day, keeping orders moving, while giving stores more room to fill even more. The packages arrive at the sortation center, where they're organized by ZIP Code, and allocated to partners for direct delivery. Last spring, we integrated Shipt's last-mile delivery capabilities into the operation. Shipt drivers pick up a batch of orders sorted by neighborhood to make fast and efficient deliveries to our guests. Even during peak season, when most orders had a standard 2-day promise, these packages were delivered in just over a day on average. At the same time, the average unit fulfillment cost dropped by nearly 1/3, and that's before we've added automation that will make these buildings more productive in the future. Our Minneapolis pilot shows how sortation centers will make stores even more efficient as fulfillment hubs and allow us to roll out a next-day delivery capability at scale. We started to expand this concept into other densely populated markets. By the end of next month, we'll have 5 more centers up and running from Dallas to Philadelphia with another 5 planned in additional metro areas later this year. This capability isn't something we built overnight. It's the result of many strategic decisions we've made over time, working together in a model that's unique to Target. It works hand in glove with our stores-as-hub strategy. It leans on technology we acquired and further developed through Grand Junction and Deliv to optimize the most efficient route for every package. And it's unlocked by integrating Shipt's delivery capability into our last-mile operation. Our sortation center expansion will add meaningful speed and efficiency to our fulfillment capabilities so we can field continued growth for the long term. [Presentation]
John Mulligan:
The ongoing investments in our supply chain are designed to keep our stores at the center of how we serve our guests. Just as important are the continued investments we make in the physical stores themselves. Since 2017, we've completed top-to-bottom remodels across nearly half our chain, bringing even more inspiration to the store environment while helping our team more effectively support online fulfillment.
This year, we'll remodel around 200 stores and keep that pace in the years that follow. And these aren't the same remodels we are rolling out when we started. Each year, our architects and construction crews update our plans to keep raising the bar on retail design. And our guests continue to tell us they like what they see. Following a remodel, traffic gains across the store helped drive an average 2% to 4% sales lift in year 1 and another 1% to 2% lift in year 2. As our full store program continues, we'll also invest in hundreds of smaller projects to support growing in-store partnerships, including Ulta Beauty, Disney and Starbucks, and they make store fulfillment even easier for our team. As we invest in existing -- in our existing store portfolio, we'll continue to open around 30 new stores a year. For the better part of the last decade, our store growth has been driven by small formats. With a more flexible footprint, these stores have enabled us to enter new markets and reach more guests. This year, we'll keep going, opening doors in iconic sites, from the historic streets of Charleston, South Carolina to the buzzing energy of Times Square. At the same time, small isn't always got planned. But our store is now more productive than ever. There are benefits to a bigger box. And given the favorable real estate market, these sites are available at attractive deals. I'm not talking about our largest store formats, though they continue to do extremely well for us. I'm talking about midsized stores, 2 to 3x bigger than our small formats. These sites are built in dense neighborhoods with enough room for a traditional store experience and digital fulfillment, helping us bring Target closer to even more guests.
This versatility is another example of how we built a flexible operation to support our growth. Ten years ago, we designed and built 2 store formats:
large and larger. Today, we have the opportunity to open and operate stores in spaces of any size so we can meet our guests wherever they are. This year, we'll open stores ranging from 14,000 square feet to 10x that size, using that flexibility to design shopping experiences that best meet the needs of each local community.
And before I hand it over to Mark, I'll close with how I started with our team. You heard it from Brian and Jen, our store director in Wisconsin, "We're still in the early days of our growth strategy." And it's our team, continuing to accelerate capabilities and build trust with our guests that will keep Target growing well into the future. As we've invested in their growth, from wages and benefits that you heard about today, to education, skill training and career progression, internal surveys show our team's engagement, morale and confidence in Target's future remain strong. That stability has led to better guest service, more collaboration, and as Brian said, a finer ability to flex, adapt and navigate the new challenges of being a bigger, stronger Target. When we take care of our team, they take care of our guests, proof that Target's culture will power our strategy to deliver ease, inspiration and joy for our guests for years to come. Take a look. [Presentation]
Mark Schindele:
Good morning, everyone. One of the best parts about my job is getting to spend time with our team every week in stores across the country. And I hear stories like those we just shared in the video, stories about what Target means to our team. And there's no doubt that our more than 300,000 store team members, who interact with our guests every day, are Target's biggest asset and our single-greatest differentiator. They inspire me as they bring our purpose to life every single day.
And I'm excited to talk about them and what they do, including ways that may not show up on the balance sheet. Take Terence, for example. He's a team member in our Fairview Heights, Illinois store who stopped what he was doing to help change a guest's flat tire in our parking lot. Her response, "He's my hero. I'll be looking for him every time I go in that store just to tell him how special he is." Or [ Manu ], a leader in our Maui store, who helped the elderly community in the remote town of Hana. She partnered with a local nonprofit to help them get the essentials they needed when they couldn't make it to the store in person. Our team is there to help our guests every day, handing them clean carts as they walk in our front doors, helping them find that perfect item on the shelf, dropping their bags into their car or shipping orders out the back to their homes. They show up for local communities and each other day in and day out. And that's why when we set out to put our stores at the heart of everything we do, it was clear that the most important investment we could make was in our team. We know an engaged team is more productive and creates a better experience for our guests. And over the last year, we've invested in wages, debt-free education and made even more of our team eligible for health benefits. We've also focused on desired hours and more reliable schedules through one-on-one conversations with our team, and we have an ongoing commitment to develop our team to get to wherever they want to go. We've also seen great growth in our new on-demand scheduling option we introduced this year, with more than 35,000 team members already signed up. It's a perfect opportunity for those team members who mainly want a couple of shifts a month or a college student who wants to work over the holiday season when she's back over winter break. Together, our investments and consistent hours for our team and the flexibility of on-demand models help us deliver for our guests while supporting the diverse needs of our team. Even as the U.S. labor market is seeing some of the highest turnover on record, our rate in Target stores remains below pre-pandemic levels. Our stores are fully staffed, and we've been able to leverage the training and the tenure of our team to easily shift against demand without missing a beat. Let's talk about the experience we're delivering for our guests. Target is the easiest place for our guests to get everything they need, no matter how they choose to shop. Even in a year as unpredictable as 2021, we saw satisfaction rise with gains in many of our most important drivers of guest experience, like interacting with our team on the sales floor and wait time at checkout. In fact, over the past 2 years, our already impressive overall Net Promoter Score increased more than 10%, a true testament to our team's commitment to service. In every store from the register, the Drive Up lane, our team is building loyalty with guests, offering ease, convenience and incredible service that keeps them coming back. For example, more than 60% of our new Drive Up guests return to use it again that month. And when a guest tries a new same-day service for the first time, they spend more at Target going forward, including in our stores. And last year, more than half of our digital sales came from our same-day services. In the year ahead, we'll fuel that momentum, deepening our trust with our guests with an experience our competitors can't match. That means clean, bright and on-brand floors that invite discovery, inspire guests with the latest products, all brought to life by an incredible team, a team that's empowered and trained across the building so they can jump in wherever our guests need us. And we've developed a flexible framework of service so every single team member can engage and connect and problem-solve with guests across the store. We'll continue to backup train every new team member on same-day services so we can easily adjust for peaks and in-store pickup. And we're offering continuous learning and development moments throughout the year in key categories and new brands. We know operational excellence and service go hand in hand, so we're focused on nailing the fundamentals and making shopping at Target easy and special for our guests. Take a look. [Presentation]
Mark Schindele:
In nearly 2,000 communities across the country, our Target team provides great in-store experience and easy fulfillment options. With same-day services already at scale from coast to coast, we are ready for when guest shopping behavior changed. And as we've seen demand grow, our team is able to support that growth and accelerate our progress to meet guests' needs along the way.
In the past year, we've added adult beverage and expanded our assortment for pickup. We built in more personalized features like sending a friend or a family member when plans change, choosing where you'd like your order placed in your car or selecting a backup option if something's out of stock. We even doubled the amount of Drive Up parking spaces in the holiday season so guests could get those last-minute gifts without leaving their cars. Our guests love our same-day services, and they provide great cost savings of nearly 90% per unit compared to shipping from an upstream warehouse. In the year ahead, we'll keep improving Order Pickup and Drive Up offerings with a focus on quality, speed and great service. We'll continue to expand the assortment available, and we'll add the Backup Item functionality to even more categories. In the months since we rolled out this option, our teams are able to substitute the Backup Items 98% of the time. Everything we do at Target is grounded in making our guests' daily lives even easier. We want every Target run to be fast, convenient and rewarding, and that includes the return process. Our teams are building the capability to accept returns from the Drive Up lane with plans to test later this year. So guests will be able to check everything out their shopping list and return a product that wasn't quite right at the same time and without leaving the car. And lastly, I'm really excited we're going to pilot the ability to order Starbucks for Drive Up so guests can get everything on their list and request their morning latte when they're on the way while never even unbuckling their seatbelt. We'll take a test-and-learn approach in select markets throughout the summer and fall with a goal of eventually making this option available from coast to coast. To bring these enhancements to life and continue strengthening our operations, our team is working to streamline on the back end, even further integrating the omnichannel experience into how we run and staff our stores. Now, of course, nothing at Target happens in a vacuum, so we're working with partners from across the organization, from tech and digital to supply chain and properties, to support these capabilities. The ability of our store teams to ship local orders out our back doors continues to increase our speed to guests while delivering cost savings of more than 40% per unit versus upstream shipping. We're working closely with our supply chain partners as we roll out more sortation centers across the country. As you heard from John, we're excited about the efficiencies they'll continue adding to our ship-from-store operation. Frequent sweeps of our stores to a local sortation center frees up space in our backrooms, and centralizing the sorting process helps our team be more productive and saves valuable time. Our teams are focused on greater ease and efficiency with store staffing, especially when it comes to same-day options, so we can be ready to flex with guest demand. We're enhancing our technology to give store leaders an even clear real-time picture of fulfillment needs and testing out new tools to help them better predict guest patterns in the future, helping us be even more efficient in staffing, the right teams at the right times, ready to do the work and deliver for our guests. We're making upgrades to physical spaces that support these services, remodeling our stores with more hold capacity, adding dedicated doors with easy access to the exterior. We're adding more Drive Up spaces to our parking lots, and we're even adding some camps in stores that get bad weather. Also our teams can get orders to guests quickly and safely every time. And inside our stores, we're making improvements to the process itself to make things even easier for our team and better for our guests, like finding the most efficient ways to pick orders from how we deploy the team members, to technology that helps reduce footsteps throughout the store, all with the goal of continuing to deliver the ease and convenience our guests expect. Our solid operational foundation and stores-as-hub model has allowed Target to be there for our guests even when the world shifted around us, and they'll continue to be the engines of our growth. That foundation is made even stronger by the deep roots of empathy and care and everything our teams do to keep us moving forward together. And before I turn it over to Rick, I can't miss the opportunity to say thank you to our team. With stores at the center of how we serve guests across the country, they've risen to every challenge with care, resilience and flexibility, not only meeting guest needs today but ensuring we'll be ready for them tomorrow. Thank you.
Richard Gomez:
Thank you, Mark. I am proud to be here today representing Target's Food & Beverage team because getting to $20 billion in sales last year, delivering double-digit growth on top of 2020's double-digit growth, achieving millions of dollars in market share gains and becoming America's fourth-biggest digital grocer and being named Retailer of the Year by Supermarket News, well, none of that happened by chance.
As some of you know, we've been on a journey when it comes to groceries at Target. Food has always played an important role in driving trips and basket size, but we knew we could do so much more in this space. Today, Target is a company that doesn't just sell food. We are a company that celebrates food with a grocery business that's driving trips and basket size and, even more importantly, loyalty. It's become part of the differentiated experience that separates Target from the pack.
Now before joining Target's marketing team back in 2013, I spent my entire career working for iconic food and beverage brands. That experience taught me that food and beverage is a business that is deeply personal for consumers, and that's what our team is delivering at Target. Central to our success is the fact that what we're doing is 100% unapologetically Target. That means we're not copying competitors or trying to do something we're not. Instead, we're listening to our guests, and we're leaning into what's special about Target:
to provide a better experience at a great value. That's led to amazing results, a deeper sense of loyalty from our guests and the opportunity to do even more.
A great example of this is our digital business. It's hard to believe, but just 2 years ago, fresh and frozen order pickup in-store and curbside was just a small test in a few markets. But when the pandemic hit, we knew we had to accelerate our plans to meet guests' fast-pacing changing needs. So in a matter of just a few months, we installed refrigerators and freezers for order pickup in hundreds of stores nationwide. We trained thousands of team members to pick online grocery orders. And we rolled out new marketing to raise awareness that if you're looking for safe, quick, easy option for getting your groceries and essentials, that's, by the way, free with no order minimum requirement, well, then Target is your place. When you think about the power of team, there are a few better examples than how in the middle of the pandemic and amidst of peak-level sales, we mobilized teams from across the company to undertake this monumental body of work because it was the right thing to do for our guests, and it was the right thing to do for our business. It really has been a game changer for so many families looking to limit trips outside their homes and into stores. And it has revolutionized our food and beverage experience, turning Target into an omnichannel grocery powerhouse. And we'll continue to make our pickup service even better. For instance, since launching Fresh and Frozen Pickup, we've also added Adult Beverage Pickup to about 80% of our stores. And I am so excited about what Mark just shared with Starbucks as part of our Drive Up experience. But it's important to recognize that there's still a lot of potential in front of us. But even as guests have started reclaiming some of their routines, including making more trips into our target stores, our digital business, fueled by Shipt, and our Order Pickup services, continues to grow. Look at the numbers. At the end of 2019, our digital penetration in Food & Beverage was 2.3%. We ended 2020 at 9.6%. We closed 2021 at 13.2%. Our 2021 digital sales were up $900 million over 2020 and up by sixfold over 2019. Our Net Promoter Scores consistently show that guests love our digital services. So as we keep driving awareness and trial and adding new experiences, we anticipate continued growth. Another area we're driving awareness and trial has led to ongoing growth is in our owned brand assortment. Back in 2019, we rolled out our flagship-owned brand, Good & Gather. It was the largest owned brand launch ever. Today, it totals nearly 2,500 items across Food & Beverage and is helping change perceptions about the shopping experience at Target. It's affordable. It's delicious, and it's on trend. Whether you're looking for a quick easy Tuesday night dinner or something fun for entertaining during March Madness, Good & Gather is everything our guests have long expected from Target's owned brands. And today, its growth is outpacing the industry average for private-label brands. And there's more. Favorite Day, a new brand of craveable baked goods and treats that draws guests into the food aisles. For instance, some of you might have come to Target because their kindergartner lost a sneaker and she has gym class tomorrow. But while dad's there, he might as well reward himself with a container of Peanut Butter Monster Trail Mix for the home office. Now Target-owned brands are only part of the story. We are also elevating our assortment by diversifying our assortment because we know that representation is critical to ensuring that we are -- that our offering is relevant to all our guests. Now when we decided at the beginning of last year to accelerate our commitment to adding more Black-owned brands, we had a dozen in our Food & Beverage assortment. But by changing the way we work, working hard to build new relationships and by using our size and scale to help brands grow for success in mass retail, we'll end 2022 with more than 50 Black-owned brands in our Food & Beverage assortment. And we won't stop there. Because these brands don't just make us more relevant, they make our assortment better. A great example is McBride Sisters wine, a Black female-owned business. We actually started working with them back in 2018 with a small partnership in about 100 stores in the South. Today, McBride Sisters is available in over 1,200 stores; or Everything Legendary, a company one of our buyers saw on television and couldn't wait to work with. So the next morning, he picked up the phone, sparking a relationship that led to Everything Legendary becoming Target's first Black-owned, plant-based meat supplier. And Target has taken a strong position in coffee, a category where our guests have especially high expectations. Black & Bold is a 3.5-year-old company founded by 2 childhood friends, and they have put social impact at the center of their business model, giving 5% of their profit to support kids and underserved communities. It's a company that we knew is a perfect fit for Target. They were our first Black-owned coffee brand. Today -- well, today, they're available in 1,300 stores and online. The response has been amazing. I love the suite.
Now you got to go to Target and by a Keurig and the Black-owned coffee, Black and Bold. That tweet also brings me to another key differentiator in Target:
the role we play as part of Target's multi-category assortment. That's something that sets Target apart on everyday trips and especially around holidays and key seasonal moments. Target dominates holiday seasons because guests love that they can get everything they need at Target
And this trend is continuing in 2022 as we saw during the first big seasonal moment of this year, Valentine's Day. Through the power of the total Target experience, the way we innovate, including our new Favorite Day, Valentine's Sugar Cookie kits, building on Target's cachet and the gingerbread space, and the platform we provide for our national brand partners to do amazing things to grow their brands, our team came through with the kind of Valentine's Day experience that makes Target special. In fact, we delivered our biggest Valentine's Candy sales ever, and we did it by the close of business on February 13. We did it with a day to spare. And we reached another milestone on February 13, finishing the week with record sales for snacks ahead of the Super Bowl. And despite all of this, what's so exciting to our team is that there's still a lot of room for us to improve, grow and gain even more market share in food for years to come. For instance, our research shows that even our best guests underestimate the breadth of our assortment, thinking they can only get some of their groceries at Target. As we continue to raise awareness of our full offering and we get credit for what we are already doing and the value that we provide, well, that is a huge opportunity. You heard Christina talk earlier about accessibility and affordability. That's why the Digital Snap payment option we're rolling out this year is so important to Food & Beverage. It's going to make our entire experience, in-store and online, accessible to all families, allowing them to shop on their terms regardless of how they pay for their groceries. And as we move more product faster than ever through our distribution network, we are continuing to look for ways to move that product even faster. Some of our improvement will come from the way we work with our national brand suppliers, encouraging them to prioritize the growth opportunity that Target represents. We're also working to better utilize our food distribution centers to keep up with the fast-growing demand. We'll continue leveraging the power of our owned brands for everyday needs and big seasonal moments. And I'm excited that for the first time, we're going to have a holiday-themed Favorite Day assortment this year. And then there's Circle. It's especially crucial to what we're doing in food, raising awareness of our assortment and the value that we offer. As you heard from Cara, we are not done growing what's already one of America's biggest and most vibrant loyalty programs. And as our marketing team continues to build on the success of Circle, that's going to help our entire business, but especially Food & Beverage. We have a lot to be proud of. And there's a lot of opportunity, and yes, a lot of work in front of us. But when I think about the future, I'd say my optimism is rooted in our team. So before handing off to Michael, I'll close with one more thought on team. Over the last couple of years, we've hired scores of Food & Beverage directors and coordinators, people with immense expertise in the grocery industry who are helping us drive continuous improvement across our operations. A few weeks ago, I was visiting stores in Colorado, and I was talking to one of our coordinators, Bridget. I asked her why she joined Target. Now keep in mind, this is someone who joined us from another retailer, someone who already had a good job and was doing well in her career. But when I posed this question, the first thing she said goes to what Brian was talking about in his intro, she talked about culture. Bridget was willing to take a risk in her career to leave a situation that was pretty good and give Target a chance because of what she heard about being a part of this team. She told me a lot about the people she works with, the support she has to make decisions that are right for the guest and the partnership she has with team members working in other categories. Bridget told me it was everything I hope for and more. In this environment, the race for talent is just as intense as the race for sales. But every day, people are opting in to be a part of the Target team. Because of what we have already achieved? Absolutely, but even more so because of the possibility of what we can do going forward. I'm just as proud of that and inspired by that as I am of any of the numbers that we've shared today. Because when I think about everything in front of us, team members like Bridget and the human touch and the guest focus that our entire team brings to their work, well, that is what it's going to ensure that our guests can always count on Target. Thank you so much. And now I'll hand things over to Michael.
Michael Fiddelke:
Thanks, Rick. At the top of the meeting, Brian shared some of the key milestones from the last 5 years. And I'd like to begin my remarks today by highlighting one more, which is the long-term financial algorithm we unveiled during that time. You'll recall that the prior algorithm anticipated low single-digit sales growth, mid-single-digit operating income growth, high single-digit adjusted EPS growth, after tax ROIC in the mid- to high teens.
In the 2 years leading up to the pandemic, our business was consistently generating top line performance in line with the algorithm as we saw average sales growth of 3.7% in 2018 and 2019. And on the bottom line during that period, our business grew somewhat ahead of the algorithm with average adjusted EPS growth of 16.7% over those 2 years and an average after-tax ROIC of 15.4%. Since the beginning of 2020, COVID has changed nearly every aspect of consumers' lives, and we've all seen its impact on the retail industry. At Target, our team and durable model navigated these changes incredibly well, advancing our business far ahead of expectations. Simply put, over the last 2 years, our financial performance blew away the prior algorithm from top to bottom. And today, we're a much larger retailer, generating industry-leading returns on capital. As we enter 2020, things remain far from ordinary, but a future beyond this volatile time is taking shape. And given the durable and sustainable model we've built and the ongoing investments we're making, we've updated our financial algorithm, which will define our long-term expectations beginning next year, in 2023, and beyond. This updated algorithm demonstrates our confidence in Target's ability to continue growing on top of the incredible expansion over the last couple of years.
Specifically, over time, our updated long-term algorithm anticipates mid-single-digit annual growth in both total revenue and operating income, high single-digit annual growth in adjusted EPS, annual CapEx of $4 billion to $5 billion, after-tax ROIC in the high 20% to 30% range. Compared with our prior algorithm, this new one leans more into growth driven primarily by comparable sales, combined with the benefit of new stores and continued growth from other revenue sources. Our confidence in Target's ability to continue growing is based on all of the initiatives you've heard about today, which are designed to drive engagement, traffic and market share gains, including:
new stores; remodels; national brand partnerships and owned brand innovations; expansion of our same-day services; growth of new and emerging revenue sources; further rollout of sortation centers; continued investments in value and affordability; leveraging guest insights to enhance our assortment and promotions while personalizing the guest experience; elevating guest service through investments in the team, training and technology, all while investing in Target Forward, to enhance the long-term sustainability of the business and the planet.
Since today is the first time we've included other revenue in our top line guidance, I want to pause and cover some of what's reflected in that line of the P&L and what's been driving its growth. And while there are many smaller items represented on this slide, profit sharing income on our credit card portfolio has historically accounted for more than half of it. But in recent years, Roundel has been the primary growth driver of this line, causing it to become its second largest component. I want to emphasize, however, that Roundel's impact extends well beyond the amount reflected on this line alone as a meaningful portion of Roundel's income reduces our cost of sales, benefiting our gross margin. Among other notable drivers, Shipt membership fees are included on this line, along with the fees we received from third-party vendors on Target Plus, which are expected to grow over time. Moving to the operating income line. You'll note that our long-term growth expectations are consistent with the prior algorithm, but we don't rely on rate expansion to get there. Now I should quickly point out, we'll happily welcome rate expansion when it happens for the right reasons, including the massive scale benefits we've realized over the last 2 years. But as I've said many times, given that we're focused on maximizing profit dollar growth, our plans account for the inherent trade-off between profit rates and top line growth. Put another way, a durable business model anticipates the need for continual investments to deliver sustainable growth. As such, we've built an algorithm based on driving and harvesting continued efficiencies in our business and continually reinvesting those savings in growth that further differentiates Target through our team, our stores and the entire guest experience. Among the factors that will drive our operating margin rate over time, we expect the headwinds and tailwinds will generally balance each other out. On the gross margin line, those factors include merchandise mix, channel mix and merchandising strategies. On the SG&A line, cost leverage, efficiency gains and team investments are most notable. On the D&A line, leverage and accelerated depreciation are the primary drivers. Also consistent with the prior algorithm, this updated one anticipates high single-digit growth in adjusted EPS driven by mid-single-digit growth in operating income combined with the benefit of continued share repurchases. Moving on to capital deployment. I want to first reiterate our priorities, which have remained consistent for decades. Our top priority is to fully invest in our business and projects that meet our strategic and financial criteria. We then look to support the dividend and build on our 50-year record of consecutive annual dividend increases. And finally, when we have capacity beyond those first 2 uses, we repurchase shares within the limits of our middle A credit ratings. Beginning with investments in our business. We expect ongoing CapEx will be in the $4 billion to $5 billion range annually, and we'll be focused first on our continued investments in our stores-as-hubs model, including new locations, full store remodels, fulfillment retrofits and projects to support key national brand partnerships. In addition, as John outlined, we'll continue to invest in our upstream supply chain, sortation centers and DC automation to further reduce store workload. Even after these sizable CapEx investments, we expect to have ample capacity for shareholder returns as well given the robust operating cash flow our business continues to generate, amounting to more than $8.5 billion in 2021. We'll maintain our focus on growing the annual dividend, something we've accomplished for 50 consecutive years and look to maintain a 40% payout ratio over time. In addition, given our expectation for continued strong cash generation by our business, we'll have the capacity to return capital through share repurchases, within the limits of our middle A credit ratings. Finally, the most dramatic change from our prior algorithm pertains to our after-tax ROIC, where our updated range of expectations is 10-plus percentage points higher than before. This change highlights the asset efficiency of our stores-as-hubs model, which has unlocked the full potential of our store locations to flexibly serve our guests. With this model, our business has generated revenue growth of more than 35% or nearly $28 billion over the last 2 years, largely on the existing asset base. Now I want to move on to expectations for this year. As I step back and think about where we are and where we've been, it's clear we're still in the midst of the pandemic, but we've entered a new phase. In this phase, we're still facing multiple challenges and uncertainties, including a tight labor market and persistent supply chain bottlenecks, which are contributing to higher inflation rates than we've seen in decades. And beyond those ongoing challenges, we'll soon get to see how the consumer and economy move beyond government stimulus as we compare over the large first quarter packages that benefited consumers both in 2020 and again, last year. However, the last couple of years have also proven the durability and flexibility of our business and financial model. Specifically, relying on stores as fulfillment hubs allows our team to conveniently and efficiently serve our guests no matter how they choose to shop. This includes our suite of same-day services, which differentiate Target and provide a reliable, fast and easy shopping experience. Our model features a unique brand and balanced merchandise -- broad and balanced merchandise assortment, allowing us to serve guests and drive trips to serve a wide variety of wants and needs. And our long history of investing in value and affordability, which has long been a key differentiator, becomes even more important in an inflationary environment. As a result, with a proven model and the multiple growth investments we've highlighted today, we expect to continue growing the top line in 2022, generating a low to mid-single-digit increase in revenue, on top of historically strong growth over the last 2 years. On the operating margin line this year, we're planning to deliver a rate of 8% or higher, reflecting several deliberate rate investments to position our business for long-term profitable growth. First on that list are continued investments in pay and benefits to support our team as we build on the enormous progress we've made over the past few years. Beyond the team, this year's investments in growth capacity will drive some rate pressure. And we're planning for a small increase in markdown rates in 2022 as we move past the dramatically low rates we've seen over the last couple of years. Finally, and importantly, we'll continue to focus on value and affordability in this inflationary environment. That means taking a thoughtful long-term approach to pricing decisions, ensuring that we deliver unbeatable value for our guests. We have many levers to combat costs, and price is the one we pull last, not first. As a result, product costs within our assortment have risen faster than retail in recent quarters, reflecting this intentional approach in deliberate pacing. We expect this trend to continue, particularly in the first half of this year as we maintain our focus on affordability for our guests. Altogether, given our expectations for revenue growth and purposeful operating margin rate investments, we're positioned to deliver low single-digit growth in operating income dollars this year. Consistent with the longer term, we expect CapEx in the $4 billion to $5 billion range this year. This range is wider than we typically see at this point of the year given continued delays in receiving fixtures and equipment, along with permitting and inspection delays in local communities. Put another way, our hope is to be at the top end of this range in 2022, but it's possible that external factors will continue to affect certain projects. Regarding the dividend, later this year, we plan to recommend that our Board approve a per share dividend increase in the 20% to 30% range as we continue to move toward a 40% payout ratio over time. In addition, given our current cash position and expectations for strong cash flow, we believe our 2022 share repurchases will be at or above the $7 billion we accomplished in 2021. Putting all of our expectations together, a low to mid-single-digit revenue increase, an operating margin rate of 8% or higher and continued robust share repurchase activity, we're positioned to generate high single-digit growth in adjusted earnings per share this year, on top of a 112% increase over the last 2 years. While I'm not going to provide detailed quarterly guidance today, I want to pause and talk about how our 2022 profit performance is expected to play out within the year given some of the unique factors involved. Specifically, in the front half of this year, we'll be annualizing last year's government stimulus while facing ongoing supply chain pressures and other cost increases. In contrast, as the year progresses, we'll begin comping over the period of higher costs that emerged in the back half of last year, while our supply chain and merchandising strategies have more time to adjust. As such, we expect our quarterly profit performance will be choppy during the year and generally improve as the year progresses. Q1 provides a timely example. This chart shows the variability of our Q1 profit rate over the last 3 years. Looking ahead, we expect our first quarter 2022 rate will move to something that's relatively high to our history but well below last year's 9.8% rate, which was unusually high due to some unique factors. As I get ready to close my remarks, I want to pause and spend a minute talking about the key role that efficiency and disciplined expense management have played in our recent success and how we're committed to maintaining that discipline going forward. And while I can provide many examples of our team's cost discipline, I want to focus on a couple of notable ones. First on that list are meaningful efficiency gains we've realized in digital fulfillment. Across each of our digital fulfillment nodes, from package delivery to in-store pickup, Drive Up and Shipt, we've implemented multiple processes and process improvements and rolled out new technology to remove costs and increase speed to our guests. As a result, over the last 3 years, our average per unit digital fulfillment costs have declined by more than 50%, reflecting both efficiency gains and the benefit of mix as our most efficient same-day services have become a bigger and bigger portion of our digital sales. Looking ahead, the rollout of sortation centers presents a compelling opportunity to further reduce the unit cost of last-mile delivery. As John mentioned, in the Twin Cities market, where we've been piloting our first sortation center, we've seen our average per unit last-mile fulfillment costs go down by nearly 1/3. The second example I want to highlight is the enormous benefit we've realized from the investments we've been making in our team. These investments have driven positive change to the lives of hundreds of thousands of team members, offering more steady income, pathways to career growth and education and access to benefits that meet their evolving needs. But these investments are delivering efficiency and growth in our business as well. A portion of these gains come directly from the fact that with high retention rates and improved training, our team can accomplish tasks more efficiently than in the past. But that's just the beginning. Because of our investments in the team, they're continually delivering higher levels of service, building on the trust we've established with our guests. This results in higher satisfaction scores, higher engagements and more return visits. And with higher service levels, Target becomes a more attractive partner for leading national brands, enabling partnerships like Ulta Beauty, Apple, Disney and Levi's. Once you've accounted for all of the efficiency and top line benefits that have come from our team investments, you can see why I reiterate time and time again that caring for and investing in our team is the best long-term investment we can make in our business. In fact, whether I'm looking at these investments as the CFO or through the lens of my earlier role supporting stores or leading pay and benefits for our HR team, the lessons are consistent. Whether you're talking about physical capital or human capital, underinvesting might lead to great-looking results over a very short period, but they're not sustainable over time. So before I close, I want to pause and express my gratitude to our team, many of whom are listening into this meeting today. You have delivered industry-leading results over the last couple of years while taking care of our guests and each other. And importantly, during that time, you've made Target a much stronger company, positioning us to deliver sustainable, profitable growth from a significantly larger retail platform. I want to thank you all on behalf of all of our stakeholders. Now I'll turn it back over to Brian for some closing remarks.
Brian Cornell:
We began this meeting talking about our path
Yes, we have the team and we have the strategy. We are 100% focused on the needs of American consumers. We have some of the most innovative and guest-centric capabilities in retail. We have a balance sheet that is the envy of the industry. And we have a record of cash generation you can count on, provide incredible value to our stakeholders. Yes, as we look at the growth horizon in front of us, we see many opportunities. As we move forward, we'll stay focused on helping our guests navigate through continued uncertainty with what's happening in the world around us, the pandemic and the macroeconomic environment. This includes the highest inflation in decades and the gradual loosening of supply chain bottlenecks. We'll stay focused on delivering value and affordability to our guests. We know how to deliver exceptional value and manage profitability. We can protect prices whenever possible. We can offer an unbeatable range of owned and national brands across our portfolio categories. We can bake value into our assortment, and we'll work with our vendor partners from sourcing to production to shipping. We'll ensure that those prices we offer will always be among the best in American retail. We have a strong record of thoughtful investment in supply chain and innovation. We provide a competitive advantage by keeping our stores stocked and our digital orders filled. We have the flexibility we need to contain with constraints so we can keep growing and thriving in any environment. And above all, we have the team. A few days ago, I visited several Minnesota stores. I was impressed with the Ulta Beauty displays, with our Disney shops, with our Apple stores, but what impressed me most was a team member who came up to me and said, "Brian, I'm so proud to be working at Target. I'm proud of how you're handling the pandemic. I'm proud to be part of the Target team." We have a team that's committed to making Target of the future even better, the Target of the future even stronger and the Target of the future even more caring. For everyone who's listening today, including our teams across the globe, know we're already working to determine the best way to support humanitarian efforts for the people of Ukraine. As we have throughout the last couple of years, we'll rally our team, put our resources to work to support families through these challenging times. And with that, I'm going to ask all of our speakers to join me on stage, and we'll start taking your questions.
Brian Cornell:
All right. As we get started, I would ask you to wait for a microphone. Please introduce yourself. While you can see us, however, it's a challenging time seeing you. So I'll look for a show of hands. We've got one right up front.
Christopher Horvers:
Chris Horvers, JPMorgan. So my first question, I have 2, is in the long-term sales guide, it seems like you're baking in about a 3.5% to 4% comp. Is that fair? And how are you thinking about the share gains component of that? Because you've gained a lot of share in the past few years. 3.5% to 4% seems like a very sort of normal rate of consumption growth in the economy. So is that -- are you baking in any share gains?
Brian Cornell:
Michael, do you want to start? And then I'll come back and talk about our approach to share.
Michael Fiddelke:
Yes. As we think about the long-term algorithm, comp growth will certainly be the biggest driver there. Where that lands in a given year, might be up or down. But I'll tell you, we expect to be a business that continues to grow and gain share year-over-year. The investments we're making are to drive outsized growth, and that should come with share gains.
Brian Cornell:
Yes. And Chris, I'll give you a sense for how we run the business each and every day. And I can tell you, this team spends hours each week looking at share by category across our markets to make sure that we have the plans in place to constantly be taking share as we go forward. So there's lots of different metrics we look at as a team. I would tell you this team spends a tremendous amount of time looking at share, share opportunities, building plans to make sure the over $10 billion of share we've gained in the last couple of years is something that we continue to move forward as the years go by. So we are very focused on share, and our guidance will certainly be a company that continues to take share across the entire multi-category portfolio both in stores and from a digital standpoint.
Christopher Horvers:
And so my follow-up question is on gross margin. It seems like there's going to be some pressure this year, more so in the first half on some of the price that you're absorbing. But if you look at the past few years since 2019, it looks like you've gained somewhere around 250 bps of promotional clearance efficiency. How do you think about the structural component of that over the long term, balancing higher levels of store productivity versus clearance and then normalized promotion?
Michael Fiddelke:
I think your question grabbed about all the different variables there, Chris. So I'll do my best to summarize. The shape of profit for the year will be like we described, where you could expect it to build over the course of the year. When it comes to markdowns specifically, there's some markdowns that we've been rooting for returning. To be better in stock with stronger inventory levels means a few more clearance markdowns, and we're planning for that outcome in the upcoming year.
When it comes to promotional markdowns, we should realize some sustained benefits in markdown efficiency as we've gotten bigger, and we'll stay close to the competitive environment to make sure that we're priced right every day and that we're competitive on promotion as well.
Brian Cornell:
Great. It looks like we've got a question right over here.
Michael Lasser:
It's Michael Lasser from UBS. One of the key messages that you've delivered today is that Target is a growth company. You've raised your long-term guidance to reflect that. What's inspiring the view that growth is going to be higher moving forward than it's been in the past? Is it that really you've proven it out over the last couple of years? And if that's the case, what behaviors do you expect to be sustained moving forward that the consumers have been engaging in during the midst of a pandemic? And then I have a quick follow-up.
Brian Cornell:
Christina, do you want to spend a few minutes talking about some of the consumer dynamics we're looking at right now?
A. Hennington:
Yes, I'd be happy to. First of all, we have seen a sustained growth over a multiyear period. That's been led across the entirety of the portfolio. We've seen this past year alone double-digit growth in every single one of our key 5 merchandising areas.
The other thing is, and Cara talked about this quite a bit, but the depth of engagement of the consumer leading to more trip frequency is what we believe will have continued sustainable growth, let alone all the initiatives we talked about. We're just in the beginning of our rollout of some of these national brand partnerships that are adding meaningful productivity, trip consolidation and opportunity for growth. So it's a paradigm that we've seen proven out over the last 2 years and is continuing to give us the confidence that that's going to drive growth going forward.
Brian Cornell:
Yes. And Michael, I might focus on 4 areas as we sit here today. One, for those of you who have been attending these meetings over the last 3, 4 or 5 years, whether in person or from a virtual standpoint, one, I think the consistency of our strategy is critically important. And I think we've got great alignment across the organization. As Christina mentioned, from a capability standpoint, we're still in some of the early days. As much as we've been talking about remodeling stores, John Mulligan going all the way back to a meeting in 2015, we've touched about half the chain. We've got another thousand stores that we're going to touch going forward.
We're very excited about the pipeline of new stores. And as John talked about, various size stores that allow us to maximize share opportunities in these catchments. From a same-day fulfillment standpoint, while we're very excited about the progress we made, Rick and Mark can talk about the potential upside as we think about temperature-controlled products going through Drive Up and pickup. So in so many areas from a own brand standpoint, from a national brand standpoint, rolling out these partnerships that we talked about a lot today, but many of them are still in limited locations. There's tremendous upside there. We think as we continue to build out our circle and our connection with our guests, there's continued upsized opportunities there. So a consistent strategy, capabilities that are still maturing, but I'll come back to the importance of our team and culture and the investments we've been making. And those are only going to strengthen our business model over time. The one point that perhaps we didn't call out specifically that I think is really a hallmark of Target today is we combine that focus on strategy and building capabilities and investing in our team and culture with a team that's focused on execution. And if you look at the results, how we got from $70 billion to $106 billion, yes, the strategy was critically important. And listening to the guests as we formulate that strategy was incredibly valuable. The capability certainly allowed us to accelerate during the pandemic. Those investments in team and culture, they have supported us throughout the pandemic. But this is a team that's been executing every day from a store standpoint, from a digital standpoint, category by category. And Michael, I think our execution will only improve in the out-years, which gives me tremendous confidence in the future growth and market share opportunities we will capture.
Michael Fiddelke:
Yes. The only thing I might tack on to that is the algorithm contemplates those investments. The CapEx we're putting to work, the way we've described operating margin and the fuel we can create to reinvest in the business. Growth doesn't just happen, you have to invest in it. The algorithm contemplates that.
Michael Lasser:
And my second question is Target's operating margin has gone from 6% to 8% over the last couple of years. Presumably, a lot of that's come from a 30% increase in your store productivity, which is pretty extraordinary, coupled with a reduction in your average unit cost to fulfill online orders. The expectation coming into the meeting was you'll give a little bit more of that 8% margin back. You're arguing, "No, we're going to keep that." So what is it about what's happened that you think is more sustainable moving forward that contrast that prior to the pandemic?
Brian Cornell:
Michael, I might ask John Mulligan to just spend a few minutes just talking about the benefits of scale. And as we've added almost $28 billion to our system, we talked about -- John talked about some of the highlights of -- our average store has added $15 million of growth. And those scale benefits and efficiency help fuel our business going forward.
So John, you may want to highlight some of the benefits from an operational standpoint.
John Mulligan:
Yes, I think that's right there. I mean you hit on what the 2 big drivers are. One is scale. And as we get bigger, there's benefits that flow through the individual store P&L. First of all, they're leveraging all the fixed stuff. That's the easy-peasy part, but everything becomes more efficient. When we go from $40 million to $55 million, we may only add one truck a week to that store or 2 trucks a week. We don't double the number of trucks that a store has to work. So you gain efficiency there in the backroom as you're moving inventory to the front of the store. Things like that just create efficiency.
Again, once you're out on the floor and stocking goods, if you're a $40 million or $55 million store, that doesn't change. You're out on the floor. If I put 2 on the shelf or 3 on the shelf, nothing really changes there. There's a marginal amount of incremental work, right? So those are the little things that create additional scale in our hourly payroll, which, of course, is the biggest expense we have. That flows down through the entire P&L. And then, of course, Michael talked about our same-day fulfillment and our ship-to-home fulfillment. We have improved individually each of those paths to the guests. Each one of those services, the cost structure and the mix helps us because the most -- the best NPS scores, the ones our guests like the best are same-day services, which are the most efficient as we've been talking about for a long time. And then you layer on sort centers where we said -- and look, we've had this open for 14 months, just 14 months, and we already said it's way cheaper than what we were already doing. So there's some -- I mean you've seen us do it over the last 5 years, continue to hone processes and improve them, Mark and his team, improving the pathing, improving the pick, improving the prep, improving the pack. That's a lot to say, improving all 3 of those. And we'll do that all over again with sort centers. So so much runway for us to continue to drive efficiency and bring expense out and continue to invest in service on the floor at the store, just a huge opportunity for us.
Brian Cornell:
Michael, just to build on that. I might ask Mark Schindele to start, just talk about some of the benefits that he's seeing because of that scale and the growth in store operations. And then Rick, one of the areas where I think we've seen a significant change in scale is in Food & Beverage. It's a $20 billion company now. And because of that growth rate and the change in our turns, particularly in fresh foods, there's enormous benefits that we're deriving.
So Mark, why don't you start from a store standpoint with a few examples? And then, Rick, I think you can walk through some of the benefits we're seeing because of the increased volume we're seeing in stores, the increased turns and just the productivity we're gaining today.
Mark Schindele:
Yes. Thanks, Brian. John shared a bit about how we're adding scale in our stores. And a couple of things I'd like to add in, when we think about our same-day services, that business just continues to grow. And that example of putting an extra box on the shelf also plays out in same-day service where you can grab an extra bag. And as we see our baskets grow, our trip frequency grows, our productivity grows.
And we've said it often, but our most important investment we can make is in our team, and our team is doing an incredible job executing and delivering scale and efficiency every single day and creating that incredible experience for our guests.
Richard Gomez:
Yes. I mean specific to Food & Beverage, we have had a tremendous positive momentum over the past couple of years. We've been able to deliver double-digit growth on top of double-digit growth. We've been able to gain billions of dollars in market share over the past 2 years. And part of those benefits have come with that bigger businesses. Quite frankly, we are more credible in the grocery business. And as a more credible grocer in the grocery business, we have more opportunities to partner with our national brand partners.
And so we are in negotiations when products are on allocation or they're limited due to supply chain constraints. Our national partners recognize that Target is a place to grow, and they're looking to us first. And I think that's a change of where we are today than where we've been in previous years. The other thing I would just say when it comes to things like produce, the faster we're moving, the fresher the product, the less the waste. So it helps us not only from a financial perspective, but actually from a guest experience perspective as well.
Brian Cornell:
Let's go to another question. I think we've got one right back here.
Antonio Morales:
Antonio Morales from Signum Research. You were talking about the national partners and national things. So do you have any plans on expanding to the international market like around the world in the short, mid or long term?
Brian Cornell:
Yes. I'll take this one. We get this question all the time. And certainly, I will never say never. But for today, as we look at the opportunities that we have right here in the United States, we're going to stay very focused on the foreseeable future, executing our plans, building on our momentum and investing in the United States before we start to think about any type of future international expansion.
All right. We got one right back here to the left.
Peter Benedict:
Peter Benedict at Baird. First question, just on Roundel, I think you noted that it delivered $1 billion in value to Target. Can you define value? Is that revenue? Is that gross profit? Is that influenced sales? I just want a clarification on that. That's my first question.
Brian Cornell:
Cara, why don't I ask you to start with some highlights on Roundel. And Michael, maybe you can fill in the blanks from a financial standpoint.
Cara Sylvester:
Yes. It's incredibly exciting to talk about the Roundel story. And the Roundel business is not a new business for us. And we've actually been able to scale it quite quickly over the last several years by really being differentiated by focusing truly at the gas at the center. And what we find is that our vendor partners love partnering with us around Roundel given those guest insights. And they -- we've been able to actually keep the guests at the center and scale that to $1 billion. We're looking to scale that even quicker to $2 billion over the next couple of years by again being truly differentiated in partnering with our vendor partners. They find incredible value in partnering with us on those guest insights.
Michael, do you want to talk a little bit about the financials, how they roll through?
Michael Fiddelke:
Yes. I touched on this a little bit in my remarks. You can think about $1 billion as kind of the size of the total Roundel business. And there's a piece of that, that shows up in other revenue and there's a piece of that, that helps us out on the gross margin line, too.
But you'll notice, we don't describe it as some separate other business. Cara's point on it starts first with our guests. When we can solve for a guest problem arm in arm with a business partner, that creates value in total. And part of that is captured in that $1 billion, part of that is captured in a better guest experience overall.
Brian Cornell:
Let's see, right up front.
Robert Ohmes:
Robby Ohmes at BofA Securities. This might be a question for John Mulligan. The question is, you guys mentioned midsized stores and why not larger stores? And help me understand sortation centers and that's taking pressure off the stores. And so do you not need larger stores? And I think you mentioned that you can put a Target store kind of in any kind of real estate. And that's -- how does that work with the store-as-hub strategy? Because I would think you would need certain kind of real estate to do the stores as hubs. So just help me understand what you guys are doing.
John Mulligan:
Yes. Well, first, let me be clear. We will open up big stores if we find opportunities to open up big stores. No question. We're going to open a 144,000-square-foot store this year. We're excited about that. So we'll keep doing that.
We went from big to small, almost exclusively small, 15,000, 20,000, 25,000, maybe 30,000. Those are great sites. We'll continue to do that. We love those, one just a few blocks from here soon. What we're saying there's this middle ground that we haven't really built in the past. And Brian and I have walked in those. We built some 60,000, 70,000, 80,000, even 90,000-square-foot stores, a lot of old Kmarts. Love them. They're big enough that you get the entire Target experience, but the backroom is big enough so that we can do all of our digital fulfillment as well. So we get this great middle ground between the 2. And I think our message today is we can do all of that. Over the past few years, between our properties team, store design, construction, Christina's merchant team because assorting these stores is critical, getting the right assortment for the neighborhood to serve that community is incredibly important. We can do all of that. And so there are these opportunities now out there where you can get into a dense urban neighborhood, a dense suburban neighborhood with a 90,000-square-foot store, great. We'll do that all day long. I think the sort center, the great thing about that is it gets stuff out of the backroom faster. Much like we want to get the inventory on to the front of the store, which Mark's team has done an outstanding job over the last 2 years, we want the boxes out of the backroom. All of that creates capacity in the backroom, more pack stations, more volume, keep it moving, just keep things moving. And that's why the sort centers are so important to that strategy. But we'll do whatever from an opening perspective.
Stephanie Schiller Wissink:
It's Steph Wissink from Jefferies. I have a question for the panel more broadly, but it's really about headroom. I think you mentioned on a productivity basis, and one of the most impressive slides is the sales increase versus the number of stores. Talk about how much headroom you have from a productivity per box basis. And how does that factor into your growth algo? And then, Cara, I have a question for you. This is a fun one. But most searched-for brand or category that you don't currently carry that you would love to have.
Brian Cornell:
Michael?
Michael Fiddelke:
Yes. So John has talked in the past about the capacity we have to continue growing in stores. And the thing I'd come back to there is we've seen over the last couple of years how well stores and stores as hubs scale. I mean we've got productivity gains and productivity per foot gains across the chain. It's actually true that the biggest stores generated the biggest productivity gains over the last few years. And so that speaks to the headroom we're creating.
We know the throughput we can get in stores. And if you kind of go through quartile by quartile in our stores, that implies we've got a lot of stores that could get a lot bigger before they tap out. And so we feel really good about the opportunity to keep growing the business. But stores as hubs is the thing that enables so much of that capacity.
John Mulligan:
I think the other thing I'd add on is as inventory turns increase with scale, you just push things through faster. Speed and flow of inventory is the key to the whole game, like we were just talking about with Robby. And as that happens, we see it in our largest stores, they just move inventory. It's constantly moving through. It shows up at night. It's out the store the next day. That's capacity. You're just moving inventory. So a lot of headroom for growth from that perspective.
Brian Cornell:
Cara, you want to tackle search, most popular item?
Cara Sylvester:
So that's a fun one, too, Steph. Thanks for the question. I think our search terms and what the guest is looking for changes seasonally all the time, always seasonal products, always newness and always the hot items that are out there. And so we see a really close look at our search really on a weekly basis and work with our merchant partners to share back those insights.
What I would tell you is over the years, the search insights, of course, are going to impact. And we're going to feed those over to the merchandising team for them as they're constantly looking for the right mix of our owned brand products and our national brand products. And so we'll continue to make sure we're feeding those over. Christina, is there anything you would add?
A. Hennington:
I think that's really well said. And you'd be surprised at how quickly those ebb and flow week by week as the consumer went through so much change over the year. And I think that's where the breadth of our multi-category portfolio has played to our advantage that, whether it's a mask they're looking for or Xbox or it's a new spring dress, we've been able to be there for them in all those moments.
Brian Cornell:
We've got a question towards the back.
Edward Yruma:
This is Ed Yruma from KeyBanc. Two quick ones from me. I guess, first, on the food assortment. You've done a very impressive job adding more food over the past couple of years. I guess as you think about the incremental share opportunity, are there more foods you can add? Do you think you can become that weekly grocery destination? And then as a follow-up, sometimes when you head into kind of a sticky consumer environment, we see trade down, focus on value. Are you seeing any of the leading indicators that the consumer is feeling pressured?
Brian Cornell:
Rick, why don't you start from a food standpoint, and then we'll come back to some of the consumer trends we're seeing right now.
Richard Gomez:
Sure. To talk about food, we, as I said before, have a lot of positive momentum on what we're seeing in the food business. We continue to see opportunity to continue to grow as we think about our assortment, and I would say that the real 3 key drivers of the growth that we see in the future.
The first is the digital business, which is our same-day services. Industry-leading in general, but particularly relative to our competitive -- our grocery competitive set. It's a real step up, not only from an experience standpoint, from a convenience and ease perspective. I think John mentioned the NPS scores. It's a differentiator relative to other particularly grocers. The second thing that I would say is different about our assortment, which you mentioned and the competition is our owned brands. Good & Gather, only 2 years in and is already over $2 billion in sales. Favorite Day is brand new. It developed during the pandemic and is already off to a really strong start. And then we have Market Pantry, which is a little bit lower price point, but we think will be very relevant during these inflationary times. So we think that assortment of owned brands, when we stack it up to our competitors, they're growing faster than grocery industry private-label brands. We think that's the third -- the second key driver. And then the third, I think, will be seasons, and we talk about that a lot. But we -- whether it's Easter or Valentine's Day, Halloween, Mother's Day or upcoming Easter, that's where we do really, really well. And Easter is coming up, and I think Target's one of the few places where you can get everything you need for the holiday. You can get the eggs for Easter. You can get the candy for Easter. You can get the basket. You can get home decor and you can get the Easter dress. And I think that's a real competitive advantage for us, particularly versus a lot of our grocery competitors.
Brian Cornell:
And from a consumer standpoint, I'll start and I'll let Christina jump in. Let's go back to what we saw in the fourth quarter. And obviously, we saw comps up 9%, but it was driven by great traffic. And we saw a pretty balanced growth between both physical stores and digital. So we're clearly seeing a guest than a consumer who's shopping in both channels.
As we sit here today, we're listening very closely to the consumer. And if there's anything, I think, we've learned over the last 2 years, it's just the resiliency we're seeing in the U.S. consumer environment. But specifically, we know consumers are still worried about COVID, yet they're looking for that touch of normal in their lives. And we saw that play out during the Super Bowl. Rick talked about some of the results we delivered. But that consumer and the Target guests, they wanted to be together with friends and family for the first time in a couple of years to enjoy the Super Bowl. We know we've got a consumer who is looking for value. But as Christina noted, they're looking for newness as well. And anything new is exciting and showing up in that basket. There's clearly inflationary concerns that are starting to pop up in the conversation. But it's still a U.S. consumer with a pretty healthy balance sheet. So we're going to have to watch this carefully. We know March, April are going to be important time frames as the consumer overlaps, some stimulus checks and child care. So we're taking a cautious approach to the first quarter. But we continue to see a very resilient consumer who has a solid balance sheet and is balancing that desire for value and concerns with inflation with a desire to find something new and just go back out and experience everyday life.
Joseph Feldman:
Joe Feldman, Telsey Advisory Group. Wanted to go back to the sortation centers. I may have missed, but how many do you plan for this year and then beyond? Like it seems like you may only need one per major market based on the map that you put up. But -- and then maybe the -- I don't know if you want to share the cost with us but to build it, to hire people, all of that would be great.
John Mulligan:
Joe, you know us better than that. We will -- by the end of next week or next month, we will have 6 of them open. We're thinking probably 5 more later this year. And of course, part of this little unknown, same supply chain problems that have impacted our ability to remodel and open new stores, things are slower, permits are slower, everything slower. We'll see. But that's where we're headed. And we think there's an opportunity over the next 4 or 5 years to continue to build at least that pace, perhaps a little bit faster. But when you look at the major or urban areas across the country, lots of opportunity.
And I wouldn't say, in the case of many cities, it will not be just one per city. Just the way you navigate some cities and the way they're carved up makes that harder to do. And so the opportunity for us to do several in the city is there for us. But that's all down the road. So you'll see us continue to build into it.
Brian Cornell:
We probably have time for 2 more questions, so let me make sure we get some new hands.
Kelly Bania:
Kelly Bania from BMO Capital. Question about the longer-term operating income outlook. I think, Michael, you mentioned you'll welcome the rate growth when it happens for the right reasons. So maybe just help us understand what are those right reasons.
Michael Fiddelke:
Yes. I think the last 2 years are pretty instructive. The rate growth we saw over the last 2 years came from scale benefits. That's a more sustainable version of rate growth. But to be clear, that's not the number in the P&L we're optimizing for. It's profit dollar growth over time. We'd expect to find the fuel to fund the investments to power the top line, and that's kind of the thing that's at the heart of the algorithm. But when we see sustainable rate growth, we'll welcome it just like you saw over the last couple of years.
Gregory Melich:
Greg Melich with Evercore ISI. A follow-up and then my question. The follow-up is AUR. This year, if we think with inflation out there, how do you think AUR plays out this year in that guide in terms of traffic and ticket or units?
Michael Fiddelke:
Yes. I don't know if my crystal ball is that clear, Greg. But the story that we've really seen most recent quarter to start with is the incredible growth in traffic. There's some puts and takes in basket, but virtually all of our growth in Q4 came from traffic. So we'll -- as you heard today, we'll continue to be focused on protecting value and making sure that our price position is strong, and that's working. It's leading to deepening engagements, it's leading to more trips to Target.
And so where exactly AUR lands over the course of the year, I think, is going to be a journey we'll all take together, and we'll see. But traffic has been the story for us.
Gregory Melich:
Still the traffic. And then maybe a 3P fulfillment. You've mentioned a little bit about extending the aisle with some vendors, with Roundel doing well. I guess I'd like to understand, what is the right assortment for Target both in-store and online? Do we want to get to 10 million SKUs? Do we need to? Is it curated? Are we selling Roundel services to trusted vendors as opposed to United Airlines? How do we think about that?
Brian Cornell:
Christina, I might ask you to start. And Cara, I know you've got a point of view on this topic.
A. Hennington:
Yes. First and foremost, our point of view on assortment is all about curation. It's making sure that we understand the consumer and that we can craft an assortment that starts with a balance of really well-designed, high-quality and value owned brands, coupled with the leading national brands that consumers would expect to find. By having a curated assortment, it fuels the stores-as-hubs model because there isn't this long extension that we have to fulfill from other parts of the network. We're using the inventory base of the stores, which creates efficiencies, which creates speed, which creates lower costs.
Additionally, we think it's a guest benefit. The ability to navigate the assortment and navigate the paradox of choice is real. And so creating options that are much more relevant in a more tight environment is important to us, and that extends to our marketplace. And so Cara can talk a little bit more about how we think about that, but it's really a complement hand in glove.
Cara Sylvester:
Absolutely. And it's in lockstep with our merchant partners. And our marketplace is truly differentiated because it is invite-only, and it will remain invite-only as we think through who are the right trusted partners that we are looking to actually complement our assortment with.
And then just a comment on your Roundel question, similar story there. That growth that I talked about of getting to $1 billion is largely with our vendor partners who are finding incredible value within the guest data and insights that we have. And we see a lot of headroom to grow with those trusted vendor partners as we think through the coming years ahead.
Brian Cornell:
So I'll wrap up from here. And I want to start by thanking all of you for joining us in person. We've really been looking forward to this. It's been a long couple of years. I hope you walk away with a clear sense of our direction as a company, the strategies that will guide us going forward, the capabilities we'll continue to invest in, the important role that our team will play and the unique culture that I believe really defines and separates us from many of our peers. So I hope you leave recognizing we are committed to being a growth company, one that is a profitable growth company for years to come, great stewards of capital and will provide great returns for shareholders. But I really appreciate your time, your engagement today. And we look forward to seeing you again in person next year. So thanks for joining us. Stay well. Stay safe. We hope to see you again soon.
Operator:
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 17, 2021. I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relation. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our third quarter 2021 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 the 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, the most important of which are described 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 quarter and his perspective on our outlook. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. Our third quarter results are consistent with what our team has been delivering quarter after quarter for years now. And they continue to demonstrate the extraordinary level of engagement we're seeing from our guests, both with our brand and with our team.
In the third quarter, comparable sales expanded 12.7%, on top of a nearly 21% increase one year ago. Consistent with recent quarters, traffic was the primary driver of this year's growth as our guests increasingly turned to Target to serve their wants and needs. Across our sales channels, store sales were the primary growth driver this quarter, while same-day services propelled our digital growth. Since the third quarter of 2019, prior to the pandemic, Q3 store sales have expanded by $3.8 billion, while digital sales have increased another $3.1 billion. This provides a vivid demonstration of the flexibility of our operating model to serve our guests no matter how they choose to shop. All of these results reflect the level of guest engagement far beyond what many would have imagined a few years ago, when we started making huge investments throughout our business, in our stores, new brands, same-day services, supply chain, and importantly, our team. Back then, Target was already known for our world-class team, a differentiated shopping experience, unique assortment and an iconic brand. But we knew there was much more to do. We saw a clear opportunity to build on that solid foundation, finding new ways to enhance our capabilities, while strengthening the bond with both our team and our guests. And today, those bonds have never been stronger. As I mentioned, within our digital capabilities, more and more of our guests are trying and embracing our industry-leading same-day services. Third quarter sales through these services have expanded by nearly 400% or $2 billion over the last 2 years. Through the first 3 quarters of the year, sales through these services have grown by more than $6 billion since 2019, a number larger than the total sales of many prominent retailers. Beyond fulfillment capabilities, our balanced multi-category assortment is another key driver of flexibility and resiliency within our business model. The breadth of our assortment, both within and across our core categories, allows our team to quickly and seamlessly serve our guests, even when their wants and needs are changing rapidly. In the third quarter, we saw consistent strong growth across our entire merchandising portfolio. More specifically, all 5 of our core merchandise categories saw a double-digit growth in the quarter, ranging from the low double-digits to the mid-teens, resulting in strong market share gains on top of unprecedented share growth in 2020. And we're not slowing down in our efforts to serve our guests. We continue to invest in key partnerships that enhance our assortment and experience, including the opening of more than 100 Ulta Beauty shop-in-shops and our recent announcement that we're doubling the number of enhanced Apple experiences in electronics. Christina will provide more details in a few minutes. In our conference call 3 months ago, we outlined multiple actions we're taking to support our inventory and in-stocks, given the supply chain challenges that have emerged throughout the pandemic. As you know, those pressures only intensified in the third quarter. And our team has done an outstanding job in the face of these challenges, identifying bottlenecks and finding solutions to keep inventory flowing throughout our network. Although efforts drove some incremental costs in the quarter, we view them as a continuation of the many productive long-term investments we're making in our business in support of the trust we have built with our guests. And obviously, our guests responded to these efforts with strong third quarter traffic, which we expect will continue in Q4 and beyond. Beyond our supply chain, the team has done a great job navigating through broader cost pressures as many vendors have raised wholesale prices to accommodate higher costs within their businesses. As our team faced these cost increases, they maintained a guest-first approach and a focus on value while managing overall profitability as well. As a result, our business delivered strong third quarter financial results, from the top to the bottom of the P&L, while building on the trust we've established with our guests. So I want to pause and acknowledge the incredible effort of our teams across the company, from headquarters to stores, from our merchandising, distribution and transportation teams to our sourcing offices around the world. Because of your agility, energy and selfless collaboration, Target delivered for our guests and our shareholders in the third quarter. And as we enter the fourth quarter and ramp up for the peak holiday season, we're really well positioned to continue delivering for all of our stakeholders and close out an already amazing year. I want to thank you for everything you do. So the theme you'll hear in today's call is that we're excited and ready for the holiday season. We know our guests are excited to celebrate, following a year in 2020 when many families stayed apart due to safety concerns. This year, our guests have eagerly started their holiday shopping, as they respond to our holiday promotions, low price guarantees and our ongoing efforts to provide ease, reliability, safety and value across every shopping experience. And importantly, we have taken multiple actions to support our guests during the holiday season and beyond. On top of the investments in inventory, in-stocks and value I outlined earlier, we've announced that we're hiring 30,000 new year-round supply chain team members to support our current and expected growth. In our stores, we're providing our team members with more pay, flexibility and reliable hours this holiday season, offering more than 5 million additional hours to our existing team, and investment of more than $75 million over the holiday season. To supplement the additional hours from our existing team, we're hiring another 100,000 seasonal team members throughout the country, many of whom will have an opportunity to stay on with Target after the holidays. And importantly, during a season in which our guests are busier than any other time of the year, our merchandising and marketing teams are focused on cutting through the clutter. That means we're keeping our marketing messages and promotions simple and our operations flexible to offer an easy and reliable experience for our guests no matter how they choose to shop. And finally, while Target has already had an outstanding year, our team is looking ahead and not slowing down. We're continuing to invest in our future, in our new stores and existing stores, our supply chain and fulfillment capabilities, in our owned and national brands, and the safety and well-being of our team. We're investing in Target Forward, an ambitious commitment to co-create an equitable and regenerative future. Together with our guests, partners and communities. All of these efforts are focused on advancing Target's leadership position within retail, taking a guest-led approach to everything we do and supporting our company values to care, grow and win together. I had the privilege of working alongside this great team as they bring our values to life every day across every part of the company. I'm endlessly grateful for their passion and support of our guests of our brand and for each other. With that, I'll turn the call over to Christina.
A. Hennington:
Thanks, Brian, and good morning, everyone. Our third quarter results demonstrate what happens when our team lives out our purpose
As you heard from Brian, third quarter comparable sales grew 12.7%, reflecting double-digit growth in every one of our core merchandising categories. Even within those core categories, sales strength was broad-based, and virtually every area of the business grew over last year. This shows the power of our multi-category assortment in driving guest relevance and affinity for Target. While growth came from all categories, third quarter performance was led by our Essentials, Beauty and Food & Beverage categories, all of which delivered comp growth in the mid-teens. These businesses continue to deliver substantial share gains on top of last year's gains through both trip frequency and basket growth. In Essentials, growth was led by baby care, pets and over-the-counter health care categories. Strength in Food & Beverage was most notable in our fresh and frozen categories as well as in snacks and candy. Hardlines, which comped in the mid-teens on top of mid-30% comps last year, was fueled by incredible momentum in our toys and sporting goods businesses, which both saw comp growth north of 20%. Electronics delivered low single-digit comp growth on top of last year's comp of nearly 60%. In our Apparel business, comp sales grew in the low double-digits despite unseasonably warm weather across much of the country. Performance was strongest in swim, young contemporary, intimates and hosiery. In Home, low double-digit comp growth was led by seasonal and stationary categories, and reflected record-setting performance in the back-to-school, back-to-college and Halloween seasons. We have seen consistently strong results across seasonal categories, results that clearly signal that our guests are excited to celebrate the holidays with loved ones in new, old and reimagined ways. However they celebrate, our guests remain focused on meeting their wants and needs with ease, convenience and value. And as the holidays approach, they are turning to Target for these solutions. This is about more than just checking items off the list. Beyond working through the logistics of the holiday, our guests are looking to us to provide joy, and a joyous holiday is exactly what we plan to deliver. We continuously evaluate our guests' mindset, which serves as a North Star for all our strategies and decisions. We remain laser-focused on their experiences with us and expectations of us. And we strive to build flexibility and agility into our plans to ensure we show up at our best for them during the holidays and all year round. We are confident in our ability to navigate the broader retail landscape. And we're eager to share all that we've planned for the upcoming holidays. Whether our guests are rekindling old holiday traditions or finding new ways to celebrate the season, we're focused on making Target the destination that makes it easy, safe, inspiring and affordable to celebrate what matters most, the magic of spending time with those we love. As John will outline in more detail, our teams are working diligently to get the right inventory to the right place at the right time. Doing so has driven some near-term gross margin pressure, appropriate long-term investment in the relationship with our guests. Bottom line, based on the incredible efforts of our team, we feel good about our inventory levels heading into the holiday season. In addition to the investments in our inventory position, we remain committed to providing great value with every trip to Target. And that value goes far beyond delivering exceptional everyday pricing. It includes offering compelling holiday deals, great quality products and an array of options to support all budgets, including accessible payment options. Last year, we spread our promotions throughout the months of November and December to avoid crowding in stores, and we heard from our guests that they loved it. As a result, we're spreading savings throughout the season again this year to give guests flexibility to get the best deals on their terms whenever and however they choose to shop. We'll feature compelling offers throughout the season on top items, great weekly deals and surprise deals of the day, both in-store and online, as well as additional deals for Target Circle members. And to reinforce value throughout the season, we recently announced the launch of our Holiday Price Match Guarantee, our most robust price match ever. When guests see Holiday Best deals at Target, they can shop confidently, knowing they are getting Black Friday sized savings with our best planned price of the season. In essence, any time they see a deal at Target, our guests can be confident it's the right time to buy. We also know that our guests want flexibility, not just in what they want to buy and how they want to shop, but how to manage their budget as well. That's why with the help of 2 new partners, Sezzle and Affirm, we've added new payment solutions that allow our guests to buy what they need now, take advantage of our best deals and pay at a pace that works best for them. With a strong inventory position and a great value proposition, we're able to lean into our uniquely Target assortment to build upon our traditional offering great gifting ideas and easy gathering solutions, like even more creative Gingerbread House making kits, Bullseye's top toys and gift sets for any budget. Spanning beauty, apparel, food and beverage and more, these gifting options will bring together the best of only our Target-owned brands with curated national brands. And for those seeking extra inspiration, our thoughtfully curated digital shopping lists will bring the joyful discovery our guests love, helping them find the perfect gifts for anyone on their list, whether they are shopping our stores or on our site. In addition to gifting, guests are focused on gathering with friends and family. And we have everything they need to create memorable moments, whether it's preparing a delicious meal, throwing a festive family party or hosting a game night with friends. From Good & Gather cheeseboard starter kits and Favorite Day baked-goods, to Threshold fall collections, including festive baking dishes, serving platters in the color of the season, and an array of plates, linens and other table toppers, all $15 and under. We want to create joy for all of our guests this holiday season, and we are excited to do so with our most inclusive assortment to date. Throughout our digital and in-store shopping experience, our guests are sure to see themselves reflected in our culturally relevant gifting and gathering solutions. We'll highlight Black-owned businesses in Beauty, Hardlines, Food & Beverage and Home, including McBride Sisters wine pairings, Bipoc Author in our $10 book assortment and a limited time Black artist partnership in wrapping paper. And our guests will see themselves represented in inclusive gift card messaging and imagery, providing options that celebrate the many meaningful holidays of the season, including Kwanzaa and Hanukkah. We're also delivering joy beyond our holiday assortment by building on our incredible legacy of creating differentiated shop-in-shop experiences that drive traffic and inspire our guests. They continue to tell us how much they love our exciting and expanding partnerships, with brands like Disney, Ulta Beauty and Apple. With each partnership, we're adding excitement, convenience and newness for our guests, while unlocking incremental growth for each of the partners. So it's no surprise we're building on this momentum in time for the holiday season. We are tripling the number of Disney stores at Target locations and doubling our Apple shop-in-shop experiences. On top of that, of course, this will be our debut holiday season featuring Ulta Beauty at Target. And on the subject of Ulta Beauty at Target, our guests are telling us it's clearly hitting the bull's-eye, with makeup, skincare, bath and body, hair care and fragrance from more than 50 top brands now available at Ulta Beauty at Target. Both in stores and online, there's plenty to love about this new partnership, and we are so excited for all that is yet to come. And we'll build on our tradition of joy making partnerships this December when we will launch an exclusive lifestyle collection of products with one of the most beloved toy brands ever, Lego. Think brick-inspired hooded sweatshirts, colorful Lego-shaped tumblers and of course, iconic Lego brick and mini figure sets. This collection builds on our long-standing partnership with the Lego Group and reflects our shared values of inclusivity, optimism and joy. With nearly 300 must-haves for the family, pets and home, and most of the colorful brick inspired items under $30, our guests are sure to find something everyone will love on any budget. Joy, ease, value, inclusivity, the ingredients helping to deliver on our purpose to help all families discover the joy of everyday life, a recipe that we refine quarter after quarter by listening to our guests, learning from their choices and working across our talented team. And these plans wouldn't come to life without the many talents and contributions of our dedicated team. So with deep gratitude and humility, I want to thank our team for serving the communities, for showing up every day for our guests and each other, and for bringing Target's values to life. You inspire me with all that you do. And because of you, I know we will win this holiday season. With that, I'll turn the call over to John.
John Mulligan:
Thanks, Christina. Every day, across the operations team, we focus on execution. On our supply chain team, the focus is on moving the right amount of inventory to the right place at the right time. In our stores, which fulfill more than 95% of our total sales, the team focuses on delivering a great guest experience across hundreds of millions of guest transactions every quarter. And on our properties team, the team focuses on optimizing our physical footprint, including the planning and construction of new stores and distribution facilities, along with our investments to maintain and enhance the productivity of our existing buildings.
Of course, all of these aspects of operations matter all year long. But in the fourth quarter, when we handle the largest volumes of the year, everything moves faster, making the need for detailed planning and precise execution even greater. That's why, every year, we construct our plans with the fourth quarter in mind so we can remove distractions and roadblocks in advance of the holiday peak. That means on the properties team, we plan our remodeling new store projects so they're completed before the holidays. And our technology team rolls out new systems and tools on the same time line. In the supply chain and in our stores, we carefully plan the ramp-up of seasonal hiring and team member training in advance of the holidays so everyone is ready to handle the additional volume. That's what happens every year. But as Brian and Christina have already mentioned, this year, our teams have been facing additional out-of-the-ordinary challenges as they plan for and deliver record-setting volumes while facing unprecedented bottlenecks in the global supply chain. So while I'm lucky to work with our amazing team every day, it's at times like these that our team shines brightest. Beyond their skill and expertise, they face every challenge with good nature and a collaborative mindset. I can't describe how proud I am to represent everything they've accomplished this year, as they've delivered historically strong growth on top of record increases a year ago. Within our supply chain, the team has been methodically working around multiple obstacles and challenges throughout the network, prioritizing our holiday-sensitive categories within our import receipts, while thoughtfully planning domestic transportation to ensure products reach the shelf at the right time. And while we continue to see some periodic outages across different items and categories, we're entering the holidays with a very healthy inventory position overall. Specifically, at the end of the third quarter, inventory on the balance sheet was more than $2 billion higher than last year, representing growth of about 18% from a year ago. Looking back to the pre-COVID period, our Q3 ending inventory has grown more than $3.5 billion since the end of Q3 2019, representing 31% growth over a 2-year period. A sizable amount of this inventory will continue to flow to our stores over the next few weeks. And our team has clear visibility to where the inventory is located and when it will arrive in our stores. In our overseas operations, we've benefited from a significant reduction in delay times. And of course, given that we were already anticipating tight conditions many months ago, the team has been writing this year's holiday purchase orders much earlier than last year to proactively mitigate the risk of both known and unexpected delays. We're also benefiting from really strong performance across our domestic transportation network. And we've secured the necessary capacity across both rail and over-the-road trucking to accommodate anticipated shipments throughout the fourth quarter. At the intersection of our overseas and domestic supply chains, the team continues to work around significant port delays, diverting shipments to less congested entry points and relying on air freight in certain cases. And while Target's port operations have long been considered best-in-class, our team has been actively collaborating with government and port officials to help find solutions that will allow everyone's containers to move through the ports more quickly. And we're encouraged with the changes that have recently been put in place. I also want to pause and emphasize the ongoing collaboration that's been happening between our supply chain, merchandising and marketing teams. These teams have worked together to develop promotional and marketing plans that are much more fluid and nimble than in the past, enabling the incorporation of real-time data on inventory availability and location within our holiday plans in order to maximize their impact to the benefit of both our guests and operations. In our stores, the team has been preparing for fourth quarter all year. And they're energized and ready to serve our guests throughout the season. This will be the first holiday season since we launched our new service initiative, which is all about empowering our teams and increasing their confidence to build authentic connections with our guests. Also new this year, we've rolled out a new point-of-sale system across more than 90% of our stores, providing more speed, efficiency and enhanced experience at both the checkout and our service counter. To continue building on our industry-leading in-store Pickup and Drive Up experiences, we've been rolling out new capabilities all year. These efforts include capital projects to add permanent storage capacity in more than 200 high-volume stores, investing in flexible fixtures to provide temporary storage areas to support seasonal peak, adding thousands of new items to the list available for Pickup and Drive Up, doubling the number of Drive Up parking stalls compared with last year, and designating stall numbers to help our teams deliver Drive Up orders more efficiently. Even as we're adding these new capabilities, we're also supporting our long-standing commitment to providing a safe shopping experience, maintaining the enhanced COVID cleaning and safety routines that we implemented throughout the pandemic. We've also been investing in team member hours, processes and training to prepare our team to handle record freight and fulfillment volumes this year, all while enhancing safety messaging and actively monitoring processes to protect the safety of both our guests and our team. And of course, as Brian mentioned, our team is focused on being fully staffed across the store and supply chain throughout the holiday season. Our stores have been hitting their seasonal hiring milestones. And because of the advancements we've made in scheduling this year, average hours per store team member are running significantly higher this year in comparison to past years. In fact, unlike what you're hearing from many others, because of the investments we've made in pay and benefits and our focus on team member training and engagement, the hourly turnover rate in our stores is actually running lower this year compared with 2019, particularly for our newly hired team members. And we're continuing to invest in our team. Following the recent rollout of the most comprehensive debt-free education program in the industry, we announced that to sustain our momentum through the holidays, we're offering pay premiums during peak periods in our stores and distribution centers over the holiday season. As we've said many times, our investments in the team are the most productive ones we've made. Turning to the work of the properties team. We expect to finish about 145 remodels in 2021, having completed more than 40 remodels prior to the end of Q3, with more than 100 additional projects slated to wrap up before the holiday. The team also opened another 15 new stores in the third quarter, bringing the year-to-date total up to 30. Among those projects, we've opened new stores ranging from 11,000 to 160,000 square feet, which demonstrates the flexibility we've developed to design the optimal store size for an individual neighborhood, based on their local needs and available real estate in the market. To increase the capacity and efficiency of our supply chain, our team has also opened 2 new distribution centers this year. In addition, we have 2 new sortation centers set to open in the fourth quarter, with 2 more on track to open early next year. While our supply chain has had to address a host of unique challenges, I also want to acknowledge the tireless work of our construction team, which enabled them to successfully bring a huge number of store and distribution projects to completion this year. These are highly complex projects across multiple geographies, which require precise coordination across a large number of regional construction providers, along with a diverse group of fixture and equipment vendors, all of whom have been facing the same bottlenecks we've been facing in our merchandise supply chain. Our construction team has handled all of these challenges with good humor and resilience, allowing us to continue reaching guests in new neighborhoods and support the growing supply chain needs of the entire chain. In support of those growing needs, we recently announced that we're adding more than 30,000 permanent positions across our supply chain network to support the growth we expect to continue delivering in the fourth quarter and beyond. These team members will support new buildings in our regional DC network, adding replenishment capacity to support an increasingly productive store network. They'll also be staffing and supporting our new sortation centers, which deliver efficiency, speed and additional capacity in support of last-mile fulfillment. And it's amazing to pause and look back at how much our network needs have grown in a short time. For the entire fiscal year in 2018, our business generated $74 billion in sales. Less than 3 years later, our business had already delivered $74 billion in sales through the third quarter, with the biggest quarter of the year still ahead of us. Our team and supply chain infrastructure have done an outstanding job in supporting that growth. And given that we don't expect it to end anytime soon, we are committed to growing our physical footprint and our team so they can continue to deliver on behalf of all of our stakeholders in Q4 and beyond. When I first started working here in 1996, Target delivered just under $18 billion in revenue, for what was then called Dayton Hudson Corporation. While many things have changed since then, both in retail and at this company, we successfully maintained what's made Target successful and unique for nearly 60 years. We've maintained our focus on offering affordable design in support of a unique merchandise assortment, providing a differentiated and outstanding shopping experience, investing in the best team in retail and giving back to the communities that sustain us. This is another example of what we call the power of 'and'. The reason Target has stayed relevant for so many decades is our ability to stay true to our values and continually evolve in the way we serve our guests. With that, I'll turn the call over to Michael.
Michael Fiddelke:
Thanks, John. Over time, we've emphasized our commitment to making the appropriate investments in our business, ones that will deepen Target's relationship with our guests, driving engagement, which ultimately leads them to shop at Target more often. And while it's our job to focus on driving performance every day, we've committed to making investment decisions with a long-term perspective, not limiting our horizon to a month, a season, a quarter or even a year, but thinking about how to position Target as a leading retailer for generations.
That's how I think about our third quarter. In the face of multiple challenges in the external environment, we maintained our focus on our guests and took specific actions to ensure we have a healthy inventory position going into the holidays, even though those actions involve some incremental cost. And importantly, as we face those decisions, we had the resources we needed, including the best team in retail, a sophisticated global supply chain and a durable model that could accommodate those guest-focused investments. And while we're making these decisions with a focus on the long term, we've already seen the benefit of this year's inventory investments, given that they helped to power third quarter traffic and sales growth that exceeded our expectations. In addition, given strong expense discipline across the organization, we benefited from a compelling amount of leverage on our SG&A and D&A expenses, resulting in solid EPS growth despite the sizable investments we were choosing to make. As Brian mentioned, our 12.7% comp in the third quarter came on top of a nearly 21% increase a year ago. As expected, within the quarter, we saw a shift in a portion of our back-to-school sales back into August, given that most schools across the country began the school year with in-person learning. As a result, our August comp was our strongest of the quarter, our September comp dipped down to about 10%, and we accelerated back into the low teens in October. Among the component drivers of our sales, growth continues to be driven by traffic, even as we retain nearly all of the basket growth that happened a year ago. Specifically, third quarter traffic increased 12.9% on top of a 4.5% increase last year, while average ticket declined only slightly, about 20 basis points, after growing more than 15% a year ago. Among our sales channels, stores comparable sales grew 9.7% in the quarter, on top of 9.9% last year, while digital comp sales grew 29%, on top of 155% growth a year ago. Within our digital fulfillment, sales on orders shipped to home increased slightly over last year, while same-day services grew about 60%, on top of a more than 200% increase a year ago. Among those same-day options, both in-store Pickup and Shipt grew more than 30% in the quarter, while Drive Up grew more than 80%, on top of more than 500% a year ago. Put another way, since 2019, sales through Drive Up have expanded more than 10x or about $1.4 billion in the third quarter alone. Moving down the P&L. Our third quarter gross margin rate of 28% was 2.6 percentage points lower than a year ago. Among the drivers, core merchandising accounted for 2 percentage points or more than 3/4 of the rate decline, driven primarily by incremental freight and other inventory costs. Among the other gross margin drivers, payroll growth in our supply chain accounted for about 70 basis points of pressure, while category sales mix contributed about 10 basis points of benefit. Notably, digital fulfillment had an approximately neutral impact on gross margin rate in the quarter, as the costs associated with higher digital volume were offset by the benefit of a shift in fulfillment mix towards our same-day options, which have meaningfully lower average unit costs compared with traditional e-commerce. On the SG&A expense line, we saw about 160 basis points of improvement in the third quarter, reflecting disciplined cost management, combined with the leverage benefit of unexpectedly strong sales. On the D&A line, we saw about 20 basis points of rate improvement, as sales growth more than offset the impact of higher accelerated depreciation, which reflects the continued ramp-up in our remodel program. Altogether, our third quarter operating margin rate of 7.8% was about 70 basis points lower than a year ago, but more than 2 percentage points higher than 2 years ago. On a dollar basis, operating income was 3.9% higher than a year ago and double the number recorded in the third quarter of 2019. Moving to the bottom of the P&L. Our third quarter GAAP EPS of $3.04 was 52% higher than last year when we recorded more than $500 million of interest expense on early debt retirement. On the adjusted EPS line, where we excluded early debt retirement expense, we earned $3.03 in the quarter, representing an 8.7% increase from a year ago. Compared with 2 years ago, both GAAP and adjusted EPS have increased more than 120%. Turning now to capital deployment. I'm going to start, as always, with our long-term priorities. First, we look to fully invest in our business and projects that meet our strategic and financial criteria. Next, we support the dividend and look to build on our long history of annual increases, which we maintained every year since 1971. And finally, we're returning the excess cash within the limits of our middle A credit ratings through share repurchases over time. On the CapEx line, we'd invested $2.5 billion through the first 3 quarters of 2021 and expect to reach about $3.3 billion for the full year. As I mentioned last quarter, this is somewhat lower than our expectation going into the year and reflects the retiming of project spending into next year, given that we've experienced delays on some projects relating to external factors like permitting and inspections in some communities.
However, as John mentioned earlier, we're eager to invest in a long list of productive growth opportunities over the next few years:
adding new stores, remodeling existing stores, building replenishment capacity in our supply chain, and rolling out additional sortation centers. As of today, we continue to believe these investments will amount to CapEx in the $4 billion to $5 billion range in 2022, and we'll continue to refine our view in the months ahead.
Turning now to dividends. We paid $440 million in dividends in the third quarter, up $100 million from last year. This increase reflects a 32% increase in the per share dividend, partially offset by a decline in share count. I want to pause here and take note of the fact that, with the payment of our December dividend, we'll officially achieve our 50th consecutive year of annual increases in the per share dividend, something very few companies have achieved. And lastly, given our cash position and strong cash generation by our operations, we continue to have ample capacity for share repurchases within the limits of our middle A ratings, even after we've made robust investments in CapEx and dividends. In the third quarter, we deployed $2.2 billion to repurchase 8.8 million of our shares, bringing our year-to-date total up to $4.9 billion. As I've mentioned in prior quarters, given our continued strong financial performance, our debt leverage has been lower and cash on the balance sheet has been higher than we'd expect to maintain over the longer term. As a result, going forward, we expect to increase our leverage and reduce our cash position at a pace that's consistent with our financial expectations, credit rating goals and assessment of the external environment. I've mentioned before that the time line to move those metrics fully back to historical levels will likely be a multiyear journey. And the rapidly changing conditions we've seen over the last 2 years demonstrate why it's prudent to maintain a thoughtful pace. As always, I'll end my review of performance with our after-tax return on invested capital, which measures the quality of our current performance in the context of the investments we've made over time. For the trailing 12 months through the end of Q3, our business generated an after-tax ROIC of 31.3% compared with 19.9% a year ago. This is incredibly robust performance and demonstrates why we are enthusiastically planning to continue investing in our business. Now let me turn to our expectations for the fourth quarter and full year. 90 days ago, we said we were planning for high single-digit growth in our comparable sales over the back half of the year. While we still believe that's in the range of possible outcomes for the fourth quarter, we just exceeded that expectation in Q3. As such, we're planning for a Q4 comp in the high single-digit to low double-digit range, consistent with the range we've seen over the last 2 quarters. In terms of profitability, we continue to expect that our business will deliver a full year operating margin rate of 8% or higher, up significantly from 7% in 2020. This rate favorability, combined with the full year sales growth we're positioned to deliver, would translate into another incredibly strong year of profit growth, following a record year in 2020. So now as I get ready to turn the call back over to Brian, I want to pause and address a question that I'm certain you'll be asking, which is, how much of the current cost pressures will turn out to be temporary and how much will turn out to be structural? And I'll give you the honest answer, which is that it's almost certainly some of both. And no one knows the precise answer. That said, there's no doubt that supply chain bottlenecks should ease over time. However, beyond the supply chain, we're also facing product cost increases from some vendors, driven by higher costs in their businesses. And while you heard from John that we're extremely well positioned given our team investments over the last few years, the labor market remains very tight across the country. So how do we think about the future? From a financial standpoint, we focus first on serving our guests and translating that focus into further growth, an area where we see a lot of runway. As you've seen with the investments we've made and continue to make, we're earning deeper trust and engagement from our guests. This trust leads to more trips and broader shopping across our merchandise assortment and fulfillment services. With a skilled and agile team focused on driving guest engagement, further growth and market share gains, we're confident that our durable model can continue to offer compelling value for our guests, accommodate continued investments in our team and deliver outstanding financial performance, even in the face of a challenging external environment like we're facing today. This is one more example of the power of 'and'. So now I want to pause and thank our entire team for delivering a great Q3, which came on top of years of already strong performance. The financial results I have the privilege of sharing quarter after quarter wouldn't be possible if Target didn't have the best team in retail. With that, I'll turn the call back over to Brian.
Brian Cornell:
Thanks, Michael. Before we turn to your questions, I want to pick up on something Michael just mentioned, which is the growing agility of our team. This comes in part from a heightened focus on prioritization in which we ask our team to focus on a small list of key enterprise-wide priorities, with a goal of making much more rapid progress towards the goals that matter most.
With prioritization, we've also seen more alignment across the organization. Regardless of where specific team members might work, our enterprise priorities guide their decision-making, allowing them to take action and change course faster when facing rapidly changing external conditions. Beyond prioritization and alignment, we've also achieved a higher degree of collaboration. When tackling business problems, it becomes easier for everyone to communicate and partner cross-functionally to achieve our common goals together.
Prioritization, alignment, collaboration, 3 important concepts that deliver compelling outcomes in a large organization like ours. And in our remarks today, you've heard us highlight some of those benefits, which helped drive strong Q3 performance despite challenging macro conditions:
a unified focus on serving our guests; collaboration between merchandising, marketing and operations teams as they optimize holiday promotions; joint efforts between our stores, supply chain, merchants and vendors to address supply chain bottlenecks and find solutions in support of our inventory.
To say we're feeling the impact of those benefits already this holiday season would be an understatement. In fact, I place them alongside our multi-category portfolio, our unmatched same-day services and the skill of our extraordinary team as keys to our holiday readiness. So once again, I want to thank our team. There is no question that because of their dedication and connection to our guests, we stand ready for an exceptionally strong holiday season. Throughout the team, across every function, I've seen the energy and passion as they prepare for the busiest season of the year. And I'm confident that same energy and passion will ensure Target's consistent and sustainable growth over the longer term as well. Now Christina, John, Michael and I would be happy to take your questions.
Operator:
[Operator Instructions] Our first question is from Michael Lasser with UBS.
Michael Lasser:
Michael, you began the question already by suggesting you're not sure how long the gross margin is going to last. Can you at least help us understand if the third quarter was the peak gross margin degradation that you expect to realize over the next few quarters? And what are you doing to mitigate this gross margin pressure in terms of passing along price increases to the consumer?
Michael Fiddelke:
Thanks for the question, Michael. As you know, we don't guide margins specifically out into future quarters. But I will say and reiterate what I said in my remarks. I think you're seeing in the third quarter, the result of some very specific investments we made. And the biggest of those investments is an investment to make sure we've got a great inventory position heading into the fourth quarter. And pulling all the levers within the system to ensure we're there for the guest has been our priority. And some of those levers, think of expediting product to come at a cost, and you saw some of that in the third quarter.
But I feel really good about the payoff from an investment decision like that. We've got inventory of $2 billion north of last year, up almost 20% on a year-over-year basis. And that's fueling the continued top line growth that we see. So I feel really good about the set of investments that we're making and how they have us positioned for the back part of the year.
Michael Lasser:
My follow-up question is, even without providing any context on the gross margin for at least the fourth quarter, can you give us a sense for how much you're able to offset or continue to offset this gross margin pressure with further SG&A reductions? Should we expect your SG&A dollars in the fourth quarter to grow at a similar rate that they grew in the third quarter?
Michael Fiddelke:
Yes. On the SG&A side, I think the theme you see in Q3 is just an example of how powerful productivity improvements that come with growth are for our business. We generate astounding leverage when the top line is running forcibly in the right direction, and it certainly was in the third quarter. That's one of the reasons. We want to make sure we're so well positioned to support continued growth because the P&L works great when we're generating that SG&A leverage, just like you saw in Q3.
Operator:
The next question is from Chris Horvers with JPMorgan.
Christopher Horvers:
So 2 question. My first question is, you raised the outlook for the fourth quarter, can you talk about what you're seeing from the consumer so far this holiday season? Are you seeing any indication of that holiday sales could be pulled forward? And does the guidance reflect any risk on stock-outs as we progress toward Christmas and then, obviously, stimulus slap in January?
Brian Cornell:
Chris, as we sit here today, we see continued momentum in the marketplace, and our guests to shopping, all of our categories, utilizing both our stores and our digital channels, and we think that's going to continue throughout the holiday season. All indications are that the U.S. consumers looking to celebrate the holiday season, they are anxious to get together with family and friends. We've seen a great response to seasonal activity as we look at the first 3 quarters of the year. Record Halloween season, very strong back-to-school, back-to-college, a guest that we believe is going to enjoy Thanksgiving with family and friends and is really looking forward to the holiday season, which means robust gifting throughout the season.
So we're off to a very good start. We think that's going to continue throughout the holiday season. And we think we made the appropriate investments in inventory. Our inventory levels are up $2 billion, almost 20%. And we think we're well positioned with those key items. The gifting items, the toys, those items the guest is going to turn to celebrate the season to make sure we build on our third quarter momentum and continue to take market share as we go through the holiday season.
Christopher Horvers:
Got it. And then I'll take a second cut probably of many on the gross margin and the gross margin outlook. Seasonally, usually, gross margin does sort of go down 200, 300 basis points just relative to the third quarter rate. However, you talked about a lot of -- I think there's like 2 components here to think about. One, you talked a lot about expediting product in during the third quarter. So there are some sort of periodic costs there.
But then you have a lot of the product that comes in overseas, has all that ocean freight. And I think that product is hung up -- that cost is hung up in the inventory. So I guess as you sort of roll those 2 pieces together, and ignoring mix for a second, how are you thinking about those 2 relative costs? As sort of the freight component that's hung up in inventory get worse, but the periodic cost of bringing in 3Q comes down and those 2 things sort of net to neutral, or in which direction?
Michael Fiddelke:
Yes. Chris, we -- you're thinking about it conceptually, I'd say, in the right way, in that the third quarter and fourth quarter kind of straddle the big inventory build and relief that happens for us in advance of the holiday season every year. And so those will be the factors at play, while I won't begin to get into the specifics of that level of gross margin for what that means in Q4. But I just zoom out and I feel really good about our ability to manage all of the levers and to see EPS growth of almost 9% in the third quarter, and yes, some investment in gross margin, but also a ton of leverage on the SG&A line. And we feel really good about how that positions us for the fourth quarter and the investments in inventory. And importantly, the investments in value for our guests, I think, will be investments that continue to pay off.
Operator:
The next question is from Karen Short with Barclays.
Karen Short:
Sorry to try this a little bit differently. So when you look at your top line growth in 3Q relative to your EBIT growth, and then -- so we look at the gap on those 2 in 3Q, and then back into 4Q, it looks like you will have much stronger -- a much wider -- or sorry, a much narrower gap on top line relative to EBIT growth in 4Q. So is that a function of the fact that a lot of the supply chain costs and inventory costs were pulled into 3Q? And then I guess what I want to ask bigger picture is, looking at '22, how should we think about that algorithm generally, top line growth relative to EBIT growth?
Michael Fiddelke:
Well, thanks for the question, Karen. It's -- I guess I'd start by saying it's wrapped into the guidance we've given for the balance of the year. We would expect op income rate of 8% or higher. And that's inclusive of a lot of moving pieces and puts and takes throughout the P&L. But I'll tell you the place that starts is growth, and that's why high single-digit to low double-digit expectations for the fourth quarter are kind of where the short-term algorithm starts. And with that kind of growth, we feel confident in our ability to put together a P&L that works.
The time will be right in the future to unpack the future year algorithm. But I will say, over time, we expect to be a growth company. We expect to be a company that's growing the top line and gaining share over time. And that's where that algorithm will start.
Karen Short:
Okay. And then just a follow-up. You didn't mention markdowns or what your thoughts are on overall markdowns. I know originally, you'd hope that you would have enough excess inventory to be able to have a healthier markdown season. Just wondering where you stand on that.
Michael Fiddelke:
Yes. I describe us as still chasing. The strength in the top line means that we're still not seeing those clearance markdowns return in force, like you've heard me talk about quarter-over-quarter. And so that said, we feel really good about how inventory is positioned for the fourth quarter. And so that $2 billion higher than last year, up almost 20%, it means we'll be ready to serve our guests for the important holiday season.
Operator:
The next question is from Kelly Bania with BMO Capital.
Kelly Bania:
Just wanted to ask really about the competitive environment. And clearly, you're maybe not passing on all the cost pressures that maybe you could. And my understanding is you're kind of investing here in that relationship with your guests. But do you see this as an investment to sustain these share gains? Or are you already seeing any signs of consumer price sensitivity? Or is it just an anticipation of that as we move forward and this is maybe more of a proactive absorption of those costs here?
Brian Cornell:
Kelly, you've heard us say a number of times already today, we're investing in growth. We're investing to maintain and continue to build market share positions and build on the extraordinary results that we delivered last year, where we added $9 billion of market share and continue to see that momentum grow in 2021. So we're a company that's going to continue to invest in growth, do the right thing for our team, the right thing for the guest, and utilize all of our assets to continue to build on the momentum that we have today and build market share across all of our key categories.
Kelly Bania:
That's helpful. And maybe just a follow-up on the supply chain. Obviously, you've been ahead of that year -- ahead of it this year and pulling inventory ahead of schedule. What is your expectation on when that resolves? And are you still pulling inventory ahead of schedule for early next year?
Brian Cornell:
Kelly, I'll start, and then I'll ask John to provide any additional comments. But we've certainly seen supply chain challenges going all the way to the start of the pandemic as demand across the U.S. continued to build. So we've done a terrific job. And I think our teams have shown great agility. They've adjusted to the marketplace to make sure that we've been able to meet the demand in our system. But we don't expect those supply chain challenges to go away as we go into the start of next year. And I think they'll dissipate over time.
So we're doing our fair share to make sure that we're alleviating some of the congestion in the ports and making sure that we're unpacking containers and off-peak hours. We've utilized other ports across the country to try to relieve some of the congestion in L.A. Long Beach. But as John can attest, we know that we're going to still face some supply chain challenges as we go into 2022. There's still uncertainty as we think about supply from Asia as different factories from time to time are closed. And we're just going to have to show great flexibility and agility to provide the products that our guests are looking for and our system requires as we plan for the next fiscal year.
Operator:
The next question is from Kate McShane with Goldman Sachs.
Katharine McShane:
I wanted to ask a quick question on labor. It sounds from the prepared comments, that from a staffing level, you might be in a good place right now. Could you maybe comment on how you're feeling about your labor in the stores versus the DCs, and what you're seeing in the competitive environment when it comes to wages?
John Mulligan:
Yes. Kate, I think we feel really good about where we're at. And this really goes back a little bit like the supply chain thing. This is something we've been on top of for a very long time. We've made investing in our team an absolute priority. You've seen us do that for years now, investments in wage, investments in training, investments in benefits and investments in their safety over the past couple of years.
And so that all starts and leads to retaining our current team. And from our perspective, that's the way we achieve our staffing goals, is retain the team we have. This year, particularly in our stores, we spent a lot of time, individual conversations with every team member about what's the hours they want and what can we do to cross-train you to get you the hours you need. And so that's been a huge success for our team and for us as we've looked at staffing. More recently, we've said we're investing in our DC team, our supply chain teams to grow the staffing, and we feel great about applicant flow. We feel great about the turnover of our team. It's below 2019 right now. So overall, we feel we're really well positioned for the fourth quarter, and more importantly, for beyond the fourth quarter, because labor is going to continue to be tight, and we'll continue to focus on retaining our existing team.
Operator:
The next question is from Paul Lejuez with Citigroup.
Paul Lejuez:
I know you don't give guidance. Obviously, you didn't for third quarter gross margin. I'm sure you had some view on where it would shake out. So I'm kind of curious just how much of what we saw in the third quarter was unexpected to you and maybe tied to decisions that you made during the quarter, intra-quarter and how much was tied to higher-than-expected sales.
And I just want to make sure I'm clear. I don't know if you'd answered the question earlier, was there an aspect of some costs getting pulled forward into 3Q out of 4Q?
Brian Cornell:
I'll start. I think one of the positive surprises for us in Q3 was just the continued strength in traffic. To see our traffic grow by almost 13% was something that we actually didn't anticipate. We certainly were planning for a very strong quarter and continued market share gains.
But to see the type of performance across our business, the strength of stores, comping up almost 10%, in a period when we were comping over a 9.9% growth rate in the prior year, to see our digital business grow by almost 30%, comping over 155% growth the year before, those numbers are actually stronger than we might have expected. To see the consistent growth across every one of our major merchandising categories, double-digit growth, just the way the guest was responding to our assortment, the value we were delivering, the great in-store experience, those were all really positive results in the quarter and actually exceeded our expectations when we were planning for Q3. Operator, we have time for 1 more question today.
Operator:
Our last question is from Robbie Ohmes with Bank of America.
Robert Ohmes:
Brian, I -- kind of a follow-up to what you were just talking about. I wanted to ask you about grocery. I know that Target historically has said, we're not a full grocery shop. But I'm looking at the numbers you guys have been putting up in grocery, Food & Beverage, Beauty and Essentials. And can you maybe just speak to longer-term opportunity given the momentum you have there? And could you do more there? And maybe also, does it tie into -- does it drive general merchandise? Is it key to driving these digital numbers on very strong digital numbers? Any help to think about that would be great.
Brian Cornell:
Robbie, why don't I start and let Christina add to my comments. But I think you've highlighted one of the real success stories within our business over the last few years. And the progress we've made from a Food & Beverage standpoint, the changes we've made in assortment, the market share gains that we've seen quarter after quarter now for multiple years, and the great response we're seeing to our own brands, and the strength and response we're seeing to Good & Gather is a real highlight for us.
But as Christina can build in more detail, we're also seeing tremendous growth in our Beauty business, and ongoing strength in Household Essentials. And that's helping drive trips and leads to cross shopping across our multi-category portfolio. So the position we're in today in Food & Beverage is dramatically different from where we were 5 years ago. We're connecting with the guest. The quality, the assortment, the value we deliver is being really well received from the guest who shops our stores. And we're seeing accelerated growth with our Food & Beverage business from a digital standpoint.
A. Hennington:
I was just going to add a little bit of commentary to Brian's point about how Food & Beverage fits into the broad portfolio. The multi-category portfolio and the strength across the entirety is part of Target's sweet spot. So Food & Beverage is certainly an incredible proof point that's grown and driven share acceleration and traffic, but we rely on all of our categories to play that role at different times of year. And it's that combination that makes it so compelling whether it's back-to-school whether it's Halloween, whether it's Memorial Day or whether it's just your everyday trip when you need to pick up milk and bread. So this is part of the strategy that's accelerating the relevance for the consumer across the board.
Brian Cornell:
Robbie, thank you. And that, operator, concludes our third quarter conference call. We look forward to talking to all of you as we go into 2022. So thank you.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation Second Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, August 18, 2021.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our second quarter 2021 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 second quarter performance and our outlook and priorities for the third 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, the most important of which are described 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 first quarter and his perspective on our outlook. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. Our second quarter performance showed that Target's leadership position is stronger than it's ever been, fueled by a one-of-a-kind strategy, resilient operations and a passionate, world-class team.
As you know, we've been investing for years to build the durable model that's in place today, one that puts our guests first and leverages all of our assets and capabilities to serve their evolving wants and needs. After years of investment and effort in building this model, it's clear that we've only begun to scratch the surface of what's possible over time. In the second quarter, our business continued to perform and grow on both the top and bottom lines, even as we comped over record performance a year ago. Of course, seeing growth on top of growth is nothing new. Our business is already delivering consistent increases in sales and profitability in the years leading up to the pandemic. This was followed by a dramatic acceleration in 2020 and this year's continued growth. In the second quarter, Target's comparable sales increased 8.9% on top of a record 24.3% growth a year ago. As a result, second quarter total sales have expanded more than 36% or more than $6.6 billion over the last 2 years. On the bottom line, we earned second quarter adjusted EPS of $3.64, up nearly 8% compared with last year and double our performance 2 years ago. As we described last quarter, guests have emerged from a year in which digital was the primary growth driver, and they're now returning to our stores in droves. As a result, the majority of our second quarter growth was driven by the stores channel, where comps grew 8.7% on top of 10.9% a year ago. In addition, traffic accounted for more than 100% of our second quarter growth, in contrast to a year ago when guests were limiting time out of their homes and the bulk of our growth was coming from bigger transactions. Comparable digital sales grew 10% in the second quarter, building on the record growth of 195% last year. The digital channel continues to be led by our same-day services, in-store pickup, Drive Up and Shipt, which together grew 55% this year on top of more than 270% last year. Given their rapid expansion, same-day services now account for well over half of our digital sales. Among those same-day options, Drive Up has quickly grown to be the largest, accounting for more sales than pickup and Shipt combined. To put it in dollar terms, over the last 2 years, second quarter sales through Drive Up alone have increased by nearly $1.4 billion. And for the spring season, they've expanded by double that amount. Beyond our fulfillment options, we continue to benefit from our unique multi-category assortment, which is perfectly positioned to serve our guests' evolving wants and needs. As a result, comp sales in all 5 of our core categories expanded in the second quarter on top of strong growth a year ago. As expected, apparel continued to lead the way as our guests continue to respond to newness and style across both our owned and national brands throughout the assortment. Also as expected, we saw more moderate growth in our Hardlines and home categories this year as they expanded on top of really strong comparisons from a year ago. And notably, we continue to benefit from impressive performance across our less discretionary Food & Beverage and essential categories. These categories have again consistently delivered strong growth and market share gains, both in 2020 and again this year. I'll let Christina provide more details in a few minutes. When we talk with many of you about what's driving Target performance, we often hear the question, "What's the one thing that's been the key?" The honest answer to that question, we can't point to any one thing. Rather, it's been everything working together that's driven our performance. This includes our supply chain work, which has positioned our stores as fulfillment hubs, while transforming the way we replenish store inventory. Then there's our rollout of same-day services, which began more than 5 years ago with in-store pickup, followed by the nationwide rollout of Drive Up and Shipt beginning in 2018. And there's the refreshment of our own brands, which began in 2016 with the rollout of Cat & Jack, followed by dozens of new owned brands over the last 5 years. At the same time, we've expanded our partnerships with premium national brands, including Disney, Levi's and Apple and, most recently, this month's opening of more than 100 Ulta Beauty shop in shops. Across our store portfolio, we began testing small formats in 2014. And we now have more than 140 of these productive neighborhood locations across the country. We've also remodeled more than half the chain over the last 4 years, transforming the shopping environment while optimizing the layout in support of our same-day services. And we've reinvented our store operating model, focusing on enhanced service and subject matter expertise in key categories while investing in visual merchandising across our network. Then there's Target Circle, which launched in 2019 and now has more than 100 million members, providing a new connection with our guests while offering meaningful rewards. And of course, we made multiple investments in our team, including the attainment of our goal to bring Target's nationwide starting wage up to $15 or more. This was certainly an important milestone, but far from the end of the journey. Just a few weeks ago, we announced an investment of more than $75 million to provide $200 recognition bonuses to all of our frontline, hourly, full-time and part-time team members across our stores, distribution centers and contact centers. I've said it many times before, but I can't say it enough. Our team is the lifeblood of Target. And our success begins and ends with them. I want to thank each of them and every one of them across the world for everything they do to make Target such a special place to shop and a great place to work and build a rewarding career. And today, given the profitable growth that comes from all of these efforts, we can continue to invest in making our business even stronger and more durable over time.
In June, we were incredibly excited to launch Target Forward, an ambitious new sustainability strategy grounded in the vision to co-create an equitable and regenerative future with our guests, partners and communities. Target Forward is centered around 3 critical ambitions:
to design and elevate sustainable brands, innovate to eliminate waste and accelerate opportunity and equity. This bold initiative is the beginning of the new chapter for how we'll define sustainability, position our business for long-term growth and resiliency and build on our rich legacy of corporate responsibility and sustainable practices.
As part of these efforts, in early August we announced that this fall, Target will be rolling out an industry-leading program to provide debt-free educational assistance for all of our U.S.-based full-time and part-time team members. This program will provide access to more than 250 business-aligned programs at more than 40 educational institutions, including historical black colleges and universities, along with institutions serving the Hispanic community. In total, we plan to spend $200 million to offer this benefit over the next 4 years, serving as a meaningful example of how we're investing to promote opportunity and equity in our communities, beginning with our own team. So now before I turn the call over to Christina, I want to acknowledge the likelihood that the second half of the year will continue to be volatile, particularly in light of the ongoing uncertainty surrounding the Delta variant. Of course, safety remains our #1 priority, as evident in the way we operate our stores and our ongoing investments to encourage vaccinations by making them easy and accessible for both our team and our guests. In terms of our business, the last 18 months have proven, beyond a doubt, the flexibility and resilience of both our team and our business model. And while sales in stores have been soaring so far this year, our operations and team have demonstrated how they can pivot seamlessly between stores and digital commerce based on how our guests choose to shop. I also want to emphasize that as proud as we are of what we've already accomplished, we see many more productive opportunities to invest in continued growth. And I also want to acknowledge the continued high level of execution we've been seeing across all of our teams. As John will outline in more detail, despite unusually high volatility for well over a year now, the Target team has been consistently setting the industry standard in terms of execution despite multiple challenges in the external environment. Our team continues to embrace every challenge as one aligned Target team, taking care of each other as they focus on serving our guests. I am truly inspired by their work and grateful to share the outstanding performance they're delivering quarter after quarter, year after year. With that, I'll turn the call over to Christina.
A. Hennington:
Thanks, Brian, and good morning, everyone. Our guests is at the forefront of every decision we make. By listening intently to them, anticipating their wants and needs and building our strategy around them, we can drive deeper engagement, trust and a stronger preference for Target over time.
We built our same-day capabilities with that guest-first focus. And as we've shared before, when guests try services like Drive Up or Shipt for the first time, their overall spending increases, including an increase in conventional store shopping. In other words, digital engagement drives more engagement in our stores, providing us with more and more opportunities to surprise, delight and inspire them. This is one example of many showing how growth today creates a platform for additional growth in the future. And of course, we wouldn't be where we are today without the best team in retail. So I want to take a moment and thank our entire team for delivering superior performance in a continued volatile environment even as they face ongoing challenges presented by the Delta variant, product cost inflation, supply chain bottlenecks and more. Target's second quarter performance also demonstrates the strength and durability of our business model. Our unique, multi-category assortment offers the right balance of what our guests want and need even as they change, sometimes rapidly. As a result, despite record-setting growth last year, all 5 of our core merchandising categories grew again this year, proving that there's still plenty of runway ahead. Second quarter results were strongest in apparel, which delivered mid-teens growth on top of low double-digit growth last year. Within apparel, swim, kids and young contemporary all delivered comps in the low 20% range. Food & Beverage delivered low double-digit growth in the second quarter. Performance was led by our bakery, cafe and deli businesses, which grew more than 50% as these departments were closed during part of the second quarter last year. We also saw double-digit growth in our fresh categories, benefiting from an expansion in the number of items available for Drive Up. In fact, nearly half of this year's growth in our produce business has been driven by the growth in Drive Up orders. The Essentials & Beauty category delivered high single-digit growth this quarter. Within essentials, baby care grew by more than 20%, and we saw mid to high teens growth in both pets and health care. Beauty continued to gain market share on comp growth in the high single-digit range in advance of this month's rollout of our in-store partnership with Ulta Beauty. Hardlines delivered mid-single-digit growth this quarter on top of more than 40% growth a year ago. We continue to benefit from strong momentum in toys, which grew in the low 20% range. Sporting goods was also a standout with growth in the high teens. As expected, electronics experienced a moderate comp decline in the mid-single-digit range as it comped over last year's growth of more than 70% during a period when some competitors were closed. Importantly, over the last 2 years, both Hardlines and electronics have delivered strong growth and market share gains. And finally, in home, following comp growth of more than 30% last year, we saw a low single-digit increase in the second quarter. Within home, we've seen moderating trends in categories like kitchen, storage and decor as they comped over outsized growth last year. At the same time, given our guests' increasing focus on gathering and celebrating holidays and family milestones, we've seen an acceleration in our seasonal and stationary categories, providing another example of the power of our broad, multi-category model. And beyond individual categories, our diverse collection of owned brands continues to grow and provide differentiation across our assortment. In the second quarter, owned brand sales outpaced the company with growth in the mid-teens. And in Food & Beverage, where we're seeing tremendous growth in Good & Gather and encouraging results in our new brand, Favorite Day, we saw an increase in owned brand penetration of about 70 basis points compared with last year. As we look ahead, despite uncertainties around the Delta variant and rising COVID cases, consumers have healthy balance sheets and remain eager to find safe ways to connect with their loved ones and find some sense of normalcy. We'll continue to safely meet their needs and add some much needed joy. First on that list is this month's launch of Ulta Beauty at Target, the next chapter in Target's already strong beauty story. The shared values and cultures between our businesses and our collective desire to inspire and elevate the shopping experience make this long-term partnership a major win for both companies and our guests. And like our guests, we're incredibly excited to see this new concept come to life following months of anticipation. But our guests aren't just excited for their glow up to their beauty game, they're also looking for affordable options to refresh their wardrobe as they cautiously plan for more in-person interactions this fall. So it's perfect timing that this September, Target is partnering with 4 dynamic and highly regarded designers, Nili Lotan, Rachel Comey, Sandy Liang and Victor Glemaud, to create a limited time, size-inclusive apparel collection of modern and classic wardrobe staples. And our partnerships go well beyond apparel and beauty. In home, we've enlisted the talent of Justina Blakeney, Jungalow founder and long-time partner, to bring Junglalow's cozy, wild and free vibe into our Opalhouse line, making it the perfect addition to our eclectic owned brand. And for our littler guests, our newest design partnership is sure to inspire their imagination and help them to create some great new looks. Christian Robinson for Target, a full-of-wonder creation of the beloved artist, illustrator and children's book author, is a limited edition collection that includes home goods, apparel and books for kids and baby. And last, not least, for the furrier family members in your household, we have just launched Kindfull, our new pet food-owned brand focusing on healthy, sustainable and affordable food options for our beloved 4-legged friends. Beyond partnerships and product launches, our guests are telling us they're hungry to celebrate key holidays, life moments and everyday occasions with their loved ones, having missed out on so many of them over the last 18 months. So even as they're mindful of the ongoing risks, our guests are carefully balancing caution with optimism and focusing on finding safe and affordable ways to celebrate. Already in progress, the back-to-school and back-to-college seasons are off to a great start. Regardless of whether back-to-school will be in-person or hybrid, Target has everything they need to be successful in any learning environment. Similarly, as college freshmen look to move on to campus for the first time, our merchandising and inventory plans account for the fact that many sophomores find themselves in that same position, having attended their first year of college in a completely virtual environment. Given the stresses that come with the start of school, Target is focused on making things as easy as possible for families with School List Assist. This feature, online and in the Target app, allows users to easily find their school-specific supply list and either shop by item or add the whole list with a click of a button. And like we did for holiday last year, our back-to-school offers will be spread throughout the entire season, providing both value and a safe shopping experience for our guests. This reflects our ongoing focus on providing value that goes far beyond price. It's about affordability and accessibility all season long. And on that topic of providing value, we're rolling out new functionality in the Target app based on hearing from our guests that the fear of missing out on a deal is real, something affectionately known as promo FOMO. With this update, when guests add items to their cart, the app will automatically show them all the applicable Target Circle offers before checking out, reassuring them that they won't miss out on a great deal. Looking ahead, we'll soon be trading in shorts and t-shirts for cozy sweaters and denim as we usher in the fall. And for Halloween, no matter how you plan to celebrate, Target has a few tricks and no shortage of treats up our sleeves. We'll continue to focus on value and inspiration with affordable and exciting costumes, including a broader-than-ever array of adaptive, size-inclusive and gender-neutral options. And of course, we'll have all the sweet treats for self-indulgence and sharing with others, including great new offerings from our Hyde & EEK! and Favorite Day owned brands. Beyond our near-term plans, what energizes me the most is our focus on creating a more equitable, sustainable and inclusive world. This is why I'm so proud of our recently announced sustainability strategy, Target Forward, which is a comprehensive vision that touches every aspect of our business in support of people and planet. You've heard me talk about my role on Target's REACH Committee, which was formed with a goal of achieving lasting, systemic change for our black guests, team members and communities, serving as a perfect extension of the broader Target Forward strategy. The recruitment and retention of more diverse team members, more products from diverse suppliers, a new direction for our philanthropic efforts in communities of color and more equity for all, these are unwavering commitments in support of our goals. While there's much more to accomplish, I'm pleased with the progress we've already made. One example is our commitment to increase black representation across our company by 20% by the year 2023. To date, we've seen progress at all salaried levels, most notably in a nearly 25% increase among our company officers. So while it's incredibly rewarding to see how well our business is performing, I'm most proud of our commitment to invest in the long-term health of our team, our communities and the planet, our company purpose, focus on sustainability and then creating a more equitable and inclusive world. These are not a collection of separate initiatives tacked onto our core business. Rather, they are the bedrock of who we are and how we make decisions. While their benefit may be hard to quantify in a spreadsheet, I strongly believe that they're the foundation of how we'll grow our business, sustain our communities and move forward together over time. With that, I will turn the call over to John.
John Mulligan:
Thanks, Christina. As I've mentioned before, I'm an engineer by training. So it probably comes as no surprise that I'm naturally interested in machines and automation. And obviously, when our team works to optimize Target's operations, both for today and in the future, we have access to every available tool and technology, robotics, automation, machine learning, artificial intelligence and more. But when we choose to invest in technology, we're not looking to remove the human element from the Target experience. Instead, we're investing to enhance the productivity of our team members, freeing them up to focus on what's most important, like serving our guests.
This is another example of the power of and how it runs through every part of our business. The choice doesn't have to be about people or technology. We can invest in both people and their productivity. Here's one way to think about it. In our 2015 annual report, we reported that Target had around 341,000 team members as we entered 2016, a year in which our business generated just over $69 billion in sales. 5 years later, our 2020 annual report showed that we had about 409,000 team members going into this year, representing about 20% growth in the number of team members over that 5-year period. However, based on our results so far and our expectations for the back half of the year, our business is positioned to deliver more than $100 billion in sales this year, representing growth of 45% or more compared with 5 years ago. So even as we've added nearly 70,000 people to our team, we've also benefited from a significant increase in their productivity, creating financial capacity to provide enhanced service for our guests and make significant investments in pay and benefits. And as Brian mentioned, our team has been performing at an incredibly high level, raising the bar on historically strong execution. Specifically, in the second quarter, we saw an improvement in already high Net Promoter Scores for all 3 of our same-day services, most notably for the in-store pickup experience. In addition, Drive Up, which remains our highest-rated service, saw an increase in guest satisfaction compared with last year, on top of last year's improvements over 2019. And we continue to find ways to enhance our industry-leading pickup and Drive Up capabilities. In the second quarter, we added another 5,000 items to the assortment available for pickup and Drive Up, ranging from items in adult beverages to fresh pet food, meal kits and greeting cards. We also continue to roll out technology enhancements, including functionality to provide backup suggestions when an item is unavailable, a chain-wide rollout of numbered parking spaces for guests using Drive Up and the ability in the app to seamlessly designate an alternate person to pick up an order. Beyond same-day capabilities, we also saw a meaningful increase in satisfaction with our in-store shopping experience, driven by improvements across multiple attributes, most notably around team member interactions, both on the sales floor and at checkout. These increases reflect the impact of our new service initiatives, which focus on serving our guests on their own terms, while authentically bringing our company purpose to life through the guest experience. This spring, more than 300,000 team members completed training on these initiatives, offering them tools to provide a consistent, differentiated shopping experience regardless of how our guests choose to shop. Higher guest satisfaction scores provide clear evidence that our team has enthusiastically embraced this training as they build their confidence and expertise in establishing authentic connections with our guests. As Christina mentioned, our teams at headquarters have also done a great job as they navigate multiple challenges across the supply chain. And while we're happy that in-stocks have improved meaningfully compared with a year ago, we have more work to do as our guests are still seeing empty shelves on some occasions. In some of those situations, we've simply sold beyond our expectations, and our team is working quickly to secure additional quantities. In other cases, the vendors themselves are facing constraints in their ability to deliver product. And we're collaborating with them to address these constraints together, securing as much product as possible on behalf of our guests. And our team has been successfully addressing supply chain bottlenecks, which are affecting both domestic freight and international shipping. Steps include expedited ordering and larger upfront quantities in advance of a season, mitigating the risk that replenishment could take longer than usual. Bottom line, with Q2 ending inventory up more than 26% or nearly $2.5 billion compared with a year ago, we believe we're well positioned for the fall and ready to deliver strong growth on top of last year's record increases. In everyday life, when you see an artist, performer or athlete who's at the top of their craft, they typically make their work look simple. The mastery they've achieved makes it easy to look past all the effort and passion behind their high level of performance. That's true in business as well. When you see a successful company generating impressive growth on both the top line and the bottom line, it's easy to miss the passion and hard work of the team that's delivering that performance. So as always, I want to pause and thank our team members everywhere in the world for everything they do to propel our business forward regardless of the challenges that come their way. Our properties team has had a busy year as they ramp up our remodel program following last year's temporary suspension. In addition, they're working to open new neighborhood stores, distribution centers and sortation centers across the country. More than 100 remodel projects are currently in flight, and we're on track to complete about 140 remodels in 2021 and an even higher number in 2022. The team has also opened 19 new stores this year, spanning from 3 more stores in New York City to all the way across the country in Hollywood. We're on track to open 12 more stores this fall, including a new location in Orlando adjacent to Disney World, a new site in Hawaii and a campus location in Madison, Wisconsin, welcome news to all my fellow Badgers out there.
We opened 2 new distribution facilities in the second quarter:
1 in New Jersey and another near Chicago, creating additional replenishment capacity within our network. We're planning to add more capacity in 2022, given the sales growth we've already sustained over the last 1.5 years and the continued growth we expect to generate going forward.
And to support our ship-from-store capability, the team is getting ready to open 2 new sortation centers in October, followed by 2 more after the holidays. These new facilities offer faster delivery times at a lower cost in markets with a high density of shipments. In addition, they free up backroom space at store locations they serve, expanding capacity for more digital growth over time. And finally, in support of our commitment to being a net 0 enterprise by 2040, the team is driving towards 0 waste to landfill in our U.S. operations and improving overall energy efficiency as we transition to renewable energy. This includes investing in contracts for off-site renewable energy and additional rooftop solar projects as we move beyond our 2020 goal of having rooftop solar at 500 facilities.
So it's clear we have many opportunities to invest capital productively across both our stores and the broader supply chain. But I want to end my remarks where I started:
with our team. I've been at Target for 25 years now, and one of the many reasons I've stayed here is the way we've always invested in our team, creating a uniquely strong culture and a high level of engagement.
But in recent years, we've doubled down on what was already a strength. Obviously, this includes our investments in pay, including our starting wage, but it goes much further. We've also made investments in benefits and recently announced that several programs we added during the pandemic have now become ongoing benefits for all U.S.-based team members, including free access to health care through virtual doctor visits and free online resources and apps to support mental, emotional and physical health. And as Brian mentioned, in support of Target Forward's ambitions to advance opportunity and equity and create an equitable and inclusive workforce, we are really proud and excited to announce our new debt-free education assistance program earlier this month. We have the most comprehensive program in the industry, offering more than 340,000 team members debt-free access to undergraduate degrees, certificates, certifications and more, beginning with their first day at Target. Importantly, the program pays for smaller out-of-pocket costs, such as textbooks and course fees that might otherwise hinder participation. And for those who want to continue beyond their undergraduate education, the program will pay up to $10,000 annually for team members pursuing a master's degree. As Brian has said many times, of all the investments we've made over the last 5 years, none have been more impactful than the ones we've made in our team. And like any investment that's generating a high return, we continue to look for opportunities to do more, deepening our team's connection with Target, while they deepen Target's relationship with our guests. Because of the investments we've made over time, store team member turnover remains low at a time when the labor market has been heating up to levels we haven't seen in a very long time. That's one of the many reasons I'm grateful to serve alongside this great team, and I'm excited about what we can accomplish in the years ahead. Now I'll turn the call over to Michael.
Michael Fiddelke:
Thanks, John. After a record year in 2020, the theme of this year's performance has been growth on top of growth. Of course, we laid the groundwork for this year's growth through the investment decisions we were making years ago in our stores, owned brands, supply chain, technology and our team. And today, we continue to see a host of opportunities to invest in our future. That certainly includes the capital we're investing in support of our stores and supply chain and the investments we're making in our team, including recently announced team member bonuses and our new debt-free education assistance program. And while the return on team member investments isn't measured as a distinct line in our financial statements, they're the most important investments we make.
Total sales grew 9.4% in the second quarter, driven by comp growth of 8.9%. Within the quarter, May saw the smallest increase this year, given that it was comping over a 33% increase a year ago. On a 2-year basis, results were much more consistent throughout the quarter, as we saw 2-year growth in excess of 30% across all 3 months. As Brian mentioned, with guests spending more time out of their homes, we've seen them shopping more often and making slightly smaller trips. Specifically, traffic grew 12.7% in the second quarter, partially offset by a 3.4% decline in average ticket. However, given that last year's comp growth was primarily driven by average ticket, on a 2-year basis, we've seen double-digit increases in both traffic and ticket since 2019. As Brian also mentioned, the store channel has been our primary growth driver this year. Specifically, store comparable sales grew 8.7% in the second quarter. And given that store comps increased 10.9% last year, we've seen compounded growth of our in-store sales of more than 20% over the last 2 years. In the digital channel, comp sales grew 10% on top of 195% a year ago. And reflecting this year's change in guests' shopping habits, the mix of our digital fulfillment changed meaningfully. Specifically, same-day services grew 55% in the quarter, while sales on orders shipped to home actually declined from last year's elevated levels. This provides vivid evidence of the stickiness of our same-day services. Once guests try them, they love them. So even as they've ramped up their in-store shopping, they've continued to rely on these services as well. Another indication of this year's shift in guest behavior, the percent of total sales from the digital channel actually fell slightly compared with last year, moving from 17.2% in second quarter 2020 back to 17% this year. Obviously, this isn't a trend we expect will continue over time, and it's important to note that this year's digital penetration of 17% is well over double the 7.3% we reported in second quarter 2019. Our second quarter gross margin rate of 30.4% was down about 50 basis points from 30.9% a year ago. Among the drivers, last year's change in the sales return reserve estimate, which contributed about $110 million to second quarter gross margin last year, accounted for about 50 basis points of rate pressure this year. In other words, without last year's benefit from this change in the reserve estimate, our second quarter gross margin rate would have been about flat compared to last year. Among other gross margin drivers, we saw about 70 basis points of pressure in merchandising, reflecting the impact of higher product and freight costs, partially offset by the benefit of low markdown rates. This pressure was offset by about 40 basis points of tailwind for merchandise mix, combined with a small benefit from supply chain and digital fulfillment, driven by the shift in digital mix toward our less costly same-day options. On the SG&A expense line, we saw a rate of 19.3% this year, down about 10 basis points from last year. This change reflected the continued leverage benefit from strong sales growth, offset by pressure from an increase in some expense rates in areas like marketing from lower-than-normal levels a year ago. This year's SG&A expenses also reflect continued growth in pay and benefits for our team. On the D&A line, we saw about 20 basis points of rate improvement from last year, driven by leverage on our sales growth. Altogether, second quarter operating margin rate was 9.8%, down about 20 basis points from a year ago, but more than 2.5 percentage points higher than second quarter 2019. On the bottom line, our second quarter GAAP EPS of $3.65 was 8.9% higher than a year ago, and adjusted EPS of $3.64 was 7.9% above last year. Second quarter GAAP and adjusted EPS have both doubled over the last 2 years. So far this year, our operations have generated just over $3.4 billion of cash. This is historically strong performance, but about $1.7 billion lower than a year ago due to some unique circumstances affecting last year. Specifically, our inventory position at the end of the second quarter last year was much lower than we'd have preferred given that our sales had far outpaced our expectations during the first half of the year. As a result, at this point last year, inventory turnover and payables leverage were running unusually high and would have been lower had we owned the appropriate amount of inventory to support our sales. As such, this year, our inventory is in a much better position, more than $2 billion higher than last year. And our payables leverage has begun to decline to a more sustainable level, both of which are near-term headwinds to operating cash flow. In addition, our year-to-date income tax payments are more than $1 billion higher than at this time last year, given the volatility in our taxable income through the first half of last year. As I turn to capital deployment, I want to start where I always do, which is to reiterate our priorities, which have remained the same for decades. First, we invest fully in our business in projects that meet our strategic and financial criteria. Then we look to support the dividend and build on our record of annual dividend increases, which we've maintained every year since 1971. And finally, we return any excess cash over time through share repurchases within the limits of our strong middle A credit ratings. So far this year, we've invested just over $1.3 billion in CapEx to support the new store, remodel and supply chain projects that John outlined earlier. And for the year, we're now expecting CapEx in the $3.5 billion range. This is about $0.5 billion lower than our original expectation and reflects the retiming of some project spending into next year. As a result of this retiming, our view of next year's CapEx is somewhat higher than our prior view, in the $4 billion to $5 billion range. And we'll continue to refine our view as we move into next year. Bottom line, we're excited about the productive opportunities in front of us and we'll govern our investment decisions with a focus on delivering continued growth and superior returns. Beyond our capital investments, we paid dividends of $336 million in the second quarter, and we returned another $1.5 billion through share repurchases at an average price of just over $230. And as we announced today, our Board has approved a new $15 billion share repurchase authorization, which will allow us to continue buying back shares once the current $5 billion program is completed. This authorization is consistent with the capital deployment priorities I outlined above. It also reflects our confidence in the ongoing strength of our business and the robust cash flow we expect to generate over time. Even after this year's investments in our business and team and the return of capital to our shareholders, we ended the second quarter with cash and cash equivalents of about $7.4 billion. This is up slightly from a year ago and well above the cash position we expect to maintain over time. But as I've said before, given our current cash position and elevated volatility in the current environment, we believe it will be a multiyear journey before our exceptionally strong cash and credit metrics move fully back to long-term levels consistent with our single A credit ratings. Before I turn to our expectations, I want to close my review of our current performance with a brief discussion of our after-tax return on invested capital, which measures the performance of our investment decisions over time. For the trailing 12 months through the end of the second quarter, Target's after-tax ROIC was 31.7% compared with 17.2% a year ago. This is an amazing number and a testament to the performance of our business model and our team over the last year. As we've said before, we expect this metric could settle back into the mid to high 20s over time, but to deliver a sustainable after-tax return in that range is a remarkable performance in any industry. And these superior returns are one of the many reasons we're eager to continue investing in the growth and resilience of our business to the benefit of all of our stakeholders. Now let's turn to our comp sales expectations for the fall season. As you'll recall, in our conference call 90 days ago, we described how our business was positioned to deliver single-digit comp growth in the back half of the year, on top of very strong growth of more than 20% in the back half of 2020. While the environment remains volatile today, and there are many uncertainties as we look ahead, Target's performance through the first half of the year has consistently exceeded our expectations. This performance, combined with the continued strength in the U.S. consumer, gives us increasing confidence that this fall, our business can generate comparable sales growth in the high single-digit range, near the high end of our previous guidance range. We have a similar outlook regarding profitability. 90 days ago, we said we expected our full year operating margin rate would be well above the 2020 rate of 7%, with a potential for it to reach 8% or somewhat higher. From today's perspective, based on our expectation of high single-digit comp growth in the fall, we expect to see an operating margin rate near the high end of our previous range. Specifically, we now believe that Target is positioned to deliver an operating margin rate of 8% or higher for the full year. I've been at Target for more than 17 years now, and I've never experienced a time like this when every aspect of our diverse strategy is coming together like we're seeing today. Obviously, our guests are noticing, too, based on their higher level of engagement, which you can see in our outstanding performance. Typically, in retail, if you saw a large, mature company like ours growing at the rate we're seeing today, you'd assume we were comping over soft numbers from the prior year. Instead, we're comping over a year of record growth in 2020 on both the top and bottom lines. Like Brian said earlier, our success begins and ends with the team. So on behalf of all of our stakeholders, I'd like to close my remarks today by thanking the entire Target team for the exceptional results we're reporting today. Now I'll turn the call back over to Brian.
Brian Cornell:
Thanks, Michael. Before we move to your questions, I want to pick up on Michael's last point, which is the way we've been able to synchronize every aspect of our strategy. A few years ago, we embarked on a project to better articulate our company purpose. Across our team, there was already a strong sense of who we are and what we stand for, but we wanted to put it into words distinctly.
Out of that work came the purpose we articulate today:
to help all families discover the joy of everyday life. Those words have deep meaning for our team
Some might ask if everyone at Target already had a strong sense of purpose, why go to the trouble of putting it into words? The answer is the alignment that it creates, alignment of our strategy and alignment of our team. In the same way we had a focus on what really matters most in our articulation of our purpose, we're relying on that purpose to focus both our strategic work and our everyday activities. If we find ourselves working on something that doesn't advance our purpose, we can set it aside and relentlessly focus on the things that will move Target forward. That kind of focus has enabled the performance we're reporting today, and it's behind all of our investments, strategies and activities as we look ahead. With that, let's move to Q&A. Christina, John, Michael and I will be happy to take your questions.
Operator:
[Operator Instructions] Our first question comes from Chris Horvers with JPMorgan.
Christopher Horvers:
Two questions. My first question is, can you talk about what you're seeing in back-to-school so far? Are you seeing any effect from Delta on purchasing patterns? And how are you thinking about growth in the different categories as you move forward relative to the second quarter?
Brian Cornell:
Chris, we're off to a really strong back-to-school start, and it is broad-based right now. Christina and Michael, John and I were out in stores yesterday, and we were seeing guests shopping our entire back-to-school assortment. I think we've got a great assortment at a tremendous value, and we're off to a really strong back-to-school and back-to-college season.
Christopher Horvers:
Got it. And then a follow-up, Mike, on the gross margin. Can you talk about how you're thinking about the gross margin in the back half overall? And within that, what are the puts and takes? Does that -- do the product and freight headwinds persist or perhaps elevate? And to what degree are you assuming higher clearance and promotion levels to drive the 8% or more operating margin outlook?
Michael Fiddelke:
Yes. Chris, you've heard us talk over time about all the levers we have within the business to offset some of those puts and takes. And I think the second quarter is a really good example of that. If you take out the sales return adjustment in last year's actuals, margins were essentially flat year-over-year. And so we found some good offsets there and feel really good about our profit performance.
I actually think that same theme comes through loud and clear if we zoom out a little bit and look at a longer time period. If you go back to first half of this year versus first half of 2019, 2019 gross margin rate was 30.1% for the Q1 and Q2 season. We're sitting at 30.4% right now in Q2 and 30.2% for the spring. And so a lot's happened over the last 2 years, and we feel really good about our ability to manage the profitability of the business. And I think that bodes well for the back half of this year and beyond.
Operator:
The next question is from Paul Lejuez with Citi.
Paul Lejuez:
Two quick ones. Just curious on the inflation front, if you can maybe talk about the cost pressures that you're seeing in the food grocery category versus general merchandise, any quantification that you might be able to provide.
And also wanted to go back to private label performance. You mentioned it grew faster in 2Q. Curious what sort of the gross margin tailwind that provided. And how do you see private label performance playing out in the second half? Is that going to be a continued gross margin driver for you?
Brian Cornell:
Well, let's have Christina talk about the strength we're seeing in our owned brand performance and how we're managing costs in this environment.
A. Hennington:
I'd be happy to take that one. Let's start with owned brands. As you know, owned brands are a huge part of our strategic imperative and desire to continue to differentiate in the market, bring great quality products to our guests. And so our commitment is to continue to accelerate our owned brands at a faster rate than our base, and that is what exactly what we saw in the second quarter. That's the pattern we've been on. And as long as we continue to find unique opportunities to meet the guests' needs, that's going to persist.
And so you also know that owned brands represent a big portion of our sales mix, but even a bigger portion of our gross margin. So that creates tailwind for us on the profit side. And then going back to your first question on costs, yes, we're seeing cost pressures on product costs as well as freight. But going back to Michael's point, this is what we do every day. We manage the profitability of the business by leveraging the full suite of levers that we have to offer great value to our guests while delivering on the financial expectations you have.
Operator:
The next question is from Karen Short with Barclays.
Karen Short:
So I wanted to just ask, you look at your sales productivity, you're up more than 40% on a sales per square foot basis since 2017. So I guess what I'm wondering is, with this higher productivity, how should we think about kind of the long-term margin structure? Or maybe said a little differently, would you look to lean into investments going forward? Or could we expect a little more sustainability in terms of the higher operating margin structure?
Michael Fiddelke:
If I step back from your question a little bit, Karen, at the end of the day, growth powers so much of our margin equation. And that's why we're so focused on investments that drive growth. And you can certainly see that in the improved productivity. That comes to bear. And the math we do on new stores, that comes to bear for how we adjust our store footprint in a remodel. And so you'll see us consistently focused on investments that drive growth. With that growth comes good productivity on a per square foot basis, and we can translate that growth to good bottom line profit.
Brian Cornell:
Karen, Michael summarized it well. I mean our theme for this quarter was growth on top of growth. But you should expect that theme to continue going forward. We're going to continue to invest in our stores. John talked about the remodel plans that we have in place. We'll continue to invest in new, highly productive stores, invest in our brands, invest in our fulfillment services and invest in our team. And our focus on continuing to drive consistent growth and market share expansion quarter after quarter will be a theme you'll hear for years to come.
Karen Short:
Okay. And then just you also commented on the 70 basis points of gross margin pressure from higher product and freight costs. On the product front, can you maybe just give a little color on what you're seeing on the cost inflation versus the retail inflation? And are you absorbing some of that cost inflation?
Michael Fiddelke:
Yes. I think Christina said it well, our teams are experts at managing the puts and takes across the business. So if we rewind the clock a couple of years ago, we'll be talking about tariffs and how we offset that. And I feel really good about how our teams manage any complexity in the business.
To underscore something Christina also said, value matters, and we'll be laser-focused on making sure our guests find incredible value on our site and in our stores. And so we've done a lot of hard work to invest in solid price perception. And we want to make sure that our guests continue to find that value going forward, inflation or not.
Operator:
The next question is from Scott Mushkin with R5 Capital.
Scott Mushkin:
I guess the first one I have is, obviously, you're holding a lot of cash on your balance sheet. You guys talked about the new share repurchase. But what is the ideal level of cash for you guys to hold? And what do you do with what you got now, I guess, in more of the short term?
Michael Fiddelke:
Yes. Well, the answer to that question, priority 1 has been and always will be invest in the business. And continuing to invest to drive growth is the first use of that cash. Our second capital priority is to support the dividend. We announced just last month a north of 30% increase in our per share dividend. And we have the good fortune of a business that continues to generate a lot of cash as we grow. And so that gives us capacity for share repurchase as well.
Over time, you'll see us carry less cash than that $7.4 billion we have today to be sure. Optimal and normal times, it's something closer to flat to a little north of that cash on the balance sheet, depending on the period of the year we're in. But we want to be prudent about how we kind of step back into the sweet spot of our middle A credit ratings.
Scott Mushkin:
Okay. Great. And then my second question is really, I guess, more strategic over the next 12 to 18 months. Brian, I think you went over just what tremendous work the team has done. But if you step back and look at the next 12 to 18 months, what are the biggest, I guess, initiatives going forward that would drive outsized growth, that market share gain compared to competitors?
Brian Cornell:
Scott, It will be a very familiar theme to you. We're going to continue to invest in remodeling our stores. And despite the progress we've made, and we've remodeled just about half our stores today. So you'll continue to see us invest in remodels.
We've got a very strong pipeline of new stores that we'll be rolling out over the next few years. We'll continue to invest in our brands and our owned brand performance. You'll continue to see us continue to invest in Drive Up and pickup and the expansion of Shipt. And we'll continue to invest in our team, again, all built around that thematic of growth. And as we think about the key metrics going forward, you'll hear us talk about traffic, and we felt exceptionally good this quarter about driving traffic growth of almost 13%, continue to drive strong comps in both our stores and digital channels. And we'll continue to make sure we always are laser-focused on market share gains. So those themes will be very consistent going forward. The investments we make in our stores, our brands, our fulfillment channels and our team will continue to drive traffic to our stores and visits to our site, continue to drive strong comps that equate to market share gains across our entire portfolio. So that's our continued commitment for not just the next few quarters but for years to come.
Scott Mushkin:
Perfect. And what a tremendous job you guys have done.
Operator:
The next question is from Michael Lasser with UBS.
Michael Lasser:
Target continues to see outsized gains in traffic. Over the last 90 days, has there been any change in the nature of the pattern of traffic, more weekly traffic versus weekend, especially as consumers go out and travel and do other activities? And how are you expecting your traffic to unfold over the next couple of quarters as you guide to high single digits for the back half of the year?
A. Hennington:
Michael, maybe I can jump in on this one. Traffic has been very consistent, and it's been consistently strong. And we're very excited about the early momentum in back-to-school and back-to-college as well. What I would tell you is that the strength of our portfolio allows us to flex between patterns in consumer behavior changes that are more at the micro level, not at the aggregate level. The aggregate has been consistent and healthy.
But there are behavior changes within businesses. We've talked about the fact that last year, there was a bigger need for household essentials and people were stocking up. Now we're seeing less of that, and we're seeing more the return to going out. And therefore, they're wearing dresses and beauty products, and luggage business has been very strong. So there are patterns underneath, but the macro and aggregate is that Target is outpacing the industry. And it's really led by broad-based strength across all of our businesses.
Brian Cornell:
And Michael, I would just come back to -- I know there's been lots of questions about the impact of the Delta variant. And we watch this very carefully. We're obviously very focused on safety. But we continue to see a very optimistic consumer, certainly shopping with caution and they're wearing masks more and more across the country. But we're seeing tremendous resilience in the consumer today. And our traffic patterns, I think, represent that, as we see this consistent flow of traffic into our stores. So a very resilient consumer. And we're seeing that as we start the third quarter. That traffic pattern and that resilience is continuing.
Michael Lasser:
My follow-up question is, after 1.5 years past the start of the pandemic, you've comped the comp, you've seen really sizable returns on the investments that you've made and you've entered into a stable operating rhythm. So why wouldn't Target now be able to sustain at least an 8% operating margin over the long run? Is there something unique about this current environment such as a low level of promotional activity that might return in the future that would weigh on Target's profitability?
Michael Fiddelke:
Yes. So Michael, there's always something unique in the environment. I can't remember one of these calls where there wasn't a specific good guy or bad guy on the margin line we weren't talking about. And so I think what matters most is our ability to put together a P&L that hangs together great, and that always starts with sales growth.
And so while we aren't in a position today to share a new algorithm, go forward, we'll be centered on continued sales growth and continued market share gains. And with those, I'm confident in our team's ability to put together a P&L that translates into a bottom line we'll all feel good about.
Operator:
The next question is from Edward Yruma with KeyBanc Capital Markets.
Edward Yruma:
I guess, first, just to click down a little bit on the ship-to-home that you said was negative, was that just a symptom of kind of tough compares and the decision with consumers see that same-day digital services?
And then I guess as a broader question between the really strong growth you've had in Target Circle and your digital businesses, you have a lot more data on your consumer today. I guess how are you acting on that on a real-time basis? And kind of what have you learned?
John Mulligan:
Ed, this is John. On the ship-to-home, I think you hit right on it, there's really 2 things going on. Just tremendous growth last year in ship-to-home at -- particularly early in the second quarter last year. So very, very strong growth, and we're just comping over that.
I think the second thing, and probably more importantly, is the continued growth in our same-day services, tremendous growth in Shipt, in Order Pickup and Drive Up. And the growth in Drive Up is truly remarkable, but the one I like to look at is Order Pickup. We started that 6 years ago, and it continues to grow meaningfully quarter after quarter, year after year after year. So all 3 of those are acting incrementally each year and not taking business away from each other. And as you know, the thing we love about that, it's great service for our guests. They're our highest-rated services. Drive Up is the single highest-rated service we have. But also for us, it's fast and very, very efficient. And we love the margin that comes along with those products. So as we've grown our digital businesses over the last several years, and in particular over the last 18 months, the same-day services have grown significantly faster, and that's good margin for our digital business.
A. Hennington:
And Ed, I can jump in on the Target Circle component. As you accurately reflected in your question, it's been a great program for us, and we're up to over 100 million members in Target Circle, 100 million. It's quite substantial. And what primarily this is about is obviously making sure that we are more relevant to our consumer in giving them great deals, more personalized offers and relevancy that they appreciate.
And so as an example, in the second quarter, guests benefited from $70 million of savings from the 1% earnings on purchases plus another $600 million worth of savings from the promotional offers. So in our commitment to offer affordability, accessibility, Target Circle is just another amazing proof point that we'll keep building on.
Operator:
The next question is from Steph Wissink with Jefferies.
Stephanie Schiller Wissink:
Congratulations on the results. My question is about the second half OpEx, and just trying to bridge your comments on operating margin for the year to the second half plans on a year-over-year basis. And I think, Christina, you might have mentioned that marketing as a focus for the back half. Maybe talk a little bit about how much you spend on emphasizing your same-day services versus how you plan to communicate to the consumer your value message in some of your key categories of emphasis.
Brian Cornell:
Steph, I might start. I think you've actually answered the question for us. You'll see us balance our messaging in the holidays around obviously, affordability, great value. We'll certainly emphasize our same-day services, and we know how important they'll be for the guests during that holiday season, and the strength of our multi-category assortment. So it will be a very steady stream of great product news, great service news and will underscore value.
Operator:
And does that conclude your questions?
Stephanie Schiller Wissink:
I did have one follow-up. I'm just trying to understand the OpEx spend for the back half. Could you just give us some context around, is that the step-up in marketing is what we're seeing in terms of the year-over-year offset versus prior year? Is there something else happening in operating expenses if gross margins are going to be flat, but operating margins are going to be down a bit to the prior year?
Michael Fiddelke:
Yes. We aren't getting into the specifics for gross margin or SG&A. It's all wrapped into our expectation for that OpEx line on the year. And similar to the second quarter, I expect you'll see some puts and takes. I mean one of the things we're excited about in Q2 is to get back to a more normalized level of marketing spend because we kind of had to put our foot on the hose last year as we changed course in the early stages of the pandemic. And so we feel good about returning to what I view as a really healthy level of marketing investment that should power growth in the back half of the year.
Operator:
The next question is from Robby Ohmes with Bank of America.
Robert Ohmes:
I was hoping you could comment on how much more items you have to go to add to Drive Up. So I think you guys said 5,000 items were added in 2Q. How much more is there to go on Drive Up that can kind of keep driving that super growth of that business?
And then kind of related to that, grocery, you added a lot of fresh items on Drive Up. Did you add a lot of fresh items in general to the grocery mix? And maybe can you speak to how much further Target can go on grocery? I know historically you've said you're not really a full grocery destination. But are you moving towards adding enough items to be more of a full grocery shop?
John Mulligan:
Robby, first on the Drive Up question, I think there's 2 things there that really are driving growth. First is category expansion, like you said. And we continue to work our way through the through the categories there. There's work for us to do. We'd like to add things like clearance to Drive Up. And we'd like to add returns to Drive Up. And so I think there's a lot further we can go there from a category or product perspective.
The other side is just improving the service itself, and you'll see us continue to do that. We added more Drive Up locations. We're adding canopies to help with the weather. We added numbered parking lots so that we can find your black SUV among the 12 black SUVs that sit out in our parking lot waiting for Drive Up at any given time. And we added substitutions. And we added the ability to add another driver to come do your pickup order for you. So I think you'll see us continue to innovate the service as well. So we see a long runway for us to continue to improve driveway (sic) [ Drive Up ]. And at the core of that, of course, is continued high execution from our store teams which leads to very, very high NPS scores that we see in Drive Up. And Christina, I'll let you talk about the food assortment.
A. Hennington:
Yes. The Food & Beverage business has been a real source of strength for us and continues to do exceptionally well, including our owned brands that we have launched. Good & Gather and Favorite Day are growing because they're just so relevant. They taste delicious. They look great. They're across the whole portfolio, and guests are finding them easily amongst the assortment.
On your question about, is the assortment expanding? Or is it really the expansion on to Drive Up. The assortment is always going to be a curated point of view. But when a guest starts in the digital experience rather than the physical experience, there is much more understanding of who we are, and they quickly are converting because of that convenience in Drive Up to Target Food & Beverage. And I think you will see a lot of upside in the future from the success that we've built over the last several years in this business.
Operator:
Our last question is from Kelly Bania with BMO Capital.
Kelly Bania:
Just wanted to ask another question about EBIT margins clearly coming in higher than expected for the year. But just looking at the first half of 9.8%, it suggests something in the low to mid-6% range for the second half. And I realized Target's typical cadence is for lower EBIT margins in the second half, but this seems -- the magnitude of this deceleration seems to be about twice as much as the historical pattern. So just trying to get a sense of conservatism or costs in the back half. You called out the marketing expense, or just what you're planning for promotional activity in the back half. Maybe any color you could help with that.
Michael Fiddelke:
You're right, Kelly, there's some seasonality to how profit flows through our P&L quarter-by-quarter, spring versus fall. We feel really good about the back half of the year and the growth we expect to deliver, and we think that yields 8% or north-of-there operating margins for the year. And so while getting too precise on any specific line, I think, would be an exercise in imprecision right now, we're really confident we'll be able to put that all together for a profit rate in the back half of the year that we feel good about.
Brian Cornell:
Well, operator, that concludes our second quarter call. Thank you for joining us today. Enjoy the rest of the summer, and we look forward to talking to you later in the year. Thank you.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation 2021 First Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, May 19, 2021.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our first quarter 2021 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 the first quarter and their thoughts on our outlook for the second quarter and beyond. Following your 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, the most important of which are described 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 first quarter and his perspective on our outlook. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone.
The first quarter felt like a first step towards a post-pandemic world. And our team and operating model continues to walk alongside our guests and communities, serving them well through another chapter of growth and healing. From our unique mix of categories, to our unmatched set of fulfillment options, our business is delivering what consumers want and need each and every day. The results we delivered in Q1 are nothing short of outstanding. Comparable sales grew by nearly 23%, making our fourth consecutive quarter in which comp sales grew more than 20%. Maintaining that pace this quarter was especially notable, given that we were comping over double-digit growth a year ago. Over the last 2 years, comp sales have grown about 36%. And total sales expanded by $6.5 billion in the first quarter alone. This year's sales growth reflected more than $1 billion in market share gains, a clear signal of how relevant guests find our experience even though they have many more shopping options available compared with this time last year. In a quarter featuring many things to celebrate, I'm most proud of the performance of our stores. With vaccinations rolling out across the country and consumers increasingly comfortable venturing out, we've seen an enthusiastic return to in-store shopping. Guests are happy to come back to our stores because they love the environment we've created and invested in over time. As a result, our store comp sales increased 18% in Q1, driven almost entirely by higher traffic and accounting for the vast majority of our growth. Contrast that to a year ago when the channel mix of our business was changing rapidly, with guests leaning heavily into our digital fulfillment options, essentially our same-day services in the midst of a nationwide lockdown. A year ago on this call, we were highlighting a digital comp of 141%, driven by growth in our same-day services of more than 275%. These 2 contrasting scenarios clearly demonstrate the flexibility of our operating model. But they also show how our stores and digital channels complement each other to drive guest engagement. Even though digital stole the headlines a year ago, our store comps actually increased about 1% in the first quarter last year. And this year, while store sales accounted for most of our growth, first quarter digital comp sales also grew 50%, on top of last year's enormous numbers. This is the power of 'and'. Guests turn to Target because of our stores and our digital options, not one versus the other. And for us, the distinction between a store sale and a digital sale is largely irrelevant. Because of our unique stores-as-hub model, more than 3/4 of our first quarter digital sales were fulfilled by our stores. That means, in total, more than 95% of Target's first quarter sales were driven by our store assets, store inventory and store teams. This store-driven growth is translating to outstanding bottom line performance. Our first quarter adjusted EPS of $3.69 established a new all-time high for the company. Compared to 2020 when profitability took a temporary dip, this year's performance represents an astounding increase, more than sixfold. If we look back to first quarter, this year's adjusted EPS was more than 140% higher, demonstrating how far our business has advanced in a short time. I want to pause here and thank our team members across the world. They have consistently demonstrated incredible passion, commitment and focus to serve our guests and take care of each other. I am grateful and proud to serve with this outstanding team and to share the incredible business results they're delivering quarter after quarter. It's also important to highlight how the category mix plays a key role in the flexibility of our model. For instance, with guests venturing out, we've seen an incredible rebound in apparel sales, with Q1 comp growth of more than 60%. On the other hand, and as expected, we experienced lower growth in Food, Beverages and Essentials, as we annualized the peak stock-up period a year ago. Most notably, we saw continued strength in our Home and Hardlines categories, which delivered outsized growth on top of very strong numbers a year ago. Christina will provide more details in a few minutes. A relentless focus on operational excellence is another key factor in our performance. This is best summarized by our guest satisfaction scores, which across all of our services, have remained stable or moved higher despite record growth that's now compounding on a 2-year basis. This is a clear testament to the diligence of our team and the return on our investments in training, hours and wages over the last several years. Over those years, sales in our same-day services, order pickup, Drive-Up and ship have accounted for the bulk of our digital growth, and they grew to well over half of our digital sales in the first quarter. Same-day penetration has more than doubled since Q1 of 2019, when sales through these services accounted for less than 1/3 of our digital sales. While all 3 same-day services continue to grow faster than overall digital, Drive-Up has been a standout and consistently receives the highest ratings of anything we do. This service only accounted for about 5% of our first quarter digital sales 2 years ago, and that ratio expanded to more than 30% this year. Put another way, in the first quarter alone, Drive-Up sales have grown by well over $1 billion in the last 2 years. As John will outline in more detail, we continue to expand the assortment available for Drive-Up, and we've earmarked capital investments to make Drive-Up even more convenient for our guests and efficient for our team, given that we anticipate continued rapid growth of this service. While it's gratifying to see what our team has accomplished over the last several years, there is much more opportunity in front of us. We're planning significant investments in our store assets, as we remodel hundreds more locations, roll out new Ulta and Apple shopping environments, invest in the efficiency of our same-day services, and enter new neighborhood by opening new small- and medium-sized stores we're also investing in our brand portfolio, as we focus on presenting the best owned and national brands to our guests, which we highlight through the best in-store and digital shopping experience in the market. We're also making continued investments in safety and cleanliness, reinforcing the trust and confidence we've already established with our guests. And we continue to invest in our team, in their pay, benefits, training and advancement, to ensure that Target continues to be a destination for top talent. And as you've seen from many of our recent announcements, we're investing to leverage our size and scale, purpose and values to work for all families. This summer, we'll share more information about our refreshed enterprise sustainability strategy that further draws on our company legacy of corporate responsibility, diversity and inclusion, and community engagement. As part of our immediate efforts, we'll focus on designing and elevating sustainable brands, innovating to eliminate waste, and accelerating opportunity and equity in all communities, all in service to a safe and prosperous future for all. It was 4 years ago, at the beginning of 2017, that we first announced our plan to double down on investments and growth. The decisions we announced that day and the investments we made in the intervening years left us well prepared to handle all the challenges and opportunities presented by the pandemic. In that first quarter of 2017, our business generated sales of just over $16 billion and adjusted EPS of $1.21; 4 years later, first quarter sales have grown nearly 50% and adjusted earnings per share have tripled. From today's vantage point, the opportunities ahead of us, both this year and over time, are just as bright as they were on that day 4 years ago. Despite what's already been accomplished, we've only scratched the surface of what this brand and this team can accomplish over time. I'm excited to stand with them as we write the next chapter in this great company's history. Now I'll turn it over to Christina, who will share more perspective on our first quarter results and for priorities going forward. Christina?
A. Hennington:
Thanks, Brian. As we enter 2021, we knew it would be a year like no other. That's because we're coming off of 2020, which was, by far, the most unusual year any of us have ever experienced. As such, we knew there'd be a wide range of potential outcomes for our sales, both by category and in total. And so far, with one quarter behind us, results have been extremely positive across every dimension.
In the face of this strength, we've seen an incredible response from our teams across the board, from our stores, to our merchants, to the supply chain, who've all worked together in service of our guests. While there are many ways to measure the impact of those efforts, guest loyalty and market share are the 2 most important measures of success in this volatile time. Consequently, it's incredibly gratifying to see that across every one of our guest segments in the first quarter, we measured an increase in average trips per guest and a larger average basket. This led to more than $1 billion of additional market share in the quarter, on top of $1 billion gain a year ago. In terms of category performance, we saw the strongest growth in our Apparel business, which delivered comp growth in the low 60% range. As Brian mentioned, we saw a temporary dip in apparel sales last year, when first quarter comps were down around 20%. Following this year's strong increase, first quarter apparel sales have grown approximately 29% over the last 2 years. Home also delivered incredible growth with an increase in the mid-30% range, on top of a high single-digit increase a year ago. Within Home, growth was strong across the board, with the most robust performance in our decorative home and seasonal businesses. Hardlines also delivered huge volume, with comp growth above 30%, on top of a 20% increase a year ago. Results were led by sporting goods and toys, which both saw comps above 40%. Beauty comp in the high teens, on top of a high single-digit growth a year ago. Within Beauty, the skin care, sun care and bath categories delivered comp growth in the mid-30% range, with cosmetics growing in the low 20s. Finally, our Essentials and Food categories both delivered comps in the low to mid-single digits. To see healthy growth on top of last year is remarkable as you'll recall that a year ago, guests were aggressively stocking up their pantries, fridges and freezers, and we sold virtually every unit of paper goods that we owned. Beyond category strength, I want to pause and also highlight that sales on Target's own brands grew approximately 36% in the first quarter, the strongest increase we've ever recorded. Because of our unique capabilities in product design, development and sourcing, our own brand products offer an unbeatable combination of design, quality and value. These brands aren't something that our guests pick up while they're at Target, they're a big reason why they shop at Target, which is why we continue to invest in them. We frequently talk about performance by category and our brands because it's important that our entire portfolio is healthy and well positioned to meet our guest needs. But it's also important to realize that they create value for our guests beyond simply the sum of the parts. Rather, it's the combination of all our offerings, including categories, brands and services across our distinct multichannel experience, that allows Target to serve our guest needs today and over time. Last year, as guests focused more on enjoying time at home, that had implications not just for our Home category, but also for Hardlines, Food & Beverage and Essentials. And their focus on health and well-being affected trends in activewear, Beauty, health care, Food & Beverage and more. The same is true for our sales channels. As guests last year focused on social distancing, they leaned into digital, including our same-day services. And this year, as they're looking to get back out in public, they're flocking to our stores, based on the trust we established over time, which was further reinforced by last year's investments. So as we plan the remainder of the year, both in total and by category, we continue to listen closely to our guests to understand how they're thinking and feeling. And when we talk to our guests today, they tell us they want to maintain some of the new habits and routines they formed during the pandemic, including an enhanced focus on the joy of home and health and well-being of their family. At the same time, there's a rapidly emerging emphasis on style and mobility as guests feel increasingly safe in public spaces. That trend is playing out in an explosive demand for dresses and cosmetics as well as luggage and categories based on being active like sporting goods and Performance Activewear. This reinforces the concept of 'and'. Target can fulfill our guests' needs as they focus on home and health and when they look to venture out. We can welcome them back into our stores and continue to serve them with the same-day services they've recently tried and now love. So after a record-setting first quarter, we're keeping our foot on the gas, based on our guests' desire to bring rejuvenated life and energy to their homes, celebrate seasonal moments with loved ones and step out in public. I could not be more excited about the ways we're ready to inspire and energize our guests. Just last week, we launched our latest limited-time collection, Hilton Carter for Target. Off to a great start, this collection features live plants, foe greenery and unique plant accessories for experienced and novice gardeners alike. Not to be outdone by their parents, younger kids want to make their spaces their own. And our popular kids brand, Pillowfort, will continue to help them do just that. For its 5-year anniversary, Pillowfort is celebrating with hundreds of new items that can grow with them and be used in any area of the house. As our guests begin stepping out, they're focused on looking and feeling their best. With this rekindled passion for fashion, our guests will be overjoyed with the latest installment of our designer dress collection. Featuring designs by Christopher John Rogers, Alexis and Rixo, this assortment offers more than 70 original and affordable dresses in bold, bright patterns and statement silhouettes. And of course, with our continual focus on inclusivity and celebrating everybody, this collection features affordable prices in a range of sizes from XXS to 4X. We've long focused on making Target a destination for holidays and life events, and we just wrapped up a huge Mother's Day season. We had solutions for mom across the store, from apparel, gifting, beauty, flowers, candy and more. And now we're gearing up for Father's Day in June. We've got a great assortment of gifts for dad, from All in Motion attire for golfing, hitting the gym or just hanging out, to a line of shave, skin care and hair care products from Goodfellow. Of course, June celebrations aren't exclusive to dad. With so many in-person celebrations canceled last year, we're ecstatic about our fabulous new assortment for Pride as we celebrate love with our LGBTQIA guests, team members and neighbors. Later in the summer, we know families are excited to celebrate the 4th of July with a long-awaited neighborhood cookout, a road trip out of town or an intimate backyard barbecue with a few fireworks. With great deals and the perfect owned and national brand assortments, it doesn't matter if the celebration is big or small, Target is everything you'll need to fill a cooler, pack a beach bag and fill up with friends, family and fun. And before we know it, it's time to head back to school, and we're planning for one of our biggest back-to-school and college seasons ever. Of course, we'll have great deals on all the traditional school supplies, but we'll also have the new normals on the school supply list, like hand sanitizer and disinfectant wipes. With local school lists on target.com and our industry-leading fulfillment options, back-to-school shopping has never been safer or easier. And with the great new apparel offerings from Cat & Jack, Art Class, More than Magic, Wild Fable, Original Use and All in Motion, all found only at Target, we'll have our school-bound guests looking and feeling fresh for that first day of school. Before I close, I want to pause and highlight some of the work I'm most passionate about, and that's our work on Target's REACH Committee, which we formed last year to achieve lasting systemic change for our black guests, team members and communities. This work aligns with our vision for sustainability at Target, and it's a strong example of how we're becoming an equitable company, creating change that strengthens our business. Hopefully, you've seen our recent announcement that Target is committed to spending more than $2 billion with black-owned businesses by the end of 2025. In addition, we've announced a new scholarship program to support students and more than a dozen historically black colleges and universities. And this summer, both in-store and online, we are adding more items to our Black Beyond Measure assortment. I'm so proud of these efforts and everything we do to help all families discover the joy of everyday life. I also want to give a quick shout out to our store teams. I recently had a chance to visit stores in the New York City market. And after more than a year in which most of my meetings have been virtual, it was an incredibly energizing experience. I visited new small-format locations across the city, from Manhattan to Queens to Brooklyn. Every location was a unique reflection of the local neighborhood, from design, to assortment and the team members serving their neighbors. Based on the energy and passion I could feel from these teams, it's clear why we're seeing such strong sales in our stores across the country. As the first Chief Growth Officer at Target, I couldn't be more enthusiastic about the opportunities still ahead of us. As you saw throughout 2020 and now in 2021, we have a long runway to continue investing in and growing our core business. At the same time, we'll continue to develop innovation pipelines and explore new initiatives, maintaining a balance between fundamentals and execution and the exploration of new opportunities. As we plan for future growth, we'll continue to listen to our guests and apply those insights to prioritize their work. With this guest-first approach, we're confident we can continue to build relevance and market share, both today and over time. With that, I'll turn the call over to John.
John Mulligan:
Thanks, Christina. At our Financial Community Meeting earlier this year, we detailed how last year's $15 billion in sales growth was more than we grew over the prior 11 years. And as you've seen today, trends are not slowing down, as we added another $4.5 billion of sales in the first quarter. Given this continued rapid growth and the opportunities still ahead of us, the operations team is focused on building capacity and enhancing processes to create and enable Target's continued growth.
That work starts in our supply chain, where we've outlined our plans to add 4 new regional distribution centers by the end of 2022, with the first 2 buildings slated to open later this year. These new buildings located in Chicago and New Jersey are set to go live in the next several months, creating additional capacity for the network in total, while enhancing service levels in high-volume markets that continue to grow. More specifically, once these buildings are operating at scale, they'll meaningfully shorten lead times to nearby stores, improving in-stock levels, while reducing the need for safety stock in those locations. Beyond the capacity we're adding with these new buildings, we're also investing in updated fixtures to create additional capacity across our current network. These changes are highly capital efficient, involving a small amount of capital to open up a substantial amount of incremental capacity within the network, equivalent to the addition of about 1.5 new distribution centers. And as we told you at our meeting in March, we're pleased with the initial results from our new sortation center in Minneapolis. As a result, we have plans to build up to 5 more of these facilities in 2021, with additional openings planned for 2022 and beyond. We're opening these centers, which are smaller than an average store in markets with a high concentration of local package delivery. They're designed to receive and sort packages from a large group of surrounding stores multiple times a day, which allows for more optimized granular sortation. This precision reduces costs for our delivery partners, meaningfully reducing what we pay for delivery. In addition, these facilities eliminate the need for sortation with the stores they serve, while freeing up packing capacity at those same locations. Sort centers have long been on our fulfillment road map, which we've built through internal development along with small acquisitions. In these facilities, we optimize the selection of delivery partners by applying technology from Grand Junction, which we acquired in 2017. And we optimize sortation to minimize costs to increase speed by applying technology we acquired from Deliv in 2020. In addition, beginning in the first quarter, our Minneapolis sort center began testing package delivery using Shipt, another 2017 acquisition, to add capacity, reduce costs and enable more, flexibility, which will benefit our rapidly growing ship-from-store capability over time. Within our store network, we've begun ramping up our remodel program, following the pause we implemented last year. We have just over 34 remodels slated for completion in the second quarter and more than 100 planned for the back half of the year. Based on past experience, we expect these remodeled stores will generate an incremental 2% to 4% sales growth in the year following completion, with another 2% incremental growth in the second year. Beyond the direct impact on sales, these transformations create an ideal platform for all of the merchandise innovations and service enhancements that we'll launch over time. In addition to full store remodels, we're planning other store investments this year, including more than 100 Ulta shop-in-shops slated to launch in the back half of the year, as well as our enhanced Apple layout in Electronics in select stores across the country. Among our store services, we've long known that our same-day fulfillment options would be popular with our guests. But their growth over the last few years has been far above our expectations. This is most evident in our Drive-Up service where first quarter sales volume was nearly 21x higher than it was 2 years ago, amounting to nearly $1.3 billion of incremental sales volume over that period. In the face of this incredible growth, there are emerging opportunities in high-volume locations to invest in capacity and efficiency in support of our same-day services. Specifically, in more than 100 locations this year, we're investing in small projects to optimize the front ends of these buildings, freeing up additional capacity for continued same-day growth, while making the layout more efficient and safer for the team. We also continue to enhance the assortments available for all 3 same-day services, adding more perishable food to our pickup and Drive-Up services and more general merchandise like apparel to the assortment available through Shipt. And we just announced that in the second quarter, we'll have adult beverages available through pickup and/or Drive-Up in more than 1,200 stores and available for same-day delivery in more than 600 stores across the country. Beyond activity in existing stores, we're expanding our new store opening plans to more than 30 additional locations across the country this year, as we continue to find compelling opportunities in urban and dense suburban markets and on our near-college campuses. In recent years, these custom formats have typically been less than 50,000 square feet. However, given local real estate conditions in dense suburban markets, we're also finding compelling opportunities to open somewhat bigger stores, between 50,000 and 100,000 square feet, which weren't available in the past. As a group, these new stores are generating higher-than-average sales productivity, above average gross margin rates and strong financial returns, and we see a very long runway to open more of them over time. And finally, after store comp growth of 18% in the first quarter, driven almost entirely by traffic, we're confident that we're already benefiting from a differentiated service model in our stores. But that's a lead we can't take for granted. So we're continually looking for ways to get even better. So this year, our store teams are rolling out an enhanced service model, focused on consistency of every interaction to ensure that our guests will always feel welcomed and appreciated. And if they need help, there will be team members who can find solutions to enhance their experience. This new engagement model is strongly connected to our company purpose, culture and values. And we're supporting it with enhanced training and tools across the chain. It's designed not to be a one-and-done effort, but a sustainable model that's integrated with our operational goals, not something separate that's added on to everyday tasks. So as I turn it over to Michael, I want to once again thank the entire team for the incredible things you've already done and your passion to continually raise the bar. This year, I'm celebrating my 25th year at Target, so you might be tempted to think I've seen it all. But when I step back and realize what this team has accomplished in the last year under the most challenging of circumstances, it's clear that there is no limit to this team's potential, and there's no doubt that we have the best team in retail. Now I'll turn the call over to Michael.
Michael Fiddelke:
Thanks, John. When I think about the underlying themes of our recent performance, the most dominant one by far has been the unprecedented growth and share gains we've seen over the last 5 quarters.
On the P&L, the leverage resulting from growth has more than offset all of the unique headwinds we faced over this challenging period, resulting in really strong performance. Target's total sales grew 23.3% in the first quarter, reflecting comp growth of 22.9%. Given last year's double-digit growth, first quarter sales have expanded more than 37% over the last 2 years, driven almost entirely by higher comps. Unlike last year, when consumers were consolidating trips and shopping less often, this year's comp growth was driven primarily by a traffic increase of more than 17% combined with a 5% increase in average ticket. As Brian mentioned, store comps were the growth engine this year, while digital was the primary driver in Q1 2020. As such, over the last 2 years, both our stores and digital channels have expanded their first quarter sales by more than $3 billion. This balance highlights the relevance and complementary nature of both channels in serving our guest needs. Our first quarter gross margin rate of 30% was 490 basis points ahead of last year when we faced a number of temporary headwinds, including markdowns and other costs to rightsize our apparel inventory. Compared with 2019, this year's first quarter gross margin rate was about 40 basis points higher, which is notable given that digital sales penetration more than doubled in that time, from 7.1% in 2019 to more than 18% this year. In terms of the year-over-year gross margin drivers, mix had a positive impact of about 150 basis points, reflecting the dramatic increase in apparel sales and continued strength in our home category. The remaining favorability was driven by core merchandising, as we continued to benefit from low promotional and clearance markdown rates, and we annualized last year's costs to rightsize our apparel inventory. The rate impact of supply chain and digital fulfillment costs was approximately neutral compared to last year, as the costs of outsized digital growth were offset by the benefit of a stronger mix of same-day fulfillment and our ongoing work to control unit costs across our entire suite of digital fulfillment options. Our first quarter SG&A expense rate was 18.6% this year, down more than 2 percentage points from 20.7% a year ago and 20.8% in 2019. In terms of drivers, leverage benefits have more than offset all of the extra costs we've absorbed over the last 2 years, including meaningfully higher pay and benefits for our team and other investments to protect the health and safety of our team and guests. While D&A expenses have grown in each of the last 2 years, this year's first quarter D&A expense rate was about 40 basis points lower than a year ago and about 80 basis points lower than 2019. Altogether, our first quarter operating margin rate increased an astounding 7.4 percentage points compared with a year ago to an unprecedented 9.8% this year, from a temporary low of 2.4% rate a year ago. However, even compared to a very healthy 6.4% operating margin rate in the first quarter of 2019, this year's rate was more than 3 percentage points higher. In terms of dollars, first quarter operating income has more than doubled over the last 2 years. On the bottom line, our business delivered first quarter GAAP EPS of $4.17, up more than 600% from a year ago and well over double our 2019 GAAP EPS. On the adjusted EPS line, which excluded the gain from the sale of our DermStore business, we earned $3.69 this year, more than 500% higher than a year ago and well over double our 2019 adjusted EPS. As you know, our capital deployment priorities remain the same as they've been for decades. We first look to fully invest in our business, in projects that meet our strategic and financial criteria. Second, we returned cash through our quarterly dividend, which we've maintained every quarter as a public company and grown every year since 1971. And finally, we returned excess cash over time through share repurchases, within the limits of our middle A debt ratings. In the first quarter, we invested just over $0.5 billion in capital expenditures to support our business. We continue to expect our full year CapEx will be approximately $4 billion, but the bulk of those expenditures will be more backloaded in the year, given the timing of this year's projects. We paid dividends of $340 million in the first quarter, up slightly from a year ago, as growth in the per share dividend was partially offset by a decline in share count. And finally, we resumed share repurchases in the first quarter, following a temporary pause in 2020, and deployed about $1.2 billion to retire 6.1 million shares at an average share price of just under $191. And in February, we completed the sale of our DermStore business, which contributed just over $350 million to our first quarter cash flow. Altogether, we ended the quarter with about $7.8 billion of cash and cash equivalents on our balance sheet. This was down about $700 million from the beginning of the quarter, but still well above where we expect to operate over time. With this cash, we'll be funding approximately $3.5 billion of additional CapEx in 2021 and we'll be recommending a robust increase in our quarterly dividends to the Board later this year. Beyond these uses, we should have ample capacity for continued share repurchases, and we'll continue to govern the magnitude and pace of repurchases in support of our goal to maintain our Middle A credit ratings. And given where we are today, it will likely be a multiyear journey before our debt metrics move fully back to where they've been over time. Now I'd like to turn briefly to our return on invested capital, which reflects both our operating results and the investments we've made to generate them. In the first quarter, our trailing 12-month after-tax ROIC moved up to 30.7%, which is well over double the 13.4% we reported a year ago. While we've indicated that this measure will likely be volatile in the near term and could revert to a very healthy number, near 20% over time, the fact that our business has generated such a high after-tax return over the last 12 months is a testament both to the strength of our model and outstanding execution by our team. Now let me turn to our sales outlook. We learned a lot in the first quarter, and notably, got our first look at how our business is successfully comping the comp, with impressive growth on top of last year's strong surge in sales. Also, and importantly, we've continued to gain market share on top of last year's dramatic share gains. Based on these results, we're now planning for our business to deliver a mid- to high single-digit comp increase in the second quarter. This expectation is in line with the 2-year growth rates we saw in the first quarter. And while we only have a couple of weeks in the quarter behind us, the results we've seen so far this month are consistent with this outlook. The range for second quarter operating income remains wide, but should remain strong, far ahead of our 2019 rate of 7.2%, but perhaps not fully as high as last year's unprecedented rate of 10%. In terms of the specific puts and takes in the quarter, we'll be comping over last year's reversal of the return reserve estimate, which added about $110 million to last year's operating income. In addition, this year, we're making purposeful investments in store labor hours to ensure we deliver outstanding service and stronger in-stocks than a year ago, when sales grew far beyond our expectations. Of course, we'll continue to benefit from meaningful sales leverage, given that we're planning for healthy growth on top of last year's record-setting increase. Putting that all together, we expect to see continued strong performance on this line. In the back half of the year, the range of possibilities for comp growth is also quite wide, and we'll gain more insights as the year progresses. As of today, based on our recent results and confidence going forward, we expect to see positive single-digit comps in the back half of the year, on top of last year's unprecedented performance. Regarding our full year operating margin rate, following an exceptionally strong first quarter, we have increasing confidence in the consumer and industry backdrop in the back half of the year. As such, the range of outcomes for our 2021 operating margin rate has moved significantly higher. So despite the anticipated headwind from higher markdown rates following last year's historically low rates, we believe that our business is positioned to deliver a full year operating margin rate that's well over last year's rate of 7%. More specifically, we believe this year's operating margin rate could reach 8% or perhaps a little higher. We'll continue to refine our view throughout the year. As the team looks ahead to the rest of the year, they're focused on staying agile in what continues to be a volatile environment. Rather than placing all of their bets on a single forecast number, they're focused on contingency planning, creating flexibility that will allow us to react to unexpected changes, and importantly, take advantage of opportunity when we see it.
We're also excited about the investments still ahead of us and the growth they'll create:
hundreds more remodels; dozens of new stores; new Ulta and Apple shopping environments; and supply chain investments to support both replenishment and fulfillment. Given the performance we're seeing today, which is the product of the investments we've made over the last few years, we're eagerly leading into future opportunities to enable more profitable, high-return growth over time.
Before I turn it back over to Brian, I want to add my voice and thanks to the team. The value our team members are creating for our business, communities, shareholders and each other goes far beyond what we can measure in a P&L. Thanks for making Target an even stronger company on behalf of all of our stakeholders. Brian?
Brian Cornell:
Before we move to your questions, I want to pause and acknowledge again the role our team plays in the outstanding results we delivered this quarter. I'm thankful for their continued focus on our guests, focus on operational excellence and passion for our brand.
I also want to acknowledge the challenges facing our India headquarter team, along with our team members who have family there, given the recent surge in COVID-19 cases. We have been carefully monitoring conditions on the ground and providing extra support to our team during this difficult time to ensure they can take care of themselves and their families. We've also funded $500,000 donation to UNICEF set to increase access to option treatment in hospitals across the country and bring testing resources to the hardest hit communities. We're hopeful that conditions there will continue to improve. So now as we get ready to move to your questions, I want to underscore the confidence you've heard throughout our remarks today. Coming off an unbelievable year in 2020, we had a lot of confidence as we entered 2021, but our first quarter results came in far ahead of our baseline expectations. With the macro and consumer backdrop that's been surprisingly positive, we've seen remarkable momentum in our performance, even as we started to comp over the period of peak increases a year ago. The flexibility of our category mix and fulfillment options, combined with an agile, energetic and engaged team, continue to resonate with our guests, driving double-digit traffic growth and an increase in average tickets in the first quarter. But as you've often heard me say, we shouldn't confuse performance with potential. So even after more than a year of unprecedented growth, we're seeing focus and leaning into the opportunities ahead of us, making investments to build on an already strong foundation. With these investments, I'm confident that our business model and outstanding team will continue to raise the bar on an already best-in-class retail experience, resulting in even stronger loyalty and guest engagement over time. With that, we'll turn to Q&A. Christina, John, Michael and I will be happy to take your questions.
Operator:
[Operator Instructions] Our first question is from Bob Drbul with Guggenheim.
Robert Drbul:
Congratulations. Great job, Brian. The question that I have is when you look at the mix of -- especially on the apparel side, can you talk about any new brands that you're excited about? You've done a great job with the private brand piece. And I think as you move through the year, any expectations that you have just on that mix and some of the margin implications around that category would be great.
Brian Cornell:
Well, why don't I let Christina spend some time talking about what we're seeing with categories, some of the highlights between our own brands and national brands. Obviously, Christina highlighted the fact that despite our overall robust performance in the quarter, owned brands grew by 36%, a record performance for us. So we're clearly seeing great performance in both our own brands and national brands.
But Christina, why don't you build on some of what we're seeing in the different categories?
A. Hennington:
Absolutely. Bob, thanks for the question. As Brian was just sharing, we really are excited about the strength across the board. Apparel was certainly a stand out in this quarter with growing over 60%, and that came from a range of brands in every segment of the business.
But the reality is the 3 trends that I talked about in my prepared remarks are benefiting our multi-category approach across the board:
joy at Home and the opportunity to celebrate everything that brings the guests to their home, eating, being with their families, and the investments that they've made over time in their home; health and well-being, the opportunities that our guests are taking to invest in proactive health care and fitness at home and activewear.
And then the newer and more emerging trend is really style and mobility. As guests are going out, they are looking for a fresh look. So our newest collections of dresses by Christopher John Rogers, Alexis and Rixo couldn't have been more perfectly timed to really help guests look their best in what they're wearing and certainly also across their beauty trends.
Operator:
And the next question is from Paul Trussell with Deutsche Bank.
Paul Trussell:
Outstanding results. Congratulations to the team. I guess my question is on, first, same-day services, which obviously continues to really showcase robust growth. I'm just wondering if you can talk a little bit more about how the business has evolved. What are the additional learnings? And what are the actions that have been taken to really improve efficiency and profitability of that particular business and service?
Brian Cornell:
Well, Paul, thanks again for joining us this morning. Why don't we let John Mulligan talk about some of the progress we've made from a same-day fulfillment standpoint.
John Mulligan:
Paul, it's good to talk to you. As you know well, we've talked about stores as hubs now for going on 4 years. And we have always said, we like it for a couple of reasons
The thing we love about all of the same-day services, pick up, Drive-Up and ship, all of them continue to grow faster than our overall digital growth, and we continue to find ways to improve them, as you said. Part of that is investing in technology for our teams, improving their sort paths and improving how they pick. We've done a great deal of process work to break things apart, to make it simpler for our teams to execute. We've done things to help them find items in the store so that we don't end up with what we call, INFs, or items not found. And then we continue to invest in helping them physically. And that's a big focus for us this year and will be over the next couple of years. In the case of Drive-Up, which as we've talked about a couple of times, Brian talked about and I talked about, has been our fastest-growing same-day service since -- basically since we started it. It also has our highest NPS score, so guests love it. We let you decide when you want to come. We don't force you into a time slot. And then our team brings it out to you in 2 minutes or less. So our guests absolutely love that. And you'll see us invest in making that easier for our team, building capacity on the front end of the store. Over the past year, we've rolled out adding temperature control products to Drive-Up. And so you'll see us have refrigeration and freezers to the front end of the store, all behind the wall so that our guests don't see that, but making it much easier for our teams to execute. And then much safer, we'll make it much easier for them to walk out to cars, protect them from the environment a little bit. So all of that experience continues to improve as well. So every year, our team comes up with multiple ways to continue to improve the service, first and foremost, for the guest, and then on the back end, improve things for our team so they can execute it easier as we continue to grow. So we see a lot more opportunity for us. And as I said, that will be a big part of our capital investment over the next several years.
Brian Cornell:
John, the only thing I might add is as we saw our guests turn to same-day services during the pandemic using pickup and Drive-Up and ship, we expect those services to be very sticky over time. And certainly, I think we've matured the awareness and the use of those same-day services by 2, 3, if not 4 years. And certainly, as we go into the back half of the year and during the holiday season, I think we're going to continue to see our guests turn to ship and Drive-Up and pick up. That's just an easy and convenient way to shop at Target.
Paul Trussell:
Just a quick follow-up for Michael. Obviously, you're really showcasing a lot of confidence in the trajectory of the business, given the outlook provided for the balance of the year. Maybe just a little bit more detail on how we should think about gross margins and SG&A for what's clearly going to be a really healthy operating margin rate in 2Q and the second half.
Michael Fiddelke:
Yes. Sure, Paul. Thanks for the question. And I touched on this a bit in my remarks, but if I had to summarize our profit story, it goes back to the scale benefits we see when we have growth. And our plan for the back part of the year is to see growth on top of some of the strongest quarters in Target's history last year. So we would expect that leave to -- to lead to improving profit rates on a year-over-year basis. And there's still a wide range of where those numbers might ultimately land, and we'll continue to refine our point of view as the year progresses. But scale is a wonderful thing. And we've seen impressive growth over last year, and we expect more to come in the balance of this year.
Operator:
The next question is from Karen Short with Barclays.
Karen Short:
I'll add my congratulations to a great quarter. I wanted to just ask a little bit about share gains. And obviously, we know the categories, and you're gaining share across all categories. But I wanted to see if you could give a little bit more color on share gains by demographic, and which demographics you think you're gaining the most share from. And then I had a follow-up to that last question that was asked.
Brian Cornell:
Karen, thanks again for joining us today. And I appreciate the question on market share. As you look at our business, and I think you know our Target guests and our Target shopper, we're appealing to all demographics. And we've had over -- now well over 30 million guests who shop us every week. Most of America shops at Target. And I think as we look at it, we're picking up share across all these various cohorts. So it's not one consumer, it's all of the guests who are shopping Target and as they return to our stores, shopping multiple categories.
And I think that's the magic behind our performance, is that great combination of in-store experience, the ease and convenience of digital, but that multi-category portfolio and that unique combination of our own brands and curated national brands, we appeal to a broad group of consumers in different cohorts. And we're picking up share across all of these different areas.
Karen Short:
Okay. And then just on inventory growth. Obviously, your inventory growth was very strong this quarter, which is impressive given the freight issues, but -- and the port issues. But maybe some color on that growth in general, and how you think about the balance of actually wanting more markdowns in 2021 versus 2020, and how we should think about that in the context gross margin?
Brian Cornell:
Michael, why don't you start? And then we can provide some additional color as Christina talks about our inventory positions.
Michael Fiddelke:
Sure. Well, first off, Karen, we feel really good about our inventory position heading into the second quarter. And you can see we're up on a year-over-year basis, and we should be given the growth in sales that we've seen and continue to expect.
When it comes to markdowns through the balance of the year, we've talked about this a little bit previously, we were sold through in a lot of seasons last year, and that's not optimal for us. We don't want to look at empty shelves at the end of a seasonal set. And so with our anticipation for growth in the remainder of this year, we'll be buying appropriately to that. And hopefully, that means we've got fuller shelves at the end of a season. And with that, will come some clearance markdowns, there will be a little bit of a drag on markdown rates on a year-over-year basis if I had to guess. But I would welcome a little bit of that rate drag because it means that we're full and in stock for the guests throughout the season.
Operator:
The next question is from Chris Horvers with JPMorgan.
Christopher Horvers:
So a couple of questions on guidance. My first question is, in the second quarter, Michael, why couldn't you reach 10% or at least be close to that? You did a 9.8% in 1Q. Sales volumes look to be similar. Is it less rich mix performance? Or perhaps you're putting in some caution around potential promotions and clearance?
Michael Fiddelke:
Sure, Chris. Thanks for the question. Well, we would expect, like I said in my remarks, the second quarter to be far ahead of the 2-year ago performance, likely not as high as last year. But there's still a broad range around that outcome. And so we'll see as the quarter plays out exactly where we land.
Worth noting, and I touched on this as well, there's some factors unique to the quarter. We've got a $110 million headwind from the way our returns reserve calendarizes between Q1 and Q2. And the second thing is, we're investing, and we'll continue to invest in the team and in-store payroll to make sure we're staffed and in stock to support the sales we expect to come. And our teams have done just an incredible job this year providing such great guest experience. And we want to make sure we're investing to continue to support that and to support growth.
Christopher Horvers:
Understood. And then as you think about the gross margin, can you talk about the puts and takes of this year versus 2019? Obviously, you have a higher e-commerce mix. But you would think that sort of the mix of the business by category could be richer. And you also have pretty lean inventories against a strong demand backdrop.
Michael Fiddelke:
Yes. So maybe I'll speak to actuals and unpack the first quarter just a little bit versus 2 years ago. If you look at kind of versus our 2019 performance, we saw markdown efficiency. And we've talked about that, lower levels of promotional and clearance markdown rates in 2019. On a 2-year basis, mix is actually about 40 basis points of a drag in the first quarter. And also, on a 2-year basis, you can see digital and supply chain pressure of a shade over 1 point given the growth in the digital business and the impact that, that has to rate. And so those are familiar drivers we've talked about over time. Where those drivers land for the balance of the year will dictate where margin ultimately falls.
Operator:
The next question is from Scott Mushkin with R5 Capital.
Scott Mushkin:
I wanted to go into labor. Brian, I heard your comments today on CNBC about that it's kind of -- you're not really having a struggle getting labor. And I also heard you guys talk about enhanced service model. So I was wondering if you could talk about whether you guys believe you have a labor advantage and kind of what you're doing with your labor force to enhance the store experience.
Brian Cornell:
Well, Scott, thanks for joining us. Why don't I start and then I'll let John build on my comments.
But as I said earlier today, we've been investing in our team for many years now. And we took an industry-leading position with our starting minimum wage. We've continued to invest over the last year in the health and wellness and safety of our teams. And I think that's allowed us to build even deeper engagement with our teams and stores and our teams and supply chain. So I do think it gives us a competitive advantage. And I think the focus we place on our team, the care of our team, making sure we're investing in their training, their development, their growth, I think that's really provided us with a unique experience. And I think it's one of our competitive advantages in the marketplace. John?
John Mulligan:
Yes. Scott, just building on what Brian said. Basically, I think our thought has always been, the best way to staff our stores and our supply chain, frankly, is to limit turnover. And so let's invest in our team, give them a great experience. And you've seen us do that for several years now. We've invested in wages. We've invested in benefits. Just as importantly, we've invested in training to help upskill them. And then over the course of the past 1.5 years or so, we've invested in safety very overtly.
And so as Brian said, engagement is very high. Turnover is down significantly relative to 2019. So we feel really good about where our store's at. And as turnover decreases, you get so many benefits, right? We get team members that know their jobs. We get team members that know their guests that are in their stores because they're in there weekly. They can engage with them. And this kind of gets to the service model where the idea is to engage with our guests, make them feel welcomed, and importantly, solve their problem. If they have an issue, solve it in the moment for them. And so you'll see us continue to do that. We're very encouraged by what we see. Our NPS scores across all of our services, including the in-store experience, are up over last year and up over 2019. So we're just getting started on this journey, but the early results are very encouraging. And I would just finish where Brian did. We -- you've heard us say for a long time, we have the best team in retail, and we absolutely believe that's the truth.
Brian Cornell:
John and I had a review just yesterday with our store team leaders who look at turnover and retention rates, and we just continue to see stronger and stronger numbers. And back to the point that John had made. So the operating model changes we've made over the last few years, putting experts in place in areas like beauty and technology, those team members are really passionate about the work that they do, and they continue to learn and grow every day. And I think that focus on providing training and development opportunities, the expertise that we're providing in those key categories, that's going to continue to provide benefits to us over time.
Operator:
The next question is from Kate McShane with Goldman Sachs.
Katharine McShane:
I wondered if I could go back to the digital fulfillment questions that were asked earlier. I think you said costs were neutral. And I wondered, is it possible for how you're fulfilling to turn into a tailwind as you continue to drive more growth towards the same-day services and away from 2-day free ship?
And then separately, you mentioned the sortation centers and the number you're opening this year. I wondered if you could talk to just the cost optimization from those sortation centers over the long term.
Michael Fiddelke:
Sure. Thanks for the question, Kate. I can start, and then maybe John can provide more color on the sortation center work that we're doing. We didn't see pressure on the supply chain and digital line this quarter. That's due in part to the just incredible strength in our store business, with stores up 18% on a year-over-year basis.
I get excited by the efficiency improvements I see us continue to make in our digital experience. John talked to some of those just a minute ago. But we can do a lot with the volumes that we've built over the last 2 years in some of those same-day services. And all of that volume translates to more efficiency opportunity as we can continue to squeeze down the per unit cost to fulfill. But I don't shy away from growth -- or from a drag on that line from a growing digital business. And the reason why is, when guests lean into digital, when we get more omnichannel guests, more guests using Drive-Up, more guests using same-day, even if that sale itself comes at a slightly lower rate, it does incredible things for the rest of our P&L because we see those guests spend more in total, about 30% more for a new Drive-Up or Shipt guest. And that's way more important than the little bit of rate drag we've seen over time from digital growth, and that's how we continue to think about it.
John Mulligan:
Yes. And on the sort centers, Kate, we remain pretty excited about this opportunity, but I would caution you that it's early days for us still. We're -- we always talk about crawl, walk, run. I'd say we're still firmly in crawl here in Minneapolis. And so we see a lot of opportunity in front of us. But the play here is a couple of things.
And first of all, it's about capacity in the stores. So if we can sweep packages out of the stores more routinely than once a day, that frees up space, and that frees up space for us to pack additional products in the store. And that's an important thing for us. Then as we move downstream, the more granular sort is where we start to see potentially cost reductions as we can sort to provide to our carrier partners further downstream in their operations. And like we'd announced about a month ago, using the Deliv technology, creating local routes for local packages, we can get very efficient on delivery using Shipt and Shipt drivers. And so put all that together and our guest gets a great experience, we create more capacity. And we have the opportunity to continue to improve what we believe are already advantaged economics because of our stores-as-hub model. So more to come on all that. It's early days, but we remain pretty optimistic on all 3 of those fronts.
Operator:
Our last question is from Joe Feldman with Telsey Advisory Group.
Joseph Feldman:
I wanted to ask you. You touched on it a little bit, I think, Christina, in the prepared remarks about back-to-school and being excited. And assuming we do have a more normal back-to-school and with this child tax credit coming, are you guys planning the back-to-school period in the second half any differently this year in terms of marketing or inventory levels maybe that you could share a little bit with us?
A. Hennington:
Yes. Joe, I'd be happy to talk about that. So we're very excited about what these life moments afford us in the back half. The opportunity for a little more "normalcy," it really creates opportunities for us to be relevant with our guests in many different ways.
And so you think about back-to-school as a huge moment where the convenience of our assortment across a multi-category portfolio is already a preferred destination. But then you think about how that leads into opportunities in Halloween and Thanksgiving and the holidays, opportunities for our families to be together and celebrate, sometimes for the first time in almost 2 years. And so this is where the power of our assortment, and the gifting opportunities, the value equation that we offer and the resonance with our brand really shine. And so that means we're very excited about what the full outlook will be.
Brian Cornell:
So Joe, thanks for that final question. It's a great place for us to wrap up. And hopefully, for all of you, you recognize the confidence we have in our business as we go forward, the execution that we're seeing across all of our different functions and the way we're focused on serving the guests.
So I appreciate everyone joining us today. And operator, that concludes our first quarter earnings call. So thanks again for joining us.
John Hulbert:
Good morning, everyone. Thanks for attending our 2021 Financial Community Meeting. This morning, we're being joined by investors and others who are listening into this webcast. Following today's meeting, Michael and I will be available to answer any follow-up questions.
Before I turn it over to Brian to kick off the meeting, I have a couple of important disclosures. First, 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. And second, in today's remarks, we refer to non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP measures to the most directly comparable GAAP measure are included in our financial press releases and SEC filings which are posted on our Investor Relations website. With that, let's begin the meeting. [Presentation]
Brian Cornell:
Good morning, and welcome to our 2021 Financial Community Meeting. We're eager to share our insights on the extraordinary year that just passed, as well as our vision for what's next. But I couldn't start today without reflecting on the fact that 1 year ago at this time, the pandemic was just beginning to unfold. And in an effort to keep everyone safe and limit travel, we decided to convert this meeting to a virtual format. While we miss hosting our in person gatherings, it's prudent to stick with virtual presentations once again this year. But we're looking forward to resuming our live events, including this one and our Annual Shareholders Meeting in 2022.
As I look back over the past year, a year when so much care and compassion was called for, I see purpose, coupled with capabilities as the essential enabler of our response. And the story of Target in 2020 is the story of a team that wanted nothing more than to take care of those around us, drawing on capabilities that were equal to that ambition after years of building an investment. So I want to start today by publicly recognizing and thanking our team. I'm incredibly proud of the resilience, empathy, care and concern they've shown for each other, our guests and communities through a very challenging 12 months and counting. None of what we'll share today would've happened without them. Even before the dramatic challenges of last year took hold, our team had been busy building the retail platform of tomorrow. But 2020 accelerated everything and, as such, our guests are already benefiting from and loving that platform today. At the heart of the platform was the belief that consumers would continue to flock to out stores for multicategory one-stop shopping; a friendly, well-trained and knowledgeable team; and joyful experiences.
As we designed our strategy and invested accordingly, we relentlessly asked ourselves what products and services those stores should offer, where they should be located, how their operations should be tailored to meet neighborhood needs and ultimately, how to make our stores work together with all of our other assets as one shopping platform that would keep guests turning to Target however they want to shop. In answering those questions, we did 2 things at once:
We placed the physical store more firmly at the center of our omnichannel platform and we created a durable, sustainable and scalable business model that puts Target on a road of our own.
Our goal was to use our proximity, nearly 1,900 stores within 10 miles of the vast majority of the U.S. consumers to offer the fastest and easiest digital fulfillment in retail. And the capabilities we built to become America's easiest place to shop also cracked the essential question of how to grow our digital sales exponentially, while maintaining the overall profitability of our business. When we began this journey, we didn't know we would be facing a global pandemic, mass quarantines, rapid unemployment and the need to limit the number of people in public spaces. And yet, when those threats emerged in 2020, we were ready. And without hesitation, millions of American families turned to Target like never before. That happened because of decisions we made 4 and 5 years ago. And today, Christina Hennington, our recently named Chief Growth Officer, along with John Mulligan and Michael Fiddelke, will join me in mapping out how our team's efforts in recent years created a new baseline from which we'll continue to climb higher for our guests. And here's what I hope you'll take away from our story. First, that our team's ability to act and react in 2020 was years in the making. Without our multiyear roadmap to develop new capabilities and bring them to scale, 2020 could've exposed essential gaps in our business model. Instead, it proved beyond a doubt the durability of our model and it signaled our potential for continued growth in years ahead.
The second takeaway stems from a question I've heard frequently, especially in 2020, "Brian, what's the secret to Target's growth trajectory?" What you'll see in our presentation today is that the one thing that's driving our success is a focused commitment to several things:
an integrated collection of strategies and capabilities that all work together, are very difficult to replicate and, ultimately, make Target unique.
I'll start today with a high level recap of our full year results. When we gathered virtually for this meeting last year, I shared how our revenue had grown by $5.4 billion since 2017, and that we were consistently gaining share in many of our core merchandising categories. In other words, we were already starting to see steady growth from our investments.
When we left that meeting, no one knew that COVID-19 would be declared a pandemic in the United States, only a couple of weeks later. In hindsight, it's hard to believe that we only receive one COVID-related question that day. But today, as we look back on 2020, the business highlights are clear:
Our revenue during the year increased another $15 billion. We gained meaningful market share across all 5 of our merchandising categories, totaling about $9 billion. Our full year comparable sales were up more than 19%, with a store comp of more than 7% in a year when people were staying home to stay safe, and a digital comp of 145%. Standing at this meeting 3 or 4 years ago, it would have been hard for any of us, or any of you, to imagine digital penetration of 18% without a dramatic deterioration in our P&L. Yet today, we announced record high full year adjusted EPS of $9.42.
Importantly, we accomplished all of this while making huge incremental investments in our team's safety and well-being and completely reoutfitting our stores to keep our team and guests safe. Far for being a fluke, this performance is further proof that we've built a business model that is working as intended, one that puts Target in a category of its own. A few consistent pillars have been and will continue to be at the heart of our playbook. The enormous investments we made in supply chain, store operations and technology capabilities are already powering exponential growth in digital commerce. They've enabled us to use our stores and showrooms and service centers, but also as hubs for digital fulfillment. Without these investments, we simply wouldn't have been able to satisfy the exploding guest demand for same-day services, represented by more than 600% growth in Drive Up. Likewise, Shipt is an extraordinary capability that grew by more than 300% last year and will continue to grow as more guests recognize the power of having their purchases brought to their doorstep in as little as 1 hour. We have consistently invested in our merchandising strength, like our differentiated owned brand portfolio, our curated national brands, inspired limited time offering and strategic relationships that run the gamut from web only start-ups looking for omnichannel scale to premier partners like Disney, Apple, Levi's and Ulta Beauty. We're continuously improving our physical and digital shopping experience, investing billions in store remodels, specialized store rows and service training for our teams, while continuing to open up new small formats in urban centers, major college campuses and iconic tourist destinations. Most importantly, we're continuing to invest in our team. Even before 2020's outsized incremental expenditures on team health and safety, Target was an employer of choice, an academy company for those looking for a rewarding and purposeful careers. In addition to accelerating our $15 starting wage in 2020, we celebrated our team's exceptional efforts with 5 separate recognition bonuses, most recently in January when we invested another $200 million to reward each of our frontline team members $500. As we develop capabilities, like Target Circle, or acquire them, like Shipt, we do so with a clear vision for how they'll work together in service to our guests. Ultimately, the value they create in our core business has to contribute to our retail offering that's greater than the sum of the parts. But when we look at these elements individually, it's strikingly clear how much value we've added in a very short time. In 2016, our digital transformation was only beginning, we weren't even a top 10 e-commerce provider, and we were just getting our same-day services off the ground. Today, we have the most complete suite of same-day fulfillment services in the industry. We're one of the leading e-commerce players. And for Click and Collect same-day services, we continue to deliver industry-leading growth and dollar volume as well as Net Promoter Scores over 80% despite record demand. In 2016, we had about 30 small format stores. Today, we have 140 and we'll add another 30 to 40 per year over the next several years. If these stores were standalone chain, they're revenue would rival that of fast-growing chains with many more locations. In 2016, we launched Pillowfort and Cat & Jack, touching off our owned brand reinvention that has since resulted in more than 30 new brands, with more on the way this year. By the time we gathered for this meeting last year, Cat & Jack and 5 other owned brands were generating $1 billion or more apiece in annual sales, and that tally has continued to grow. We cleared 2020 with 10 of owned brands each generating $1 billion or more and 4 of those across the $2 billion per year threshold. Any one of these brands alone would be a sizable retailer and, as you know, their contribution profits is outsized. Of course, owned and exclusive brands are just one component of our merchandising strategy, which is always run on curated national brands across our assortment. As we've expanded capabilities in recent years, we've also steadily built our roster of strategic partners. Levi's is an excellent example of how we can build upon a longstanding collaboration and help strategic partners catapult into new product categories. We started partnering with Levi's years ago on the DENIZEN denim brand and that partnership grew to include Levi's Red Tab apparel and build out presence in hundreds of stores and on target.com. Just this last Sunday, we launched the Levi's for Target collection, a limited time offering of home goods. This is the first foray by Levi's into this category and it's a great example of combining their strengths with ours, including our incredible sourcing and product design and development capabilities to forge new potential for both of our brands. Meanwhile, our team is also gearing up to introduce Ulta Beauty at Target to our stores and target.com, starting with the first 100 stores later this year. From this initial batch, we'll test, we'll learn and we'll expand hundreds of additional locations over time. This partnership combines Ulta Beauty's unparalleled assortment, category expertise and guest loyalty with our large high-growth traffic-driving beauty business and the ease and convenience of our fulfillment services. Together, we'll be able to offer guests access to established, emerging and prestige beauty brands as well as expert beauty consultation in an industry leading omnichannel retail experience. As a standalone or isolated innovation, each of these elements I mentioned, has something in common with the other. Each was advanced based on how it would complement out other assets and capabilities and we tested each one with an eye towards scale. In fact, the ability to integrate and scale is a key component of our decision making. And to emphasize the critical importance of scalability, I simply think back to what we could've done in 2016 but didn't. At that time, conventional wisdom held that the only way forward was for retailers to build capacity, to send more packages to homes. Instead, we went our own way, built a fulfillment model with our guest local store at the center and took the initiative on same-day. We could just as easily have constructed additional fulfillment centers and driven the shift to digital sales with more ship-to-home capacity. But as you know, the economics were terrible and we wouldn't have been differentiated. In short, we didn't see the textbook solution as scalable or as likely to do what we've done, namely set the groundwork for years of guest satisfaction and brand loyalty, as represented by comments like this, "Thank you for providing curbside pickup. It actually was the determining factor in me buying from Target instead of one of those online retailers." Or this, or this or this note from a guest who simply said, "Please always continue to do curbside pick up. It is such a help even outside of COVID. This is a wonderful service and I'll continue to choose Target for this very reason." So where do we go from here? And how do we keep climbing from this strong new baseline? In the near term, we'll continue to generate incredible value by executing on our strategy. Throughout the pandemic, we've built deep trust and loyalty with our guests who clearly prefer the ease and everyday inspiration of shopping at Target, along with our relentless commitment to the safety and cleanliness of our shopping environment. This is a decades long commitment that was only emphasized by the pandemic, and it will continue to be a differentiator in the months and years ahead. Our multi-category merchandise portfolio is a huge advantage, particularly as shoppers continue to consolidate trips. And we're absolutely committed to delivering value and everyday affordability, which is important in any environment, but particularly as the economic consequences of COVID continue to play out. At the same time, we'll continue to listen closely to our stakeholders and to build upon our strategy. So in the years ahead, you'll see continuous iteration and improvement in the pillars I've mentioned already. But we'll also focus on better localizing our experience, applying learning from our small format expansion. And we'll continue to build scale and personalizing the experience, leveraging capabilities like Target Circle to better understand our guests and find new ways to engage and reward the 90 million members who have joined so far. To ensure we're continuously delivering great value and emphasizing everyday affordability, we'll stay laser focused on being priced right daily. And on showcasing our value with clear messaging and relevant promotions. Importantly, we'll also double down on an approach to sustainability that builds on our rich legacy and company purpose. This includes decades of community relations, corporate responsibility and philanthropic leadership grounded in our 75-year track record of giving 5% of pre-tax profits in the support of vibrant and inclusive communities. Our intent is to further use our size and scale to benefit people and the planet, building on the work we've done already to elevate our offering of sustainable brands, to create equity and opportunity in our communities and to help protect the environment. High stakeholder expectations for corporate responsibility only increased in the pandemic and the 2020 demonstrations for social justice. And as we've seen for years, sustainability builds resiliency in our operating model and fuels growth and innovation. So this is work that's important, not just to our guests, our team members, our investors and our communities but to ensuring our business model remains durable for years to come. The best predictor of whether we can follow through on our aspiration is a track record of taking care of our team, serving our guests and communities and responsibly growing our business. And to give you a more detailed picture of how we'll continue to do that in the years ahead, I'll ask Christina, John and Michael to weigh in. Christina?
Christina Hennington:
Thanks, Brian. It's great to be joining all of you today, and I'm really excited to discuss how our teams have differentiated Target in the marketplace and some of the potential we see in front of us. Now I should mention upfront that I joined Target back in 2003. Since then, I've held a number of roles across merchandising. Over that time, I've seen a lot in our business, ups and downs, good years and rebuilding years, economic booms and a great recession. But I've never seen anything like last year. Of course, COVID-19 is an unprecedented event, challenging our team and our guests in ways we never could have imagined. But how we responded at Target, empowering our teams, moving quickly and leveraging the power of our multi-category assortment, that's Target at its best. In fact, that's Target better than I've ever seen us.
So when I think about my new role in bringing together insight, strategy and innovation, plus planning, design, sourcing and buying functions, it's not about fixing anything, it's about improving on what worked so well last year. It's about keeping Target relevant by staying ahead of what our guests need and it's about positioning Target to drive growth in 2021 and for years to come. We were successful last year because we gave our guests a lot of reasons to be confident in shopping at Target. The work of our frontline teams to keep our stores safe and clean has made Target a destination, a happy place as our guests limit other trips out of their homes. Our suite of same-day fulfillment options was a game changer, driving triple-digit growth in our digital sales. And regardless of whether our guests were strolling our aisles or scrolling on our app, we struck that balance between replenishment and discovery. Through the breadth of our assortment, along with a single view of inventory and teams leading across all channels, we were able to move with speed and agility, meeting guest needs despite the fastest changing environment we've ever faced. A lot of you probably saw this last spring in observing our business or in your own lives. In the space of just a few weeks at the outbreak of the pandemic, guests stocked up on food, beverages and essentials. Then they turned to us for help in converting kitchen tables into classroom space and spare bedrooms into home offices. And then they look to Target for fitness gear, games and other entertainment as they settled in for the long haul. That kind of volatility continued throughout 2020. In fact, one of the only constants last year was that no matter what happened, our guests turned to Target for help to meet functional needs to get through the pandemic and for inspiration and joy, especially around those key seasonal moments that took on added importance for so many people last year. So we never looked at our business from the perspective of a particular category. Instead, we shaped our business decisions around what was happening in the world. That's something we'll continue to guide us. Because when we focus on what's happening in the lives of our guests, it's obvious what categories we need to flex to keep building on the trust they placed in Target. Our multi-category assortment is a competitive advantage because it keeps Target relevant no matter what. But how we manage that assortment, the premium we place on curation, partnerships and product design and development, that's what differentiates Target. Brian touched briefly on our billion and multibillion-dollar owned brands. Our owned brand portfolio, which spans all categories, is vital to the success of our business. It represents about 1/3 of our total sales and even more of our gross margin, which helps to sustain key enterprise investments. And Target's owned brands continue to generate strong growth because of our approach to creating, designing and maintaining these brands. They're not just private labels, they're brands our guests trust, they're brands our guests love. A great example of this is in the athleisure space. Even before athleisure became work-from-home apparel, this was a hot category, and it was an area where we had room to raise our game. So early in 2020, we launched All in Motion. And last month, it became a $1 billion brand. That didn't happen by chance. We were able to respond to this trend quickly and build a beloved brand because we invested in co-creating this brand with our guests. Our team talked to 15,000 people, we consulted with 65 fitness pros and we had team members attend dozens of workout classes with our guests. That's the kind of work we put into owned brands across our assortment in every category. So whether it's sweating through a spin class or talking to parents and kids about how Cat & Jack can meet their needs or taste testing every recipe in our Good & Gather assortment before we launch, we go the extra mile, resulting in brands our guests don't just buy because we offer them at a good price, but instead, brands they love, brands that are the reason why they're shopping at Target in the first place. And that work continues. This year, we'll announce and launch several new owned brands in areas where we know Target can make a difference for our guests. This focus on making Target irresistible through our products and our experience also applies to how we work with our national brand partners. And it's an approach that has made targeted place where national brands thrive. You've heard about Levi's, including the limited time Home Collection that just set and the Ulta Beauty at Target shops we're adding to our stores and target.com this year. Those are great examples of what Target represents for our partners. Levi's is an iconic brand that, for a long time, have thrived largely in department store environments. But as they began exploring new platforms, they turned to Target. And Ulta Beauty is an incredible leader in specialty beauty. Through our new partnership, we'll provide access to brands we know our guests love, but previously had to go elsewhere to get. This kind of work is a big part of what makes Target special, and we're not stopping there. Just last week, in fact, we began rolling out a dedicated Apple experience, starting in 17 stores across the country and online. We're doubling the Apple footprint in these stores with new lighting fixtures and displays for Apple products, including an extended assortment of accessories. We have a new dedicated Apple landing page on our digital channels and we'll offer our guests more expertise with Apple train team members in these stores and enhanced product videos on our app and website. This is really exciting because we're taking the work we've done with Apple over the last 15 years and making it even better. Finally, I want to touch on a body of work that's incredibly important. The efforts underway to make Target more relevant and more welcoming for black guests. Over the last few years, we've listened carefully to our multicultural guests as a whole, and we recognized there was an opportunity to do more for black guests. So we've added more brands and products that we know they love. A great example is what we've done in the beauty space with 50 black-owned and black-founded brands now available in our industry-leading assortment. But we're committed to doing even more in key categories through our owned brands and partnerships, building on our progress to ensure that we're delivering on our purpose of helping all families discover the joy of everyday life. The retail landscape is never static. So the retailers that will win are the ones that have a durable business model, something we've built at Target. But just as important, the retailers that will be best positioned for the future are the ones with the closest connection to their customers and the ability to flex to meet their changing needs. That was critical to Target's success last year. And that obsession with listening to our guests, understanding the things that are shaping their world and meeting their needs for convenience and ease, inspiration and discovery across all channels is what has Target poised for continued growth in the years ahead. Thank you. And now I'll hand the meeting over to John.
John Mulligan:
Thanks, Christina, and good morning, everyone. While most people expect the operations guy to get right into the technical stuff, like capacity, throughput and automation, and don't worry, I will get there, I'm going to start with our people, the Target team. In a year when the flexibility and scalability of our operation was pressure tested, our team rose to the challenge, just like they always do. They were the connection between processes, technology and physical assets, that allow us to deliver safety, ease, reliability and even a bit of joy during a year of uncertainty for our guests. Of course, the team wasn't starting from scratch. As you heard already this morning, we've been investing in them for years and building capabilities that would set them up to better serve our guests in any time, let alone a global pandemic.
Let me take you back for a minute to one of our favorite reference points. It was early 2016 and Target's strategy was coming into focus. After years of testing and listening to our guests, we knew that betting on our stores, an uncommon proposition at the time, would be at the heart of a durable and scalable model. And we needed an operation with the right capabilities to drive it. Getting there wouldn't be fast or easy. Quarter-after-quarter, we tested, iterated and learned how to modernize our supply chain, update our stores, use them as fulfillment hubs and train our team to bring every part to life. Then we had to learn how to do it at scale. In 2019, all these efforts started operating together, and we saw tangible proof through financial results, market share gains and guest satisfaction scores that our work was paying off. Fast forward to 2020, we were ready for the world to change. But only because of the years we'd spent laying the operational foundation. The story of how we navigated the twists and turns of 2020 starts with replenishment because the whole operation relies on getting the right product to the right place at the right time. This last quarter, 95% of all sales, online and in person were fulfilled by our stores, which is why it's critical they have enough of the inventory our guests want to buy. Without that piece, the operation simply stops. When the pandemic hit last spring, our guest shopping behaviors changed nearly overnight. We saw heavy stock up trips, huge in-store surges and then a quick shift to online shopping. To meet the needs of the guests, our supply chain had to turn on a dime. We sent hundreds more deliveries than we planned every day to replenish stores fast and often. Flexibility we'd learned from opening dozens of small format stores. We prioritize the flow of essential inventory like paper towels and cleaning wipes, to quickly send stores more of what they needed, not just what was planned. As we sold every paper product we had last March, we expedited everything we could from our vendor partners and secured greater allocations of additional inventory as they ramped up to produce more. In a normal year, we just spent months preparing for the traditional Q4 shopping spike. But in 2020, our peak season started in March. And after months of moving record volume, we have become increasingly efficient in how we managed high levels of demand. So when the holidays actually did arrive, we leaned into what was already working. We sent more inventory to stores than ever to prepare for an earlier holiday rush. We front-loaded those deliveries with the seasonal merchandise guests would expect so our stores would be stocked and ready, and we continue prioritizing essential products, like cleaning supplies and health care items, so we could keep meeting the pressing needs of our guests. The flexibility of our supply chain set up our stores to play an essential role in our communities. Because we could restock shelves quickly, guests could count on Target for what they needed, whether they came inside or shopped online. And when our digital business picked up last spring, our fulfillment operation went into high gear. Up to that point, our same-day fulfillment services had already been rolled out nationwide. Millions of guests were loving them because they're fast and easy. We always love them because they're incredibly efficient. Without the shipping expense, these orders look much more like a store sale than a traditional online transaction, costing on average 90% less than if we'd shipped it from a warehouse. And at the start of 2020, our same-day sales were growing at a healthy clip. Come spring, when consumers saw the need for more contactless ways to shop, those services exploded. And we had the infrastructure in place to grow alongside demand. Brian gave you the full year highlights on Drive Up, up more than 600%, and even Order Pick Up, which has been around for years, still grew more than 70%. Beyond our pickup options, the delivery capability we have in Shipt became even more important. It filled the need for guests who wanted an online order, especially for perishable items, but also for so many other essentials across Target, brought right to their front doors. It offered more personalization, reliability and speed than they could get from a packaged shipment. And as a result Shipt's target sales grew more than 300%. Of course, we continue to ship online orders from the back of our local stores, saving 40% of the cost of shipping from a warehouse, an economic advantage for us as digital sales now account for even more of our total revenue. With third-party carriers fielding historic levels of volume, we worked closely with our partners to plan for capacity constraints and send millions and millions of packages to guest store's steps. But the popularity of our same-day services gave guests another option to shop from home, yet receive their orders faster, reliably and on their own time. Guests had Shipt deliver when it matched their schedule instead of guessing when a shipment would arrive. They drove through our pickup lanes when they were already out and about. No appointment required. This gave guests a flexibility they couldn't find anywhere else. The extraordinary growth of those services has shown just how much guests value that convenience, speed and peace of mind and the comfort they find in having a contactless option. In fact, we found that what we built to make Target the easiest place to shop had also set us up to be one of the safest. I've said countless times that a benefit of using our stores as hubs is our ability to ramp-up in peak times and ramp back down based on demand. This last year, the stores ramped up and stayed there. In early spring, our stores were fulfilling more in a single day than they had an entire week the year before, day after day after day. At the same time, they were also continuing to support a safe and easy in-store experience, which also drove strong comps. As our digital business continued to pick up steam, our stores sustained that pace for months on end. Records were set and then broken again and again and again. But the years we spent building a rock-solid fulfillment capability in our stores prepared us to handle waves of volume without sacrificing the guest experience. Stores knew how to staff for peaks, train other store team members to pitch in when things got busy and adjust storage space to hold more orders. Despite wild growth, our Net Promoter Scores that represent guest satisfaction stayed incredibly high. It's one thing for our teams to adjust to record volume, but it's even more impressive to do it while we enhance the services themselves. As digital demand surged, we simultaneously broadened the assortment to make even more of the store available for same-day fulfillment. We added apparel to Shipt's delivery offerings and tested adult beverage pickup in a handful of markets. Most notably, we added fresh and frozen grocery to Drive Up and Order Pick Up. Although this expansion was already in the plan, we accelerated the rollout to go nationwide this summer, offering even more guests essential groceries through our contactless services. Importantly, we also adjusted the process to make our services even safer and more efficient. With Drive Up and Order Pick Up, guests now display a PIN on their phones from a distance or through a car window so teams can securely deliver the right order while staying farther apart. We gave additional store team members back up training and fulfillment. For example, when we temporarily closed our Starbucks cafés, we taught hundreds of baristas how to efficiently pick and pack an order. That allowed us to keep those team members on the schedule and build their skills, while also helping us manage high volumes during peak times. And we added thousands of Drive Up parking spots, so guests could get in and out even faster. At the same time, Shipt more than doubled its shopper network to increase the number of delivery windows it could offer to keep up with soaring demand. It's worth taking a minute to emphasize that using our stores to support digital demand is only possible because of the trust and collaboration across many teams at Target. It's not just a stores operation or a supply chain effort, it's the product of many teams strategizing around a common purpose to deliver for our guests. That one team mindset is what built the capabilities we have today and is what allowed us to adjust swiftly when the business accelerated unexpectedly. We built an operation to handle the healthy digital growth we expected through the middle of this decade. The only surprise was that we got there last year much sooner than planned. Although we designed for that kind of flexibility and scale in the long run, our team hadn't planned for it to come all at once, and that's what makes their outstanding execution with no advanced warning, all the more remarkable. Advancing the business several years in a matter of months prove that our model is scalable and also prove we have the capacity to grow. I'd remind you of what I've shared in several of our past earnings calls. A reliable way to assess our stores throughput capacity is to look at the sales we do per square foot. And you can see that productivity has grown a lot over the last couple of years for our average stores, but also for our top quartile. The fact that we continue to see more throughput in our highest-performing stores shows the capacity we have across the rest of the chain for even more growth in the future. With all the expectations we have for our stores, the physical buildings themselves play a huge role in our strategy. We're as committed as ever to our years long initiative to remodel stores with an inspirational specialty store feel that makes shopping easy and convenient. At the beginning of last year, we'd started about 130 full store remodels. In mid-March, to reduce distractions in our stores, we decided to complete the projects we'd started. Then we pivoted to more targeted improvements that emphasize safety, like installing plexiglass dividers and reformatting our sales floor for greater distancing. The timing for our small-format stores also shifted. After pausing construction in the spring, our teams accelerated the work through the summer and fall to finalize more than 2 dozen stores for new local guests. Despite stopping the work for part of the year, we still opened 29 small format stores, the most completed in 1 year-to-date. From the Las Vegas Strip to UC San Diego, our first store right on campus property, we tapped into new communities. And we continued expanding across markets like New York and L.A. With each one, Target brought a safe and essential shopping experience to even more guests, while positioning us to serve those neighborhoods for years to come. Our construction and store design teams also adjusted following the demonstrations for racial justice this summer. One of our Minneapolis stores required an entire rebuild. Without it, the local community had nowhere nearby to get essentials like baby formula and fresh food. So we partnered with local nonprofits to distribute needed supplies while putting plans in motion to reopen fast. We leaned on the expertise we developed remodeling stores and opening small formats to meet the community's needs. We listened to nearby residents, worked with local contractors, personalized the in-store experience and reopened months later as a convenient shopping destination, but also as a better partner to the neighborhood. Take a look. [Presentation]
John Mulligan:
From that video alone, it's clear that our team is dedicated, tireless and incredibly compassionate when it comes to serving our communities. You saw it in the opening video and you've heard it throughout this morning. Our team is the heartbeat of Target. And even when faced with challenges, they bring their A game.
Several years ago, we implemented a new operating model in our stores to lift up that drive. It was a shift towards specialized roles to give our teams expertise, empowerment and a sense of ownership in how they serve our guests. With that model in place, our team could quickly adapt to the ups and downs in 2020, execute well and play an essential role in our communities. Now like anything in life, balance is good, and we found opportunities to train our specialists in other areas like teaching a hardlines expert how to fulfill an online order. So they gain skills beyond their specialized position. Those investments in their development also add flexibility to our operation. We've always known that supporting our team would have great returns and it has. In addition to the bonuses, time off options, wellbeing benefits and expanded nationwide starting wage that Brian mentioned, we also gave our team even more hours. With a greater investment in our trained and expert workforce, we saw turnover drop and guest satisfaction rise. It's a strong testament to what can be done when we empower our teams to use their skills and passions to serve our guests. The bottom line is that as our business grew exponentially, our operation flexed alongside. And as we delivered for our guests, we built on the trust they put in us to meet their needs and make it easy. Going forward, we're taking the capabilities that drove Target in 2020 and accelerating them to continue making Target, the safest and easiest place to shop. As we do, we'll invest in more capacity and greater efficiencies. So we're positioned to continue growing for the long term. In our supply chain, that starts with expanding our network so we continue to have replenishment capacity that can support our future growth. In recent years, we accommodated steady sales growth through our existing supply chain network by increasing the productivity of our buildings. In fact, the average sales per foot supported by our distribution centers rose nearly 30% between 2016 and 2020, thanks to a series of process and technology improvements. During those years, we didn't open any new DCs to support replenishment. But after our business grew nearly 20% last year, with 95% of sales driven by our stores, it's time to expand our supply chain so we can support a much higher base of sales and continue growing. This year, we'll open 2 distribution centers to support replenishment, 1 close to the New Jersey Delaware state line and another in the Little Village neighborhood of Chicago. And we currently have plans for one on each coast in 2022. We're also continuing to simplify the unload process once product reaches the stores. In a nutshell, it all comes down to how we sort and organize millions of items before they arrive at the stores' loading dock.
We've shown you the robotics capabilities we're building to help us sort inventory to the precise amount of store needs and organize it by store aisle. When we do, replenishment in stores is fast. Team members grab a tote, walk to the aisle and stock the shelf. No sorting in the back room or finding places to stash cases of excess product. We have 2 solutions that help us do that. We showed you both of these independently last year:
1 called auto-rebin sorts individual items. This is most useful for slower moving inventory, when stores only need a handful of items to put back on the shelf. Auto-rebin started in one of our local Minnesota warehouses, rolled out to 2 more and we'll expand to another 2 this year.
The second is the robotic ships order we've been building at our Perth Amboy facility. This sorts everything, from boxes of individual items to entire cases of product. After the sort, robot sequence inventory so our team can load pallets in an order that saves stores even more time. Individually, these capabilities are hugely valuable, but they're designed to work together. This spring, we'll put both solutions in 1 warehouse to test how they bring more precision and speed to store replenishment. In Q4, we'll run them together at a small scale, doing what we always do to learn and iterate before we go bigger. Opening new warehouses and expanding our robotics capabilities are both about moving product more easily to stores. But just as important is being ready to send what stores need before they even know it. This year, we'll continue expanding the rollout of our predictive inventory positioning capability across our assortment. This helps us more precisely order and position product close to where we anticipate guests will want it so we can react quickly when there's demand. In turn, it improves out of stocks and lowers backroom inventory levels. In 2020, when sales spiked, this capability allowed us to order and restock products 25% faster than using our old systems. This year, we'll use it to order and position even more items in our assortment, so we can replenish the majority of the store faster for our guests. We've talked about how store replenishment feeds store fulfillment. This past year, our team was able to keep filling online orders because our supply chain was replenishing that inventory with speed and precision. While we continue refining our replenishment operation, we'll also build on our fulfillment capabilities to enhance the guest experience and make way for future growth. Today, the majority of our store assortment is available through our same-day services, but we're continually working to give guests even more choices. In coming months, we'll expand our pickup options further into categories like apparel and fresh food and roll adult beverage pickup to 800 more stores. We're also continuing to improve the Target Run so it's even easier for our guests and faster for our team. For example, Drive Up guests will be able to share more preferences in the app, like telling the team where to place the order in their vehicle or signing an alternate pickup person so it's easier for a spouse or family member to pick it up. We're numbering our Drive Up spaces so our teams can find guests sooner for those times when a guest pulls up in a black SUV next to 8 other black SUVs. And we're updating the team member app, so they can more easily see what orders are in progress and where they can help. Our same-day services have grown faster than any other fulfillment method. But when we do ship online orders, we'll continue sending the majority of those packages out the back of our stores. Since 2016, we scaled our ship-from-store capability from a low tech test in a few hundred stores to a sophisticated fulfillment operation in most Target backrooms. Now before anyone gets too worked up, I don't mean we have robots hiding in the back. Instead, we've got efficient tools, technology and process design working together, continually increasing the number of orders a store can fulfill. Next, we'll take it a step further, developing last mile capabilities that help us continue scaling this operation so we can ship more orders from stores on even lower cost. To do it, we're testing a new type of facility here in Minneapolis called a sortation center. The idea is to make our stores' hub model even more efficient, while also reducing our load on external carriers. Take a look. [Presentation]
John Mulligan:
This capability frees up time and space in our stores, which we can redirect into fulfilling more orders. In the end, it allows us to get orders to guests faster and at a lower cost. While we're still ramping up production at this first test facility, we're very confident in this concept and plan to open 5 additional sites in other urban markets later this year.
In 2021, we'll also open more stores, accelerating our growth with 30 to 40 new locations a year, a pace we'll keep up for the foreseeable future. With our small format strategy, we'll expand in urban markets like Portland, L.A. and New York City, where there are still opportunities to serve new guests. And we'll continue our focus on college stores with the University of Georgia and the University of Michigan planned for later this year. We remain extremely bullish on our college sites. Even as the pandemic sent students to online classrooms and sales softened at many of those stores, we see them as a long-term play to serve the college guests, many of whom are on the brink of adulthood and building lifelong shopping habits. We'll also open a number of midsized stores to serve dense suburban neighborhoods from Denver to Brooklyn. As hundreds of retail vacancies have left holes in communities across the country, we've committed to sites where we can fill a need for the local guests. And as retail real estate prices have declined this year, we found these opportunities to serve new communities to be even more affordable. Along with opening new stores, we'll get back to remodeling our existing fleet. After stopping our full store remodels last spring, we'll pick back up later this year and complete about 150 stores in time for holiday, and we'll plan to ramp up to more than 200 stores a year in 2022 and beyond. Safety and ease have become the heart of Target shopping experience, and we'll incorporate what we learned during 2020 into our future store design. That includes implementing more contactless features, from our restrooms to our checkouts and adding distance between merchandise and at the check lanes. And as you heard from Christina, we'll also bring brand partnerships to life in our stores throughout 2021. A great example is the work we'll do to add Ulta Beauty to our sales floor, creating a specialty environment that's seamlessly integrated into the Target experience. Similarly, we'll use store design elements to highlight additional brands like Disney and Apple for our guests. We're investing in a lot of really exciting developments to fuel Target's growth. But what they all have in common, they're giving our team the tools or the backdrop to take better care of our guests and each other. That shows up most in our stores where the vast majority of our 350,000 team members bring our brand to life for guests across the country. A huge priority for our stores this year is adjusting our staffing strategies to create more predictability for our team. That's a challenge in any retail job, where ours are based on dynamic factors like consumer shopping patterns and changing team needs. But we know having an engaged team with more consistent hours leads to higher productivity, greater efficiency and lower turnover. It creates a place where people join to learn a job and stay to build a career and better serve our guests in the long run. So we'll train team members to take on other roles across the store and offer the option for longer shifts. We'll also build on our stores' operating model by introducing a new standard of service to our teams. It's not a checklist, but a set of principles that define great service, like welcoming a guest and paying attention to what they need, which might be as simple as finding an item or as big as building an outfit. It's meant to give our team flexibility and empower them to do what's right for the guests in the moment. Without our team, everything else you heard today comes to a standstill. The Target team continues to be the most important part of our operation, and I want to say an enormous thank you to all our team members for all they do to serve our guests and our communities. You've seen us make a lot of operational investments over the last few years, in our team, in our stores and in our capacity for long-term growth. In the most recent quarter, those returns were clear. We've created an operation unlike anyone else with our physical assets working together, centered on our stores and fueled by our team to serve our guests and grow for the long term. The capabilities we built not only allowed us to navigate the most volatile time in retail history but show that they can flex and grow to serve the ever-changing needs of the consumer. The work isn't done. We're constantly refining an operation that is efficient, fast and supportive of Target's durable and scalable business model. From an engineer by training and a finance guy at heart, I can attest that you can't get too efficient or relevant enough. There's no finish line for continuous improvement and innovation. We'll keep making bets on the capabilities that give us the flexibility to serve guests well into the future. We have a lot of strength heading into 2021 and a lot of work still in front of us. But with a sound operational foundation and the talent and resilience of the Target team driving us ahead, I look forward to sharing our progress in the quarters and years to come. With that, Michael, I'll hand it over to you. [Presentation]
Michael Fiddelke:
All I can say is wow. Those news clips paint a vivid picture of the roller coaster our team and our business experienced throughout 2020. All in all, it was a standout year in which everything we've spent years developing and building came together to serve our guests like never before.
So today, after a year of record growth, I want to start my remarks by expanding on a point Brian mentioned earlier because investors often want to know, how much of Target's growth is being driven by specific strategies or specific assets? For example, they want to know if we can isolate how much of our growth is coming from Drive Up, from digital and total, our owned brand work, remodel program and any other way we can slice and dice the data. And I understand the impulse. Our internal team often wants to do the same thing. And of course, as a self described data geek, I'm inclined to think the same way. But then I see data like we first shared with you last year. Guests who tried Drive Up for the first time spend about 30% more on average compared with before, including an increase in conventional store shopping. And we see a similar change in behavior among guests who try Shipt for the first time. These findings demonstrate that the benefits of Drive Up and Shipt go far beyond the value of an individual trip. They're both capabilities that drive guest affinity, creating value that extends well beyond the services themselves. That same thinking applies to our merchandise categories. If you focus only on the amount of sales or growth by category, you can miss how they all work together to drive guest affinity. I see how this plays out with my own family. Over the next few months, the cold weather in Minnesota will finally end, and my kids will need warm weather clothes. On the next Saturday morning Target run, we'll shop for those clothes, and we'll also pick up some food, a few office supplies, laundry detergent and maybe a prescription from CVS. We might wander over and purchase some spring decor. And we'll probably need some more earbuds since the kids seem to be inventing new ways to lose or destroy them. And on our way out, we'll probably stop at the Starbucks near the entrance so my wife and I can enjoy a coffee on the way home. So now if you're going to analyze that basket, is there a way to know which category drove the trip? And beyond the basket itself, shouldn't we broaden the analysis even further since that trip depended on a conveniently located store that's clean, safe and fun to shop, featuring low everyday prices and a friendly and engaged team? Over time, I've come to understand that guest engagement and financial performance are driven by everything we're doing at the same time, not any factor in isolation. Among the critical factors, of course, there are the tangible assets that show up on our balance sheet, including our stores, distribution centers and technology, but the list goes way beyond the balance sheet and includes our team, our reputation and the trust we've established with multiple stakeholders, which only deepened in 2020. Then there's the Target brand itself. Our owned and exclusive brands, capabilities like marketing, merchandising, product design and development, sourcing and so much more. And of course, there's our culture, our mission and our values, which helped to unify a diverse and widely dispersed team in support of a common purpose. So what's the key to our future performance? It's our continued investments in the assets and capabilities, both tangible and intangible, that we can build and integrate to drive guest engagement and growth. And how should we determine what to focus on? The answer comes from continually listening carefully to our guests. The better we know them, the more effectively we can invest in what they want and develop new ways to deliver joy and inspiration while making their lives easier. If we invest the right way, guests will reward us with more engagement and growth, which in turn will create additional opportunities to invest. Our success in 2020, which was years in the making, is a perfect example. It started many years ago as we engaged in a comprehensive evaluation of our business, our strategy and took a deep dive into the wants and needs of our guests. That work led to a new strategic focus, followed by years of investment of both capital and expense to roll out new fulfillment capabilities, rejuvenated stores and brands, a modern store operating model and more. Through that work, we built the foundation that allowed our team to deliver unprecedented results in the face of a rapidly changing landscape in 2020. So this year, our focus is to lock in last year's gains, build on that foundation, continue to deepen guest engagement and drive long-term growth. And following last year's growth of $15 billion, more than we grew over the prior 11 years combined, we're entering 2021 as a much larger company with a host of opportunities to build on last year's success. Digital is one of those opportunities. As John mentioned, in 2020, the penetration of digital sales advanced many years in a single year. With COVID as the catalyst, guests who had never tried our digital services quickly changed their habits and tried them sooner than they would have otherwise. We've long told you that, on average, a multichannel guest spends nearly 4x as much as a store-only guest and nearly 10x more than a digital-only guest. Now just in case there are any stats majors listening, that's a statement about correlation, not causation. So I'm not saying that a guest spending immediately changes that much after they move into a new channel. Even so, these averages help us to understand how deepening engagement translates to a more valuable guest relationship. And last year, Target gained an additional 12 million multichannel guests. Of course, a portion of those guests were completely new to Target, but the vast majority had previously shopped with us, but only in a single channel. The opportunity this year is to build on our now deeper relationship with these guests as we engage with them more frequently and help them migrate toward the much higher average spend we see from our multichannel guests over time. And today, even though we already have an unmatched suite of digital fulfillment options, there's more we can do for our guests. One way is to continue expanding the assortment of fresh, refrigerated and frozen food items available for Pick Up and Drive Up. When we study the behavior of guests who first shopped for these items through one of these services last year, we saw an average increase in shopping frequency of about 1 visit per month compared with the control group. On average, these guests increase their food and beverage spending between 20% and 30%. And importantly, spend about 20% more in other categories. As you heard from Christina, we also have an opportunity to continue developing and launching new owned brands while we become an increasingly attractive partner for leading national brands. In the years ahead, we'll likely have many more partnership opportunities. And given our strong performance and financial position, can be very thoughtful in approaching every one of them. This begins by ensuring the partnership is right for our guests and that the partner and financial arrangement are appropriate long-term choices for our business. And of course, there's a huge opportunity to create value through Target Circle, which has grown in less than 2 years to include more than 90 million members. Circle is easy and free to join and members enjoy rewards that drive engagement directly, which we can measure by the increase in spending among guests who joined. But the value of Circle only begins there because it also helps us to gain an ongoing, deeper understanding of our guests and their changing preferences, helping us to connect them with the services, brands and categories that address those wants and needs. So it's clear that we're entering 2021 with a lot of momentum and a really strong foundation with a lot more room to grow. As you heard from John, we still have a long runway to expand the available assortment for our same-day services, while we invest to broaden Shipt's reach by entering new markets while expanding in existing ones. When we acquired Shipt in late 2017, we were confident that same-day delivery was a capability every successful retailer would need to have, and we've spent the last 3 years integrating Shipt into our strategy and operations. At the same time, the acquisition has made it easier for Shipt to grow and achieve scale in new markets, given the volume that Target immediately brings to the platform. And as John covered, we're investing to modernize our network and add replenishment capacity to support future growth. Obviously, we came into last year with a great deal of capacity, but we used up a lot more of it than expected. Here's one way to think about it. At our current average sales per store, last year's growth of $15 billion was equivalent to the addition of more than 300 new Target stores. If we had actually opened that many new locations, we'd have needed some additional upstream capacity, and that need is the same, whether growth is coming from a bigger store footprint or higher productivity in our existing footage. While I'm on the topic, I want to pause and address the question of whether our stores are going to run out of capacity to grow digital sales. And I'd start with what John mentioned earlier, how our top quartile of stores demonstrate the continued potential for our average stores to handle more throughput. But I want to drill down into a really specific example to provide another view of our untapped capacity. And what we can do when an individual location reaches its limit. To do that, I'm going to go way back in history and talk about our experience at the Target store in Colma, California, part of the San Francisco market. 20 years ago, Colma had grown to be our second highest volume store in the chain, generating more than $90 million in annual sales, nearly 3x our chain average at the time. Given its extreme volume, we suspected the store was running out of capacity, which was limiting its ability to grow. So when the site of a former Montgomery Ward's became available just across the highway in Daly City, we decided to buy it and build a new Target. This was unheard of in our history, building a new store less than a mile away from an existing one, and it was a calculated risk because the new store would only make sense if it drove incremental volume. And that's exactly what happened. The combined sales of the 2 stores quickly grew far beyond what the single store was able to generate. And today, each of those locations is in the top 5% of our stores based on sales volume. So let's come back to today. Last year, our stores fulfilled more than 95% of our total sales, which works out to an average of about $47 million in fulfilled sales per store. That means our average store today is fulfilling about half of what the Colma store was already supporting 20 years ago. This offers another clear window into the growth potential of our average store today. But will there sometimes be extreme examples of stores that hit their capacity? I hope so because we know what to do when that happens. If we have a viable real estate opportunity nearby, we can invest in another one of these modern multichannel assets we happen to call a Target store. To be clear, based on what we see today, we don't expect a lot of these opportunities over the next few years, but I'd love to be wrong about that since we'd likely generate strong returns on the new stores we could open in those markets. In the meantime, we continue to make productive investments in new small format stores, and we're eager to begin ramping up our remodel program in 2021 and beyond. So with all these options to generate profitable growth, we're in a position to play offense and lean into the opportunity to build on last year's momentum. As such, we're planning for annual CapEx in the $4 billion range in each of the next few years to support remodels, new stores and supply chain projects to add replenishment capacity and modernize the network, including sortation centers. Beyond full store remodels, we'll also invest in Ulta Beauty shop in shops, while optimizing front end space in our highest volume locations, increasing the efficiency of our Pick Up and Drive Up services. So now this is the section of my remarks in which you typically expect me to cover our P&L expectations for the year. But today, given the high level of uncertainty we continue to face, providing a lot of guidance would be an exercise on false precision. Instead, I'm going to spend a few minutes talking about the most important factors affecting our near-term plans as we maintain our laser focus on investing for the long term. So first, as I think about implications for Target's top line in the months and years ahead, I think about the drivers at 3 levels of a funnel. At the widest part of the funnel are macro factors, including uncertainty about the path of COVID-19 and the speed and effectiveness of the vaccine campaign. How consumer attitudes and behaviors will evolve as we emerge from the pandemic. For example, there's an emerging consensus that the nature of work will permanently change as employers move to a more flexible model and allow for more work from home. This will likely have long-lasting implications for consumer spending. And finally, beyond changes in the consumer mindset, macro considerations include the health of the economy, the near-term impact of stimulus and how quickly various industries and communities will recover from the pandemic. The middle stage of the funnel involves questions around potential industry trends in each of the categories we sell and every industry has its own story. And categories consumed mostly at home, including food and beverage, essentials, home and hardlines, industry trends have accelerated over the last year and could see some softness as we emerge from the crisis. However, the timing and extent is hard to predict and could be offset by permanent changes in consumer habits, including a higher percentage of work time spent at home and an elevated focus on cleanliness and health resulting from the pandemic. In the beauty and apparel industries, which experienced softness in 2020, trends are expected to improve over time. Specifically, as people resume working in offices, attending concerts, movies and sporting events, traveling and eating out, they're likely to focus more on their appearance and spend more on these categories than they did in 2020. But let's be clear. These are just quick high-level thoughts on potential industry trends and they're far from ironclad predictions. So as we move to the bottom of the funnel and think about how those trends are likely to play out at Target, we first need to think about market share within those industries and on the topic of share, we have a lot of confidence as we look ahead. In 2020, Target saw unprecedented share gains across all 5 of our core merchandise categories. Importantly, these gains were not limited to the categories in which others were forced to close, and they stayed remarkably consistent throughout the year and across the country. Based on this experience and our investment focus going forward, we're optimistic about our opportunity to lock in recent share gains and deliver long-term growth on top of the foundation we've already established. So now I want to move beyond the top line and illustrate how we're thinking about other lines on the P&L for the year. And in this discussion, beyond prior year comparisons, I will often be looking back to 2019, since that year provides a more stable baseline compared with the extreme volatility we encountered in 2020. Let's start with our gross margin line, where in 2020, we experienced large but offsetting variances related to specific factors. The first was supply chain and digital fulfillment costs, which drove about 110 basis points of pressure last year. While that headwind was notable, it was less than I believe most of us would have expected, given that we saw $10 billion of digital sales growth, accounting for 2/3 of our total growth. As we look ahead to this year and beyond, we expect to see a smaller amount of pressure from supply chain and digital fulfillment, given that digital growth is likely to moderate, and we continue to make progress in reducing average unit fulfillment costs. A second headwind to last year's gross margin rate was category mix as lower margin categories grew faster than our higher-margin categories, accounting for about 90 basis points of rate pressure. At a minimum this year, we expect category mix to exert less pressure than last year. And notably, it could easily become a tailwind like it was in prior years. However, our crystal ball is not nearly clear enough today to predict this year's category mix with any precision. The third factor in last year's gross margin performance was our merchandising decisions, which include our pricing, mix of owned and national brands and the magnitude of our promotional and clearance markdowns. In 2020, the combination of these factors provided a significant tailwind of about 150 basis points, driven primarily by favorability and markdowns. A portion of this favorability was related to promotions, but the biggest single factor was a significant decline in clearance markdown rates as demand in seasonal and other clearance sensitive categories far outpaced our expectations. In 2021, we expect our markdown rates will increase somewhat from these abnormally low levels, which will create some gross margin pressure compared with 2020. So how do these expectations come together in 2021? As we consider the range of expectations for the combined impact of these 3 drivers, we believe that our 2021 gross margin rate will remain somewhat lower than our 2019 gross margin rate of 28.9%. On the SG&A expense line this year, we'll be annualizing last year's significant investments in safety measures and team member pay and benefits. We'll also be annualizing the fixed cost and other scale benefits we realized throughout the year. Looking ahead, given that we're focused on locking in last year's gains, we expect to retain significant scale benefits compared with 2019. In addition, we expect to deliver continued efficiency improvements, driven by investments in our supply chain, technology and operating model, which will help to offset continued investments in our team. Altogether, we expect that our 2021 SG&A expense rate will also be lower than our 2019 rate of 20.8%. On the D&A expense line, we expect to see moderate dollar growth in 2021 as we ramp up remodels and accelerate depreciation on the assets we replace. Of course, rate performance will depend on the total sales we deliver this year. So as we consider how all of these rates come together on the operating margin line, we're facing a wide range of possibilities as we enter the year. I've already talked about the unpredictability of sales and how category and channel mix alone can impact our margin. But even with that uncertainty, we should continue to benefit from the leverage we gained in 2020. Altogether, our expectation is that this year's operating margin rate will move down from the 7% we recorded in 2020 but remain above our 2019 operating margin rate of 6%, with the most likely outcome in the lower half of that range. So now for those of you hoping we provide a more precise view of our expectations today, I want you to know that I feel the same way. I know that it's difficult to model our business right now. Our team is facing the same challenge. In the face of this uncertainty, we continue to put a huge premium on flexibility and agility, which served us extremely well throughout 2020. After all, flexibility is a cornerstone of our business model, which features a uniquely diverse category mix and a store-based fulfillment model that can quickly adapt to changes in guest shopping patterns. With the benefit of this model, an outstanding team and a strong balance sheet, we're perfectly positioned to navigate any near term uncertainty, while we continue to invest in long-term growth. And while it may sound counterintuitive, our expectations for the next few quarters feel cloudier than our view of the longer term, when we're highly confident in our ability to grow profitably and build on recent share gains. So now before I move beyond the P&L, I want to spend a minute talking about the prior year comparisons we're facing in the first 2 quarters of this year. As you'll recall, in the first quarter last year, sales accelerated meaningfully after the onset of COVID, but our gross margin rate for the quarter declined an astounding amount, more than 4 percentage points in light of the cost to rightsize our apparel inventory. Also in the first quarter, we began making meaningful investments in the health and safety of our team and guests, which we'd maintained throughout the year. Altogether, our first quarter earnings per share were down more than 60% compared with 2019. Contrast that with the second quarter last year when our comp sales grew more than 24%, our gross margin rate also increased and we saw a jaw dropping amount of leverage on the SG&A and D&A expense lines, which more than offset investments in team and guest safety. As a result, last year's second quarter EPS grew more than 80% compared with 2019. That's a swing of more than 140 percentage points in our EPS growth rates between Q1 and Q2 last year. So as we plan and analyze our performance in the first 2 quarters of 2021, we're going to lean heavily on comparisons to the much more stable environment we experienced in 2019. This will help all of us to look through the extreme volatility and year-over-year comparisons we'll be seeing throughout the first half of this year. So now let's move beyond the P&L and turn to cash and capital deployment, and I want to reiterate that our priorities remain the same as they have been for decades. First, we look to invest in the business and all of the projects that meet our strategic and financial criteria. Second, we look to support the dividend and build on our record of annual increases, which we've maintained every year since 1971. One note, if we attain that goal in 2021, it will mark our 50th consecutive year of uninterrupted dividend increases, putting us in a very small group of companies who can make that statement. And finally, we look to deploy excess cash through share repurchases only after we fully supported the first 2 goals within the capacity of our middle A credit ratings. As you know, last year turned out to be a very strong year for cash flow in light of our sales growth and strong operational performance. As a result, we ended the year with about $8.5 billion of cash, well beyond the amount we'd maintain in ordinary times. But as strong as our year turned out to be, we can't forget the volatility we just encountered and the environment today remains far from ordinary. It's in that context that we evaluate our 2021 capital deployment expectations. Regarding CapEx, I already outlined our plan to invest about $4 billion this year. Regarding the dividend, later this year, we expect to recommend that our Board approve a robust increase in the per share dividend. But as always, this recommendation will depend on how our business is performing. Beyond those priorities, we've resumed share repurchases this year. And depending on how the virus, the economy and our performance progresses, could have ample capacity within the limits of our middle A credit ratings. But I will quickly say, we'll continue to be cautious and maintain an ample amount of liquidity to carry us through a wide range of near-term scenarios. As such, it may be a multiyear journey before our credit metrics move fully back to historical levels, depending on the speed with which we see more normal volatility across the economy and our business. So now I want to turn to our after-tax ROIC. As we've long emphasized, we rely on this metric to assess the health of our business and the effectiveness of our capital deployment over time. However, as is often the case, we sometimes need to look past near-term volatility and 2020 presents a great example. That's because last year, we delivered an astounding aftertax ROIC of 23.5%, up more than 7 percentage points from already strong performance in 2019. While this outcome is remarkable and a testament to our team and operating model, I'm going to quickly say that it's artificially high and likely to come back down over time. That might sound like a strange thing to say, but it's based on a number of factors that are clear today. First, with unexpectedly strong sales, our inventory turns shot up last year, and we saw abnormally high payables leverage. While that had a positive near-term impact on working capital, we also saw really choppy in stocks, which isn't how we want to operate under normal conditions. In 2021, we're planning for full shelves and better in stocks, which will bring inventory turns and payables leverage back down to more sustainable levels. This will require a net investment of working capital for the year. Similarly, as I mentioned earlier, we're leaning in to support a strong set of growth opportunities over the next few years. As we accelerate investment in stores, supply chain modernization and replenishment capacity in support of those growth prospects, we'll likely see an increase in the invested capital portion of this metric over the next few years. Bottom line, while I believe this metric will stay very healthy and compare favorably to other retailers, I expect it will move back down into the 20% range over time. This would represent very strong absolute and relative performance on a larger asset base than we've maintained in the past. So as I get ready to turn things back over to Brian. I want to take you back to this meeting 4 years ago, when I was listening from my headquarters in Minneapolis. During my career at Target, I've been lucky to spend time working with our stores, and I've developed a deep appreciation for the value they can deliver. So when Brian and John stood up and said we'd be investing to put our stores at the center of everything we do, including both digital and physical shopping, I had a ton of confidence in that plan. It was a plan based on carefully listening to our guests, it was differentiated and we were fortunate to have the necessary resources to get there. In the years following that meeting, our team worked hard, and we encountered many doubters but we continued to invest with a long view and last year's results showed the value of that focus. And as we sit here today, we remain committed to making future investments with that same long view. Rather than sitting back, taking a break and waiting for the virus to subside, we are focused on playing offense and investing in continued growth. And just like 4 years ago, my confidence in the future starts with the team. So I want to acknowledge everyone on the Target team, from headquarters to our distribution centers, to our stores in all 50 states and our offices around the world for their dedication to our guests and passion for taking care of each other. Without you, we couldn't have delivered such an amazing amount of value on behalf of our stakeholders in 2020. And with your help, I'm confident we'll continue to deliver long-term value for all of our stakeholders in the years ahead. I can't say it enough. Thank you. Thank you. Thank you. Now I'll turn it back over to Brian for some closing remarks.
Brian Cornell:
Thanks, Michael. As we wind down today's event, I'll leave you with a couple of thoughts. 5 years ago, we envisioned a future for ourselves, in which the key to guest preference and breakout growth lay in an unappreciated omnichannel asset called the store. Many were skeptical, which is why we said from the beginning that we were playing our own game and creating a category of one. Many thought the inevitable drift was for our store guests to become digital guests, and that the current only ran in 1 direction.
We saw something different. We saw a future in which even the most committed digital-only guests would find the best and easiest shopping experience at Target because of how we connect that experience to our stores. We knew that to make our stores function for the future that we envisioned, we'd have to build, acquire and bundle a unique set of capabilities. The technology, the supply chain inventiveness, the physical assets and operations and the team of trusted neighbors that millions turn to for friendly service and a bit of everyday joy. We began to put all those pieces together like no one else had. And the experience was taking hold, on the timetable we expected. Then 2020 accelerated everything. And today, Target is as synonymous with same-day and safety as it is with style and swagger. That is a very strong position to be in. And here's where we intend to go with it. First, we'll continue to focus on market share over the long term. We believe our experience, including our fulfillment options, inspiring assortment, ease, safety and personal service will convert more and more consumers into guests. And we'll also work tirelessly to engage established guests across more of our channels and offerings. With new guests choosing Target and established guests engaging with more of our platform, we'll be able to listen to them even more closely. And capabilities like Drive Up, Shipt and Circle will give us a wider window than ever into their preferences. Meaning, we can further improve the experience we provide in the near term, while continuously anticipating where we should go next. Staying closely connected to our guests always points us in the right direction. That's what helped us see a future 5 years ago, that today is a reality. And it's why we're stepping up our investments to drive additional profitable growth. Unlike in recent years, when we needed to shore up our foundation or create new capabilities, today's investments will build on an omnichannel Target platform that is already working incredibly well. A platform that has raised expectations, not just among Target guests, but for consumers across U.S. retail. Few can meet those expectations like we can because what we've created is based on a unique combination of differentiated assets. But this is just the beginning of our story on which we'll continue to iterate, innovate and continuously improve for our guests. So in closing, I want to express my complete confidence in this company's future. I'm confident in our strategy and in our capabilities. And above all, I'm confident in our team. They know that no platform succeeds without purpose. And that our ambitions are always informed by the millions of families we serve. The results we're sharing today and what we envision for the future simply wouldn't be possible without the best team in the business. And I want to thank them once again for all they do for Target, our guests and communities. Finally, I want to thank you for joining our Financial Community Meeting. We appreciate your interest in Target, your engagement in our journey and your long-term investment in a growth horizon that we believe will remain bright for years to come. We look forward to hearing from you in the Q&A portion of our program. And I'll turn it back to John Hulbert to move us into that discussion. John?
John Hulbert:
Thanks, Brian. Before we take a short break, I want to pause and review logistics for the upcoming Q&A session. For those of you planning to listen in, but not ask a question during Q&A, you should simply stay on this webcast, and you'll hear this session in a few minutes. However, if you received our conference call invitation and you plan to ask a question today, you'll need to exit this webcast and dial into the conference line provided on your invitation. Once you're on the conference line, the operator will provide further instructions. But again, if you're planning to access the Q&A session in listen-only mode, your best option is to stay on this webcast even if you received an invitation.
With that, we'll pause for a few minutes to provide ample time for conference call participants to dial in and begin the Q&A session shortly. Thank you. [Break]
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation 2021 Financial Community Meeting Q&A Session Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Tuesday, March 2, 2021. We are now ready for our first question from Chris Horvers with JPMorgan.
Christopher Horvers:
A near - a '21 question, and then I have a follow-up on a longer-term question. Okay, in the SG&A outlook, on our math, you have about $1 billion related to COVID costs, such as special bonuses and cleaning, while you raised to $15 an hour midyear. To what extent are you assuming these costs come -- are tailwinds in '21? And can you quantify how significant the operating expense related -- is related to investment that's pressuring SG&A dollars?
Michael Fiddelke:
Sure. I can take that one first, Chris. When you think about [ SG&A ] through the year, we'll be annualizing the move to $15, and there'll be some onetime things that don't repeat. You think about buying plexiglass dividers, you only do that once. The final story in SG&A will be written by what our sales outcome looks like too. But we've got a lot of levers within the model to continue to bend the cost curves in a direction we like throughout SG&A, the benefit of the volume growth that we've seen is that, that helps us get more and more efficient on how we fulfill that volume.
Christopher Horvers:
So then does it mean that sort of the SG&A rate coming back up is more of an embedded sort of negative top line outlook?
Michael Fiddelke:
No, I wouldn't think about it that way necessarily. With the SG&A, we expect that our SG&A rate will be lower than 2019's rate, and that's a benefit of the significant scale that we've gained since then. If you zoom out, I think there's going to be a lot of movement between the different levers within margin and SG&A. And so that's why we've tried to give some of our best thinking on operating rate in total. And so a wide range. Not every meeting I would sit here and be describing a 1 point gap in operating margin between the incredibly strong 6 that we had in 2019 and the 7 we just put up. And that whole range is in play. I think it's slightly more likely we're in the bottom half of that range when all the dust settles in the top half, but we're going to have a lot to learn throughout the year based on where we ultimately land.
Christopher Horvers:
Understood. And then longer-term and bigger picture, we used to talk about showrooming with Best Buy. I was wondering what the organizational's thought change is on showrooming is versus national brands? You launched Apple and now you have Ulta. What's the thought change here? And what does it say about the willingness to take on more national brands in the apparel space where maybe the brands need to replace volumes from the mall? And is the bar higher here in terms of what those brands will need to bring to get into the Target store?
Brian Cornell:
Yes. Chris, it's Brian. I think one of the things that we underscored throughout the pandemic has been the strength of our stores. And despite many of Americans really avoiding public places, we've seen very strong store comps, obviously, in excess of 7%. And we saw very solid store traffic. So I think we've continued to build trust. And I think coming out of the pandemic, our stores are going to be -- continue to be very relevant, very important. I think they go far beyond showcasing. We know our guests are inspired by shopping in our stores. They enjoy browsing. They enjoy seeing the combination of our owned brands and national brands.
And now I think we just punctuate that further with the addition of brands like Ulta Beauty, Levi's, the expansion of Apple. The work that we've done throughout the year to create a showcase of owned brands and national brands and continue to invest in building a trusted and safe shopping experience. So as we think to the future, stores are going to play a very important role. It's going to be a place where our guests enjoy shopping each and every day. And I think they're going to continue to enjoy our multi-category portfolio for years to come. So we are -- continue to be very bullish on the role stores play. And I think these new national brand partnerships will only accentuate the importance of stores and drive future traffic to our stores.
Operator:
Our next question is from Karen Short with Barclays.
Karen Short:
I also had kind of '21 question and then a bigger picture question. So trying the SG&A question a little bit differently. If I look at what I think your COVID costs were and expenses were in 2020, it was north of $1 billion. And I think I calculate around $750 million in wages for the 2 quarters in the back half of 2020. So in theory, that would imply you lose about $1 billion in SG&A dollars in 2021. Is that the right way to think about it? Because it definitely gets me closer kind of to 7% on the operating margins, obviously, depending on sales.
Michael Fiddelke:
Karen, like similar to the answer I gave, Chris, I think there's going to be a lot of moving variables through the gross margin and SG&A lines. And to get overly precise today about where any one of them comes in, I think, would be a bit of an exercise in false precision. The biggest factor versus a couple of years ago on the SG&A line is going to be the benefit of scale, and we can put that to use in so many ways across the business. And we've got a long history of investing in our team. That was a big part of the journey we embarked on in 2017 and attracting and retaining the best team in retail has been a center of our strategy for the last several years. And we continue to put the team at the forefront this year, and that will continue as well.
Brian Cornell:
Karen, I might as well take the guidance question upfront and kind of remove the bull's eye from Michael's chest, again, no pun intended. But as we sit here today, I think we all recognize this is a very uncertain environment. We're still speculating around what's going to happen with the economy, how employment rates start to recover. While the trends are encouraging right now with the virus, we're all battling COVID each and every day. And while vaccine distribution is accelerating, millions and millions of Americans are still waiting for their turn to get that vaccine. We're still wondering when children go back to school. And when we'll return to the workplace.
So we approach guidance, recognizing there's lots of uncertainty. But I'll go back to the fact that for most of the last year, we haven't provided guidance, but we have focused on execution. And I think our team has proven to be very flexible, very agile. We responded to the environment and we've been focused on delivering a trusted and safe experience for our guests, whether they're shopping in our stores or online. That focus on execution will continue in 2021. And I wouldn't confuse guidance or the lack thereof with our confidence to continue to take market share and outperform in the coming months and years. So I recognize the frustration of not being more precise, particularly on the top line as we think about sales, but I can guarantee you, our entire leadership team and every part of this organization is focused on retaining and growing market share no matter what the variables are we have to face. So I recognize, and we certainly like to be in a different position today, providing more precision. But what I can tell you is we're going to continue to execute our strategy, leverage our capabilities, our owned brands and national brands, our multi-category assortment and our team to continue to build on the momentum we gained in 2020, leverage the additional $15 billion of revenue we now have inside of our P&L and continue to build on the market share we gained in 2020 and make sure that's very sticky for years to come. But I recognize for all of you, you'd love more precision around market share. You'd love some more top line insights. I can tell you, we're off to a very strong start in February. In fact, our comps in February started with a 2 handle, and that's a 20 comp in the first part of the year. So we'll see how that plays out in March and April, but we're off to a strong start. We took significant market share in the fourth quarter. If you recall our comments in earlier meetings, we talked about the fact that in the first 3 quarters of the year, we had picked up approximately $6 billion of market share. So we added another $3 billion of market share during the holiday season, where all of our competitors were operating. So I think the vibrancy of our model, our ability to execute is something that I would ask all of you to focus in on. And I recognize you've got to do that in light of the fact that we haven't provided the precision that we normally do at this time.
Karen Short:
No, I appreciate that. And I just wanted to ask a bigger picture question. With respect to the partnerships that you've announced, what is the gating factor on accelerating or not accelerating some of these partnerships at a faster rate? I mean you've obviously given us the number of remodels that you've done, and I'm sure they're not all a primary target for some of these partnerships, but it seems like you could move a little faster on those. So a little color on that would be great.
Brian Cornell:
Yes. I'll go back over time and think about the work we've been doing for the last 5 or 6 years. We always start by testing and learning. Listening to the guest, listening to our team, iterating along the way, validating our assumptions, both from a sales standpoint and a financial standpoint, before we accelerate. It's the same approach we've taken with remodels over the years and new small formats. It's the same approach we took to Pick Up and Drive Up. And we're doing the same thing as we think about partnerships with great partners like Apple and Ulta Beauty. We want to test and learn, make sure we get the model right. And then as we've demonstrated in the past, we'll hit the accelerator and make sure we expand and leverage scale as quickly as possible.
Karen Short:
Great. And congratulations on a great year.
Operator:
The next question is from Edward Kelly from Wells Fargo.
Edward Kelly:
Maybe just one on '21 and then also a bigger picture for you. So on the gross margin, can you just provide a bit more color on the '21 gross margin settling in a little bit below '19. Is that just simply a function of digital growth getting ahead of sort of potential offsets and merchandising? And then how are you thinking about the gross margin outlook beyond '21?
Brian Cornell:
Sure. The biggest factor in '21 was the supply chain and digital pressure, about 110 basis points of pressure on the year from that. But I think that's actually a good place to illustrate somewhat how we think about rate. Because to me, it's all about the dollar impact, not the rate impact. And digital is a perfect example. If you would have told us we could double the digital business and only see 110 basis points of pressure last year, I think we all would have taken that outcome. But more important than that, when we're growing digital, we're deepening our relationship with guests. And great things happen in aggregate to us when that occurs.
And so sign me up for more digital growth going forward. We know that's a behavior that will be sticky. Because what comes with that, in addition to a little bit of rate pressure on the margin line, is hugely accretive sales benefits in total. And so biggest driver in 2021 for sure and I would welcome more digital growth going forward and we expect that's a place where we'll continue to excel.
Edward Kelly:
Okay. And then I just wanted to follow-up with a question on Shipt. Can you provide just a bit more color on what you've seen this year from -- or this past year from like a membership trend standpoint, retail partnership growth? And then taking a step back, what's the competitive synergy of owning this business versus utilizing it as if it was a third party provider? And if there was potential to amount value in something like Shipt, would that be something that would interest you?
Brian Cornell:
John, you want to talk about, Shipt?
John Mulligan:
Yes, sure. So we were incredibly pleased with Shipt's performance over the past year. They gained market share, very strong results for the business serving our retail partners. And just as important, and I'll come back to this, is Shipt has become an integral part of Target and our fulfillment on same-day operations. So incredibly important there. But I think the team down in Birmingham did an outstanding job this year, just scaling the business, right? They doubled the number of shoppers. We talked about how the Target sales on Shipt grew by 300%. Memberships grew by 130%. We continue to add great retail partners like Best Buy and Bed Bath & Beyond and several local and regional grocers. And so they've done just a really great job continuing to scale that business.
I think when it comes to Shipt and obviously, the relationship with Target, incredibly important part about our same-day options. And you heard us talk all morning today about the key lever that having that suite of fulfillment, same-day fulfillment options for our Target guest has been over the past year and really over the past several years and will continue to be in the future. Not only is that the preferred way our guest continues to grow with us, but they're also economically advantaged. And so we see -- we continue to see huge opportunities for Shipt to continue to work directly with Target to continue to fulfill our guest's needs. The other thing I would say, is we see when a -- very similar to Drive Up, when a guest engages with Shipt through Target, again, we see growth in our sales in-store and online on the Target platform as well. So they get more engaged with Target. That is hugely valuable for us. So we bought that capability 3 years ago thinking this is what it would be. It would be incredibly important for us from a same-day perspective. It has only become more so has that accelerated through 2020.
Brian Cornell:
And I'd just go back to a point that we've made a number of times. Our most valuable guest is a guest that uses -- utilizes all of our assets, shops in our stores, leverages Order Pick Up, uses Drive Up when it's convenient for them. And also, more and more, leverages the benefits of a personal shopper through Shipt. So we think that continues to be the easiest place to shop in America. Having all of those assets available for our guests is critically important. And we think those are going to be very sticky over time. Those guests who utilize Drive Up and Shipt during the pandemic, we think there's going to be a lasting connection to those fulfillment options as we go forward in 2021 and beyond.
Operator:
The next question is from Ed Yruma with KeyBanc Capital Markets.
Edward Yruma:
I guess, first, you were pretty early on in raising wages. Do you think that having a premium relative to some of your competitors is important to kind of keep the customer service level high? I guess I'm just asking that because it does seem like industry wages are moving up. And it's kind of a longer-term question, you guys have done a great job of differentiating your soft goods and your hard lines based on design. I guess as you think about food, particularly fresh food, how do you think you can differentiate and grab share?
Brian Cornell:
Ed, I'll go back to the commitment we made at this meeting in 2017, when John Mulligan and I laid out our strategy for the company and talked about the billions of dollars of capital we'd invest in stores, in remodeling stores, in building new stores and building out our digital and fulfillment capabilities. At that time, we said the most important investment we were making was in our team. And I think the results we've seen in 2017 and 2018 and 2019 and 2020, is a by-product of that commitment to our team. Investing in wages and benefits, investing in training and career opportunities. And I think it's allowed us to build the best team in retail that's incredibly engaged, that's focused on taking care of our guests, but also taking care of each other. And our team was really the star of 2020. They stepped up during the pandemic and made sure we created a safe shopping environment.
As we scale Drive Up and saw growth rates of 500% or 600%, they flexed and we're able to meet the needs of the guests. So I think the fact that we've taken a leadership position with wages, invested in our team, provided them the opportunities to grow their careers, that's a hallmark of the commitment we've made at Target to creating the best team in retail. And I think it's provided great returns on investments for shareholders. So we'll continue to make sure we invest in our team. To your question around design, the investments we've made in food and beverage, Good & Gather is off to a tremendous start, a multibillion-dollar brand in a short period of time. It's been well received by our guests, great quality, had a great value. And I think it typifies the things we do with our owned brands. And we're very excited about the momentum we had in food and beverage. We took significant market share throughout the year. And the guest has certainly recognized and appreciates the Good & Gather brand. So we think that's a way for us to continue to differentiate our offerings. And as John mentioned, we'll continue to add fresh products to our Drive Up assortment and Pick Up assortment throughout the year, providing our guests access to more of those products that they're looking for each and every day.
Operator:
The next question is from Scott Mushkin with R5 Capital.
Scott Mushkin:
So I think the first question I have is really more of, I guess, strategic, structural. Just looking at the growth rate of your fulfillment cost just generally, is that going to be able to go below the growth rate of sales conceivably or conceptually?
Brian Cornell:
Scott, I think on fulfillment costs, we continue to make progress on our fulfillment costs through 2 paths. First is each individual fulfillment service, we continue to lower the absolute cost of providing it. So Order Pick Up today, Drive Up today, Shipt today, ship-from-store, all of those are cheaper than they were 2 years ago. So we continue to see our costs come down there.
The second way we see our costs come down is through mix. Drive Up, Order Pick Up and Shipt all have much better economics, as we've said for years than shipping from the back of our stores, which also has better economics than shipping from our fulfillment centers. So we -- and they are the fastest-growing portion of our portfolio. In addition to that, ship-from-store grows much faster than fulfillment. So we see favorable mix as well. So we continue to be really pleased with the progress we're making on the unit economics of shipping or delivering goods, fulfilling goods to our guests. The only thing I might add to that is, I mean, John talked about the power of having stores hit the hub of that fulfillment equation, and that helps all those marginal economics. But also important not to forget is the thing that matters most economically with digital is the growth in guest spend in total as they become those omnichannel guests that have a deeper relationship with Target overall. And so any time we're looking at the slice and dicing of the P&L by channel, which we do a lot of, and we've made a lot of progress getting more efficient over time, that always has to be stapled to the greater impact of that greater guest spend in total as they use more and more of our digital fulfillment services. Scott, one of the examples we've shared over the last year is the Target guest that is now using Drive Up, actually spends more money in store. It just deepens that relationship. So we can look at the economics, fulfillment node by fulfillment node, but it's really how it all comes together and how we deepen relationship with our guests, get them to use all of our assets and utilize both stores and digital fulfillment channels over time. So as John said, we're going to continue to improve the economics of each one of those capabilities but it's really the sum of the parts and that deeper relationship we build as our guests use more of our fulfillment nodes over time.
Scott Mushkin:
I appreciate that answer. I mean as a follow-up to what you guys are saying. I mean, obviously, Amazon has struggled with this, too, right? Their fulfillment costs grow faster than their sales. So if we're -- and I think, looking at it, as in kind of just as one kind of fulfillment cost, I mean, do you guys see a path ever for -- because I know Amazon struggled here too, like to getting fulfillment costs to grow on a slower basis than your sales? Because that's obviously where the leverage would be able to come in if you can make that happen.
Brian Cornell:
Scott, the place I'd start is the power that the store gives us to fulfill because everything is cheaper when it comes to the store. And that helps us on the cost question that you asked. It's cheaper to ship a box a shorter distance from a local store after it's ridden our supply chain rails all the way to that store. Same-day fulfillment economics look a lot like store economics to us. And that's the piece to John's point that's growing fastest. And so the stores give us an incredible advantage to have advantaged cost profile as we fulfill.
The other thing that the stores give us that has been incredibly valuable this year is great flexibility. We've seen the ability for stores to scale to meet guests' need in a way that I think probably would have surprised us if we can go back a year in time and see it all coming. But stores are so flexible. There's real power in being able to say, it's that same piece of inventories sitting on a shelf, and we can put it in a box and ship it out the back. We can drop it in a guest's trunk via a Drive Up. They can place it in their cart on a store trip and not having to be able to see perfectly exactly how that demand is going to come, but knowing the inventory can fulfill it and our great store team can make it happen however the guest chooses to shop gives us a huge flexibility advantage as well.
John Mulligan:
Yes. And just piling on now. The other thing, I go back to what Michael and Brian both said, it's the sum of the parts. And I don't think we need any more than to look at last year to see that when the sum of the parts operate together, we grew digital at an astronomical rate. We grew the store at a great rate. And together, we generated significant profits. So it is the sum of the parts working together that is the real power for us. And then Michael, I think, talked about this today that when you start to disaggregate them, you start picking at things that don't make a whole lot of sense because of the way we package the whole thing together to deliver that for our guests and the economic returns that provides for us in total.
Scott Mushkin:
Perfect, guys. And hats off to you guys in the stores and everything else for doing what you did this year. It's just amazing, you could do so much more volume and perform so well. So congratulations on that.
Operator:
The next question is from Simeon Gutman with Morgan Stanley.
Simeon Gutman:
My first question, I want to ask, I guess, longer-term question on margins. It's sort of outside of '21 so I know '21, there's not a lot of visibility. But I know the conversations we've had about margins is more about there an outcome and you're not managing to a particular margin. Beyond '21, is there anything that could hold margin back in terms of some of the investments that you have planned for the out years?
Brian Cornell:
Thanks for the question, Simeon. When I think about margins in the long run, the straw that will stir that drink is sales growth. And we're incredibly confident in the way we're positioned to build on the deepening guest trust the beginning of this year with long-term sales growth. You can see the power of leverage in our model in an exaggerated way in 2020, no doubt. But that's the focus of where we're investing going forward is to continue to gain share and grow the top line because that gives us a lot of levers to pull below there on the margin line. Yes.
So the other thing that we've talked about periodically is the importance of mix in our business. And over time, our multi-category portfolio is a huge asset. Christina has been obviously in a merchant chair for a number of years and understands the importance of balancing our multi-category portfolio, the balance between our owned brands and national brands. And as John and Michael have talked about periodically, as we think about the future from a digital standpoint, we think that's going to continue to move more and more towards same-day, which from a mix standpoint is very advantageous to us. So I think our outlook for margin over the long-term is very bullish. As we leverage our multi-category portfolio, we continue to build our owned brands as well as great national brand partners. But as we continue to see guests take advantage of the speed and convenience of same-day digital fulfillment, all those things add up to a very healthy mix management and margin control.
Simeon Gutman:
Great. Okay. And my follow-up is on the $9 billion of share that you gained in 2020. I saw it was one of the pillars in that pyramid debt foundation. Can you talk about how you're thinking about retaining it? Anything more in terms of -- you're hoping to keep 100% of it and build from it. Can you share a range of outcomes in terms of share retention? And then anything on the categories that you think you can make the most headway with in 2021?
Brian Cornell:
Simeon, I'll come back to -- we saw a really strong share performance against our entire portfolio in 2020. And that continued in the fourth quarter, and we expect to continue to be in a strong share position in 2021. Obviously, we're still sorting through what the overall industry performance will look like, category by category as we think about 2021. But I'll let Christina comment on some of the early observations that we have as we think about the strength in our owned brands, some of the newness that we're bringing to market, the new national brand partnerships and the great investments we have with both our owned brand and national brand vendor partners. So I think we're well positioned to continue to grow share. And I think the investments we're making in our stores and the store experience and in digital positions us well to continue to grow share for years to come.
Christina Hennington:
Yes. I might add a few points there, but to really punctuate what Brian said is the multi-category portfolio that we have gives us so much flexibility. And if we follow the guest, we will deliver. We -- when the guests chose not to really change their order very much and more yield pass all year, it had an impact on the apparel industry, yet we significantly outpaced the performance in that industry. This year, people are going to buy new clothes because people don't want to wear the same thing over and over. They'll do their makeup. They might even buy a piece of luggage if they're venturing out of the trip. And that ability to flex with the needs of the guests through the breadth of our portfolio is what's going to keep us growing share and gaining against the industry for years to come.
Simeon Gutman:
Great, and congratulations.
Operator:
The next question is from Stephanie Wissink with Jefferies.
Corey Grady:
This is Corey Grady on for Steph Wissink. I wanted to follow-up on the February comp comment. How much of that strength would you attribute to stimulus? And can you compare the impact of this round on what you saw last summer?
Brian Cornell:
Yes. We've spent a lot of time trying to sort through some of the factors behind that. Again, I think so much of it has been the investments we've made in safety and the shopping experience throughout the last year. We certainly have seen guests shop all of our categories in the month of February. So broad-based strength. And I think, again, the guest is responding to some of the newness in our assortment. And to Christina's point, they're looking for the opportunity to shop our stores and find new items. They're tired of the yoga pants and really appreciate some of the new assortment we have in apparel. They're still shopping for their homes as they refresh the core. They're still heating at home so kitchen and food-related items are still really important.
So we see a guest shopping all of our categories, taking advantage of both stores and our digital channels. And I think it's a byproduct of the investments we've made throughout the pandemic to build trust to make sure they know we've got a safe shopping environment and the great work that our teams have done to make sure that they're focused every day on meeting the needs to our guests. So very encouraged with the month of February. And we'll continue to make sure we stay agile and flexible to meet the needs of the guests throughout the next 11 months.
Corey Grady:
As a follow-up, I wanted to ask about your inventory position. Where do you stand on in-stock positions today? Are you seeing any gaps that you feel you need to remediate in the near term?
Brian Cornell:
Christina?
Christina Hennington:
We're very pleased with our inventory position. We continue to build in support of sales. And the reality is that we are -- we're looking to fill in the gaps where we have a few selectively, but it's been a marked improvement throughout the year and the responsiveness of our team is incredible. We have not only a very responsible supply chain team here in the United States, but across the whole world. That intel and insight allows us to manage a very complex supply chain with efficiency and always been focused on getting our out of stocks in the best position possible.
Brian Cornell:
And Corey, an opportunity to really thank our vendor partners who have been very responsive to meeting our needs. Obviously, no one anticipated the kind of comps we were driving in 2020. I talked about the almost historic number we delivered in January, and our vendor partners have been very responsive, working with our merchants and supply chain teams to ensure that we fill in some of those gaps and have the inventory we need as we go forward.
Operator:
Our next question is from Paul Lejuez with Citigroup.
Paul Lejuez:
Curious when you look back on 2020, how many new customers were new to Target? And how did that break down versus when you acquired them first half or second half? And is there anything you can share in terms of the patterns that you saw in terms of those gained in the first half? How did they spend in the second half? Maybe talk about the frequency and spend in their purchases.
Michael Fiddelke:
Sure. I can start. Thanks for the question, Paul. As we think about new customers, no doubt, there are some new customers to Target this year. We've shared some of the digital guests that we've gained in past calls. The thing that we're most focused on is deepening the relationship of those guests that have really stepped up their trust and their spend and their share of wallet with Target over the last year. And so we talked about the 12 million new omnichannel guests this year. That's the place where we focused a lot of that kind of deepening of the guest relationship and the things that we're tracking. We're encouraged to see the stickiness of a lot of the new behaviors that were tried in 2020.
So things like Drive Up, thanks to the incredible experience our store teams provide. Once guests try a service like that, they come back and we've seen higher rates of stickiness this year than historically for some of those digital fulfillment services. And that bodes well for the stickiness of those guests and those behaviors going forward. And so while we do watch new guests, and it's great to get a new guest and convert them to a deeper Target guests over time, a lot of America shops Target and it's the deepening of those existing guests as they shop us in new and different ways and more often, that's our focus.
Brian Cornell:
Yes. Paul, the only other point I would add is, as we've looked at the guests during the pandemic, we know they're consolidating where they shop. And we may have had a Target guest that was shopping for home or beauty, but they're now shopping for apparel, picking up food and beverage, exploring new categories. They may be coming to us for electronics and toys. So to Michael's point, while most of America shops with Target, during the pandemic, we've seen consumers consolidate the number of places where they shop. They're now experiencing and are active in more categories, and we think that provides lasting benefits for us for years to come.
Operator, it looks like we've got time for one final question today.
Operator:
Our last question is from Joe Feldman with Telsey Advisory Group.
Joseph Feldman:
I wanted to kind of continue on that train of thought, Brian, with regard to customers come in for one thing, they shop for others, what are you guys doing from a data analytics standpoint and to really stimulate the customer to buy more items beyond what they normally buy? And I was just curious where we're at in terms of the data analytics and leveraging the data to really harness it and make it more useful.
Brian Cornell:
Joe, obviously, it's been a big area of focus for us for many years. And I'll come back to something we haven't talked about a lot today, which is the membership within Target Circle. The fact that we now have 90 million members in Target Circle, which gives us an understanding of their needs, their wants, how they're shopping, new categories and new items we can introduce them to. So we're going to continue to make sure we leverage Target Circle to build deeper relationships, introduce that guest to new categories, new fulfillment options. And over time, we think that's a very valuable asset that will continue to drive growth, help us build market share and continue the momentum that we established in 2020.
So with that, I want to thank everyone for joining us today. We look forward to seeing all of you in person in 2022. And obviously, John and Michael will be available for any follow-up questions today or over the balance of the week. So thank you for joining us, and stay well.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation third quarter earnings release conference call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, November 18, 2020.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our third quarter 2020 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; and Michael Fiddelke, Chief Financial Officer.
In a few moments, Brian, John and Michael will provide their perspective on the third quarter and our priorities as we move into the holiday season. Following the 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, the most important of which are described in our SEC filings. Also in these remarks, we refer to non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP numbers to the most directly comparable GAAP number are included in this morning's press release, which is posted on our Investor Relations website. With that, I'll turn it over to Brian for his thoughts on the quarter and our focus going forward. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. Before I move to our third quarter results, I want to acknowledge our team. In an incredibly challenging environment, they have stayed focused on our guests, looked out for each other and built on the purpose and a clear set of priorities we've had in place for several years, making Target an even more relevant and responsive company for the millions of families we serve every week.
The pandemic has presented new challenges for all of us, and our team has successfully navigated every one of them. They've stayed laser-focused on safety, agility and reliability as they seamlessly adapted to abrupt changes in guest needs and shopping patterns. They've handled supply constraints in essential categories while chasing inventory in long lead time categories that are experiencing explosive growth. They've been a calming presence and a friendly face to our guests, who are craving normalcy at a time when hardly anything feels that way. And our team members have passionately played an active, positive role in our communities during an incredibly turbulent year. With a deepening level of trust our guests are placing in our team and our brand, we've continued to see very strong business results. Third quarter sales grew nearly $4 billion over last year, bringing our year-to-date growth to more than $10 billion. This unprecedented growth, both in the quarter and the year, has been driven by meaningful share gains across every one of our core categories as guests increasingly rely on Target to reliably and safely serve their wants and needs. Based on the cost leverage driven by steeply higher sales, our business continued to deliver impressive bottom line performance despite the outside investments we have been making in our team, safety and digital fulfillment. Our third quarter adjusted EPS of $2.79 established another record high for company and was up more than 100% from last year. Third quarter comparable sales increased 20.7%, reflecting a 4.5% traffic growth, combined with an increase in average ticket of more than 15%. Since the pandemic began in March, we've experienced a meaningful acceleration in basket growth, both in stores and online, as guests have consolidated their shopping into much larger trips. Across channels, our store comps grew nearly 10% while our digital comp sales grew 155%, contributing nearly 11 percentage points to the company comp. Within digital, we continued to see the strongest growth in our same-day services, Pick Up, Drive Up and Shipt, which, together, grew more than 200% in the quarter. These services are fast, convenient, reliable and contactless, which explains why they continue to generate very high levels of guest satisfaction. All our financial reporting counts these same-day orders as digital. These services are entirely enabled by our stores. Specifically, same-day orders are fulfilled by our store teams, along with Shipt shoppers, who rely on store inventory and systems to deliver to the front of our stores, our parking lots or guest front doors within a couple of hours receiving an order. Beyond same-day services, well over half of our packages we ship to guest homes are also fulfilled from our stores, providing speed to our guests while reducing shipping costs on our P&L. Altogether, between same-day services and packages shipped to our guests, about 75% of our third quarter digital sales were fulfilled by our stores. And of course, if you add that on to our conventional store sales of more than $18 billion, you can see that more than 95% of our total third quarter sales were fulfilled by our stores. This store-as-hub model is the foundational element of our strategic plan we announced at the beginning of 2017, just over 3 years ago. Our performance for the first 3 quarters of 2020, which includes digital sales growth of nearly $6.5 billion and a store sales increase of more than $3.5 billion is the direct result of our stores-as-hub strategy combined with the tireless work of our team to bring it to life. In terms of the cadence of our business throughout the quarter, we began with mid-teen comp growth in August. This reflected a slow start to the back-to-school season as many school districts across the country began their year in distance learning mode. However, sales trends in Back-to-School, Back-to-College and our overall business strengthened in September, driving comp growth in the mid-20% range for the month overall. In October, comp growth settled back to approximately 20%, consistent with our comp growth for the full quarter. Across our core merchandise categories, third quarter growth was strongest in Hardlines, which saw comp growth in the mid-30% range. Within Hardlines, result was strongest in electronics, which grew more than 50%, driven by particular strength in computer software, video games, portable electronic and office equipment. Within our style categories, results were strongest in home. We saw comp growth in the mid-20% range, with the strongest growth in decor and kitchen. Comp sales in apparel grew by nearly 10%, led by results in intimates and sleepwear as well as men's apparel. Consistent with the second quarter, both our Essentials & Beauty and Food & Beverage categories saw third quarter comp growth in the high teens. In Essentials & Beauty, we saw strength across the entire portfolio with the strongest results in paper and pet. Similarly, in Food & Beverage, we saw broad-based growth with a particular strength in adult beverages and dry grocery. Following our announcement in the second quarter, this was the first full quarter in which our starting wage was $15 or higher across the country, up from $13 a year ago. The attainment of this milestone was the culmination of a commitment we first announced in the fall of 2017 when our starting wage across the country was $10. Our team has always been a key differentiator for our stores and our brand. And this $15 commitment was intended to attract, reward and retain top talent for what has long been the best team in retail. Beyond our longer-term goal to raise Target's starting wage, this year, we've also focused on recognizing our team's outside efforts during these extraordinary times. Specifically, we have awarded 4 separate recognition bonuses so far in 2020. Most recently, in October, we awarded $200 to each of our frontline team members in support of our plan to invest more than $1 billion in our team for the year. As we build our plans for the fourth quarter, our team focused first on flexibility and agility, knowing how volatile and unpredictable the external environment continues to be. We focused on leveraging Target's strengths, including the emotional connection between our brands and our guests and the convenience and speed of our stores-as-hub model. We're focused on listening to our guests to understand what they're experiencing, and they've told us that safety is one of their top concerns. So on top of our goal to be the easiest place to shop, we're committed to being the safest place to shop as well. In support of that goal, we've implemented a number of technology improvements to make shopping at Target more contact-free. These include an enhancement to our self-service lanes, which means guests no longer need to use the hand scanner to pay with their wallet function in our app. We made changes to Drive Up that eliminate the need for a team member to scan a guest phone when they deliver an order. We've rolled out a new capability on Target.com, allowing guests to check in, in advance to see whether we're currently metering traffic in their store and allow them to reserve a spot in line before leaving home. In addition, we have altered our promotional cadence to avoid events that typically cause crowd. And we announced that we'll be closed on Thanksgiving and open at the regular time on Black Friday. Rather than concentrating holiday deals around Thanksgiving and Black Friday, we've spread our Black Friday offers throughout the entire month of November with weekly promotions spread across different categories throughout the month. And in the spirit of transparency and trust, we've assured our guests that they see any of our Black Friday items for a lower price later in this season, we'll happily make up the difference through our extended price match policy. To minimize lines, we've added more than 1,000 mobile checkout devices across the chain, allowing our team members to help guests check out anywhere in the store. We've also added thousands of gift items eligible for same-day fulfillment. And we're entering the holiday season with more than double the number of Drive Up parking spaces compared with a year ago. In addition, we've added fresh, refrigerated and frozen items to our Pick Up and Drive Up assortment in more than 1,600 locations across the country, making this the first holiday season in which guests from coast-to-coast can use these convenience services to pick up everything they need for a holiday meal. We're also continuing to expand the number of our merchandise categories available through our Shipt service, most recently adding kids and adult apparel. This change provides a new contactless option for guest to shop these categories and have them delivered to their front doors in as little as an hour. While many things will be different this year, our guests have told us that they still plan to celebrate the holidays, and we know they'll be looking to Target for some holiday magic. That's why we're so excited about our recently announced partnership with FAO Schwarz. New for this holiday season, Target and FAO Schwarz have collaborated on an exclusive 70-piece toy collection with many items priced under $20. This collection will be available at Target stores nationwide, on Target.com and the flagship FAO Schwarz store in New York City. Beyond this unique election, this holiday, we've created our biggest ever list of Top Toys, including more than 600 exclusive items, which will feature at an incredible value all-season long. In decor, we're focused on bringing Target's brand promise to life by offering value and quality with hundreds of ornaments priced at $3, $5 and $10. On Target.com, more and more of our guests are shopping for decor using See It In Your Space technology, which makes our digital shopping experience more inspiring than ever. This feature allows guests to visualize what Christmas trees will look like in their homes as they prepare to decorate for the holiday. Guests who utilize this 3D rendering feature are 2x more likely to purchase a tree compared with an average digital guest. In speaking with our guests, we know that finding the right gift can be a source of stress during the holiday. So this year, to make it easier than ever for our guests to share the joy, we've expanded our gifting assortment, including items for even the toughest individual on their list. With many items priced at $15 or less, we are offering incredible value, making it easier to celebrate the season with family and friends. And while the holiday season is top-of-mind right now, we shouldn't forget that the fourth quarter also includes a full month after the holiday. We're planning to kick off the new year on a positive note with a focus on wellness and nutrition, new exclusives in Beauty and the introduction of seamless T-shirt, fleece and performance bottoms to celebrate the 1-year anniversary of our new activewear brand, All in Motion. And speaking of Beauty, we couldn't be more excited about our new long-term strategic partnership with Ulta Beauty, which we announced last week. Because it embodies book style and frequency, the Beauty category is ideally suited to our strategy and it's one of our strongest growing categories over the last few years. This new partnership will help us to build on that success, providing our guests access to dozens of new beauty brands nationwide with elevated service and presentation in select store locations. We plan to open the first 100 Ulta Beauty shop-in-shops later in 2021 with the potential to open 100 more in the years beyond. So now before I close, I want to provide a brief update on our plans for Target's 2021 Financial Community Meeting. While no one can accurately predict the future of the coronavirus and the impact of potential vaccines, we have decided to host this meeting virtually in 2021. We made this decision out of an abundance of caution in keeping with our focus on the safety of our team and our investors. We look forward to hosting it again in person beginning in 2022. So now as I get ready to turn the call over to John, I want to come back where I started and acknowledge our amazing team. When I arrived at Target a little more than 6 years ago, I already knew that Target is an academy company, a place that attracts and develops the level of talent that's the envy of other companies. That was already true before I arrived, and I couldn't be more proud of the team investments we've made in recent years, investments intended to cement Target's position as an inclusive home for top talent. What I didn't appreciate until I became and immersed with this team is the warmth of the culture and the team's sincere desire for Target to play a positive role in the world. This desire often shows through in our marketing and our assortment and you could certainly see it in our stores. But for those of us who had the privilege of working with every part of this team, we see it every day behind the scenes even when no one else is looking. So I'll close with a simple thank you to this team for your passion to make Target a welcoming place for all families and a great place to work for everyone on the team. With that, I'll turn the call over to John for an update on our operations and plans for the holiday season. John?
John Mulligan:
Thanks, Brian. When you pull back and consider what's happened in our business this year, it's clear that a couple of defining themes have emerged. The first is flexibility. You've seen that play out in our merchandising assortment, enabling us to satisfy our guests' rapidly changing wants and needs throughout the year.
You've also seen it play out in our operations as our stores-as-hubs model allowed our team to pivot seamlessly when guests move their shopping between stores and our digital channels. This flexibility will continue to serve us well in the fourth quarter and beyond, given that we continue to face an elevated level of uncertainty across multiple aspects of our business. Our third quarter results continue to demonstrate the power of our same-day services to deliver speed and convenience for our guests while driving an impressive amount of the company's growth. In the third quarter, our same-day services grew well over 200% compared with last year, adding more than $1 billion of incremental sales. Nearly $700 million of this growth was from our Drive Up service alone, which increased more than 500% compared with last year. Amazingly, this growth was not at the expense of in-store pickup, which increased more than 50%. And while Shipt remains the smallest of our same-day services, it continues to grow rapidly as Target sales on Shipt increased nearly 280% in the quarter, accounting for more than $200 million of incremental sales. I want to pause and give a shout out to our team at Shipt and congratulate them on an incredible year of growth and expansion, which has included a doubling of their shopper base. Altogether, our third quarter digital sales grew more than $2 billion compared with last year. For perspective, $2 billion is more than our company's total digital sales for the entire year in 2014. Somehow, I think I should pause for a second and let that sink in. But instead, maybe I'll pile on by making the same point a different way and point out that between the first 3 quarters of 2014 and the same period this year, the compound annual growth rate of our digital sales was 45% over that 6-year period. Another area in which we've seen amazing flexibility is in the management of our inventory as we've adapted to huge swings in the pace of sales among individual categories and worked to support overall growth that's been well above expectation. As I mentioned last quarter, while we continue to make progress, we've seen some persistent inventory shortfalls for a couple of distinct reasons. First, in several of our long lead categories, like electronics, home and apparel, our team has been playing catch-up given that we experienced an unexpected sharp and sustained explosion in demand for these categories. The team has done a great job of chasing and expediting inventory to support these categories, which enabled the unusually strong comps that Brian outlined earlier. Even more encouraging, we ended the third quarter in a much better position than where we started, and we expect to see additional recovery in the fourth quarter. The other driver of inventory shortfalls in 2020 is related to industry dynamics as the producers of cleaning and paper products have been working to ramp up production in the face of a dramatically higher demand across all of U.S. retail. Happily, we're also making progress in these categories. While we're not yet back to pre-COVID levels, we saw supply improve during the quarter and we expect to make continued progress in the fourth quarter. Overall, our progress is reflected in the aggregate numbers. Specifically, we started the third quarter with inventory down about 3% compared with the year ago and ended more than 11% higher than a year ago after a quarter in which our sales grew more than 20%. This is a remarkable progress and puts us in a much better position as we move into the fourth quarter. I also want to highlight the flexibility of our properties team who just opened 18 new stores in October. For the year, our team successfully opened 30 new stores, of which 29 were small formats, making 2020 the biggest year of small format openings ever. In any year, setting records would be notable. But in a year in which COVID caused us to delay our new store construction, it's been amazing to watch how quickly our team was able to restart such a large number of projects and successfully bring them to completion in advance of the holiday season. Beyond flexibility, another key theme this year is capacity as we consider the physical resources we'll need to support our business over time. As Brian mentioned, we've already grown our sales by more than $10 billion through the first 3 quarters of 2020. And again, for context, that $10 billion of incremental sales is more than our total sales growth between 2011 and 2019, an 8-year period. You might well have wondered whether compressing 8 years of growth into less than a year was even possible. But clearly, the capacity was there. And while capacity is a function of replenishment as well as fulfillment, the question we hear most often is whether we'll continue to have enough capacity for our digital fulfillment. And in that regard, the primary factor is our strategic decision to place our stores as the center of fulfillment. By relying on the same asset to fulfill both our conventional and digital sales, the key to fulfillment capacity is the store asset itself and the speed with which we can move inventory through it. You might refer to that as our ability to increase turnover. But sometimes you'll hear engineers like Michael and me refer to that metric as throughput just to sound smart. As we said in the past, sales per foot is a useful proxy for throughput. So let's consider how that has progressed so far this year. As a baseline, for the full year in 2019, average sales per foot at Target were about $320. And so far this year, that metric has grown about 19% compared with last year. So just as a thought exercise, if you assumed we were going to grow our sales productivity at that same pace for the full year, we'd end 2020 at about $380 per foot. Now I need to pause to quickly and reinforce. I'm using a hypothetical 19% number. I'm not providing guidance for the quarter. I'm just giving us something to anchor on. So the critical question is after growing sales per foot from the lower end of the $300 range into the upper 300s, do we have any more capacity in our stores? The answer is certainly yes. Last year, in our second quarter call, I mentioned that our top quartile stores averaged well over $400 a foot back in 2018 and that number has grown to nearly $500 since then. If we can average nearly $500 a foot on nearly 500 of our most productive stores, I think it's clear we have capacity to grow the chain average well beyond where it is today. And that capacity would be there even if we kept doing what we're doing today. But of course, we continue to find ways to improve throughput. And one of our newest options is to deploy sortation centers in markets where delivery density is high. To better assess this concept, we recently opened our first sortation center here in Minneapolis, which will allow our teams to test, learn and assess its ultimate potential before determining whether to roll out the concept further.
The business case for our sortation center is straightforward:
by moving the sorting and staging prospects out of the stores, it frees up backroom space, enabling additional throughput. Stores can simply focus on packing the orders, which are then transferred multiple times per day to the sortation center where they can be sorted and staged at a larger scale, driving per-unit efficiencies and potentially reducing the number of split shipments. In addition, we can reduce per-unit shipping cost by deploying technology from Grand Junction, which helps us to allocate packages across different providers and applying recently acquired technology from Deliv to help us to optimize sortation and injection into those provider networks.
But unit efficiencies are only part of the potential benefit. While these centers require some capital investment, they are designed to increase both throughput and capital efficiency of our existing network, which should reduce the need for us to invest capital in upstream fulfillment centers. Net-net, our expectation is that investing in sortation centers will be a more capital-efficient way to add capacity, and we'll be assessing that potential through the test. Before I move on from this topic, I should quickly acknowledge, there are a number of other important considerations regarding capacity. Beyond overall capacity, within each store, we need to ensure we have allocated appropriate space to fulfill both our conventional store sales and our entire suite of store-fulfilled digital sales. There are a number of ways we account for this in our plan. First, we continue to find ways to optimize space within our stores, including options to free up front end space to accommodate growth in Pick Up and Drive Up and backroom space to accommodate peak demand for our ship-from-store capability. We're planning for this expanded capacity in our new stores and remodels, and we developed robust processes across the rest of the chain to free up space outside of a full remodel. Second, within each market, we route the bulk of our ship-from-store orders to lower-volume stores, allowing the highest volume stores to devote most of their capacity to conventional sales. And third, we've developed tools and processes to create temporary peak capacity in both the front end and the back room, which allows us to handle the fourth quarter surge in both same-day and ship-from-store volume without building a permanent solution that we wouldn't need for the rest of the year. We've already deployed this additional temporary capacity across the chain in advance of this year's holiday peak, which we expect will be far larger than anything we've seen in the past. The other consideration in planning for future capacity is our upstream supply chain, which handles the bulk of the product we receive from vendors and then routed to the stores across the country. Even going into this year, we told you that we would need to be adding to our upstream capacity to accommodate future volumes. And with this year's unprecedented growth, upstream capacity has become an even more important aspect of our plan. So as I've said before, I hope these metrics and our demonstrated ability to grow well beyond expectations this year can help to address any of your concerns that we're going to run out of capacity. But in the meantime, I want to cover our plans for the fourth quarter peak. The team is in place and ready, and while stores will be busy, both our promotions and operational plans are designed to minimize crowding to allow our guests to shop safely. Digital penetration always peaks in the fourth quarter. And this year, our store central fulfillment model is well positioned to handle an unprecedented amount of digital volume. And while all of our digital options will likely see huge volume, we're really excited about our capacity to satisfy guest demand through our same-day services. We're ending the fourth quarter with double the number of Drive Up spaces compared with a year ago. And as Brian mentioned, we've made technology changes to make it completely contactless. We're also entering the fourth quarter with more than 1,600 stores able to fulfill fresh, refrigerated and frozen items through our Pick Up and Drive Up services, making shopping for holiday dinners incredibly easy. Among guests who have been shopping this enhanced assortment using Drive Up, we've seen half of the orders picked up within 2 hours and 2/3 within 4 hours, demonstrating how guests are using this service to conveniently serve an urgent need. And finally, as we plan for seasonal hiring this year, we prioritized additional hours for our existing team members first and then added seasonal help to provide the necessary capacity. In training our teams to ensure we've accommodate peak digital fulfillment needs, we rolled out a plan to ensure that at least 50% of each store's team is cross-trained and able to support fulfillment this year. So like Brian, I want to close with a simple and sincere thank you to the entire team. While peak is still ahead of us, you've already made this a year to remember, and I can't wait to see what we can do together to deliver for our guests throughout this holiday season. With that, I'll turn the call over to Michael who'll provide more detail on our third quarter financial performance and provide his initial thoughts as we plan for next year. Michael?
Michael Fiddelke:
Thanks, John. Similar to each of our every day lives since the onset of the coronavirus, hardly anything in our P&L has felt the same as before. But a few factors are most important in understanding our business results so far this year.
First off, for the headwinds of which there have been several, including merchandising mix, digital fulfillment costs and an avalanche of first quarter apparel markdown. In addition, we've invested nearly $1 billion in additional pay and benefits for our team, along with safety measures to protect both our team and our guests. Yet in the face of those pressures, our business has delivered outstanding profit. And while there are various places on the P&L where you can see the favorability, they all tie back to the $10 billion of incremental sales that John mentioned earlier. On the expense line, this growth has resulted in an extraordinary amount of leverage, which has more than offset the pressure from additional costs. In addition, this year's unusually strong growth has resulted in exceptionally low markdown rates as I'll discuss in more detail in a few minutes. When you pull back from the detail, it's clear that our business has been able to deliver both incredible top line growth and strong bottom line results. This is a hallmark of the durable model we've been building over the last few years. Our third quarter comparable sales increase of 20.7% reflects the continued pattern of trip consolidation by our guests as our average transaction size grew by more than 15% on top of very healthy traffic growth of 4.5%. Total sales grew 21.3%, about 60 basis points faster due to sales in new and nonmature stores.
On the gross margin line, we recorded a rate increase of about 80 basis points in the third quarter, driven by the net impact of 3 separate factors. The first is the benefit of our merchandising efforts, which contributed well over 2 percentage points to our gross margin rate in the quarter. While there are many individual factors within this larger bucket, the most notable is on the markdown line as we saw exceptionally low promotional and clearance markdown rate. On the promotional markdown line, we've seen a year-over-year benefit since the pandemic began. And the reason is simple:
when unit volume in commodity categories is so high that production is struggling to keep up with demand, it makes sense to stick with our low everyday prices and reduce the number of stock-up and other volume-driving promotions, which would only increase the number of out-of-stocks faced by our guests.
On the clearance markdown line, we've seen even more favorability, and the reason is somewhat different. As demand for our noncommodity categories has stayed persistently higher than expected, we've sold a higher-than-average mix of our units at regular price with fewer-than-expected units sold on clearance discounts at the end of the season. Even more notable, favorability on the clearance line has been the primary driver of our overall markdown favorability on a year-to-date basis despite the exceptionally high apparel markdowns we recorded in the first quarter. Offsetting the benefit of our merchandising efforts, there were 2 distinct headwinds to gross margin in the third quarter. The first was from digital fulfillment and supply chain costs, which drove about 110 basis points of pressure, driven by rapid growth, digital fulfillment, along with incremental team member pay, benefits and safety costs for our supply chain team members. The other gross margin headwind came from category sales mix, which was worth about 60 basis points of pressure as lower-margin categories grew faster than higher-margin categories during the quarter. On the SG&A expense line, we recorded about 180 basis points of favorability in the third quarter. As I mentioned earlier, the favorability on this line reflects exceptionally strong cost leverage due to sales growth of more than 20%. This benefit was so strong, it was able to offset about $300 million of incremental investments in team member pay and benefit, along with safety measures to protect our team and our guests. On the D&A line, dollars were down about 6% from a year ago worth about 70 basis points of rate improvement as we continued to annualize higher levels of accelerated depreciation on last year's larger remodel program. Altogether, the business delivered an exceptionally high operating margin rate of 8.5%, more than 3 percentage points higher than last year. On a dollar basis, operating income grew more than $900 million or more than 90% compared with last year. On the interest expense line, we recognized a $512 million loss on debt extinguishment related to a debt tender offer we executed in October. In light of our higher profitability, income taxes grew by about $90 million compared with last year. On the bottom line, despite the loss on debt extinguishment, which was equivalent to $0.75 of pressure, third quarter GAAP EPS from continuing operations established a new record high of $2.01, representing an increase of 46% compared with $1.37 last year. Adjusted EPS, which excluded the debt extinguishment loss and a couple of other small factors in both years, also established a new record high of $2.79, more than 100% higher than $1.36 last year. Our business continues to generate very strong cash flow. Specifically, through the first 3 quarters of the year, our operations have delivered just over $7 billion of cash, which is nearly $3 billion more than a year ago. Obviously, our profit performance is an important factor in this increase, but we also continued to benefit from unusually high payables leverage, which is running well over 100%. Consistent with my comments last quarter and despite the inventory growth John mentioned earlier, we would have chosen to have less cash at the end of the quarter and more inventory if that option had been available. In light of the continued strength of our cash generation and resulting cash position on our balance sheet, our treasury team recently elected to take a couple of actions. The first was the execution of a debt tender offer in October, in which we invested $2.3 billion of cash to retire $1.8 billion of high coupon long-term debt. This transaction created significant economic value and it will significantly reduce future interest costs. In addition, it allowed us to deploy the bulk of the extra cash we added in the first quarter when, like many other well-capitalized companies, we chose to take on additional liquidity insurance at a time of extreme uncertainty following the onset of the pandemic. The other decision was made earlier this month when we terminated a supplementary 364-day credit facility, which was also added during the period of extremely high uncertainty during the first quarter. Beyond those actions, we also announced today that we have lifted the share repurchase suspension that we initially announced in the first quarter. We don't intend to engage in any repurchases before the end of the holiday season, but under appropriate conditions, we would look to reinitiate repurchases in 2021. As a reminder, we currently have $4.5 billion of remaining capacity under the repurchase program approved by our Board of Directors in September of 2019.
As always, the timing and quantity of repurchase activity will be governed by our decades-long capital deployment goals:
we first look to fully invest in projects that meet our strategic and financial criteria; second, we support our dividend and look to build on our nearly 50-year record of annual increases in our dividend per share; and finally, we deploy any excess cash beyond the first 2 uses to repurchase our shares within the limits of our middle A credit ratings. These capital priorities have served us well for decades and have played a critical role in supporting both strong operations and a strong balance sheet over time.
In terms of capital deployment, we made capital investments of about $600 million in the third quarter, bringing our total for the year to just over $2 billion. We continue to expect full year CapEx in the $2.5 billion to $3 billion range, below our original expectation of about $3.5 billion, driven primarily by the reduction in remodel activity following the onset of COVID-19. We paid dividends of $340 million in the third quarter, reflecting a 3% increase in the dividend per share, partially offset by a decline in share count. And of course, we didn't repurchase any shares in the third quarter in light of the suspension I mentioned earlier. Turning now to our after-tax return on invested capital. Our business delivered an extraordinarily high 19.9% in the trailing 12 months through the third quarter, up nearly 5 percentage points from 15% a year ago. While our longer-term plans have focused on delivering higher after-tax ROIC over time, the acceleration over the last 2 quarters has been well beyond anything we would have expected. And given that our inventories have been consistently lower than we'd prefer, we gladly would have traded some cash for more inventory over the last 2 quarters even though that would have driven this metric somewhat lower. So now before I close, I want to comment a little bit about our outlook. While we stopped driving financial guidance back in the first quarter, I want to outline a number of important considerations as we move into the holiday season and the fourth quarter overall. The first is the continued headwinds facing the consumer and the economy. In light of uncertainty around the path of the pandemic and continued elevated levels of unemployment. Offsetting this pressure, beginning with the onset of the pandemic, there has been a significant change in the mix of consumer spending as a meaningful portion has shifted away from travel and multiple forms of out-of-home entertainment and into many of the categories we sell. We also continue to benefit from trip consolidation as consumers have increasingly relied on our stores and digital services to satisfy a wide variety of their wants and needs in a single trip. Beyond these macro trends, there are a number of more specific considerations as we enter the holiday. The first is the expected change in the category mix of our fourth quarter business as typically both our electronics and toy categories generate half their annual sales in the fourth quarter. Given that both of these categories have seen dramatically stronger sales since the pandemic began, it's more difficult than usual to predict how the pattern will play out in the fourth quarter. Similarly, the digital mix of our sales, an important factor in our overall profitability, typically reaches a seasonal peak in the fourth quarter. This year, it's difficult to predict how high our digital mix will become given that we've already seen dramatically higher levels of digital penetration all year. So the natural question is, once you quantify all the potential headwinds and tailwinds you've just outlined, what's your fourth quarter forecast? Well, I think that's a great question. The reality is that none of us can accurately predict the future as all of us are facing a much higher level of uncertainty compared with a normal year. That's the reason why we've suspended financial guidance, but that doesn't mean we can't affect the outcome. As I've mentioned before, we continue to prioritize flexibility as we plan our business and focus on agility in our operations. That way, when the unexpected happens, our team can respond quickly and effectively as you've seen so far this year. Looking ahead to next year, the crystal ball doesn't get any clearer. Not only is it uncertain when the coronavirus will be fully behind us, it's also unclear how the consumer will behave in a post-COVID world. That creates uncertainty about the path of multiple categories as you consider how the mix of consumer spending will evolve and what the competitive landscape will look like. In adapting to that new world, we'll need to understand what that will mean for our business and how the financial metrics that have been dramatically changed this year will settle down over time. And today, while we can't answer these questions any more accurately than you can, it's clear that flexibility and agility will continue to be vitally important. So while specific metrics will continue to be difficult to predict, we continue to have a high degree of confidence in our business and our ability to outperform. That's because based on the hard work of our team over the last few years, we now have a business model that's demonstrated its ability to deliver market share growth and profitability across a range of environments that's been far wider than any of us would have expected. And importantly, in a time where virtually nothing has stayed consistent, the one reliable through line across weeks and product categories has been consistent share gains throughout the year. In addition, we've seen a massive increase in guest engagement this year as they ventured into new categories and service at Target. And as I mentioned in our first quarter call, we've long known that engagement with guests at a time when their habits are changing is an incredibly important factor in deepening long-term loyalty. It's the reason we prioritize the Back-to-College season when many consumers are moving away from home for the first time. It's also the reason we're there for young couples when they get married and when they have children because our relationship with young families has long been a foundational aspect of our strategy. But most importantly, our team is a huge reason why we're confident in our future. We've long told you that we have the best team in retail, and this year's experience has demonstrated why we feel that way. Throughout the year, our team has stayed optimistic, they've taken care of each other, they've offered friendly service to our guests and they've successfully overcome a host of unforeseen challenges. The longer I've been at Target, the more I've seen how our team is Target's secret sauce, and I want to express my sincere gratitude to all of them for everything they've accomplished so far this year. With that, I'll turn it back over to Brian for some final thoughts. Brian?
Brian Cornell:
Thank you. I want to reinforce Michael's commentary on our connection to families, which is so fundamental to our strategy. It's right at the center of our corporate purpose
Even though the holidays will be different this year, we know our guests still want to discover the joy and connect with those closest to them. So our team is focused on helping to make that happen while providing helpful and friendly service in a safe environment during the busiest time of the year. So with that, we'll move to Q&A. John, Michael and I will be happy to take your questions.
Operator:
[Operator Instructions] And our first question comes from Chris Horvers from JPMorgan.
Christopher Horvers:
So I have a near-term question and a long-term question, starting with the near term. I guess curious what your thoughts are on how this holiday plays out. What's the mood of the consumers that you've seen as you head into holiday? You've had some events already that could probably test where you're seeing strength and where you're not seeing strength. So how are you thinking about -- what's the outlook here for the holiday and the timing and so forth?
Brian Cornell:
Well, Chris, it's Brian. Why don't I start out, give everyone a sense for how we're viewing the holiday season. And we've spent a lot of time talking to guests throughout the year. And as it pertains to the holiday, they're clearly telling us that they want to celebrate this holiday season, but they know it's going to be very different
They've reacted very positively to our new promotional plan to start early and actually make those deals available throughout the holiday season. We've heard very positive responses to closing on Thanksgiving and really minimizing those big traffic-driving occasions that we've seen in the past. So we expect this to be a season that's going to be very different, unlike any other we've ever seen. But we expect that guests will decorate their home, and there'll be gifts under the tree and they'll find special ways to celebrate the holiday season. And they'll turn to Target and our multi-category portfolio and our suite of fulfillment services as a way to make that happen.
Christopher Horvers:
Understood. And then on the long term, so you've seen the likes of Levi's, Disney shop-in-shops, Ulta last week. Today, WWD has an article that Journelle is coming to Target. It's clear the level of fashion is on the rise at Target. There are plenty of well-known brands that sell into likes of Penneys and Kohl's and Macy's that now seem like a natural fit from Under Armour, Chaps, CK. Is this an active strategy that you are pursuing on the apparel side? What's been the dialogue there? And is there any pushback that you've heard from these types of brands?
Brian Cornell:
First, to be really clear, our focus will always be on curation and making sure we balance the right mix of our own brand and select national brand partners. And that will be an approach we'll take for years to come. So we're very excited about some of our new partnerships and working now with Levi's. And next year, in 2021, welcoming Ulta Beauty to our stores and to Target.com. But we'll always be curators and finding the right mix for our guests between our own brands and iconic national brands.
Operator:
Our next question comes from Stephanie Wissink from Jefferies.
Stephanie Schiller Wissink:
I have a follow-up question to Chris' question just on brand expansion, but I'm curious if we can look through the lens of your guest profile. Any insights into new to file guests, where they might be coming from and how those baskets may look relative to your historic average guest?
Brian Cornell:
Stephanie, we've talked about the number of new guests that have turned to Target during the pandemic. As John and Michael and I referred to in our opening comments, we're seeing a guest shop multiple categories, take advantage of our vast multi-category portfolio. Some days, they're shopping our stores. Some days, they're taking advantage of our same-day fulfillment services. And we expect that to continue. So the guests that are shopping our stores right now are taking advantage of the multiple categories that we sell. They are shopping in apparel and home. They're coming into Hardlines and Food & Beverage. They're taking advantage of our Beauty offerings as well as Household Essentials. And again, some days, we see them taking advantage of the investments we've made to create a safe shopping experience in-store. And other days, they're taking advantage of the ease and convenience of our same-day fulfillment services.
Operator:
And our next question comes from Edward Kelly from Wells Fargo.
Edward Kelly:
Your gross margin performance this quarter was excellent obviously. But can you provide a bit more color just on the markdown situation? So of the 200 basis points that you mentioned, was that all markdowns? How much of that was just less promos versus clearance?
And then how do we think about Q4 as it relates to these line items? It's obviously pretty hard for us to predict at this point. I'm sure for you as well. But any color there, I think, would be helpful.
Michael Fiddelke:
Sure. I can take that one. When you think about the drivers in Q3, the north of 200 basis points of good news from a bucket of levers within merchandising. The single biggest of those, for certain, was markdown efficiency. And we've seen continued efficiency on the promo markdown line throughout the year.
And then clearance, and so much of that is a function of our sales -- our higher-than-expected sales in some of the seasonal categories. As you guys well know, a big part of our recipe for assortment in stores is bringing seasonal relevance and newness. In Q3, we changed over a lot of the store heading into the fall. And we had sold through a greater degree of that assortment this year than we typically see, and that provided some real tailwind on the margin line in Q3. When it comes to Q4, as one said, Q4 is always its own animal. So we build Q4 bottom-up with a clean sheet of paper and that's the way we've done it this year with admittedly a few more uncertainties in that equation than we might have typically. But we feel really good about, importantly, how our inventory is positioned heading into the holiday season. And we expect and feel good about our prospects for the quarter looking forward and the strength of the multi-category assortment and the strength of our fulfillment options and the ease and convenience that we'll be able to bring the guests should bode well for the fourth quarter as well.
Brian Cornell:
Yes. It's Brian. I'd only add and really recognize the great work our merchants teams have done throughout the pandemic and certainly in the third quarter, making sure that we quickly adjust assortment to make sure it's relevant for the guests in today's environment. And I think you'll expect to see that in the fourth quarter as well.
But our merchants have worked very closely with our key vendor partners to make sure we're making the adjustments and we've got the relevant items in our stores and online that guests are looking for today. And that's certainly been a big part of our success throughout 2020.
Operator:
[Operator Instructions] Our next question comes from Edward Yruma from KeyBanc Capital Markets.
Edward Yruma:
You guys have been very successful in operating and opening stores in some of these more densely populated urban areas. Wonder if you could give us some sense to how they performed, maybe as some folks have left these cities.
And I guess the flip side it, if real estate becomes more accessible, is this a strategy you could continue to lean into longer term?
Brian Cornell:
John, you want to talk about small formats in 2020 and some of the outlook that we have for 2021?
John Mulligan:
Sure. Yes, we remain really bullish on the small-format stores and the opportunity in front of us there. We have many different types of trade areas that we have opened small formats in over the years, and by and large, they are all performing well.
There's a couple that I would say are probably not quite where we'd like to be given the year. One is college campuses. Those stores that are heavily dependent on just students have lagged the company a little bit. And the other one is really on employment centers, not really around dense urban neighborhoods. Dense urban neighborhoods have continued to perform very, very well. Employment centers where people have been working from home, those have also lagged a little bit the rest of the chain. But as we look forward, we continue to see great opportunities across all the different trade areas. We believe college campuses, we're very bullish on those for the future. And so you'll continue to see us look to open small formats in many of the same areas that we've opened them in historically. And you'll see us begin to accelerate a little bit next year, potentially 30 to 35, perhaps over time get to 40 stores a year as we continue to think about opening those smaller stores to address trade areas where guests are seeking the Target experience, but today can't get that store experience. So like I said, we remain very bullish on that whole concept.
Operator:
And our next question comes from Karen Short from Barclays.
Karen Short:
I'm just wondering, with respect -- a short-term question and then longer term. You gave a lot of color in terms of the things that you're doing near term and also for January to the extent that January slows down. But I guess I'm wondering how you're thinking about December from the perspective of there's been so much pull-forward of shopping. Do you think there's some risk from a December perspective that December kind of fizzles a little bit? And how are you planning for that?
And then I just had one other bigger picture.
Brian Cornell:
Karen, why don't I start? I think as we've looked at the holiday season, we expected the guests to start shopping earlier but continue to shop throughout the holiday season right up to Christmas eve. So we think it's going to be a prolonged shopping season. I think we're going to see very different shopping patterns. We don't expect to see those big spikes during Black Friday and on weekends. I think it's going to be spread across the holiday season.
And we think December is going to be a very important gifting season for our guests. So we're watching it carefully. And again, we'll put a premium on flexibility and agility as we work through the months of November and December. But all indications, as we've talked to the consumer and talked to the guests is they're going to look to celebrate this holiday season. They're going to be focused on gifting and celebrating with their family and close friends. And we expect them to be in our stores and shopping online right till the very end of the holiday season.
Karen Short:
Okay. And then my second question is just for -- as we look to 2021, obviously, there are some tough comparisons on the top line and maybe some tougher comparisons on the promotional from a lack of promotions this year. How are you thinking about the environment in 2021 as some retailers have to lap some of the tough comparisons? Or is it a function of the fact that there are many retailers that really can't be promotional because they don't have the balance sheet and capability to do that?
Brian Cornell:
Karen, right now, we're very focused on the first half of 2021. And this is going to be a familiar theme
We certainly expect certain trends will continue. We think guests will continue to consolidate the number of locations where they shop. We think our multi-category portfolio will continue to be very important as we serve the needs of families. We think ease and convenience, combined with safety, will continue to be important. And we'll continue to deliver great value. So Michael talked about our continued focus on market share and the market share opportunities that are in front of us, and I think we'll be very focused on continuing to build off of the market share gains that we achieved in 2020 and further share opportunities in 2021.
Operator:
And our next question comes from Paul Lejuez from Citi.
Paul Lejuez:
A couple of quick ones. Just I'm curious if you can quantify the percent of your sales increase that's being driven by new customers versus existing customers? Curious about the store comp, if you can talk traffic versus ticket.
And then, Brian, you mentioned, I think the top quartile of your stores are doing $500 a foot. Curious if you looked at that top quartile, let's say, as of 2019 versus the bottom quartile, how are each of those performing this year in 2020?
Brian Cornell:
Yes. Why don't I start and then I'll ask for both John and Michael to provide a perspective.
But I'll start with the recognition that on an average week, we see well over 30 million guests shopping our stores. And as you've seen in our third quarter results, we've seen traffic continue to grow at a rate of 4.5%, basket expand over 15%, and certainly, there are a mix of new guests to Target. But the Target guests and the families that shop us each and every week are visiting us more frequently. They're certainly shopping more categories. And that's creating greater trips either to our stores or to our fulfillment channels, and they're shopping a wider array of categories to take advantage of our multi-category portfolio. So we're seeing both growth with our existing guests and new guests to Target and to Target.com. Mike, can you give perspective on top-tier versus lower-tier store performance?
Michael Fiddelke:
Yes. I'll take that really quickly. As you'd imagine, given just the magnitude of the number of stores, those tiers tend to move in unison. So we talked about the top tier being up, the bottom tier move the same amount. And any individual store will have its own story. But in quartile, they tend to move pretty consistently.
Brian Cornell:
So I think the only thing I'd add is we look at our performance, our comps by geography each and every week. And we're seeing very consistent results literally across the country. From both coasts and the heartland of America and in the Southern market, really consistent comp and growth performance. So certainly, it's not 1 or 2 markets that are driving it. It's not our top-tier stores versus some of our lower-volume stores. We're seeing a consistent lift across the entire fleet of stores and obviously very strong growth in our digital channels.
Operator:
And our next question comes from Paul Trussell from Deutsche Bank.
Paul Trussell:
Very strong quarter. The question I'm not going to ask is to John on whether there's enough capacity for the holiday season. I think the point is very well made there.
But I do want to ask about -- I do want to ask about the evolution of the same-day services. And just curious on what you're learning given the robust growth, how you're improving efficiency, your ability to add additional items of merchandise in categories to be included in those services?
John Mulligan:
Yes. Well, first, thank you, God bless you for not asking about capacity. I would tell you, our store teams and the Shipt team continue to execute our same-day services at a very, very high level. And I think you hit on one of the things we've been very focused on this year, which is really assortment expansion. For Drive Up and for Pick Up, that has meant adding frozen, refrigerated and fresh foods. We are on a trajectory when we started the year to add it to about 300 stores. We obviously paused in the early spring. And then as things started to open up, really proud of the way our store teams responded and decided we could execute that across our properties team, supply chain and stores to get that in close to 1,600 of our stores today. And so that's available and that's been a huge win for our guests.
We see the unit increases -- the number of units in the basket increase as guests start shopping that. It was the #1 guest satisfier. If I can come and get diapers and a couple of other things, why can't I get a gallon of milk and some eggs. And so now we're able to fulfill that. Right along with that, in OPU and Drive Up -- with Order Pick Up and Drive Up, we've added adult beverage, another key category for us where, again, it just tops off the basket. So a real guest satisfier and we'll continue to work to add other categories at Shipt. The opportunity there was to get some more of our discretionary categories available for our guests as they use our same-day service. And so as Brian mentioned earlier in the call, we added children's and adult apparel to that right here before the holiday. We think that will do very well. So the teams continue to execute, continue to build efficiencies into what we're doing. But importantly -- I think the most important thing is they continue to ask the guests what it is they want and what we can fulfill for them and you'll see us continue to work toward that. And that will guide really how we continue to improve those services.
Operator:
Our final question comes from Robby Ohmes from Bank of America.
Robert Ohmes:
First, Brian and team, I just want to say congrats on the execution of your strategy. It's been plain remarkable.
My question, I'm sorry, I'm going to ask two. Brian, you mentioned Shipt. I was wondering if you could give us a little more on Shipt and profitability and maybe growth outside of Target, maybe a little more color on what Shipt is becoming. And then the second, maybe a shorter question, just a Target Plus, your marketplace. Anything changing with your strategy there that you can share with us, given your momentum online?
Brian Cornell:
John, you want to start with Shipt and then we'll wrap up with Target Plus.
John Mulligan:
Yes. We continue to be really, really pleased with the performance of Shipt and the execution of the team. As we said, Shipt at Target has grown 280% this quarter, $200 million of incremental sales. So -- and it's a key part of what we're going to do here in the fourth quarter, we think you'll see us throughout the fourth quarter really lean into our same-day service as Order Pick Up, Drive Up and Shipt as a way -- as our way to fulfill our guest needs, and Shipt will be a big part of that.
I think beyond that, Shipt continues to experience very strong growth. They continue to add retailers. There are over 100 national and regional retailers. They added Bed Bath & Beyond this quarter in addition to a few others. They've doubled the number of shoppers since the spring and are planning to add another 100,000 shoppers here for the fourth quarter. So we continue to see really strong growth, and we're very pleased with Shipt's performance overall.
Brian Cornell:
And Robby, on Target Plus, our approach continues to be the same. We're very selectively curating some vendor partners. I think we're up to about 175 right now. We probably have now close to 400,000 SKUs available through Target Plus. But we'll continue to make sure we curate very carefully and complement our store and online assortment.
So with that, I do want to thank everyone for joining us today. I wish everyone a safe and happy holiday season. We look forward to the day when we can all be back together in person. But thanks for joining us. Thanks for your support, and have a safe and happy holiday season.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation second quarter earnings release conference call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, August 19, 2020.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our second quarter 2020 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; and Michael Fiddelke, Chief Financial Officer. In a few moments, Brian, John and Michael will provide their perspective on the second quarter and our continued focus on our guests and our team as we navigate through the current environment. 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, the most important of which are described in our SEC filings. Also in these remarks, we refer to non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP numbers to the most directly comparable GAAP number are included in this morning's press release, which is posted on our Investor Relations website. With that, I'll turn it over to Brian for his thoughts on the quarter and our focus going forward. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. Today, we're sharing second quarter results that are, by virtually any measure, exceptional. But I want to say at the outset that what's most extraordinary of all is the environment in which we generated those results. The incredible resilience of our team, the way they've risen first to the pandemic, then to social trauma touched off in May here in Minneapolis is unlike anything I've seen or I'm likely to see again in my career. And I say in all humility that it has been a huge privilege to work alongside this team in this moment.
The results we reported this morning are truly unprecedented. On the top line, we delivered second quarter comparable sales growth of 24.3%, the strongest we've ever reported. Equally remarkable on the bottom line, we generated adjusted EPS of $3.38, a new record high and strong enough to offset the significant profit headwind we faced in the first quarter. These results are a testament to our team and their passion for our guests and the increasing trust our guests are placing in our brand. Our performance also reflects the meaningful investments we've made in recent years, building a business model that is durable enough to perform in any environment, incorporating flexibility in both our merchandise assortment and the fulfillment options we offer to our guests, while articulating a unified purpose to help all families discover the joy of everyday life. In our last earnings call, we described how our business and operations adapted quickly and seamlessly to rapid changes in consumer behavior. As our guests reacted to the implications of the emerging pandemic, we encountered multiple abrupt changes in shopping patterns throughout the first quarter, both across categories and channels. Near the end of that quarter, we returned to growth in our store sales and once again saw growth in categories like apparel. This improved sense of balance in both channel and category mix continued through the second quarter, and we didn't see the dramatic swings we experienced in the first quarter. In terms of channel mix, we saw very healthy growth across the board, with store-originated comparable sales growing 10.9% and digital comp sales up nearly 200%. It's worth pausing to acknowledge that at just under 11%, this store-only comp stacks up as one of the best in our history and yet, it happened at a time when American consumers are adopting digital shopping like never before. In addition, as I've mentioned in previous calls, channel numbers don't tell the full story because they don't measure the benefit of our work to position our stores as hubs at the center of our digital fulfillment. When you look beneath the surface of the reported numbers, you find that our stores actually drove more than 90% of our second quarter growth, given that they enabled more than 3/4 of our digital sales and an even higher percentage of our digital growth. Store-based fulfillment is uniquely suited to our business model because of the way it fits within our overall strategy. In particular, it aligns with our merchandising approach, which is based on curation, both in our stores and online assortments. As a result, the majority of our digital demand is driven by items that are already available in our stores, which positions us to efficiently rely on those locations to fulfill the demand. Among our store-enabled digital fulfillment options, we continue to see the most rapid growth in our same-day offerings in-store pickup, Drive Up and Shipt. These services offer speed, reliability, convenience and value to our guests. They are digital capabilities enhanced by human interaction, even though they're contactless. This explains why they generate some of the highest levels of satisfaction of anything we provide. Together, our same-day services saw more than 270% comp growth in the second quarter, outpacing overall digital growth. Among these services, we saw the fastest growth in Drive Up, which grew an astonishing 734%. We also saw incredible growth in Target sales fulfilled by Shipt, which were up more than 350%. However, even though we have offered pickup in all of our locations for more than 5 years, in-store pickup sales increased more than 60% in the quarter. Across all 5 of our core merchandising categories, we delivered very strong share gains in the quarter, driven by the acceleration in our discretionary businesses, combined with continued strength in our frequency categories. We mentioned in the first quarter that we had already gained a year's worth of market share in the quarter alone. Rather than slowing down, our share gains accelerated in the second quarter, and we gained double the dollars compared with the first quarter, bringing our year-to-date share gains to more than $5 billion. Among our discretionary categories, we saw the most dramatic comp acceleration in apparel, which moved from a 20% decline in the first quarter to double-digit growth in the second quarter. Hardlines generated the strongest comp overall at more than 40%. This was the result of an even stronger increase in electronics of more than 70% as guests continue to focus on office equipment, home electronics and gaming. Not surprisingly, our guests heightened focus on staying at home was also evident in our home category, we saw more than 30% growth, with particular strength in decor, domestics and kitchenware. Beauty also saw healthy acceleration, doubling its first quarter growth rate to more than 20% in the second quarter. Our less discretionary Food & Beverage and Essentials categories each saw second quarter comp sales growth of about 20%. For both categories, this was slightly slower than we saw in the first quarter, which was marked by dramatic stock-up shopping as the pandemic emerged. At a time when every retailer is facing increased uncertainty and unforeseen challenges, we have chosen to continue investing in our business and particularly in our team. Following hundreds of millions of dollars in team investments in the first quarter, in June, we announced that beginning July 5, we would currently raise our starting wage for U.S. team members to $15 per hour. Additionally, we announced a onetime bonus of $200 to our frontline store and distribution center hourly workers in recognition of their efforts throughout this extraordinary year. We also announced free access to virtual doctor visits for all team members through the end of the year, regardless of whether they currently subscribe to a Target health care plan. And we announced additional extensions of our 30-day paid leave for vulnerable team members and free backup care for family members. As I've mentioned before, the return on these team investments may be hard to quantify in a spreadsheet, but I am confident that they have been among the most important investments we've made over the last few years. In late May into June, our team had to navigate the challenges presented by the killing of George Floyd and the civil unrest that it sparked nationwide. While we all experienced the heartbreak caused by the murder itself, our initial focus was on the safety of our team. As a result, in areas affected by unrest, we closed locations or reduced operating hours, affecting hundreds of our stores across the country. Most of these stores were able to safely resume normal operations in a matter of a few days, but a handful of locations sustained more significant damage. All but 2 of those stores have already reopened, and we're hoping to have those locations reopened by the end of the year. Through it all, I'm happy and grateful to say that none of our team experienced physical harm through the unrest. But beyond physical safety, our team is passionately demanding equity and justice for our black colleagues and guests. We are united in that passion and committed to supporting our team while playing an active role in addressing the persistent racial injustices that have sparked protests around the world. Beyond our team's volunteer efforts across the country, we have dedicated $10 million, half from corporate giving and half from our foundation towards Twin City rapid response needs, local rebuilding efforts and national social justice initiatives.
We've also formed a committee called REACH, consisting of senior leaders who have come together based on their experience and expertise. Together, they represent a broad enterprise view, and their work is focused on advancing racial equity for our black team members and guests across all areas of Target's business. To deliver the most impact across our business, REACH is aligned around 4 key areas of focus:
team, guests, communities and civic engagement and public policy. With their help, we're putting our influence to work in our hometown and in the country, bringing together our team, our neighbors, other businesses and community partners to determine actions and resources that will move us towards a more inclusive, equitable and just society.
Now let's turn to our plans for the third quarter and beyond. Our research tells us that guests still want to celebrate seasons and holidays even as they acknowledge that things will be different in this new environment. To help our guests adapt to these changes, we're building flexibility into our merchandising and operations to allow our guests to celebrate the season in new ways. Knowing that many parents about the country are still facing uncertainty about whether their children will be attending school in person or virtually, we'll be featuring our Back-to-School assortment for an extended period this year, allowing parents to delay shopping until they have more certainty on their school district plans. In Back-to-College markets, we'll be moving in-store shopping events outside into our parking lots and highlighting contactless options like Drive Up. Across the chain, we'll be promoting the wallet feature within the Target app as a fast, contactless alternative to paying with a physical card. And for Halloween, we'll continue to feature costumes and decor to celebrate the season. But we'll be adjusting our candy merchandising in anticipation of a reduction in trick or treating this year. In addition, we'll be giving away surprise boo bags to our Drive Up guests in October, featuring surprises along with tips and suggestions for celebrating the season. Also this fall, we'll roll out the third and final phase of our Good & Gather assortment, adding more than 600 items to bring the total number of items to nearly 2,000. The Good & Gather brand is clearly resonating with our guests and delivering on our Food & Beverage vision to enhance the Target experience by making it easy for families to discover the joy of food. We launched this new flagship brand less than a year ago, and it has already generated more than $1 billion in sales. With the momentum from this new brand, our own-brand Food & Beverage business has been growing more than 30% so far this year, significantly outpacing the market and growing market share. Beyond Good & Gather, we continue to benefit from an unmatched portfolio of owned and exclusive brands that spans our entire assortment. Together, these brands whose sales have outgrown national brands so far this year, offer guests quality and style at an unmatched value while enhancing Target's differentiation and delivering attractive gross margin rates. In June, we launched Casaluna, a collection of more than 700 quality bedding and bath items featuring elevated natural and sustainable materials like linen, hemp, silk, cashmere, all at an amazing value. And of course, it was only in January that we launched our new activewear brand, All in Motion, and the timing couldn't have been better. All in Motion was designed with a commitment to quality, sustainability and inclusivity at incredible Target prices. As guests across the country have moved to working from home, they embraced the quality, comfort and value provided by this new brand, driving sales well beyond our original expectations. Also this quarter, Target Circle will be celebrating its 1-year anniversary of its national rollout. At more than 75 million members, Circle has exceeded our expectations in its first year. To celebrate, we'll be highlighting Circle in our marketing with a focus on driving acquisition and engagement in advance of the fourth quarter shopping season. And finally, as we look ahead to the fourth quarter, we're focusing first on guests and in team member safety, developing plans to reduce crowds and spread out demand throughout the season. Specifically, we'll be spreading our best-priced holiday offers over a longer time frame, beginning in October, so guests can shop safely and conveniently without worrying about missing out on deals that usually come only late in the season. We've also announced that we'll be closing stores on Thanksgiving, sending a clear signal to guests that they won't need to stand in line and crowd into stores to get a great deal. In addition, we'll be making thousands of additional items available via same-day services this holiday season, including more gifts, essentials and everything in between. In addition, as John will describe in more detail, we'll offer fresh and frozen grocery items, via Order Pick Up and Drive Up at more than 1,500 Target stores this fall. As I said in the beginning, I'm incredibly proud of our team and the performance they've delivered on behalf of our guests. As we focus on transforming our business over the last few years, we began with a focus on our guests and how we could better serve them by leveraging our strengths. We emerged from that effort with a durable business model, differentiated from our competitors and designed to perform in a variety of environments.
When we contemplated the range of environments we might face, I don't think anyone could claim that they knew what we'd be facing today. Yet in the face of unprecedented changes in the environment, our business is doing what it's designed to do:
It's delivering convenience, reliability, safety and value, driving increased engagement and trust among our guests. It's supporting and rewarding our team, the best team in retail. It's playing a positive role in the communities where we live and work. It's generating strong, sustainable business results in the support of our shareholders and is accomplishing these results by relying on our stores when many others are walking away from their physical locations.
As we look ahead, we're prepared to navigate through a host of potential challenges, including the ongoing threat from the coronavirus and economic headwinds resulting from high levels of unemployment. Yet, as we said in our last call, we have never been more confident in our differentiated strategy and our long-term potential. Throughout this crisis, we have deepened our relationship with American consumers and introduced millions of them to our digital fulfillment services. As a result, we've seen unprecedented growth in market share, a trend that we expect to continue. With a strong business and deep financial strength, we feel well prepared to weather any near-term economic headwinds and continue to serve and delight our guests. Our team is ready and eager to seize the opportunity in front of us. Now I'll turn the call over to John, who will provide an update on operations and our plans going forward. John?
John Hulbert:
Thanks, Brian. If the overall theme of our first quarter was unexpected change and rapid adjustment, in the second quarter, it was an increasing sense of normalcy. I will quickly say things today are far from the old normal. In fact, hardly anything feels the same today as it did 6 months ago. And while second quarter trends were much less volatile than the first quarter, the team still had to navigate through a great deal of variability, something they've done exceptionally well throughout this crisis. But at this point, the team has gained significant experience with new routines, all centered around safety, and we've returned to many of the routines we paused during the first quarter.
Now that our new cleaning routines are fully established, they are operating successfully in a run-state condition. We continually hear from our guests that safety is even more important than ever, and they appreciate that cleanliness and safety are visible priorities for our team across every aspect of what we do. In late April, we began accepting in-store returns again, following a 5-week pause. Soon after, in May, we began a phased reopening of the Starbucks locations in our stores. As the quarter progressed, many other activities resumed, including a steady reintroduction of the Weekly Ad in select markets and a resumption of a more normal cadence for handling clearance, promotions and merchandise transitions. In our Super Target locations, we initiated a contactless form of sampling in June, along with a phased-in plan to resume deli and bakery production. Across the chain, we reintroduced product samples into our pickup and Drive Up bags and began moving store hours back to their pre-pandemic levels. After opening 3 new store locations in March, we took a pause in our new store projects as uncertainty from the pandemic emerged. Since then, we have been ramping up our new store construction activity, and we are now on track to open up to 27 more stores this year. Nine of these new locations are slated to open this month with another 16 to 18 expected in October. We continue to be pleased with the performance of our new small format stores, and our pipeline is expected to support 35 to 40 of these new locations annually in future years. Perhaps the most vivid example of our progress is the fact that we've resumed our plans to add fresh, refrigerated and frozen items to our pickup and Drive Up services. Going into the year, we had planned to roll out this capability to half or more of our stores this year. However, in March, given the severe swings we were seeing in store traffic and the onslaught of new routines we are asking our store teams to perform, we paused on this rollout to provide our team more time to focus on safely serving our guests. By the time of our first quarter call in May, we had already resumed the rollout. And since then, we have made more progress than we had originally planned for the full year. In fact, we are already offering an extended food assortment for Drive Up and pickup in more than 1,500 of our stores, far exceeding our original goal. By this holiday season, we expect to have this capability in nearly 1,600 stores. In addition, we've added adult beverages to our pickup and Drive Up assortments and more than 300 stores in selected markets. And we'll continue the rollout of both perishable items and adult beverages to additional locations next year. Our teams and systems are successfully handling the additional complexity that comes with these expanded assortments, and our guests are happy as well. They're telling us they appreciate the ability to receive these items without shopping our sales floor, providing them a contactless option when that is their preference. Following the introduction of an expanded assortment into markets, we see a steady increase in usage week after week as more guests learn about it. Our guests tell us they're eager for us to make even more items available, and we'll be exploring further assortment enhancements over the remainder of the year and beyond. Beyond assortment, we continue to implement process enhancements to our digital fulfillment services, driving both efficiency and speed for our guests. New this quarter, we introduced improvements to the Target app, allowing guests to toggle their fulfillment choice between pickup and Drive Up orders up until the point the guests arrives at the store. This option provides additional flexibility for the guests to update their fulfillment option as their plans change. Given the explosion in demand we've seen this year, we've been adding additional Drive Up spots in locations across the country. This additional capacity was contemplated in our original plan, but with the recent growth, we are adding these extra spots earlier than originally anticipated. The process is straightforward as we add 2 to 12 additional spots, depending on store-specific needs, repainting the parking stalls and using additional temporary signing to highlight the change. For our ship-from-store capability, we continue to roll out process improvements for processing orders and packing boxes, increasing efficiency and reducing waste. And we've also enhanced prioritization algorithms to ensure that the orders with the most time-sensitive items, including COVID-sensitive categories, are prioritized earliest for packing and shipping. While digital orders inherently involve more handling and more cost compared with conventional store transactions, we've been realizing meaningful improvements in average fulfillment cost per unit, reducing the impact of digital growth on our operating margin rate. These efficiencies are driven by multiple factors. First, as we continue to roll out new tools and processes, we have been seeing increased efficiency across each of our digital fulfillment options. Second, we are benefiting from favorable mix within digital fulfillment. As our same-day options continue to grow faster than overall digital growth, average unit costs go down because these options are much less costly compared with shipping to home. Third, we are seeing meaningful leverage on digital fulfillment given the unusually high-growth rates we've seen this year. Some of this leverage is more subtle than conventional fixed cost leverage. For example, as a store's Drive Up order volume increases, more and more of the time, our team is able to pick multiple orders together, gaining efficiency in the pick process. In addition, we realized a similar benefit in the parking lot where our teams are increasingly delivering multiple orders at a time, reducing the cost per order of that delivery trip to the parking lot. And finally, as we've seen meaningful trip consolidation this year, we realize a benefit as fixed order costs are spread across more items. Aggregating all of these benefits, our second quarter average unit costs for digital fulfillment was approximately 30% lower than a year ago. This provided a significant offset to the cost pressure we would otherwise be seeing from our unusually high rate of digital sales growth. While we'll always focus on driving efficiency and reducing costs, we embrace digital transactions because they drive guest engagement, which ultimately benefits every part of our business. Our most recent data indicates that a multichannel guest spends 4x as much as a store-only guest and 10x as much as a digital-only guest. Our research also continues to validate that after a guest tries Drive Up for the first time, we see a nearly 30% increase in their overall spending, including an increase in their conventional store shopping. It's particularly notable that this increase in store shopping is occurring despite the unusual environment in which consumers are minimizing time spent in public places. However, the data certainly provides some additional context for the unprecedented growth of more than 10% in conventional store sales we reported this quarter. As we gain new digital guests in unprecedented numbers, we are also seeing higher engagement from these guests than we've seen in the past. Specifically, among our new digital guests in the first quarter, we've seen nearly double the rate of repeat purchases within 7 days compared with a year ago. And the rate of repeat purchases in the intervening 90 days has been fully double what we measured a year ago. Given that we've added 10 million new digital guests in the first half of the year, we feel good about our prospects for building on their elevated level of engagement over time. Now I want to spend a minute talking about our current inventory levels and in-stock performance. While we made a lot of progress in the second quarter, we are still facing challenges across multiple parts of our assortment driven by a couple of distinct factors. First, in many of our frequency categories, our vendors continue to face capacity constraints as they work to accommodate unexpectedly high demand across the U.S. While these vendors continue to ramp up production, and we have been successful in negotiating higher allocations for many of them, demand in our stores continues to outpace supply. As a result, on-shelf availability in many of these categories continues to look sparse even as our allocation quantities are increasing. We will continue to work with our vendor partners to make more progress in the back half of the year. Second, regarding import categories, we successfully increased receipts throughout the second quarter. But as Brian outlined earlier, we also have seen a meaningful acceleration in the pace of sales in these categories. Based on our current plans, we expect that our import inventory will reach last year's levels by the end of the third quarter and should expand well beyond last year's levels in the fourth quarter. And finally, I want to address the nagging questions we continue to hear regarding our capacity and ability to further scale our store-based fulfillment model. I've addressed this question multiple times in prior earnings calls, and I would think that our recent results would dispel these worries. But we clearly haven't convinced everyone yet, so we'll continue to provide facts to support our modeling. Here are some fun facts from the first half of this year. Of our $6-plus billion in comparable sales growth so far this year, conventional store sales have grown nearly $2 billion, while digital sales have expanded more than $4 billion. Our year-to-date digital sales of nearly $7 billion have already eclipsed our full year digital sales in 2019 even though the peak holiday shopping season is still ahead of us. Of this year's digital growth, sales on orders shipped from stores have grown more than $1.6 billion. Sales from our pickup and Drive Up services have also grown more than $1.6 billion so far this year, with Drive Up accounting for well over $1 billion of that growth. And of course, much of this year's growth has been unplanned, meaning that our systems and store teams have had to adjust quickly in real time. So again, we hope these facts help you put your capacity concerns at ease. But if not, we'll continue to address them in the future.
With that, before I end my remarks, I want to pause and thank our team for their resilience, dedication and flexibility during a tumultuous year. It has been incredibly gratifying to watch how our team has adapted to unprecedented change, serving consumers in record numbers while staying laser-focused on what matters most:
the safety of our guests and our fellow team members.
While we all can't wait for the day when we can look at this pandemic in the rearview mirror, the reality is that it's not likely to end soon. In the meantime, we are committed to supporting each other and building on the foundation we've created over the last several years, allowing us to emerge from these tough times as an even stronger company with a deeper relationship with American consumers. Now I'll turn the call over to Michael, who will provide more detail on our second quarter financial results and our priorities going forward. Michael?
Michael Fiddelke:
Thanks, John, and good morning, everyone. While aspects of our second quarter performance could hardly have looked any more different than the first quarter, many of the themes we covered 3 months ago remain true today. Guests are consolidating trips and increasingly turning to Target as the flexibility of our assortment and fulfillment options make us a convenient one-stop shop. We're continuing to invest hundreds of millions of dollars in paying benefits for our team and in new measures to enhance safety and cleanliness in our stores. We're seeing unprecedented market share gains across our multi-category assortment and in virtually every week. And we're focused on financial strength and flexibility as we look ahead given continued volatility and uncertainty in this environment.
As Brian mentioned, our second quarter comp sales growth of 24.3% is the highest we've ever reported. Total sales grew 24.8%, reflecting 0.5 point of benefit from new and nonmature stores. Among the drivers of our comp growth, comparable traffic grew 4.6%, while average basket grew 18.8%, reflecting trip consolidation in both our stores and digital channels. Across those channels, store-originated comp sales grew 10.9%, meaning stores growth alone matched our total comp sales growth in the first quarter. On top of those store sales, digitally originated comp sales grew 195%, contributing another 13.4 percentage points to our total comp growth. Within digital, we continue to see the fastest growth in our same-day services, in-store pickup, Drive Up and Shipt, which together grew 273% over last year. As John mentioned, these services have much lower unit costs compared with the orders we ship to our guests, helping us to control costs even as our digital sales continue to explode. Our second quarter gross margin rate of 30.9% was about 30 basis points higher than last year. Among the tailwinds to gross margin, we saw about 180 basis points of rates benefit from core merchandising strategies, which played out most prominently in lower markdown rates compared with last year. In addition, we saw about 50 basis points of benefit from the change in the sales return reserve estimate that we held at the beginning of the quarter. Among the headwinds, digital fulfillment and supply chain costs accounted for a rate headwind of about 130 basis points, while category mix drove about 70 basis points of pressure. On the SG&A line, the second quarter results included $400 million of investments in team member pay and benefits and measures to protect the health and safety of our guests and team. However, these investments were more than offset by the leveraged benefit of exceptionally strong sales growth. And as John mentioned earlier, the benefits of this leverage extended well beyond strictly fixed costs, leading to an astounding reduction in our SG&A expense rate of about 180 basis points in the quarter. On the depreciation and amortization line, we also saw healthy leverage on a small reduction in dollars, driving about 60 basis points of rate favorability compared with last year. Altogether, our second quarter operating margin rate of 10% was about 280 basis points higher than a year ago. This performance was well outside anything I have seen in my 15 years at this company and certainly beyond anything we would have anticipated going into the quarter. However, these results followed a first quarter profit decline that was also well outside of anything I have ever seen or would have anticipated. As such, it's useful to look at the 2 quarters together and see how things have played out so far this year. On very strong comp sales growth of nearly 18% in the first half of 2020, our operating margin rate is about 30 basis points lower than last year, reflecting meaningful pressure on the gross margin line, mostly offset by rate improvements on both the SG&A and D&A expense lines. This performance translates to a very healthy operating income dollar growth of 12.6% for the first half of the year, which is a testament to the durability of our model in a very unusual environment. On the bottom line, our business generated second quarter adjusted EPS of $3.38 and GAAP EPS of $3.35, both up more than 80% compared to last year. Year-to-date, both of these measures have seen increases in the upper teens, stronger than we anticipated as we entered the year. Turning now to cash flow and capital deployment. Many of the themes we outlined in our last earnings call remain the same today. Regarding cash flow, we saw strong second quarter performance on top of a strong first quarter. As a result, through the first half of the year, we've generated cash from operations of about $5.1 billion, which is $2.3 billion higher than last year. The largest driver of this favorability is our inventory leverage, which was well above 100% at the end of the quarter. A portion of this leverage is the natural benefit of rapid sales growth, which increases inventory turnover and enhances payables leverage. However, as I mentioned last quarter, this benefit is exaggerated by our inventory position, which continues to be leaner than we want it to be. Specifically, at the end of the second quarter, our inventory position was 3% lower than a year ago compared with a year-to-date sales increase of more than 18%. Put another way, at the end of the quarter, we'd have preferred to have less cash and more inventory to support the frequency and import categories John highlighted earlier. And we have plans in place to invest in that stronger inventory position in the back half of the year, which will unwind a portion of the favorability you've seen in the front half. Turning to capital deployment. Our priorities remain the same as they have been for decades. We first invest fully in our business in projects that meet our strategic and financial criteria. Second, we support the dividend and build on our nearly 50-year history of annual increases. And finally, we return any excess cash beyond these first 2 uses through share repurchases within the limits of our middle A credit ratings. Regarding CapEx, we invested $660 million in the second quarter, bringing our year-to-date total to just over $1.4 billion, slightly higher than last year. As John mentioned earlier, following a brief pause in the first quarter, we are back in the business of building and opening new stores, and we're on track to open nearly 30 new locations this year, just short of our original plan. However, given the dynamics of remodel projects, we are maintaining our revised plan to complete about 130 remodels this year, well below last year and our original plan. As a result, we are expecting 2020 CapEx in the $2.5 billion to $3 billion range, down from our original plan of about $3.5 billion for the year. Turning to dividends. We paid a total of $330 million in the second quarter, up from $328 million a year ago. And in June, our Board of Directors approved a 3% increase in the quarterly dividend, keeping us on track to deliver our 49th consecutive year of annual dividend increases. We didn't invest any cash in share repurchases in the second quarter following our first quarter announcement that we were suspending repurchases in the current environment. Today, if you looked casually at our current cash position and second quarter results, you might wonder if we were ready to resume share repurchase activity. And the answer to that question is not yet. While second quarter profitability was unexpectedly strong, it was only 90 days ago that we reported a quarterly profit decline of more than 60%, highlighting how volatile the environment has been and may continue to be. Moreover, as we look ahead, there are many potential challenges on the horizon, including uncertainties surrounding COVID-19, economic headwinds from historically high unemployment, uncertainty surrounding government stimulus and a contentious November election. So while we have very strong confidence in our long-term prospects, our ability to continue to expand market share and grow profitably over time, we believe it's the prudent, long-term decision to preserve liquidity in the current environment, giving us the flexibility to safely navigate through any near-term headwinds. So finally, I will close this section with a quick comment on our after-tax ROIC, which grew to 17.2% this quarter, up from 15.2% a year ago. Even though we report this metric on a trailing 12-month basis, it has been unusually volatile this year given the dramatic changes in performance we've seen. Specifically, at the end of the first quarter, this metric was nearly 4 percentage points lower than today at 13.4%, driven by the steep profit decline we faced in the first quarter. So while this metric may continue to move around during this period of heightened volatility, we will remain focused on making the right long-term investments in our business, allowing us to deliver higher after-tax returns over time. Now I want to turn briefly to our outlook. And consistent with last quarter, I won't be providing any precise guidance. However, I want to reinforce what I was just saying earlier, which is that we are moving through a period of unusually high uncertainty and volatility. And while John was correct that we felt a much stronger sense of normalcy in the second quarter, volatility continued to be elevated. Specifically within the second quarter, May was by far the strongest month with a 33% comp, followed by June at 21%, and July at about 20%. And so far in August, due largely to softer sales in our Back-to-School categories, month-to-date comp sales have been running in the low double digits. Now let me be clear, a double-digit increase is still quite strong in the context of history, but a 20 percentage point spread between our May and August to date comps is an incredibly wide swing within a few months, highlighting the difficulty of forecasting our business right now. So given that our Q1 performance was not a good predictor of our second quarter results, our Q2 results should not be viewed as a predictor of our performance going forward. And given that we can't eliminate uncertainty in the environment, we continue to place a premium on flexibility in our plans. This will allow us to quickly pivot when we see changes in our business, as you've seen us do successfully multiple times this year. So now I want to conclude my remarks in the same way I did 90 days ago by saying that a single quarter's financial results are not the basis for our long-term confidence. That confidence springs from the fact that we continue to focus on investing for the long term because Target's long-term prospects have never been brighter. We have a durable business model with flexibility in both our merchandising assortment and the fulfillment options we offer. We're building on an already deep relationship with our guests as they trust us like never before to conveniently and safely fulfill their wants and needs. And with a strong balance sheet and robust cash flow, we have the capacity to navigate any near-term challenges and play offense, just like we have over the last few years.
But most importantly, we have an amazing team across our stores, headquarters, distribution facilities and offices around the world. We have all rallied around a common purpose:
to serve our guests, serve our communities, fight for racial equity and to support each other. All of us who work here know how special the team is. So I want to thank our entire team for all they are doing in this exceptional time and for making Target special, truly a company like no other.
Now I'll turn it over to Brian for some final remarks.
Brian Cornell:
Thanks, Michael. Before we move to your questions, I want to pause and thank everyone on the call today for listening in and for your continued engagement in our business. For those of you who've been on these calls for a while, I think you'd agree it's been quite a journey. In fact, when you look back at our release and remarks from the second quarter 5 years ago, you can quickly see how far we've come. In the second quarter 2015, we reported healthy growth in our earnings per share, with both GAAP and adjusted EPS expanding to just over $1.20 or more than $2 lower than the quarter we just reported. Digital sales grew 30% and accounted for just under 3% of our total sales compared with just over 17% this year. Five years ago, after-tax ROIC expanded 2 full percentage points to 13.3%, nearly 4 percentage points lower than the 17.2% we just reported.
Among the priorities we covered in this call 5 years ago, becoming a leader in digital, having just introduced our ship-from-store capability, defining our category roles and reasserting our authority in style categories like apparel and home, and ramping up our test of the small-format stores in dense urban areas. Also in the quarter 5 years ago, we sold our pharmacy business to CVS and announced that John Mulligan will become the company's first Chief Operating Officer with a goal of modernizing our supply chain and operations. As in every upward journey, our progress over the last 5 years has not been a straight line. Along the way, we reached some plateaus and sometimes even lost some altitude before resuming the climb. That's why it's sometimes helpful to look back over a longer distance to get a true picture of the progress. But unlike the ascent of a mountain, our journey will not end up with a climb back down. Success will be defined by further growth with a constant eye on what consumers want and need. To meet those ever changing needs, we'll need to continue to reinvent ourselves, changing our operations along the way. Yet, some things will sustain over the longer term, like our culture, values and our team's commitment to one another. These strengths have defined this great company for decades, and our commitment to maintaining them has never been stronger. With that, we'll move to Q&A. John, Michael and I will be happy to take your questions.
Operator:
[Operator Instructions] Our first question is from Karen Short with Barclays.
Karen Short:
Congratulations on a great quarter. I want to -- I don't want to take away from the success of the quarter because it obviously was outstanding. But I do want to focus on gross margin. Because I know while it's impossible to predict what things will like look on the top line, I think we probably have a pretty good handle on SG&A in terms of how that will look, obviously, depending on sales. But gross margin kind of in the back half seems to be a little more of a wildcard. So wondering if you could talk about that a little bit and I think in the context of that 180 basis points in rate benefits from lower markdowns. Because presumably, you had marked down things. And you pre-marked down in 1Q, and you're benefiting from that in 2Q. So we really have to look at the back half without that 180 basis points. And then I had one other quick follow-up.
Brian Cornell:
Michael, why don't you start?
Michael Fiddelke:
Sure, Karen. And maybe I'll start by saying, I empathize with those of you on this call trying to extract trends from our Q1 and Q2 margin rates. You can see the underlying volatility of the business if you pick apart those trends in Q1 and Q2. To focus for a second on where we've been, I actually think it's useful to zoom out and look at the year-to-date trends. If you unpack margin on a year-to-date basis, we've got just over 1 point of pressure from the accelerated growth in digital and supply chain investments and have just over 1 point of pressure in category mix. And you've got a wide variety of movement across the markdown front
Those will be key levers as we look ahead going forward. But like we said before, predicting them is an exercise in imprecision at this point.
Karen Short:
Okay. That's helpful. And then you gave us, obviously, a lot of color on your digital and fulfillment capabilities. But I was wondering if you could just give a little more color on the new 10 million customers that you've gained. Anything you could point to on demographics, behavior, ticket type of behavior relative to your more regular customers?
Brian Cornell:
John, anything else you want to add?
John Mulligan:
Yes. Karen, I'd say, the great thing is, is that from a behavior perspective, they behave just like the rest of our guests. When we convert someone to a Drive Up order, historically, we've seen them become more engaged with Target, see 30% more sales. That's exactly what we see with this 10%.
Probably more encouraging from our perspective is that from a repeat purchase perspective, we've seen that increase. 7-day repeat purchases are higher than we have seen historically. 90-day repeat purchases on digital are higher than we have seen historically. So it appears that, at least to start with, they're much more engaged with us. And we know that the deeper they get engaged, the more they use our services, that the more they will be engaged and the more they will use our services. So from our perspective, very encouraging results as those guests have come on to Target.com.
Brian Cornell:
And Karen, the only thing I would add is we continue to see the most valuable and profitable guest to Target is the guest that uses all of our channels. And we continue to see stickiness as store guests discovers Drive Up or discovers the benefits of Shipt and also digital guests that are now coming into our stores because of the investments we've made and the trust we're building. So we'll continue to report more about those new guests in quarters to come. But certainly, we're very excited about what that means to our future.
Operator:
The next question is from Edward Kelly with Wells Fargo.
Edward Kelly:
I was just curious on the August comp, obviously, impressive results quarter-to-date given stimulus rolling off Back-to-School. I was hoping that you could provide a little bit of category color in terms of what you're seeing in August.
And then as it relates to Back-to-School, I guess, what are your thoughts on how the season is going to end up? I mean obviously, we're getting off to a late start in a lot of areas. Just curious as to what you think the impact to the comp will end up being this quarter?
Brian Cornell:
Ed, why don't I start. And I commented earlier today that our August comps are off to a very solid start with low to mid-teen growth at this point in the month, and it's been broad-based. So we're continuing to see the kind of performance we saw in the second quarter continue into Q3
And each and every week, as we look at IRI and NPD performance, we continue to see a lot of green boxes and continue to pick up market share across the board and across our entire multi-category portfolio. Obviously, we're all looking at Back-to-School and Back-to-College trends. And each and every day, there's new information. As we sit here today, and I think the number is there's something close to 56 million students in the K-12 bracket that are waiting to go back to school. And as of this week, it looks like well over 60% will start school remotely. And we'll look for more information. We don't know if those students will be welcomed back into a classroom in September or October. Many may wait actually until January. So we've made the decision to be flexible. And we'll extend the season and extend our assortment because we know at some point in time those students will need backpacks and uniforms. They're going to need school supplies, so we've got to make sure that we continue to flex. And I think it's been the hallmark of our performance throughout the first 2 quarters of this year, our ability to stay agile, stay flexible, meet the needs of the new environment, and we'll continue to take that approach with back-to-school season and with the back-to-college environment as well.
Edward Kelly:
And then maybe just to follow up quickly. I had some comments around holiday and sort of stretching out holiday. Maybe just a little bit more color on what you're looking to do there. Do you think shopping patterns, consumer-wise and traffic, will actually follow that? Just a little bit more color in terms of how you're thinking about holiday at this point.
Brian Cornell:
Ed, we do think it's going to be a longer holiday shopping season. We're certainly preparing to start earlier than ever before in the October period. We're going to make some big changes. We announced recently that we'll be closed on Thanksgiving. And we certainly expect it's going to be a different rhythm to the shopping season. Obviously, we're going to put a big premium on ease and convenience, delivering great value, but we'll emphasize safety. And we'll also make sure that our guests knows that those top items and that great value is going to be available throughout the season and give them the option of shopping, obviously, in a well-managed, safe Target store or taking advantage of our same-day fulfillment options to give them the certainty that they can get those great gifts, those great items whenever they want.
So we think it's going to be an extended holiday shopping season. We think it plays well to our multi-category portfolio and the flexibility of our stores and our convenient same-day offerings. So we'll prepare for a very different holiday season. We'll have to stay nimble. We'll have to adjust. But again, I think the team has demonstrated the flexibility and the adaptability to this new environment, and we expect to continue to build market share and delight our guests throughout the holiday season.
Operator:
The next question is from Paul Trussell with Deutsche Bank.
Paul Trussell:
Congrats on stellar results. The -- reflecting on your omnichannel business, first, just curious of the cadence of the channel mix. Just interested in seeing if there was an acceleration of in-store taking any moderation of the digital sale as the quarter progressed and economies reopened?
And then second is, obviously, the same-day services are quite robust. I'm just curious what are some of the learnings that you have over the last few months as it relates to Order Pick Up, Drive Up and Shipt. And how are these businesses, therefore, evolving and improving from these learnings?
Brian Cornell:
So Paul, why don't I start. And I'll go back to our comments during our first quarter call. We certainly saw, literally starting in the middle of April, a resurgence of traffic to our stores, and that certainly continued in the second quarter. I commented earlier today when I was speaking with CNBC that despite the tremendous top line growth of 24.3% and digital growing at almost 200% during the quarter, the real star of our performance was the performance we saw in stores, where our store comps were up 10.9% despite an environment where we've seen unprecedented digital shopping. So we certainly saw that guests returning to stores throughout the second quarter, and that was consistent from May into June and July. And we continue to see guests shop our stores. And I think the investments we've made in safety, the investments we've made in our team, the investments we've been making for years and years, putting capital into remodeling our stores and creating a great shopping environment, that's certainly connecting with the guest during the pandemic.
So we continue to see very strong store traffic. We saw excellent traffic overall during the quarter, up almost 5%. And John can comment on some of the learnings from our same-day fulfillment. I would tell you, I think the biggest learning is just how adaptable and flexible our teams have been and how quickly they've responded to a surge in something like Drive Up that grew over 700% during the quarter alone.
John Mulligan:
Yes. Paul, I think Brian hit right on. Probably the core learning is the ability of our team to be incredibly agile. And we went in a matter of weeks from normal digital sales to volumes that exceeded Q4 last year for many weeks in a row. So the ability of our teams to do that very quickly where typically, planning for Q4 takes us several months. We have a detailed plan. But the teams understood what we were doing, how they needed to execute, we -- the tools that the store teams have built to help them execute proved very scalable and very efficient. And so our ability to do that was outstanding.
The other side of that, I would say, again, to point to how well the teams executed while taking care of the guests in store, as Brian pointed out, our NPS scores remained very, very high the entire time. Drive Up growing over 700% and still having an NPS score in excess of 80 is just outstanding work by our teams. I think the last thing that had kind of changed our thoughts on the thing we've worried about -- only worried being not quite the right word, but thought about a lot is the stores are busy in Q4 serving guests in store. And so how do we continue to balance that with our fulfillment? And what we've seen over the past 3 months is that's not a problem as long as we give them the right tools, staff the stores appropriately, we can take care of running a 10 comp in the stores and running a 20 comp on digital, both of those together. And so we feel really good about the model we've built and the team has built over the past several years, and I think that's probably the biggest learning over the past 3 months.
Brian Cornell:
Yes. Paul, I'd add only one other detail. And I think it's a tribute to John's leadership and the quality of the store and supply chain teams. In Q1, we noted that we had turned off our plans to expand pickup and Drive Up to include fresh and frozen food and beverage products. We've turned that back on. And the team recognized that, that was very important to our guests. It was going to continue to be important as we went into the second half of the year. And despite the unprecedented same-day growth and the demand we've seen for Drive Up and pickup, the team has put that back on the road map, and we're now expanding that across the country. And to me, that just points to the further upside opportunity we have with our same-day services. So again, a big tribute to the team, the leadership they provided to recognize that, that was going to be important to our guests. And as opposed to waiting until 2021, we're going to get that back on our road map and begin to stand up those capabilities in the second half of the year. And I think that's going to be just one more aspect that will be appreciated by our guests when they shop Target in the third and fourth quarter.
Operator:
The next question is from Matt McClintock with Raymond James.
Matthew McClintock:
May I also say congrats to the broader Target team, outstanding execution this quarter and, honestly, all year.
Brian Cornell:
Thank you, Matt.
Matthew McClintock:
John, my question actually is for you. I want to take the supply chain from a different angle. You did talk that you're in discussions with vendors right now. You mentioned that some categories have had some out-of-stocks probably because they're just longer lead time categories. I'm not really sure. But I want to -- given the massive volatility in your sales, as Michael talked about, how are your thoughts changing or evolving towards demand forecasting? And how are you thinking about just sourcing in general from those vendors that maybe have long lead times in manufacturing themselves?
John Mulligan:
Well, it's a good question. And I would start in a place where demand forecasting is difficult right now, both for us -- and we import a lot of our goods, as you know, directly and from -- for our vendors who have long lead times as well. I think the thing we're working on with them is, we would call it joint business planning, just being sure we're both aligned and that we've built flexibility and agility into what we want to do. There are ways. You can set up sourcing strategies. We do this where we get an initial set order, and then we have very quick ways we can chase into demand through other avenues if we need to.
So -- and then the same is true domestically. For our vendors that are continuing to build capacities, who have us on allocation, having conversations with them about what we see in demand and what demand we're leaving on the table because we perhaps don't have the inventory we need. So to me, this is mostly about conversations and then agility and being flexible when we see the data coming in because it is moving rapidly. And we know when we -- and we talk about it. When we write down a forecast, the only thing we know is that it is wrong. And so how we adjust to that as we see the data coming in is the most important thing.
Brian Cornell:
And I'd only add if we had Christina or Jill or Steph on the call right now, they would talk to you about the changes we've made in assortment, and in many cases, SKU optimization, learning how to do more with less. And we've partnered closely with some of our key vendors to make sure that we're focused on getting the top-selling items into our store and into our system. And we've made some adjustments in SKU rationalization along the way. So I think out of the pandemic, I think we've learned that we can do a lot more with fewer SKUs in certain categories. We've got to focus on the most important items that are in demand with our guests. So we're continuing to learn along the way, and I think we'll become even more efficient going forward.
Operator:
The next question is from Oliver Chen with Cowen.
Oliver Chen:
Congratulations. Regarding the assortment, it's all been performing so excellently. What do you see as opportunities ahead in the assortment? What are you most focused on in terms of areas that we'll see further innovation? And I would also just love your take on Target Circle and the next step in that program as well as your thoughts around the marketplace model and the -- on the e-commerce platform?
Brian Cornell:
Oliver, you've got quite a few questions in the queue. And I'll start, and I'll certainly let Michael and John also jump in. I think as we think about our strategy from an assortment standpoint, I'll go back to something we've talked about for years now. We're at our best when we're a curator and balancing a curated assortment of our own brands and great national brands. And I think you'll continue to see that focus from Target going forward. And as I think about the work and the great work that our merchants have done, it all comes down to being great curators. And they've done that both with our in-store and our online assortment, and I think that is a huge point of difference for us. It served us well. It allows us to meet the growing demand in the digital channel because those items that we're fulfilling the same day are largely coming out of our core store assortment. So you'll see us focus on being great curators.
As we think about something like Target Plus, we're also taking a very different approach. We're inviting people in. It's an invitation-only platform. And we want to make sure that even in that environment, we're constantly curating, making sure we're delivering the right extension for our assortment and for our guests. So we'll continue to take a very different path, focused on curation in this environment, both with our physical assortment and digital assortment. And we think that's a hallmark of what makes Target such a unique company, and it really complements our multi-category assortment. Oliver, on the Target Circle front, we noted that we now have over 75 million members in Target Circle. And obviously, going forward, it's another opportunity for us to deepen our relationship with the guests, to make sure we're even more relevant in their lives and that we continue to enhance the trust that I think we've gained throughout the pandemic. So we're very excited about the opportunity. And I think about the 10 million new digital guests that we've invited in over the last few months, 75 million and growing Target Circle members, it's just one more way for us to continue to meet the needs and delight the guests who shop Target each and every week.
Operator:
Our last question is from Michael Lasser with UBS.
Michael Lasser:
So would you attribute all of the slowdown that you've seen in August to the Back-to-School categories? Or would any of it be attributed to some of the enhanced unemployment benefits going away as well? And the question really gets at the heart of once we get past the back-to-school season, shouldn't you see your sales accelerate? And then I have a follow-up.
Brian Cornell:
Mike, honestly, we're watching it carefully and a lot of conversation around the impact of stimulus, what this means going forward. We certainly hope there's a second round of stimulus for small businesses and American consumers. But as we look at our trends right now, I think it's largely adjustments in some of the Back-to-School categories. But we continue to see strength across our portfolio. We continue to see strength in our stores and our digital channels. We continue to grow market share and see momentum within our business. So we'll watch it carefully.
Obviously, as Michael and John have stated several times, it's a very challenging environment for us to provide guidance. We've got the pandemic in front of us. We've got uncertainty about Back-to-School, Back-to-College, the state of the economy. We do have an election coming up in November. So lots of different dynamics that we have to try to sort through, and we're putting a premium on being really responsive and really flexible. But it's just hard for us to provide an outlook beyond a couple of weeks at a time.
Michael Lasser:
My follow-up question is that you provided a lot of helpful statistics about how the average unit cost to fulfill an online order is now 30% below last year, yet the -- because the digital growth is so strong, that led to 130 basis points of gross margin pressure. So if we assume that some of the incremental sales that you're generating right now recede when consumers go back to traveling and eating out, and yet consumers have really gravitated to these digital fulfillment options like in-store pickup and Drive Up, and those stick around and that digital penetration remains where it is, should we think that this gross margin pressure of about 100, 130 basis point sticks? Or do you have offsets on the horizon that can reduce that pressure?
Michael Fiddelke:
I can take that one, Michael. I think that the -- well, we don't know exactly what those numbers will look like for the back half of the year, and so I'm not going to attempt to predict those. I think what you see in the first half of the year is the durability of the model overall. And as you've heard us say many times, that growth in digital is way bigger to us than just the sales or profit on that one digital transaction because it deepens our relationship with the guest, and that pays off in spending in aggregate. And I think you can see evidence of how that flows through the durability of the model even in the first half of this year amidst all the volatility. If you would have told me before this year that digital would be up over -- almost 200% on the year, and that we would have had a point or more of pressure in gross margin from category mix, but that our operating income rate would be within 30 basis points of the year prior, I'd have taken that outcome in a heartbeat. And so I think that just shows how if you zoom out from the specifics of just one digital transaction, you get a sense of the durability of the model in total.
Brian Cornell:
Yes. Michael, I'll just finish up and perhaps to wrap up the call. Well, I think all of us on the call, and I know our entire Target team is looking forward to the day when the pandemic is behind us, when we're spending time with family and friends, we're traveling again, kids are back in school. One of the things that I think will stick around for us is the consumer who's going to continue to consolidate their purchases, is going to appreciate value, is going to look for a safe shopping environment. And we know digital is going to be critically important. And I think what's going to stick around for us is the growth we've seen in market share, the relationship we've built with the consumer during the pandemic and the growing trust that we've formed with the guest who shops our stores or shops with us online each and every day.
So we're excited about the future. And I think sitting here with Michael and John, we've never felt better about the prospects for the company. And we've certainly advanced our digital maturity by several years. But I think we've really matured our overall operating capabilities during the pandemic. And I think that's going to provide returns for us for years and years to come. So operator, with that, that completes our second quarter call. I really appreciate all of you for joining us today and your continued support. So thank you, and stay well.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation First Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, May 20, 2020.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our first quarter 2020 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; and Michael Fiddelke, Chief Financial Officer.
In a few moments, Brian, John and Michael will provide their perspective on the first quarter and our continued focus on our guests and our team as we navigate through the current environment. 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, the most important of which are described in our most recently filed 10-K and the 8-K we furnished this morning. 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 first quarter and the short-term and longer-term implications for our business. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. We appreciate that you've joined us on this morning's call, and we hope that you, your family and friends are safe and healthy. It goes without saying but this quarter was unlike anything we've seen in our company's long history. And while we didn't establish another all-time record for this quarter's EPS, I have never been more proud of our performance.
Over the last few years, we built a strategy and operating model that's designed to generate strong performance in a wide variety of environments, and the first quarter demonstrated the strength of that model. Unprecedented volatility within the quarter presented the most extreme test of our business and operations that I could have imagined, and in that environment, we drove industry-leading growth with a total comp sales increase of 10.8% and digital comp growth of more than 140%.
As I reflect on all that's transpired since the quarter began in February, there were 2 key factors in our success:
our strategy of positioning stores and fulfillment hubs and our unbelievable team. When guests began flocking to our stores to stock up, our team was ready. And when digital demand exploded as guests began to shelter in place, our teams have the tools, processes and capability to flex to meet that shift in demand.
But it goes well beyond processes and tools because our team's efforts on behalf of our guests and communities have been monumental. The pride our team has shown and their willingness and ability to deliver essential products and services to our guests is humbling and inspiring. Our guests are putting their trust in Target. The team is delivering, and they deserve our enduring gratitude. At our financial community meeting at the beginning of March, we highlighted multiple dimensions of flexibility built into our operating model. We offer a balanced merchandising assortment that is unique in retail, allowing Target to serve our guests' rapidly evolving demands for wants and needs. We have a unique digital strategy based on a curated assortment of the categories and items that our guests expect from us. We deliver this digital assortment through a comprehensive suite of fulfillment options, including our rapidly growing same-day services, in-store pickup, Drive-Up and Shipt. In support of our digital strategy, we place our stores at the center of fulfillment, which gives us both speed and efficiency. This structure also allows our teams to pivot seamlessly when our guests' channel preferences change. We have teams at headquarters, stores and throughout the supply chain who are relentlessly focused on our guests and who place a premium on agility and adaptability. And with a strong balance sheet and a business model that generates robust cash flow, we have the financial flexibility to handle difficult times like this, allowing us to fund investments in the safety of our guests and our team while serving a critical role in communities as a trusted essential retailer. Given our unique assortment and comprehensive suite of fulfillment options, we could see firsthand as our guests' mindset rapidly evolved during the first quarter. While it already feels like years ago, during the first 3 weeks of February, we experienced a relatively normal mix of sales across merchandising assortment and a typical mix of sales between our stores and digital channels. Towards the end of February, we saw an acceleration in traffic and sales, particularly in our stores. However, we continue to see a lot of cross-shopping in the more discretionary categories when the guests made trips to stock up on food and essentials. Around the middle of March, the mix of guests' purchases became much more nearly focused on food, beverages and household essentials, and we began seeing much softer trends in discretionary categories, most notably in apparel. In addition, as shelter-in-place rules were adopted across the country, guests began to pull back on store trips, and we saw a dramatic surge in digital traffic and sales. We also began seeing higher demand for products oriented around staying at home, including home office products, video games, puzzles and board games, along with the housewares and kitchenware in our home assortment. And finally, around the middle of April, we experienced a rapid increase in traffic and sales in our stores and a broad surge in sales of more discretionary categories, including apparel, which persisted throughout the end of the month. The surge in stores occurred while our digital growth continued at unprecedented rates of 200% to 300% above last year. As a result, over the last couple of weeks of April, we saw some of the strongest comparable sales growth we've experienced in our history. When you put all these chapters together and look at the first quarter in total, our comparable sales grew nearly 11% with a wide range of performance across categories as guests changed their shopping pattern in response to the crisis. Among our 5 core merchandising categories, we saw the strongest performance in Hardlines, which grew comparable sales by well over 20%. Growth was particularly strong in electronics where comps grew more than 45%, reflecting high demand for video games and home office items. Essentials & Beauty saw high-teen comp growth while comps in Food and Beverage grew by more than 20% as guests trusted Target for both their stock-up trips and their everyday needs. In Home, we saw high single-digit comp growth, led by kitchen, which saw comp growth in excess of 25%. And in apparel, first quarter comparable sales declined about 20%, reflecting soft sales in late March into early April, followed by a resumption of growth in the last 2 weeks of April. As we evaluate these category trends relative to overall U.S. retail and on a category-by-category basis, we are seeing unprecedented share gains across every measure. Clearly, in portions of our business, share statistics reflect the fact that nonessential retailers across the country have remained largely closed. And even though we compete with them, we sincerely look forward to the day when our retail colleagues can reopen. After all, a healthy retail sector is critical to the overall health of the U.S. economy. And of course, employees of our competitors often shop at Target, too. More fundamentally, we believe recent share numbers reflect the trust that our guests have placed in our stores, our digital capabilities, our team and our brand. In particular, as our teams have risen to meet our guests' needs and deliver friendly, reliable service during this unprecedented time, we believe that our guests' level of trust has only become deeper throughout this crisis. From a channel perspective, first quarter store sales grew about 1% while digital comp sales increased by 141%. Of course, these quarterly numbers mask how quickly trends changed within the quarter. Specifically, we began the quarter with a relatively normal February, in which we saw overall comp growth of 3.8% and digital comp growth of 33%, and ended in April which saw total company comp growth of more than 16% and a jaw-dropping 282% increase in digital comp sales. I want to pause and comment on that April digital performance for a moment because I suspect that many of you might have wondered whether our operations could sustain such a strong increase for an entire month. After all, to put this volume into perspective, on an average day in April, our operations were fulfilling many more items and orders than last year's Cyber Monday, a day for which we had planned months ahead of time. In contrast, this unprecedented surge in volume was completely unexpected at the beginning of the quarter, and it ramped up from normal trends in a matter of weeks. And by design, it was our stores that enabled this surge in digital volume, fulfilling more than 80% of our digital sales in April. Even more impressive, within our April digital sales growth of just over $1.1 billion compared with last year, store fulfillment accounted for more than $950 million of that growth as both our same-day services and shipments to guests' homes saw significant increases.
How is this accomplished? John will provide more details in a few minutes, but I'd reiterate that it comes down to 2 factors:
our strategy of using our stores as hubs and the ability of our team to quickly pivot to meet shifting demand. And while we incurred extra costs to accommodate this incredible surge in digital fulfillment, we expect to gain a long-term benefit in terms of guest loyalty.
During the first quarter, more than 5 million guests shopped on Target.com for the first time, with more than 2 million of those guests making their first Drive-Up trip. And because of the amazing flexibility of our team, we saw consistently strong levels of satisfaction with the Target.com shopping experience even in the face of crushing increase in demand. So now I want to turn to our focus going forward, which isn't going to change. We continue to focus on serving our guests while taking steps to provide for their safety. And we'll continue to focus on our teams, investing in their safety and their well-being while working to remove obstacles and allow them to serve guests during this critical time. Throughout this evolving crisis, we have continually adapted our operations and processes to enhance guest and team member safety. Looking ahead, we'll continue to quickly adapt to changes in the environment and emerging guidance from the CDC and other authorities. Already during the first quarter, we took numerous steps to protect our guests, Shipt shoppers and our team members, including enhanced cleaning standards, providing personal protective equipment to our team members and Shipt shoppers, installing plexiglass dividers at checkout and implementing metering protocols in our stores where appropriate. For our team, we rolled out a wellness checklist for them to perform before each Shipt and provided free thermometers to team members who needed them. We also invested hundreds of million dollars in extra pay and benefits for our team, adding $2 to their hourly wage, investing in enhanced backup daycare options across the country and offering enhanced paid leave for team members with vulnerable health conditions. Consistent with our long-standing commitment to the communities where we live and work, we donated personal protective equipment to over 50 health care organizations and shared tools and expertise with government partners and other businesses to help protect health care workers and assist other businesses in reopening and operating safely. In addition, we recently announced our foundation's biggest single donation in company history, $10 million, to assist team members, communities, national organizations and the global response to this pandemic. Beyond our corporate commitment, thousands of team members are volunteering in their local communities, including a group of 3D-printing enthusiasts on our technology team who are using their personal devices to produce and donate plastic face shields to local hospitals. And most recently, just this week, we announced the extension of higher pay and enhanced benefits for our team through the end of June. We initially announced these temporary changes to the end of April, and last month, we announced we were extending them through May. And today, even as the country is starting to talk about how things will look when we get back to normal, our teams continue to face unprecedented challenges as they serve families and their communities. As a result, we're proud to support our amazing team members as they navigate through these challenging times. In terms of our financial expectations, Michael will offer his perspective in a few minutes, but we're maintaining our recent suspension of financial guidance. From today's perspective, the one thing that seems most certain is continued volatility, and whenever possible, we're building flexibility into our plans and commitments. But let me be clear, the expectation of continued volatility in the external environment doesn't translate to a lack of confidence about our future. If there's one thing our team and operators have demonstrated, it's the ability to adapt to rapid change and continuing delivering outstanding service for our guests. And as I said before, it's at times like these that we can all see the benefit of a strong balance sheet and fundamentally sound business model. The financial strength gives us the flexibility to focus on what matters most, our guests and our team, giving us confidence that we'll emerge from this crisis as a stronger, more relevant retailer with an even higher level of affinity and trust among our guests. So as I turn the call over to John, I want to once again offer my thanks to the entire Target team, from headquarters to our operations and offices around the world. I've never been part of a stronger team, and I share your pride in the essential role that Target is playing in the lives of our guests. Thank you for your inspiring efforts every day. John?
John Mulligan:
Thanks, Brian. On these calls over the last few years, I've described our long-term journey in operations to completely transform our supply chain and fulfillment infrastructure, moving from our prior linear model based exclusively on store shopping to a unique modern structure designed to support a broad array of fulfillment choices; to position our stores as the hub for guest fulfillment, whether a guest trip is based on traditional shopping, use of one of our same-day services or delivering a package to their front door; to invest in technology, data and analytics to increase our inventory accuracy and better forecast demand throughout the network, leading to improved in-stocks, higher guest satisfaction and ultimately, stronger sales; to transform how we select and build store sites, moving from a rigid, large-format prototype model to a model in which we focus first on the neighborhood we want to serve, design a store to fit within the available space and then curate a merchandise assortment to fit that particular neighborhood; and finally, to transform our store team, moving from a model based on general athletes to one in which different parts of the team have accountability for individual businesses, supported by tools and processes that allow them to make decisions in real time and focus on serving our guests in new ways. One goal of all these changes was to make our operations and our team far more nimble and agile in support of our guests. And while the journey is far from over, this quarter demonstrated the benefits of everything we have already accomplished.
As Brian already described, over the course of the first quarter, our team had to pivot dramatically and rapidly in response to multiple changes in shopping behavior:
comps in essentials and Food and Beverage moving from single digits in February to peaks above 50% in March before settling down into the teens in April; apparel trends moving just as rapidly in the other direction, from positive single digits at the beginning of the quarter to trough declines of more than 50% beginning in late March, before resuming growth in the last half of April. With this volatility in category sales, managing our inventory has also presented a significant challenge. In apparel, given the recent dramatic slowdown in sales, teams have been working closely with vendors to make appropriate changes based on our current inventory and future purchases.
Across the remainder of our core merchandising categories, we've seen a dramatic increase in the pace of sales causing out-of-stocks to rise well above where we'd like them to be. In need-based categories like Food and Beverage and essentials where comps have accelerated into the 20% range, we have been on allocation from multiple vendors as they work to ramp up production to cover the higher level of demand. Among some categories like paper, in-stocks have been recovering in recent weeks. But across many portions of both essentials and Food and Beverage, we continue to sell out quickly when we receive shipments of products from our vendors. In other categories like Home and electronics, we have been increasing order quantities to match the higher pace of sales. However, given that many of these categories are primarily imported, we will likely see some persistent out-of-stocks until we can receive replenishment inventory from these overseas producers. Beyond categories, the volatility in shopping channels has been just as extreme, store comps moving from positive numbers to double-digit declines in late March and early April, then back to growth towards the end of April; digital comps moving from around 30% in February to nearly 10x that pace in April. Through all of these extremes, the team maintained a positive attitude and demonstrated their pride in the positive role that they're playing in our guests' lives. I am humbled and inspired by what they've been able to deliver on behalf of our guests. The ability of our team and our network to attain and sustain digital comps of nearly 300% for the entire month of April has been incredible to watch. There are too many stats to share, but I'll tick through a few because I think they're helpful in understanding how remarkable it's been. Multiple measures of unit volume, including ship-from-store, Target orders fulfilled by Shipt and overall digital, were higher in the first quarter of 2020 than in the first 3 quarters of 2019 combined. Units provided through Drive-Up in the first quarter were higher than in all of 2019. Sales of orders shipped from stores or picked up in stores increased nearly 150% in the first quarter. Target sales fulfilled by Shipt were up more than 300%, and sales through Drive-Up were up more than 600% higher than a year ago. In April, sales on Drive-Up increased nearly 1,000% compared with a year ago. These growth numbers reflect the fact that Drive-Up continues to be our most popular service and the number of guests who are trying and repeatedly using Drive-Up continues to increase rapidly. Specifically, more than 5 million guests used our Drive-Up service in the first quarter, with 40% of these guests new to the service. And amazingly, despite this unexpected explosion in first quarter digital volume, the team continues to execute with amazing speed. Both the percent of orders shipped from store on time and the percent of pickup and Drive-Up orders picked on time was approximately 95% in the quarter, and both measures were higher than the first quarter a year ago. One thing we've observed about this crisis is that it is causing an acceleration in consumer trial and adoption of digital shopping. The ability of our operations to handle this unexpected acceleration has given us even stronger conviction that we have the right model and we have ample capacity to handle continued change in the future. Specifically, as part of our long-range plans at the beginning of 2020, our first quarter digital volumes weren't anticipated for another 3 years, but our operations accommodated that extra volume without any advanced planning. Like Brian said, it was an extreme test of our model and our team, and both performed admirably in the face of the challenge. Another area in which the crisis has accelerated existing trends relates to the amount of retail square footage in the U.S. We have long understood that the U.S. market is over-stored, and we've all observed the rationalization of unproductive retail space in recent years. But let me quickly say we continue to strongly believe that the future of U.S. retail will be based on an omnichannel model, in which quality retailers will serve their customers through both physical and digital capabilities. That's why we've consistently pursued a strategy based on investments to enhance both physical and digital shopping. And while we have temporarily slowed down our plans for remodels and new stores because of the crisis, that doesn't mean we have less enthusiasm for these projects. Rather, we slowed down our plans for 2 specific reasons. First, we wanted to remove obstacles and distractions facing our team so they could focus exclusively on day-to-day execution in the face of extreme volatility across multiple dimensions of our business. And second, we adjusted our plans in anticipation of construction process changes needed to accommodate social distancing and other measures, which we expect to slow down time lines in some cases. In addition, we expect that more time will be required for inspections and permitting related to these projects given the incremental demands facing local governments in light of this crisis. So while it is too soon to lay out longer-term time lines for our remodel and new store programs, we look forward to resuming these projects when appropriate. This will allow us to continue to transform our real estate footprint, both through modernization of existing space and the selective addition of productive new small-format locations located in neighborhoods that couldn't be served when we only opened larger stores. A strategic initiative that we temporarily paused during the first quarter was integration of fresh, refrigerated and frozen items into our pickup and Drive-Up capabilities. While we are eager to add this capability and we know our guests want the option, we decided not to add the distraction of implementing this test during the period of peak volatility. However, we recently resumed the test in the Twin Cities market, where it had already begun last year, and we've just expanded the test into the Kansas City market. Operational results have been positive so far. And while we will continue to govern the pace of the rollout based on the circumstances facing our team, we are committed to rolling out this capability to as many stores as possible this year. Another exciting strategic development was our recent acquisition of local route optimization technology from Deliv. Following encouraging results of recent tests of this new capability, we elected to purchase the technology and hired members of their team to assist with the integration into our existing systems and processes. We are excited about this new technology because it offers the opportunity to add capacity to our fulfillment network while also reducing the cost of last-mile delivery. And given that last mile is the biggest cost driver within digital, the opportunity to control those costs will play an important role in our operating margins over time. With the benefit of this new technology, we can begin testing the addition of sort centers, downstream of our stores within our fulfillment network. These centers, which we expect to be smaller than our average store, will be placed downstream in select markets in which we have a high density of packages being sent to guests' homes. By eliminating the need to sort packages in the individual stores, the throughput of packages from these locations would naturally increase, and we can achieve lower average shipping costs through the scale and route optimization that these downstream centers will provide. Given that we only recently acquired this new technology, we don't yet have a time line for this test. What I can say today is that we are planning to test the first of these centers in the Minneapolis market and that we plan to follow our normal discipline of testing and iterating before we decide to scale up. So now as I get ready to hand the call over to Michael, I want to end where I started and give a special thanks to our store, distribution and fulfillment center teams. Our society has long recognized the sacrifice of essential workers in the health care industry and public service like police officers and firefighters, but what's been remarkable on this crisis is to see how it has helped people to realize there's a huge army of essential team members at Target and many other retailers who make sure that parents can get food for their family and the essentials they need to manage their health and their household. I've long appreciated the work of these teams since I've been lucky to work alongside them for more than 2 decades, but now with our efforts in the spotlight, I could not be more proud to see their significant contributions recognized. Thank you to every one on our team for your hard work and sincere desire to serve all of the families that place their trust in Target every day. Michael?
Michael Fiddelke:
Thanks, John. As you've already heard several times today, this quarter was far different than anyone would have modeled 90 days ago across multiple dimensions of our business. And like everyone else, for the last few months, our team has been deeply involved in the details, helping our business to effectively respond to the rapid changes in both our category and channel performance.
But when you pull back from all the detail and day-to-day volatility, a couple of themes have clearly emerged. First, this environment has provided an accelerated real-time test of the investments we've been making in our longer-term strategy and operational model. And our business has performed better under these conditions than we would have ever imagined. Second and also important, this environment provides a vivid illustration of why quarterly profitability isn't always the best indicator of long-term potential. If you only looked at our first quarter EPS, which was down more than 60% compared with last year, you might be tempted to say that our performance was disappointing and that our long-term prospects have been getting weaker, but I'd strongly assert the opposite. Because of what our team has been able to accomplish and deliver for our guests, I believe our long-term prospects have gotten stronger over the last 90 days. Put another way, I wouldn't trade Target's future prospects for anyone else's in the marketplace. With that context, I will run through our financial results, providing our longer-term perspective before I turn the call back over to Brian. Overall, our first quarter comparable sales grew 10.8%, reflecting some of the strongest growth our business has ever seen. Total sales grew 11.3%, about 50 basis points faster due to sales from our nonmature stores. Among the drivers of our comp growth, comparable traffic was down 1.5% and average ticket was up 12.5% as guests consolidated their shopping trips into fewer bigger baskets. Among channels, store comparable sales increased 0.9% while digital comp sales grew 141%. As Brian and John highlighted earlier, quarterly averages for category and channel growth don't show the volatility we saw throughout the quarter. On the gross margin line, our business delivered a rate of 25.1%, down about 450 basis points from a year ago. Obviously, this is well below what you would expect in normal times, but these times have been anything but normal. There are 3 major drivers of this quarter's decline. First, we incurred hundreds of millions of dollars of incremental costs, including inventory impairments resulting from the severe slowdown in apparel sales. For context on these costs, it's important to note that prior to the first quarter, comp sales in Apparel & Accessories had been growing more than 5% but quickly decelerated to more than a 20% decline in the first quarter. Put another way, if those prior trends in Apparel & Accessories had continued, first quarter sales in that category would have been more than $800 million higher. A second source of pressure was category sales mix as we saw wide divergence in sales trends across our business. Our 3 lowest-margin categories, Hardlines, essentials and Food and Beverage, each saw first quarter comp increases in the high teens or higher. In contrast, our 2 highest-margin categories, Home and apparel, saw slower trends with Home in the high single digits and the Apparel decline of more than 20%. Altogether, category sales mix accounted for more than 150 basis points of this quarter's gross margin decline. The third major factor was digital fulfillment and supply chain costs as digital penetration more than doubled compared with last year, driving nearly 10 percentage points of our sales growth. As John mentioned earlier, we were already planning to reach this level of digital sales penetration over time, but this crisis has rapidly increased the pace of digital adoption among U.S. consumers. But importantly, given the outstanding performance of our team and operations in the face of this unprecedented surge in volume, we've continued to see high levels of guest satisfaction with our digital fulfillment, which is a positive leading indicator of guest loyalty, engagement and market share over time. Moving down to the SG&A expense line. Our first quarter rate was 20.7%, about 10 basis points lower than a year ago. As always, expense performance was driven by many factors, but there were 2 primary drivers of our year-over-year performance. The first was the incremental costs we've incurred as we responded to the crisis, including higher pay for hourly team members in our stores, extended paid leave and backup daycare provisions across our team and enhanced cleaning routines and other investments to protect the health of our guests and our team across the country. Against these higher costs, we realized a meaningful rate benefit from sales leverage given our unusually strong comparable sales growth in the quarter. On the D&A line, first quarter dollars were approximately flat to last year, resulting in about 40 basis points of rate improvement on higher sales. Altogether, our first quarter operating margin rate of 2.4% was about 400 basis points lower than last year. On the interest expense line, we saw a slight decline in dollars, reflecting the benefit of lower average floating benchmark interest rates. Income tax expense declined about 80% compared with last year, driven primarily by the decline in our profitability. On the adjusted EPS line, we earned $0.59 in the first quarter, more than 60% lower than last year. GAAP EPS was about $0.03 lower at $0.56, reflecting the loss on our investments in Casper Sleep. Now I want to turn to cash flow and capital deployment. But first, I want to outline a number of actions we've taken this quarter in response to the environment. The first change, as John already outlined, was a reduction in the number of remodels and new stores we are planning for 2020. John already made it clear that this decision was based on removing distractions for our team, combined with the impact of other factors in the external environment. Like John, I want to emphasize that we haven't changed our view of the ultimate long-term value of these projects nor was the decision to slow down these projects driven by the desire to preserve capital. Regardless, this change in our plans will affect our anticipated CapEx for the year. At this point, we expect that our 2020 CapEx will be $3 billion or lower in contrast to our prior expectation of about $3.5 billion. At this point, things are too uncertain to provide a view of our plans for future year remodels, new stores and overall CapEx, but we expect to provide more clarity over time. The second change occurred in March when we announced the suspension of our share repurchase program in light of the high level of uncertainty in the current environment. This decision was prudent and consistent with our long-term capital deployment priorities in which share repurchase only occurs when we have excess cash within the limits of our middle A credit ratings after we fully invested in our business and supported our dividend. And finally, during the first quarter, we issued $2.5 billion in new debt and added another $900 million revolving credit facility to supplement our existing $2.5 billion revolver. We took these actions out of an abundance of caution given the high degree of uncertainty in the environment and the possibility of a very challenging external environment throughout this year. As we've pointed out many times, we entered this crisis in a very strong position with ample cash on our balance sheet, strong credit ratings and a business model position to generate robust cash flow across a wide range of conditions. Given that strength, our modeling indicated we have a very wide range of potential economic scenarios in which we'd have sufficient liquidity even without the extra capacity resulting from these actions. Even so, given that we were able to issue new debt at historically low rates, we view these decisions as prudent, affordable insurance, giving us an extra layer of cushion to accommodate even more extreme downside scenarios should they arise. Turning to cash flow. We actually saw really strong performance in the first quarter as operating cash flow grew nearly $1 billion compared with last year. This performance reflected a number of factors, including an increase in payables and a decrease in inventory compared with last year, along with various timing issues, which more than offset the decline in earnings we experienced this year. Regarding our inventory position, while the year-over-year decline looks good on the cash flow statement, it reflects the lack of availability and elevated out-of-stocks we're seeing in multiple categories. As such, we have elected to invest more cash and ended the quarter with a higher level of inventory in those categories if it had been available. In terms of deployment of cash, our first quarter CapEx was about $750 million, nearly $100 million higher than last year. In addition, we paid dividends of $332 million to our shareholders and returned another $609 million through share repurchases prior to the suspension of the program in March. And finally, on the ROIC line, our business delivered a trailing 12-month after-tax return of 13.4% in the first quarter, down from 14.3% a year ago. Obviously, this decline reflects the dramatic decline in our profitability during the quarter, which does not reflect where we expect our business to perform over time. However, I will quickly add that even though this performance is down from a year ago, a 13.4% after-tax return is still quite strong on an absolute basis and favorable compared to results across a wide array of companies in retail and beyond. So now I want to leave you with a couple of important thoughts. First, our long-term priorities for capital deployment have not wavered. At the top of the list is our goal to invest fully in all projects that support our long-term strategic and financial goals. Second, we support the dividend with a goal to build on our long-term record in which we've paid a dividend every quarter in our history as a public company. And finally, over time, we expect to return any excess cash beyond those first 2 uses through share repurchases within the limits of our middle A credit ratings. These capital deployment priorities have served the long-term interest of both our business and our shareholders over many decades. It is our investments in our stores, in our fulfillment capabilities, in our assortment and in our team that have positioned us to succeed now and will power our future. The other important point pertains to the resilience of our business combined with the strength of our balance sheet. As I said at the beginning of my remarks, I believe that our long-term prospects have only gotten stronger as our operations and team have reliably served guests during this crisis. Because of our multi-category portfolio, we were able to quickly pivot as guest demand evolved from stocking up on food and essentials to focusing on home and electronics as they sheltered in place until we saw a broad-based acceleration across multiple categories toward the end of the quarter. Because of our curated digital assortment and store-based fulfillment model, our operations and team adjusted seamlessly as guests increasingly chose digital fulfillment, allowing digital sales to account for nearly 10 percentage points of our first quarter comparable sales growth. And because of the strength of our business, we could afford to make hundreds of millions of dollars of incremental investments in team member wages and benefits, along with actions to enhance the safety of both our guests and our team. As we look ahead, we are focused on continuing to deliver for our guests and our team throughout the crisis while preparing to emerge strong and ready to play offense when our economy recovers. And we think the opportunities when that happens will be compelling. Unfortunately, this crisis will cause a lot of dislocation in multiple parts of the economy, including retail. As a result, we expect to have many potential opportunities to invest, including possibilities in real estate, brands, capabilities and obviously, in our existing strategic initiatives. So while we always monitor our short-term financial results and focus on strong execution, I think it's more important than ever for us to maintain a laser focus on the long term when I expect we could have unprecedented opportunities to create value for all of our stakeholders. Now like Brian and John, I want to pause and thank everyone on the team for their endless energy, alignment with our values and for taking care of each other. It's said that you don't really know how strong your team is until it goes through challenging times, and I couldn't be more proud to see how our team has risen to the challenge by serving our guests and our communities over the past few months. Now I'll turn it back over to Brian for some closing remarks. Brian?
Brian Cornell:
Thanks, Michael. Before we move to your questions, I want to close by reiterating some of the points we shared today. I want to start with something Michael said earlier.
These times are anything but normal. Guests are facing unprecedented changes in the way they're living and the way they're working. In a matter of weeks, the economy has moved from historically low levels of unemployment to some of the highest ever recorded. Not surprisingly, consumer shopping patterns have been changing significantly and frequently as everyone tries to navigate through these changes. And so things that we might have once taken for granted have suddenly become front and center in our minds. We have renewed appreciation for the things we need in our homes every day, items like food, paper goods and cleaning products that are now more important than ever as we shelter in place and work remotely. In addition, we have a renewed appreciation for the people that make sure we have those products, including the people who produce them, the supply chains that move them and the teams that provide them in stores and bring them to our homes. The crisis has clearly demonstrated the essential role of our team members as they offer compassionate, friendly service and do everything possible to ensure that their neighbors have what they need. Like John said, it's humbling and inspiring to work alongside our team and feel their passion and resolve as they persevere through this crisis. They're the heart and soul of Target and the reason I'm so confident in our future. With that, we'll move to Q&A. John, Michael and I will be happy to take your questions.
Operator:
[Operator Instructions] Our first question comes from Edward Kelly.
Edward Kelly:
Congratulations on strong execution in obviously challenging environment. Brian, I want to -- just want to start with comps. So you obviously saw a significant acceleration in the back half of April. What are you seeing so far in Q2? Any category color here would be helpful.
What do you think drove this acceleration? Is it just stimulus? And what does it tell us at all about how to think about Q2 comps overall at this point?
Brian Cornell:
Ed, thanks for joining us. We certainly saw an uptick, as we reported, starting on April 15 as stimulus checks arrived across America. And as we reported, we saw a return of a guest who was shopping in our stores but continuing to use our digital fulfillment channels. And we started to see normalization across all of our categories, an uptick again in categories like apparel and Home, but continued strength in our entire portfolio.
And that's continued through the balance of April. That stabilization, normalization of category shopping has continued in May as we continue to see an uptick in digital fulfillment. So while we're not providing guidance today, we certainly are seeing a more normalized shopping environment both in our stores and online and a guest who's shopping all of our categories, including those discretionary categories like Home and apparel.
Edward Kelly:
Maybe just one follow-up to that. In terms of where you have stores in states that have begun to reopen, how has performance of these stores compared to states where restrictions are still high? I'm just kind of curious as to what you're learning there and how we should be thinking about the business once a broader reopening trend really emerges.
Brian Cornell:
Ed, we're watching it carefully. It's still very early, but I think what we're seeing throughout these last few weeks is the trust that we've earned with American consumers who continue to turn to Target for those household essentials, their food and beverage and now apparel and home items as well as the strength we've seen in Hardlines throughout the quarter. As Americans still work from home and educate their families at home, we provide essential services throughout the pandemic, and we're seeing that continue as states open up across the country.
Operator:
The next question is from Chris Horvers with JPMorgan.
Christopher Horvers:
So a couple of financial questions. The first one is can you talk more quantitatively about the gross margin drivers, especially the markdown in inventory reserve and the digital Shipt component of the decline? You said hundreds of millions of dollars for the inventory component, which is $300 million, that's 150 basis points. So how close are we?
And then as you look ahead to 2Q, given what you've seen in apparel over the past month, has it cleaned -- has your inventory cleaned up? And how do you think about the potential markdown risk in the second quarter? [Technical Difficulty]
Michael Fiddelke:
All right. Chris, can you hear me?
Christopher Horvers:
Yes. Well, the anticipation is very high so…
Michael Fiddelke:
All right. I had a great answer that you heard none of, so I'll try to do my best paraphrasing again. To decompose margin a little bit more, if I had to dimensionalize it into the 3 biggest drivers of what we saw in Q1, the first would be a set of merchandising actions that we took throughout the quarter. And the biggest of which, to your question, was the inventory write-downs and adjustments that we made, especially in apparel given the deceleration we saw in apparel throughout the better part of Q1. That's probably the biggest factor.
And then as I mentioned in my remarks, category mix at about 150 basis points would be the second biggest factor. And then the third would be the pressure from supply chain in general, and there's a couple of things there. A portion of our investment in the team shows up in margin because supply chain labor shows up in margin. And then the mix shift to digital is there as well. But I think it's worth pausing for a moment on that mix shift to digital and the rate pressure that comes with that because I want to spend a second on how I think about digital economics because I think there's real risk in over-rotating on the profit rate headwind that shows up there for a couple of reasons. The first is for the vast majority of those digital transactions and especially the ones where the guest's taking advantage of our same-day services, the sales dollars, the market share dollars and the variable profit dollars from those sales are definitely a good thing. And second, and this is most important, the economics of a digital transaction, as I've said before, are so much bigger than just the single transaction. When we see guests engage with more of our fulfillment choices, they become stronger customers of Target and we build relevance with them in total, and that's where the economics of digital get most powerful. As I referenced in the financial community meeting discussions a few months ago, when we see a guest use Drive-Up for the first time, they spend more at Target in total and even more in store than they did previously. And so there's a powerful accelerant of guests becoming stronger users of all of our services. And we had 2 million guests use Drive-Up for the first time in this quarter, and so the long run prospects of that digital growth in terms of what it means with relevancy to our guests, I think, are very powerful.
Brian Cornell:
Chris, it's Brian. Why don't I talk a little bit about Q2, and I'll answer your question but I think a question that's on everyone's mind right now. And before I talk about Q2, we'll go back to the volatility and rapid changes we saw throughout the first quarter, which makes it really difficult for us to project with any kind of certainty how consumers are going to continue to shop in the second quarter and for the balance of the year. As we sit right now, I think the guest that's shopping at Target is still seeing the benefits of the stimulus check. They're shopping in our stores, and we've seen store traffic increase. We're seeing them shop all of our categories while continuing to utilize our same-day fulfillment services.
But our ability to project how that's going to play out over the balance of the quarter or year is unfortunately something that we can't do today. I think there's just too much uncertainty, too many different variables. As we sit here today, we spend lots of time each and every week talking about what will happen when and if students go back to school or back to college, how will guests shop during the holiday season, starting with Memorial Day. It's all to be determined right now. And one of the things that I think we're most proud of as we think about our first quarter performance is how we've adapted week by week, almost day by day to the changing consumer needs. And the flexibility that you've seen in our system is something that we'll lean on throughout the balance of the quarter and the year. But I know everyone is anxious for us to provide a perspective on the second quarter and the full year. Unfortunately, our perspective right now is that we have to be flexible, we have to be adaptable, we have to continue to meet changing consumer needs. And I think we've demonstrated the ability to do that in the first quarter.
Christopher Horvers:
I guess just to push a little bit on it, I mean, to the extent that -- how did you -- as you booked that inventory reserve, I mean, how did you think about the ability to take some of that second quarter risk down? I mean is there a scenario where you could see that gross margin impact from clearance be anywhere near what you just experienced in the first quarter?
Michael Fiddelke:
Yes. What I'd say, Chris, is this is what our teams do each and every day. And so we react to changing trends and take inventory actions appropriate. And I'd give just a huge hats off to our merchandising teams who have worked through the volatility and sales trends throughout the quarter, both the softness in apparel that leads to some of the write-downs we're talking about in Q1, but in every category that's seen trends deviate from history in such meaningful ways.
Brian Cornell:
And said another way, Chris, I think we feel very good about our inventory position as we go into the second quarter.
Operator:
The next question is from Ed Yruma with KeyBanc Capital Markets.
Edward Yruma:
You guys have done an incredible job ramping Drive-Up. I guess as you kind of assess the service today, what are the key limiters in enhancing throughput there? Is it staffing levels, social distancing? Or is it literally like the physical parking spots? And I guess as you think about ramping it into a more normalized environment, what's your expectation on keeping some of those customers that are trialing it right now?
Brian Cornell:
Ed, I'm going to let John answer this question, but I am smiling. When I think about the fact that during the first quarter, our same-day services grew by 278%, I think John and his team have shown their ability to ramp up as needed.
John Mulligan:
Yes. I'll just start where Brian left off there. I think that's exactly right. And you saw it accelerate throughout the quarter. Like I said in the remarks, Drive-Up accelerated to 1,000% growth in the month of April. So from a limiter perspective, we think a couple of things which we're looking to address, and we don't really view these as limiters as we know these are things that come with volume. One is parking spaces, to your point, and you'll see us add additional parking slots over the next several months. The second is in-store space, and we are already in process of adding incremental storage space -- flexible and incremental storage space for the store teams. So we feel good about that.
But from a process perspective, from a team perspective, there are no limiters. And we've talked about this for a few years now, about the scalability of the model of using the stores as hubs. And I think that's really shown through this quarter. The other thing I would add that we're really excited about from a Drive-Up perspective, as I said, we've throttled back on expanding temperature-controlled, so fresh, frozen types of products into Drive-Up earlier this quarter. We've resumed that in Minneapolis, also added Kansas City. And early on, our plans have been to get to 3 states this year and then pause and react in scale over next year. Our plan now is to accelerate that and to get to as many stores as possible over the next several months because it's clearly something that our store -- that our guests would like our stores to deliver. We're excited about the opportunity there. We're excited to deliver another service for our guests. And the store's ability to execute that has been just phenomenal.
Brian Cornell:
Ed, sitting here today, I've said a number of times to the team, I think we've accelerated our digital fulfillment awareness with the guest and fulfillment capabilities by upwards of 3 years. And I think we'll come out of this first quarter with a much greater awareness around the type of services Target provides, the trust that we're building in same-day, the knowledge that guests have today that if they place an order with Target.com, within 2 hours, they can come to our stores and pick up. They can pull into one of our Drive-Up lanes, and within 2 minutes, we'll put it in their trunk or we'll have a Shipt shopper bring it to their Home within 2 hours. So I think we're going to see a dramatic acceleration in awareness and utilization of those same-day fulfillment capabilities.
Operator:
The next question is from Matt McClintock with Raymond James.
Matthew McClintock:
Congrats to you and the rest of the Target team. Brian, I want to kind of think about this uncertainty in the macro from a different angle. How do you think about consolidation of the industry going forward, whether that be through your digital capabilities or whether that be through, quite frankly, retailers that don't reopen their doors? And how does this compare and contrast to prior economic difficult scenarios or recessions, et cetera, where maybe that type of consolidation didn't happen so when we try to assess your risk going forward, we can actually think about this relative to the past?
Brian Cornell:
So Matt, thanks for joining us again this morning. And I think for several years now, we've been talking about this movement towards consolidation in the industry and the bifurcation that's been taking place over the last couple of years with pronounced winners and, unfortunately, losers in the retail environment. I think, unfortunately -- and I do say that sincerely, unfortunately, due to the pandemic, I think we're going to see an acceleration in that bifurcation. And we've already seen a number of retailers filing for bankruptcy. We expect even further store closures over the next couple of years. And I think it's going to only accelerate the opportunities that companies like Target will have to consolidate market share and continue to grow profitably in this environment.
I also think from a consumer standpoint, as we survey our guests and as we talk to consumers, I think we're going to see a consolidation in how people shop. And I think our multi-category portfolio positions us very well in an environment where today's consumer is looking to make fewer stops. And the ability to come to Target and pick up their food and beverage needs, their household essentials, their beauty products, their home, apparel items and their household essentials and Hardlines each and every week makes us an attractive choice in a consolidating environment. So sitting here today during, obviously, a point of crisis across America, while we're very humble as we look at our performance and the role we played, we're equally optimistic about the future of Target, and we think this consolidation both in the retail market and how consumers shop will benefit us for years and years to come.
Matthew McClintock:
And then just as a quick follow-up, All in Motion, you clearly launched that into a difficult situation. But I was just wondering if we could get an update on that brand because it does seem like athletic apparel has actually done quite well relative to the rest of the apparel industry during this time of crisis.
Brian Cornell:
Matt, I'm glad you asked. And while we've talked about, obviously, some softness in apparel throughout the quarter, one category that did perform really well was the performance category. As consumers are working from home and spending a lot more time at home, that was certainly a category that performed well, and we are very excited about the potential of All in Motion.
Operator:
The next question is from Karen Short with Barclays.
Karen Short:
Congratulations on managing through obviously a very tough quarter. I just wanted to go back to the gross margin for a second. And I guess the question is people who are a little more skeptical on how this year is going to shape out for you kind of harp on the fact that there will be significant inventory liquidations across all of retail, and that, that will be something that you have to address from a pricing perspective in your store. And I wanted to just get your thoughts on that a little bit because it does seem that you have pulled forward some of the markdowns that you would otherwise see in 2Q, and 2Q does seem like it might shape up to be better than you'd expected. But wondering if you could just give us some thoughts on how you're thinking about that in terms of your inventory from like a third quarter, fourth quarter perspective even.
John Mulligan:
Yes. I can start. Thanks for the question. As Brian mentioned, we feel really good about how our inventory is positioned, especially in apparel right now. So we feel like we took the right actions in Q1 to position us right to pursue the sales opportunities in front of us. With respect to the price and promotion environment, again, that's something that we got a lot of history navigating, and we'll be committed to be priced right with appropriate promotion in any environment around us. We watch pretty carefully what's happening in the competition. But especially to see some strength return to apparel at the end of the quarter, I think we feel really good about the go-forward prospects.
Brian Cornell:
Yes. And Karen, one of the teams that we really need to acknowledge as we sit here today is our Target sourcing team who, throughout the quarter, has done a terrific job of, at some points, canceling and then chasing inventory as we've seen changes in trends. And the relationship we have with our own brand vendors, the strength of our vendor matrix that supports us each and every day is something that's really put us in a unique position. And that sourcing team is one of our key capabilities that allows us to adjust to market need. So that team served us well in the first quarter and will position us well over the balance of the year.
Karen Short:
Okay. That's helpful. And then I just want to ask one other question. It seems like, at least on the food side, we're definitely seeing a lot of conventional competitors really raise prices pretty rapidly in light of the heightened demand. And you guys seem to be holding price points or price positioning. So can you maybe provide a little color on how you think that might be helping you gain share? Because it does seem like the price gaps have widened to unprecedented levels, and I say that on the food side specifically.
Brian Cornell:
Sure. And Karen, as you've heard us talk about for a number of years now, we're committed to being priced right daily, each and every day. And that includes during this pandemic and as we go into the second quarter, and it certainly includes our Food and Beverage category. So we've seen very little change in our everyday pricing throughout the quarter. You have seen a reduction in promotions based on, obviously, limited supply of certain products. But our commitment to delivering great value to our guests in Food and Beverage and in all of our categories persist as we sit here today.
Operator:
The next question is from Simeon Gutman with Morgan Stanley.
Our next question is from Paul Lejuez with Citi.
Tracy Kogan:
It's Tracy Kogan filling in for Paul. Two questions. I was wondering about the new customers you said you've gained during the quarter. Is there any particular demographic group you're attracting? And then I was also wondering what you've seen with repeat purchases from those customers. And then I just have one follow-up.
Brian Cornell:
Yes. So Tracy, we talked about the fact that we saw 5 million new guests use Target.com. And John talked about the number of new users for Drive-Up, 2 million new Drive-Up users during the quarter. So we're certainly looking at the profile of that customer. But we recognize the stickiness that comes along with that. And I'll let John talk about the reaction we get when people use our same-day services and the high Net Promoter Scores we continue to receive.
And I think we're going to recognize, coming out of this first quarter and the pandemic, that guests are going to continue to gravitate towards the convenience and the contact-free element that Drive-Up allows. So we're seeing a great response. Lots of new guests using Target.com and Drive-Up, and we expect that to continue over the balance of the year.
John Mulligan:
Yes. The thing I would add, the great thing we saw throughout the quarter, and again, really proud of our teams, is Drive-Up is our highest Net Promoter Score, Shipt is a very high Net Promoter Score, pickup is a high Net Promoter Score. And then the in-store experience Net Promoter Score -- across all of those scores, absent the usual week-to-week volatility that we see, all of them remained steady even at the peak. When we were -- as things accelerated very quickly into our digital channels, we saw a great Net Promoter scores.
And as Brian said, that is the best indicator of guests coming back to us. We've already seen 40% of the Drive-Up guests repeat purchase. So we focused all quarter long with all of our teams on ensuring that we can provide a great guest experience. And when we do that, we see them come back and use our services again.
Tracy Kogan:
Great. And then my follow-up was if you could comment generally on the national brand versus private brand performance in the quarter and then specifically how Good & Gather performed.
Brian Cornell:
I'll start with Good & Gather, and that was an important part of the over 20% growth we saw in Food and Beverage. You'll see us actually as we move into the second quarter begin to expand the number of items in the Good & Gather brand. So we feel really good about the guest response during the pandemic, and we expect that to continue over the balance of the year.
And at this point, I probably need to just pause and thank many of our national branded vendors and the support that they provided us during the first quarter. Obviously, unprecedented levels of growth. We talked about the type of growth we saw in household essentials, in Food and Beverage but -- in so many of our categories. And our national branded vendors did a superb job of working hand in hand with our buyers, our supply chain team to meet the demand and get us the product we need, and a big thanks to all of our national branded partners. We appreciate everything they've done.
Operator:
The next question is from Robby Ohmes with Bank of America.
Robert Ohmes:
My congrats as well on the execution, pretty incredible, so thank you for that because I am a customer. Actually, just some follow-up on digital. One was on Shipt. I was wondering if you could talk about the membership growth that you saw in the first quarter. And we've seen pretty dramatic app download data on Shipt. And also, are you signing up a lot more partners on Shipt?
And then my follow-up would just be maybe for Brian or John or Michael. Just with this huge digital volume, are there anything you're learning about whether it's going to be tougher or easier over the long term as you average out much higher digital volumes? Are you seeing new ways to get the profitability up that maybe you weren't seeing before this big ramp-up in volume?
Brian Cornell:
So Robby, why don't we let John start by talking about the outstanding performance we saw with Shipt, and then we'll come back and talk about digital profitability over time.
John Mulligan:
Robby, good to talk to you. Shipt, consistent with everything else we've said about digital, has seen -- saw significant acceleration in that they and their team did an outstanding job hiring into that or getting Shipt shoppers. Order volume over the course of the quarter for Shipt business independent of Target's portion of that order volume was up 2x. In April, it was up 3x. They had 60% growth in membership, so a significant acceleration in members. They engaged 100,000 additional shoppers, so doubling the number of shoppers they had going into the quarter, and so a significant acceleration across Target. We saw a 300% increase in sales to last year through our Shipt channel. So again, significant acceleration there.
And like I said on a previous caller, probably -- perhaps most importantly, the NPS score, very, very high, and they maintained that throughout the quarter. A few dips when sales really accelerated quickly within a week to 10 days, but beyond that, the team did an exceptional job in really getting shoppers to meet that demand. And so we're really enthusiastic about the Shipt performance and encouraged by what we saw.
Michael Fiddelke:
And I can maybe just chime in on the prospects for increased efficiency over time. We've seen across wherever we've had growth, whether it's the growth in Drive-Up over the last several years, Order Pickup, volume helps us. And with volume, we can bring efficiency. And when it comes to digital, as John mentioned, we've been investing in planning and capability to support this volume. We just thought it would be 3 years from now. And so we've seen an acceleration for what we would have expected to take 3 years that's now happened in a matter of weeks. And so as we get the chance to optimize some of our operations against that volume, we should be able to drive increased efficiency over time.
But the thing I'm most excited about on the digital front that we've touched on a little bit already is just the opportunity we have to capture relevance with guests as their shopping habits change. We know over the long run, when guest behavior changes -- and that's why a family with a new baby in the house is such an important guest milestone for us, where we want to show up because that's when shopping habits can change. Back to college, the first time you move into your new home, those milestones matter to us as a retailer and always have because that's when shopping habits can change. And I think across America right now, we're seeing an acceleration in the change of shopping habits as it relates to digital. And the way we've shown up with 280-plus percent growth in digital in April means we're capturing a lot of that mind share and those new routines as they're forming.
Brian Cornell:
And Robby, I just -- I'd finish up by going back to our strategy and using our stores as fulfillment hubs. And as we talked about our performance with digital, although the 141% growth rate is a stunning number, the number I really focus on is the same-day fulfillment, which grew by 278%, and that was all fulfilled by our stores. And if you actually look at a different metric, if we think about store-fulfilled comps during the first quarter, while we grew by 10.8% overall, if I look at that store-fulfilled comp number, that increased by over 9%. It means our stores are driving tremendous productivity, and they are the center of our strategy. And that's a number you'll hear us talk about more and more and more.
So when we talk about store comps during the quarter, they look relatively low at just under 1%. But those stores actually drove over 9% comp growth during the quarter. And from an economic standpoint, we know over time, that's a really healthy and profitable transaction. So the stores did tremendous work during this quarter. And America turned to Target stores because they trust our service and our reliability and rewarded us with a store-fulfilled comp of over 9%.
Operator:
Our last question is from Oliver Chen with Cowen.
Oliver Chen:
Brian, what would you prioritize as some of the most surprising and/or permanent changes from the crisis? And John, I was curious about the future of automation and robotics. Especially as you do a really great job using stores as hubs, how do you see that playing out in store with Drive-Up and with inventory management accuracy?
Brian Cornell:
Oliver, why don't I start. And when I think about the quarter and some of the learning from the quarter, I'll have to go back with the importance of stores. And at the start of the pandemic, and we've talked about the different chapters, America turned to Target stores. And that's where we saw the uptick. That's where they came for household essentials, they stocked up on food and beverage. So when America was asked to shelter in place, they started to use our same-day fulfillment channels and were picking up in store and driving to our parking lots to use Drive-Up or using a Shipt shopper.
But when I think about the quarter, it just reinforces to me the important role that stores play, both our traditional stores and even our smaller formats in urban markets. There's a number of e-mails I've received from guests in New York City and Boston and Chicago thanking us for that small format in their neighborhood that supplied all of their household and family needs during the pandemic. So my highlight and takeaway is stores are vitally important, and stores will continue to play a really important role to America as we go forward.
John Mulligan:
And then on your second question, Oliver, on automation, analytics, technology, as you know, we've been pursuing that on several fronts. I think to the last half of your question about inventory allocation, inventory placement, as you know, we've been developing analytics and technology across something we call inventory planning and control, IPC. We're about 1/3 of the way into that deployment. We paused much of that for this quarter. The teams are assessing right now what time line we want to get back on to begin deploying that further across the chain. We feel really, really good about the opportunity for us to improve what we're doing from an inventory placement with that technology and analytics.
And then from an automation perspective, we've talked about we had analytics -- or automation pilot going on in Minneapolis, also at Perth. In Minneapolis, we actually deployed that automation to 4 more locations. We have not started that up yet because that will require some travel, and we want to -- we will take the safety of our teams into account as we think about getting back into the travel game. But when we are able to do that, we'll get that to 4 more locations this year and then continue to expand. Out of Perth, the teams have made great, great progress here even while we haven't been able to get into that building. And so when we do get into that building, we'll do some final testing to scale it out and then begin, as I said a couple of months ago, to think about where we deploy that next, somewhere within our network and an existing facility. So you'll see us continue to expand automation. When it comes to store automation, I think we've shown the ability to scale very, very rapidly with our teams and with the technology that we have provided them. And so we feel very, very good about the productivity and scalability and reliability of our current processes and teams. And we'll continue to explore other avenues as we go forward to improve that.
Brian Cornell:
So to John's point, automation will be important, Oliver. But as we sit here today, I think the most important thing to focus on is execution. And I think in this environment, we've earned the trust of American shoppers with great execution and our commitment to providing a safe shopping environment. And you'll see us continue to commit to safety and trust as we go forward over the balance of the year.
So operator, that concludes our call today. I want to thank everyone for joining us. I hope you stay safe and healthy, and we look forward to the day when we can be meeting again face to face. So thank you.
John Hulbert:
Good morning, everyone. Thanks so much for joining us today, and thanks for your flexibility as we have adjusted our plan for this meeting.
Before we get started, I have a couple of important disclosures that we need to cover that will apply to all of our remarks and Q&A today. First, 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. And second, in today's remarks, we refer to non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP measures to the most directly comparable GAAP measure are included in our financial press releases and SEC filings, which are posted on our Investor Relations website. With that, I'll turn it over to Brian who can get us started.
Brian Cornell:
First, I want to thank all of you for dialing in this morning. While we would have loved to have seen you in New York today, given the circumstances, we wanted to make things easier for out-of-town travelers who might want to stay closer to home.
For the first part of the meeting, John, Michael and I will walk you through the highlights of our recent performance, the continued evolution of our long-term strategy and our outlook on the future. After that, we'll open things up and take your questions for the balance of the meeting. Again, I want to thank you for your flexibility and look forward to an engaging conversation with all of you this morning. And with that, let's get started. [Presentation]
Brian Cornell:
By any measure, 2019 was another strong year at Target. You've seen that in our financial results and in the media coverage. But it's this chart that really tells the story. Trace those bars back to this very meeting 3 years ago. That morning, we said we'd invest more than $7 billion in capital to reengineer our supply chain, to reimagine our stores and to reinvent our own brand portfolio. We said we'd take $1 billion in operating income and invest in our team and our pricing. And we said this while many others were headed in the opposite direction, closing stores, cutting jobs, trying to save their way to success. But we've never been the kind of company that follows the herd, and this was no time to start. But we also weren't placing bets just above conventional wisdom. We had every reason to believe this would work because we've been doing our homework, testing these bets and listening to our guests. And for them, stores weren't dead. They were just boring and uninspiring. Our guests still loved our brand. They just wanted us to do more. And it was this dose of tough love that inspired our team to redefine the Target Run and change the future of our company.
We started by unpacking the big questions. What would it take to combine the hallmarks of the physical experience:
discovery, inspiration and service with the ease, convenience and personalization made possible through digital? In an age of AI and robotics, where do people fit in? When everyone's talking endless aisles, what's the role of curation? In an on-demand world, could digital ever become more than a drag on the P&L? There are lots of theories, but nobody had the answers, and there certainly wasn't a playbook. So we started writing our own. We set off on a different path. We used our purpose as a guide, and the rest is now history.
Today, nobody is doing what Target is doing. Nobody. Target is a category of one. In 3 years' time, we've redefined the Target Run. We've built a durable financial model that consistently drives top line sales and strong and sustainable bottom line growth. And today, Target's among the top performers on retail's leaderboard, a competitive position we intend to keep for many years to come. While our teams love to win, they'll tell you the same thing. We're proud of what we've accomplished, but we've got to stay humble, and we're going to stay hungry if we want to stay ahead. That means ensuring our winning strategy continues to evolve as we test, as we scale, as we refine our multiyear initiatives, constantly challenging ourselves to develop new pathways for growth and innovation. If you look at our playbook, we've done just that by elevating the shopping experience and winning with high-touch service by curating at scale across our multi-category portfolio a great mix of our guest-favorite national brands and Target exclusives and of course, by delivering ease and convenience with the most comprehensive set of fulfillment capabilities in the industry. Each piece of the strategy is working, creating value for our guests, differentiating us from our competition and delivering profitable growth and consistent returns for our shareholders. So I thought I'd start today talking about our progress, where we're investing and what's next. John Mulligan will share a deeper look at how we're driving stronger operational performance. And then you'll hear from Michael Fiddelke, our new CFO, who will share his perspective on the business and our outlook for the year ahead. While I had a brief opportunity to introduce Michael during our Q3 call, you should know, like John, he's an engineer by training, whose heart belongs to finance. In his 16 years with the company, he's worked in every part of the business, tackling many of our most stubborn challenges, conquering them all with a rare combination of logic, curiosity and grace. I'm confident, as you get to know Michael as I have, you'll see he possesses all the qualities you'd want in a leader for a role like this. And with that, let's dig a little deeper into the business. So you've heard me say many times, we're putting our stores at the center of our strategy. In the last 3 years, we've spent more than $4 billion remodeling our stores, completing hundreds each year, transforming them into showrooms, fulfillment hubs and service centers. With these projects, we're seeing an average sales lift between 2% and 4%. And we're getting smarter with each cycle, enhancing the shopping experience, driving operational improvement and driving down cost through efficiencies of scale. I can't tell you how many times I've heard guests say how much they love the broader range of merchandise in all the new categories we're putting in these stores. The truth is we're not adding categories. We're not adding SKUS. In fact, in many cases, we're taking them away. But it's the way we've cross-merchandised product and the improving presentation that's making these stores more inspiring and easy to shop.
We've also continued to grow our store network, opening about 30 new small-format stores each year in key urban markets and college campuses. And just like our remodel program, we're fine-tuning our approach with each project. Like any new neighborhood, you have to really live in it to figure out the daily rhythms and routines. In Tribeca, for example, we knew there'd be a steady stream of office workers over the lunch hour and tourists on weekends. But we didn't realize just how much room we need to accommodate all the double jogger strollers in our aisles. Trust me, they're huge. So we spent a lot of time flexing our merchandising, replenishment and operation strategies to match the unique shopping patterns in each store. Collectively, these stores are well past the $1 billion threshold for annual sales. Per square foot, they're much more productive than our average stores. And if you're watching these closely, you might detect a new trend. We're opening up Target stores near America's most iconic tourist destinations:
Times Square, Disney World and the Las Vegas Strip. Because we learned from our store at Herald Square, there are few places that help travelers feel more at home than Target.
Bringing stores at the center of our strategy goes a lot further than the physical experience or proximity to our guests. Stores gives us the opportunity to make human connections with tens of millions of guests who shop each week. So we've reinvented our store model. We're investing in high-touch service, using technology for task-based work and giving our people the time and training they need to better take care of our guests. From the industry-leading commitments we made on wage to the expansion benefits like family leave, we're incredibly proud of the investments we're making in our team. Today, Target is an employer of choice and an even better place to build a rewarding career. In 2019, we promoted more than 6,000 people and invested almost 7 million payroll hours in training. This is an organization designed for advancement. In fact, almost 500 of our store directors started as hourly team members on the sales floor. Almost half of them are women. They're leading huge teams, multimillion-dollar businesses and serving as leaders in their communities. Last year, the average store director earned about $182,000. These are good jobs. These are important jobs. And we're more committed than ever to providing the development opportunities to help our store team members thrive.
When you look across the retail landscape:
department stores, discounters or DTC, there's not a single competitor with a category mix like ours
So you're probably wondering, "Brian, what's the secret?" Well, the truth is we've always had a world-class product design and development team. What's changed is our approach. We've gone from designing brands for our guests to designing brands with them. Let's take a look. [Presentation]
Brian Cornell:
I spent 30 years working with CPG companies all over the world. And I can tell you, I've never seen this kind of care and connection anywhere else. In fact, this approach is what earned Target a top spot on Fast Company's list of the World's Most Innovative Companies. And this philosophy was a driving force behind our new brand, All in Motion, a brand created with everybody in mind.
Of course, own brands are only one prong of our assortment strategy. In 2019, we struck premier partnerships with 2 of the most recognizable brands in the world, Levi's and Disney. And we're attracting more and more new brands across the assortment, including most recently Boar's Head in food. We also continue to be the preferred distribution channel for America's most innovative DTC brands, like Harry's, Native and Quip, who see Target's platform as a launchpad for scale and mass market appeal. When companies like P&G, PepsiCo, L'Oréal, Dyson or Mattel want to introduce innovation to the market, Target is the first call on their list. Add it all up, these partnerships, combined with our 20-year legacy of limited time-only collaborations, make Target the retailer of choice for great companies who want to extend their reach and see their brands shine. Perhaps the most game-changing element of our store-centric strategy is our approach to fulfillment. It wasn't that long ago that a Target Run involved a handwritten shopping list and a Sunday afternoon with a shopping cart. And spoiler alert, millions and millions of guests still really, really like to do that when they have time. But sometimes they don't. That's why we've built the most comprehensive suite of same-day services in the marketplace. Now we can put tens of thousands of items in your basket, in your trunk or on your kitchen table within a couple of hours max. It's really that simple. Of course, Prof. Mulligan will walk you through the economics. And believe me, they are incredibly favorable compared with any other option in the last-mile system. But beyond cost, frankly, more important than cost, we're changing consumer behavior with same-day. Same-day shoppers are making more trips, spending more money and putting Target first in their consideration set. You could call it our very own operations-based loyalty program. Today, our guests are letting our team pick the bulky stuff like bottled water and paper towels, and then they're coming in to shop the categories that are just a lot more fun. Once a guest tries a service, 3 out of 4 times, they'll do it again within 3 months. In fact, our adoption rates are continuing to outpace expectations. In 2019, Pickup was up almost 50%; Drive-Up, more than 500%. And today, we have more than 100,000 Shipt shoppers delivering orders for Target and almost 100 other retail brands. When you pull back the frame, what we're really after is ensuring that Target is our guest's first choice no matter what's going on in their lives on any given day. And to do that, we had to focus on the entire end-to-end experience, not just a store trip or a digital trip but new ways to lace them together. If you talk to our friend Kevin Johnson over at Starbucks, he's really clear. They are investing to create experiences based on occasion. Sometimes you're on the run, order in the app, skip the line, grab the drink. Sometimes you're on the road, you've got time to kill. Starbucks is a pretty great place to hang out. Kevin will tell you, you have to design your experience to fit either occasion. At Target, we see the world exactly the same way. It's our job to create the kind of experiences that inspire guests to spend a couple of hours or a couple of seconds. And that's exactly what we're doing. So let me give you an example of how this plays out in real life. I know a lot of you are parents. Your kids are heading off to college, probably terrific schools, maybe out of state. So let's say your daughter got accepted at Emory, great school, right outside of Atlanta. Now you can either hit a Target in North Jersey, pack up the SUV and drive south, or you can order literally everything on Target.com and have it delivered to campus. Or you can order a 6-month supply of essentials, pick them up at our store near campus, then spend move-in weekend shopping for dorm room decor. A couple of weeks later, you can send her anything she needs via Shipt. Whatever you need, we have you covered because our physical stores and digital platforms are seamlessly working together. 3 years ago, we set out to become America's easiest place to shop, and today, we are. So you can see a lot of progress, a lot of momentum. This work has created a renewed sense of guest love and loyalty. And it's translating into tangible financial results on the top and bottom line, proving each quarter that our durable model works. I showed this slide up top, but I'm happy to show it again. 11 straight quarters of positive comp growth. But what could get lost in this view is our total revenue growth. Between 2017 and 2019, we grew the total revenue $5.4 billion. Dig into those numbers a bit further, and you see broad market share gains in multiple categories. Over the last 3 years, we've captured more than $2.5 billion in apparel and beauty, with almost $1.5 billion coming in the last year alone. Baby, essentials, food, electronics, since TRU's market exit, we picked up more than $1.7 billion in toys and baby. And there's not a day that goes by where you don't see a headline predicting another share donation of Target from a struggling competitor. And then there's this chart, which I think is remarkable. For 6 years running, digital has grown at least 25% each year. And given the magic of compounding growth rates, since 2014, we doubled the business and then nearly doubled it again. More and more guests are gravitating to our more cost-advantaged fulfillment methods. In fact, today, our stores are fulfilling 80% of the digital volume, which is relieving a lot of margin pressure despite the aggressive sales growth. And that's just one example of how we're managing growth with a keen eye on profitability. When you look at our ROIC for the past 3 years, you can see strong, efficient and responsible growth in this key metric. And finally, much like this first chart, our bottom line story looks a lot like the top. Our model is churning out steady EPS growth quarter-after-quarter, year-after-year and healthy returns for shareholders as well. Up next, John and Mike will share more about our long-term confidence in our model, how you can expect to see low single-digit sales growth, produce mid-single-digit operating income and high single-digit EPS over time. They'll also give you a sense for where we're going to continue to invest to fuel this momentum and propel our strategy forward. And without stealing their thunder, I'll tell you, because of our results, because our strategy is working, we're going to keep investing in each piece. For example, in addition to our remodel work, we're going to start testing new ways to reimagine the front-of-store experience not only to create a more engaging and inspiring first impression but to enhance guest service. With small formats, we're starting to explore new ways to shrink the box even smaller, half the size of our smaller stores, so we can fit into even more spaces around the city. With same-day, our teams are going to work around the clock to optimize the experience for ease and convenience. Today, Target can put a gallon of milk in your fridge but not in your trunk. In 2020, that's going to change as we start to test our fresh Pickup and Drive-Up capabilities and scale as we go. When you think about curation, you'll see more investment in our brand management capabilities. We'll continue creating new brands when white-space opportunities arise, like you saw with Open Story, but we'll also focus on building equity in our more established brands and ensuring they continue to thrive, continue to expand our assortment across key categories in Good & Gather or ensuring Cat & Jack, which is now in year 4, continues to evolve with the trends. In electronics, a category dominated by a few global players, brands really matter. So we're rolling out plans to transform the physical environment to give them a bigger stage. We'll create more interactive experiences that allow our guests to play and explore. As we think about curation, in the digital space, we'll also continue to expand our digital offering through Target Plus. But we're taking a very different approach with this third-party marketplace than others in the industry. As a brand built to serve busy families, our guests have a good idea of what they can expect to find at Target and what they won't. If you're looking for farm equipment, Target is probably not your spot. That said, we have a lot of parents whose kids play baseball. We see it in our search data every day. And if you were to visit our store, you'd see a carefully curated selection of bats and gloves. But if you were looking for more specialized equipment, you had to look elsewhere until now. With Target Plus, we can partner with Mizuno, one of the best brands in baseball, and they'll fulfill the order directly. Mizuno is just 1 of nearly 100 brands we brought on to the invitation-only platform, each 1 carefully vetted and aligned with our high standards, no question about authenticity or origin. Target Plus is just another way we're using what we know about our guests to offer them more value in the shopping experience. Another is Target Circle. We rolled out this new loyalty program in October, and it already has more than 50 million members. Many of you are already familiar with the program. Guests opt in for personalized deals, earn 1% back on purchases and points that let them direct charitable giving in their community, no membership fee required. In the year ahead, we'll build an even deeper relationship with Circle members, and our offers and promotions will only get more meaningful and personalized as we go forward. And that concept is a good one to end on because if you think about what we've accomplished during the last 3 years, the most important thing we've done is strengthen the relationship we have with our guests. It's a relationship rooted in trust and integrity. We understand what a privilege it is to be welcomed into their families' busy lives and what it takes to honor that responsibility every single day. And it's because of the strength of our relationship that we've earned the invitation to keep creating new products, services and solutions that will keep inspiring our guests to make that Target Run today, tomorrow and well into the future.
John Mulligan:
Good morning, everyone. As you heard from Brian, the path we've set for Target is different than what you see across retail. We designed a strategy around the unique capabilities that set Target apart and built an operation to support our durable financial model. It's all about having the right assortment with great service and easy fulfillment options that keep our guests coming back. The difference maker for us, our stores. We put our nearly 1,900 stores at the center of how we offer inspiration and convenience. As you know, we spent the last few years investing to do that, from opening new stores to making our existing ones work harder. In 2019, we continued to scale those capabilities. We opened small formats by the dozen and completed remodels by the hundreds, just like the year before. We expanded same-day fulfillment options to millions more guests, took our new operating model to every store and laid out more automation, robotics and artificial intelligence throughout our supply chain to help our stores run better than ever.
By leaning into our stores, we've emerged as an omnichannel leader with competitive fulfillment options and a differentiated store experience. This year, we'll take it to the next level and use our foundational capabilities rooted in our stores to serve guests in new ways. We'll get closer to new guests, continue to elevate the store experience and redefine ease and convenience to serve guests in ways no one else can. Remember when we opened just one small-format store back in 2014 and then opened only a few more the next year? We took it slow to learn and build the right foundation so we could scale those stores successfully. We refined how to find sites to balance population density and local needs. We built a process to localize the assortment for each neighborhood but at scale. And we reoriented our supply chain to replenish these stores as the backroom space got smaller and smaller. Because of those learnings, we keep growing. We plan to open about 30 of these stores a year for the foreseeable future. And this year, we'll open nearly 3 dozen, making 2020 our highest year ever for small-format growth. We'll keep expanding in key markets like New York and L.A. and will reach new guests on campuses, making shopping even easier for Boilermakers and Georgia Bulldogs. And for our resident Hawkeye fan, Michael Fiddelke, we'll open our doors right off the Ped Mall in Iowa City. Every small-format store is unique and comes with its own set of complexities, but we've built the capabilities to be successful in a wide variety of sites and sizes. This year, we're exploring designs that redefine our idea of just how small our stores can be. I'm not talking about a new format but another turn of the dial that gives our strategy even more flexibility to reach new guests. While our smallest location today is about 12,000 square feet, our team is exploring sites half that size. Think a convenience store-sized box nestled in neighborhoods across Chicago, Philadelphia or New York or right in the middle of a bustling campus, with still enough space to offer the categories guests want from Target like beauty, home and grab-and-go food. This design could open up hundreds of additional site options to serve even more people in new trade areas and to give guests a nearby pickup spot for online orders. We expect to sign the first lease of this kind this year, with plans to open and test in 2021. And just like our first small formats, we'll go slowly at first to learn and refine before moving faster. While we're opening new stores, we keep remodeling the rest of the chain to modernize the in-store experience. We've topped 700 remodels over 3 years, and this year, we'll expand the count to 1,000. Guests tell us they love our store design after remodel, and the sales lifts prove it. Beyond the average 2% to 4% lifts we see in year 1, we're seeing over a 2% bump in year 2. Not only are they buying more, they're adding more discretionary items to their baskets. And it's giving us a meaningful improvement in gross margin rate that we hadn't planned. In 2021, we'll continue to remodel stores, but we'll rightsize our pace to touch 150 to 200 stores every year going forward. Beyond our remodels, we're continuing to test new design elements, like our latest front-of-store concept. The moment a guest walks in a store, our layout sets the tone for the rest of their trip. So we've redesigned that first impression to be even more welcoming with fresh flower displays, hot coffee and relevant products to create a friendly greeting right from the start. We've also lowered walls and removed counters to make it even easier for our team to connect with our guests and offer help, from registry and returns to pickup and checkout. We're testing this design to learn first, like we always do, before applying them to our remodel efforts going forward. Our store investments will never be done, but the remodel itself is only part of our strategy. In a digital age, we need to give guests a compelling reason to come into a store to shop. For us, it's wrapping store design, compelling product and guest service together to create an experience that you can't get online. And at the heart of that is our team, which is why we invest in them year-after-year. We continue adding millions of paid training hours to help our team build deep retail knowledge and skills. And we're on track to reach a $15 starting wage by the end of this year to keep attracting and retaining the very best talent. But beyond training and pay, we've long seen the potential of engaging our skilled and passionate team to make a difference for our guests and manage the growing volume moving through our stores. To do it, we fully rolled out a new operating model to all stores last summer. This change meant that more than 300,000 people got new roles, new titles and new routines. It was without a doubt the largest organizational change in our company's history. In a world where technology is everywhere, we know our guests are looking for help and human connection while also craving even more ease and convenience in their lives. So we redefined what it means to work on a Target store to better serve an omnichannel guest with expertise and ownership that leads to really great service and tools and tech that knock out the task, so our team can take better care of our guests. And as much as I could try to give you a picture of that philosophy, I think our team can say it much better themselves. [Presentation]
John Mulligan:
Just 6 months in, this new model has shown tangible proof in guest satisfaction. During our busiest time, the Net Promoter Score for our Black Friday experience rose 12 points over last year because our team was staffed and trained to help guests find products and check out quickly. Led by our new Chief Stores Officer, Mark Schindele, a 20-year veteran leader across operations, our teams will always be refining what a truly guest-focused service model looks like. They'll bring even more joy to our guests while streamlining how we keep shelves stocked and backrooms organized. This new operating model is also how we enable our growing suite of fulfillment services. From Drive-Up to Pickup and delivery from Shipt, our stores are serving up a whole range of options to meet guests however they want to shop and as soon as an hour.
Last year, as you know, we made our same-day options available to millions more guests. We took Drive-Up even further, now in 1,750 stores across the country. And this year, we'll turn it on at many small-format stores with parking lots to make shopping even easier for local guests. Remarkably, even as Drive-Up grew more than 500%, sales from our more mature order pickup services rose nearly 50%. And 1/3 of the time, those pickup guests made additional purchases when they came inside. We also continue to grow Shipt same-day delivery offering with 2.5x the sales from the year before. And we integrated the delivery option into our Target.com checkout. Now guests can use their REDcard to get 5% off and pay per order if they don't have an annual membership. Outside of Target, Shipt continues to establish itself as a leader in the delivery space. It's steadily growing its membership and broadening its marketplace of regional and national retailers, which now include Petco and CVS. Shipt's momentum shows the growing consumer demand for fulfillment in minutes, not days. At Target sales fulfilled by our same-day options grew more than 90% last year, far outpacing the demand for shipping and drove the majority of our digital growth. And because all of our same-day services have better economics than 2-day shipping, our average fulfillment cost per unit has come down nearly 25% over the past year. And that's played an important role in our margin performance. The engine behind our same-day operation is no doubt our stores and the more than 300,000 people running them to serve our guests every single day. There's no one else who will run an order out to your car in less than 2 minutes and throw in a Good & Gather sample just to say thanks. And our guests are loving our same-day options because they make an extra Target Run that much easier. Take a look. [Presentation]
John Mulligan:
This convenience is giving our guests new reasons to shop at Target. Last year, nearly 1 in 3 people who placed a same-day order had never before shopped on Target.com. And our existing guests are shopping us more frequently. On average, nearly 1/4 of our Drive-Up sales and all of our same-day delivery sales are incremental, which shows that as we give guests new ways to shop with us, they're actually spending more. Combining our curated assortment and great service with the ease and convenience of getting it in an hour has brought guests to shop us more often. No one else is doing that at scale like we are. And it's building loyalty with our guests that will sustain our growth over the long term.
This year, we'll expand our assortments so our services are even more essential and fit with how guests are shopping at Target. Time and time again, they tell us they love Drive-Up, but it sure would be nice to pull up for their order and a gallon of milk, not to mention adult beverages. Whether it's a 6-pack and chips on the way to a party or a bottle of wine to go with a box of diapers and crying kids in the back seat, our guests want that option. Starting this spring, we'll test a curated assortment of fresh grocery and adult beverage items available through order pickup and drive-up. We'll start in a few states and learn how to do it well before we scale fresh pickup to nearly half of our stores and take adult beverage to the majority of the chain, all by fourth quarter, just in time for holidays with the in-laws. All of this is possible because of the supply chain investments we've made to support our stores, so they're both shopping destinations and fulfillment hubs. That only works when there's a solid replenishment operation behind the scenes, sending stores the right amount of product when they need it and simplifying how it moves from truck to shelf. Using our stores as local hubs continues to be the right strategy for us. You heard Brian say that our stores today are handling about 80% of our online volume. And for Target, that's the sweet spot. As our digital business keeps growing at a rapid pace, our stores still have a very long runway of capacity. I'll reiterate how the productivity of our top stores today demonstrates just how much more our average store can handle. Last year, on average, sales per square foot in our top quartile of stores was more than $100 higher than our chain average. And the math says that for every additional $1 billion fulfilled by our stores, the sales productivity goes up by $4. That's only just over a 1% increase in productivity of an average store. So it makes only a marginal difference for our operation and our teams. It means our stores still have the capacity to manage many, many billions of additional sales with our current footprint. At the same time, with all the growth we've seen and still see ahead of us, we need to invest in our upstream capacity to replenish those stores. So between this year and next, we'll open a handful of new warehouses in their key markets, like New York and Southern California, to serve the growing needs of our stores.
We've long said that, like any business, we'd be making these investments to support our future growth. And importantly, we built that need for excess capacity into our original capital plan. While we're adding capacity to support replenishment, we'll continue to improve the end-to-end supply chain operation. We're using machine learning to predict what product we'll need and where we'll need it. It applies automation to an age-old inventory problem:
having the right product in the right place at the right time. In 2019, we used it to position about 30% of our essentials merchandise. We saw out-of-stocks and our backroom inventory drop by more than 1/3, which is a win for the guests and our operation. We'll keep adding new categories to the system and learn how this improves the guest experience. Strategic positioning is just one of our many efforts to reduce out-of-stocks, which continue to be a major priority.
For the past few years, we've gone deep into the supply chain to make improvements in how we move and position our inventory. And we've made a lot of progress. We'll stay focused on building solutions that improve the guest experience for the long term and, of course, the robots. For several years, we've been talking about the robotic capabilities we're building to support the work of our warehouse team and make our supply chain even faster and more efficient. We spent time testing and learning, and this year, we're ready to start scaling. The robotics solution we've been building in the Minneapolis market over the past few years is designed to sort and organize millions of individual units. It fills boxes with the exact amount of product we need in a store, so we keep the shelf full and the backroom clean. Each box is organized by aisle, so it's literally minutes for our team to unload and restock. Here's how it works. [Presentation]
John Mulligan:
The solution you just saw is about organizing what goes into every box. We've designed it to sync up with the systems we showed you last year from our Perth Amboy facility, which is about organizing those boxes, sorting them by store and then sequencing them on the truck for easy unloading. When those 2 solutions work together, we'll revolutionize how our store teams receive inventory and get the products our guests want on the shelf as quickly as possible. By summer, we'll use the robotics to send presorted units to hundreds of our stores. And we'll take the box sort and sequence operation to another facility where the 2 systems can work together in service of our stores before we expand it further across our network.
This year, all of our supply chain investments:
the systems, robotics and processes that make each individual part of our operation better, will start working together, and our stores will really start to feel the impact. Inventory positioning will be even more precise. Replenishment will be even faster. Our backroom inventory levels will keep declining, and out-of-stocks will continue to improve.
We've spent the last several years building capabilities that would support a strategy to put our stores at the center of how we serve our guests. We said physical was the answer to digital and knew it wouldn't be easy for others to imagine. We'd have to put up the points to prove our case. This year, we showed quarter-after-quarter how our stores are driving growth, profitable growth for our business. We still have a lot of work in front of us, but the foundation is set. From here, we'll use our capabilities to keep building an experience that sets us apart from the pack, and it'll be our stores, powered by our supply chain and brought to life by our team, that sits at the heart of the fastest and easiest Target Run yet.
Michael Fiddelke:
Good morning, everyone. We're grateful that you've taken the time to listen to our remarks today, and I'm looking forward to having many more in-depth discussions with you in the months ahead.
Today, I'm going to share a little bit of my perspective on our business, how we've worked to create a healthy and sustainable model and how we plan to build on that success over time. But you shouldn't expect any big surprises in my remarks today because our long-term financial algorithm remains the same as we first shared with you a year ago. Specifically, we have built a business and financial model that's positioned to generate low single-digit growth in comparable sales, mid-single-digit growth in operating income, high single-digit growth in earnings per share and continued expansion of Target's after-tax return on invested capital.
But before I get to the model, I want to share a little bit about my experience here at Target and how it's informed my perspective on our business. As Brian mentioned earlier, I began my career in finance, and that's always been my passion. However, I've also been able to benefit from several experiences outside of finance, which helped me to gain a deeper understanding of our business and operations. Now that I'm back leading the finance team, I plan to leverage those insights in support of the organization as we help our business partners solve problems and evaluate trade-offs. And we face potential trade-offs all the time:
focusing on our quarterly numbers or investing in the future, focusing on profit rates or profit dollars, minimizing the cost of a single transaction or maximizing the lifetime value of a guest relationship, investing in promotions or in everyday prices or managing the cost of labor on the P&L versus making deliberate investments in the team, the company's most important asset.
Analysis of all these questions involves in some way the question of whether to focus on the short term or the long term. And if every choice was completely binary, we would naturally choose the option on the right-hand column. But that perspective is too narrow. We should always ask if we can replace the word or with the word and. If we can do that successfully, we will generate superior performance today and over time. Put another way, we should always focus first on the long term but deliver it through strong execution 1 quarter at a time. When I think about the long-term trajectory of our business, the one thing that's clear is the need to focus first on strong top line growth. When a retailer is growing, there are so many more levers to pull, more ways to build a model from the top line to the bottom line that makes long-term financial sense. The benefits of growth go well beyond the straightforward reasons like fixed cost leverage. Growth makes Target a more attractive partner for our vendors, which helps us control costs and attract new partners. Growth makes us a more desirable member of a retail development, which opens up more potential sites for our small-format stores. And most importantly, growth is confirmation that we're deepening our relationship with guests, keeping Target top of mind when they decide where to shop.
So for instance, when I think about the potential trade-off between profit rates and top line growth, I'm very mindful of the risk that occurs when companies focus only on expanding rates. Now obviously, if we can generate healthy growth in traffic and sales while some rate expansion comes along for the ride, that's an ideal outcome. It's what happened in 2019, and it explains the outstanding year our business just delivered. But as we plan for the future, we have to be careful not to take our primary focus away from relevance and growth. We've all seen it:
companies who focus too much on rates and then realize only too late that growth is slowing, traffic is stagnating, and customer loyalty is beginning to evaporate. The message from that experience is clear
I think it's worthwhile to pause and take an example from our own history and look back at our journey in digital. 10 years ago, Brian hadn't yet joined our team, but John and I know firsthand we were very hesitant to invest in digital. Like today, we were fortunate to have great stores and a great team. And like today, we had millions of loyal guests who loves Target. We thought that was enough, but it wasn't. Even though our guests still loved us, they began shopping at Target a little less often and elsewhere a little more because we stopped winning on convenience. It happened slowly, but we lost a trip here, another trip there, and growth became harder and harder to generate. The good news is we realized the need for change before it was too late. Beginning 5 or 6 years ago, we committed to being a leader in digital and began investing. It took patience and dollars. And we took the time to develop a strategy that makes sense for Target given our assets, our assortment and our brand. And now as you've seen over the last several years, with the right strategy and renewed growth, we've built a business model that's delivering strong top line and bottom line performance. Once we committed to investing in digital, new fulfillment possibilities emerged, and we proved something that wasn't obvious 5 years ago. It turns out that digital isn't just about delivering cardboard boxes to your house. It's really about ease, convenience and reliability. Sometimes that can mean a box on your front porch, but more and more guests are telling us that our same-day services are the new model of convenience. Brian covered the statistics on repeat usage earlier. Our same-day guests are making a choice. After all, they're intimately familiar with how to order a box for delivery. And we're still happy to provide that service when it's preferred. But in many cases, our same-day services are faster and more convenient, and that's what guests are choosing.
Whenever we roll out new products and services, we typically see 2 distinct changes in guest behavior. The first is a change in the way they shop as they embrace the new product or service, but importantly, we also see an increase in their overall level of engagement. So for instance, when guests find out about our same-day services, we see a meaningful change in the mix of their shopping as they begin choosing same-day services as a replacement for other options. However, as John mentioned earlier, that's only part of the story. We also see incremental growth in spending from guests who begin using our same-day services, which benefits all categories and channels. Take, for instance, the change in behavior among guests who use Drive-Up for the first time. Following that first Drive-Up trip, we see their overall spending go up by nearly 25%. This increase is the result of higher digital spending, which grows by nearly 50% as guests begin using Drive-Up and also spend more on order pickup, ship-to-home and Shipt. However, this increased digital engagement doesn't come at the expense of store sales, which also increased by 9%. The causation is clear:
this new service drives engagement, which in turn leads to higher sales in all channels.
I've witnessed the impact of Drive-Up on my own family's behavior. With 3 kids between the ages of 6 and 13, my wife and I sometimes feel like Uber drivers as we shuttle our kids between different sports and activities. So Drive-Up is the perfect solution. When we realize we need something like post-game snacks or a replacement water bottle, we don't need to wait. We place the Drive-Up order and it's ready in less than an hour. The next time we're passing the store, and I can assure you that happens multiple times on a typical Saturday, we drive up, and the order is in our car in less than 2 minutes. Because the service is so fast and convenient, it allows us to make an additional last-minute trip that wouldn't be possible in any other way. This is the essence of our digital journey. By designing solutions focused on our guests and investing in capabilities that make sense for our business, we reestablished Target's credibility in delivering convenience, which drove growth across our business. With that growth, our team was able to develop capabilities and a business model that also makes financial sense. So as we think ahead and evaluate our long-term financial algorithm, which we first articulated a year ago, it starts with our focus on growing the top line. To do that, we'll continue to invest in our store experience, digital fulfillment, supply chain, our brands and our team to ensure we stay relevant with our guests. In a typical economic environment, we believe these investments will enable Target to generate low single-digit growth in our comparable sales, with additional growth coming from our new stores. And here, I want to pause and address a question that we hear a lot, which pertains to whether we can isolate the impact of each of the drivers of our growth. And the honest answer is we can't. All of the initiatives that we are pursuing right now are working together to drive our growth. And these investments build momentum over time.
Beauty is a great example, where our continued investments are driving an acceleration in performance. As we rolled out new brands, invested in our presentation and staffed the area with specialized team members who have passion and expertise, the category's performance has gone from strong to even stronger. Specifically, comp growth in beauty accelerated from 1.7% in 2017 to 7.1% in 2019, outcomping the company by approximately 1.5 percentage points over that 3-year period. This demonstrates something Brian says all the time:
we should never confuse performance with potential. Year-after-year, investments in beauty are driving sustainable, profitable growth in our business.
When we move down the P&L to consider our long-term operating margin rate, we think it's optimal to plan for only a small amount of leverage over time driven by the D&A line. Otherwise, we are planning for generally small and offsetting changes in our gross margin and SG&A expense rates. This expectation is first informed by our bottom-up analysis of the drivers of both our gross margin and SG&A expense rates and an expectation that we can generally balance the headwinds and tailwinds over time. On the gross margin line, we expect to continue to benefit from the ongoing efforts of our merchant teams to optimize performance within categories, including assortment, cost, pricing and promotions. These efforts were a meaningful driver of favorability in 2019, and we expect they will continue to contribute to our gross margins in 2020 and beyond. A second and important factor in our gross margin performance is the mix of our sales. In 2019, with unusually strong growth in our apparel category, sales mix was a meaningful driver of our overall gross margin rate. As we look ahead, we believe it's prudent to plan for our margin mix to be neutral to slightly favorable, with periodic opportunities for outperformance like we saw in 2019.
And finally, growth in digital fulfillment will continue to put cost pressure on our gross margins. The reason for this expectation is simple:
digital fulfillment involves incremental costs compared with the traditional store transaction. While our same-day services are much less costly than traditional digital fulfillment and we continue to increase efficiency within each of those fulfillment modes, we expect those benefits will serve as mitigating factors rather than driving an overall rate benefit.
The analysis of the SG&A line is similar, but the drivers are different. And while there are hundreds of separate expense lines that can affect SG&A in a given quarter or year, there are 2 factors that will be most important over time. The first is the cost of labor, including both pay and benefits. We expect that growth in these expenses will continue to be a headwind in the years ahead for a couple of important reasons. First, we continue to make strategic investments in team member hours, wages and benefits to position Target as a leading employer of choice, allowing us to hire and retain a high-quality team. The second is overall wage inflation in the U.S. driven by labor market conditions which remain very tight when compared to historical averages. To help offset this cost pressure, we expect to continue to deliver productivity improvements like you've been seeing in recent years. These productivity gains will happen in our stores where we continue to benefit from a variety of efforts to eliminate non-guest-facing work, combined with the benefits of the operating model John highlighted earlier. A portion of those store savings will be driven by our supply chain efforts as we transform our store replenishment model and roll out automation, which will help us control hours while we take on many of the activities that used to be completed in store backrooms. But importantly, beyond these specific drivers of efficiency in our stores, we will continue to work to prioritize all of our activities across the company, concentrating our efforts on core initiatives that are most important to our business. This focus on disciplined prioritization will play an important role in controlling costs in the years ahead. So when we put it all together and consider the factors likely to affect gross margin and SG&A rates over time, we expect the pluses and minuses to remain essentially balanced with very little net impact to our operating margin rates. As a result, based on a small amount of expected leverage on the D&A line, our plan envisions a similar amount of annual leverage in our operating margin rate as well. This rate performance will allow us to deliver mid-single-digit annual increases in operating margin dollars on a low single-digit increase in comparable sales. But let me be clear. We will continually monitor our performance to ensure we are optimizing our business for the long term. If, like in 2019, rates can expand while traffic, sales and market share are all growing, we will be happy to deliver another year above expectations. And if, on the other hand, down the road, we see an opportunity to grow long-term profit dollars faster by allowing rates to go lower, we can certainly take a hard look at that opportunity. But that's not what we expect to happen. Based on what we know today, we believe that small increases in our operating margin rates based on leverage on the D&A line will continue to be optimal for Target over time. Moving on to capital deployment. Our priorities remain the same as they have been for more than 20 years. We focus first on investing in our business, then we look to support our dividend and build on our 48-year record of consecutive annual increases. And finally, we look to deploy any excess cash beyond those first 2 uses to share repurchase within the constraints of our middle A credit ratings. Turning first to capital spending. Our long-term expectations have not changed. However, based on our revised outlook for the timing of certain expenditures, we have an updated view of the cadence by year. Specifically, in 2019, our CapEx was lower than expectations at about $3 billion compared with our original plan of $3.5 billion. This performance was driven by unexpected project savings combined with the benefit of timing changes in certain expenditures. In 2020, we continue to expect CapEx of approximately $3.5 billion as we maintain our recent pace of about 300 remodels for 1 more year. And in 2021, CapEx is expected to move down somewhat into the $3 billion to $3.5 billion range, which is a little higher than our prior expectation. Beyond 2021, we expect our annual CapEx will settle down to a level of approximately $3 billion or perhaps a little less based on our bottom-up plans for investments in stores, supply chain and technology. Regarding dividends. For some time, we've had a longer-term goal to maintain a dividend payout ratio of around 40%. However, if you've been following us over the last decade, you've seen that ratio peak at more than 50%. The reason for that peak was simple. During that period, we encountered some temporary headwinds to our financial performance, and we chose to continue to build on our record of annual increases. Today, following renewed growth in our profitability over the last couple of years, our dividend payout ratio has moved back down toward 40%. And given that we are now operating near our goal payout ratio, we expect to begin growing the annual per share dividend at a somewhat faster rate in the years ahead. Regarding share repurchases, you've seen our pace change a lot over the last 5 to 10 years based on variations on our cash flow and level of Capex. As we look ahead, our plan anticipates additional capacity for share repurchases compared with the last few years, beginning this year. This ability to reduce share count will allow us to deliver high single-digit growth in earnings per share on a mid-single-digit increase in operating income. I want to stress that we'll continue to govern the pace of our share repurchases in support of our goal to maintain our middle A credit ratings. Those ratings ensure we have the financial flexibility to invest when there are opportunities in our business even in challenging times. And finally, before I get to our 2020 guidance, I want to consider the implications of our long-term algorithm for our return on invested capital. I can tell you that ROIC has long been an important metric at Target because it reflects both our operational performance and the effectiveness of our investment decisions. Because of this long-term focus on ROIC, our business is already generating very healthy performance at 16% on an after-tax basis. That's a high bar to clear. But if we deliver performance in line with our long-term algorithm, we will continue to build on that ROIC performance over time as we grow Target's operating income on a relatively stable base of invested capital. So now before I turn it back over to Brian, I want to briefly cover our guidance for the first quarter and full year 2020. But first, I want to address the question of whether we've accounted for any known or anticipated impact related to the coronavirus. And the answer is that, as of today, we haven't seen a large impact on our business or outlook. Of course, we are monitoring our import programs down to the purchase order, and we've already made some slight adjustments to our plans to ensure we are well positioned throughout the year. But because of our size and the flexibility that comes from our multi-category portfolio, we haven't seen anything so far that would cause our financial expectations for 2020 to deviate from our longer-term algorithm. Regarding recent sales trends, we experienced solid results across the month of February, which support our expectations for the first quarter. As you'll recall, when we announced our holiday performance, we came out of the holidays with very low levels of clearance inventory, which held back our January comps due to a lower-than-average level of clearance sales. However, that same lack of clearance sales played a key role in our fourth quarter profit performance, which was strong despite the shortfall in sales. Since then, we have seen the strengthening of sales trends we expected to see broadly across categories and across multiple weeks of the month of February. So back to the question of what's reflected in our outlook. The answer is that we've included everything that we know about today. Obviously, in every quarter, there is some uncertainty about trends going forward, and that's only exaggerated by the fluid situation regarding the coronavirus. So to reiterate, we've built in everything we know today, but we haven't incorporated a placeholder for anything we haven't yet seen. So with that as context, I'll provide our current guidance, starting first with the full year. We are planning for a low single-digit increase in comparable sales. Total revenue is expected to grow nearly a full percentage point faster driven primarily by the contribution from non-mature stores. We expect our gross margin rate will be essentially flat for the year, in line with our longer-term algorithm. We expect a moderate increase in our SG&A expense rate based on our bottom-up forecast across all of the items within SG&A. This increase is being driven by anticipated labor cost increases, reflecting investments in store service and training combined with the continued growth in average wages across the country. On the D&A line, we expect to see a small amount of favorability for the year, consistent with our longer-term algorithm. Altogether, we expect our operating margin rate will be flat to up slightly in 2020, resulting in a mid-single-digit increase in operating income dollars. And for both adjusted EPS and GAAP EPS from continuing operations, we expect performance in the $6.70 to $7 range. Performance at the midpoint of this range would result in high single-digit EPS growth on top of mid- to high teens growth in 2019. For the first quarter, our expectations look very much like our view of the full year. We expect to generate a low single-digit increase in comparable sales. Total revenue should grow more than 0.5 percentage point faster driven by the expected contribution from nonmature stores. We expect a moderate increase in our first quarter gross margin rate driven by favorability in clearance markdowns compared with last year. We expect this gross margin favorability will be offset by an increase in our first quarter SG&A expense rate. This expected increase will be driven by continued growth in labor costs along with pressure from remodel expenses driven by the timing of projects compared with a year ago. On the D&A line, we expect to see a small amount of rate favorability, similar to our view of the year. Altogether, we expect a small increase in our operating margin rate for the first quarter, resulting in a mid-single-digit increase in operating income dollars. And for both adjusted EPS and GAAP EPS from continuing operations, we expect performance in the $1.55 to $1.75 range. The midpoint of this range would result in high single-digit growth on top of last year's first quarter when our business delivered record-high EPS performance. After working at Target for nearly 16 years, I have developed a strong appreciation for our culture and our people. And one thing our entire team has in common is a lot of pride in working at Target. We're proud of our brand, proud of what we do and proud of the positive role we play in our guests' lives. I've seen it throughout my career, during both the good times and the challenging ones. That's why it's been so amazing to have played a part in the turnaround of our business over the last few years. Because we care so deeply about this company, we all work hard to ensure that Target stays healthy and continues to thrive well beyond each of our individual careers. Today, we're growing again. And all of our stakeholders are sharing in the benefit from our guests to our team, from communities to vendors and, of course, our shareholders. It's our job to build on this success and ensure Target generates sustainable, profitable growth both this year and for many years to come. And we're confident we have the right plan in place to do just that. So now I want to thank you for your time today, and I'll turn it back over to Brian for some final remarks. Brian?
Brian Cornell:
Thank you, Michael. By now, I hope you have a sound understanding of the strategic choices we're making. I hope you have a keen sense of our disciplined investment agenda, and I hope we've made clear all the ways our durable financial model and industry-leading capabilities position Target to capture more market share, deliver more profitable growth and earn more love and loyalty from the tens of millions of guests who we've asked to expect more from our brand.
But before we turn to Q&A, I want to underscore what I think is the most important point:
Target is different. We've always been different. That's what our guests love about our brand. We're not like everyone else. We are Target. And it was that simple fact that inspired us 3 years ago when the fate of the industry was far from certain. We asked our guests what more could we do, what mattered most in their lives. And then we took what they told us and we reimagined our company with them, putting them first in every decision we made. That meant leaning into our purpose, pursuing our own path, writing our own playbook, betting on our brands, our team and the millions and millions of guests who shop Target every day. 3 years later, it's clear. That was the best bet we could have ever made because today, our guests are choosing Target more than ever before. They're depending on us to bring a little bit of joy every time they shop.
And look, I know you read the headlines and keep close tabs on our competition. Because our strategy is working, others are taking note and applying some of our pages to their own playbooks. But for us, the whole is greater than the sum of the parts. It's our stores and our digital channels plus our approach to high-touch service; our expertly curated assortment plus our scale plus our balanced multi-category portfolio; it's Drive-Up plus Pickup plus Shipt; it's ease plus convenience plus inspiration; it's families plus joy that make us who we are, that make us Target. We are a category of one, a competitive position we intend to keep for a long, long, long time to come. And with that, we're going to take a 10-minute break to allow some of you to dial into a conference line for the Q&A portion of this meeting. John Hulbert will provide more detail shortly. But before we transition, I know you have questions about the coronavirus and the potential impact we see to our business and our team. Michael has already addressed how we're considering this situation in light of our guidance. Like all of you, we're monitoring the situation hour-by-hour as conditions evolve. At Target, we've been prioritizing our team, starting by ensuring that all of our China-based team members have been able to work from home. More broadly, we spent considerable time focused on the best way to support our team members all around the world to make sure they stay healthy and safe. On the business front, we've been continuously planning for weeks with our vendors and team members, both here in the States and overseas. As you know, we have a highly sophisticated sourcing and supply chain organization. And like Michael said, we're tracking this by category and by factory, even at the PO level, to ensure we're on top of it and able to plan accordingly. We feel confident in our plans to manage through this situation. And most importantly, I want to thank our team members around the world for all they're doing to take care of our guests. So now I'll turn it over to John Hulbert who will cover a few logistical details before we take a 10-minute break. John?
John Hulbert:
Before we break, I wanted to pause and make sure everyone understands what's going to happen. And the good news is that most of you can simply stay on this webcast, and you'll hear the Q&A session beginning in about 10 minutes. However, if you received a conference call invitation and you want to ask a question during Q&A, you will need to leave this webcast and dial into the number for the conference line, which was sent with your invitation. But again, even if you received the invite but don't intend to submit a question, you want to stay on this webcast to listen in.
With that, we can begin a 10-minute break. Thanks. [Break]
Operator:
[Audio Gap]
gentlemen, thank you for standing by. Welcome to the Target Corporation 2020 Financial Community Meeting Q&A Session Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Tuesday, March 3, 2020. We are ready for our first question from Christopher Horvers with JPMorgan.
Christopher Horvers:
So I have 2 questions. First, a bit of a retrospective on the fourth quarter. How much do you think there were some industry factors that went on there, like in electronics and toys, versus the 6 fewer days and versus what maybe you left on the table in non-gaming electronics and home? And then related to that, as you get into the fourth quarter next year, I know it's far out, but you do have 2 extra days. You have a new PlayStation and Xbox launching. So are you more optimistic on the potential top line outlook for the fourth quarter next year? And then of course, related to that, there's probably a gross margin headwind there given the mix probably turns upside down relative to what you saw this year.
Brian Cornell:
Thanks for joining us. And I want to thank everyone for being so flexible today. We look forward to seeing you in person throughout the year, and certainly, we look forward to gathering again in person next year.
Chris, as I think about Q4, and we've talked about some of the implications, obviously, we felt really good about our performance in many categories, very strong growth in apparel, strength in beauty, in household essentials and also in food and beverage, which was offset by softness in toys where we ran a flat comp but actually grew share in a category that was facing some pressure overall, and we were disappointed with our performance in electronics. That being the case, we're feeling very confident that we're already putting plans in place for the fourth quarter of this year. We'll learn from last year. We'll make sure that we enhance our inventory position on key items. As we've said many times, we exited the fourth quarter of this year and went into January with very little clearance inventory. We're going to make sure that we rebalance inventories as we go into next year. We're excited about some of the newness in electronics, some changes we'll make in our home cadence. But overall, we're already working on our plans for the fourth quarter of 2020 and feel very confident that we'll certainly learn from this year and build some exciting plans for our guests as we think about the holiday season of 2020.
Christopher Horvers:
Got it. And then from a long-term perspective, the third-party assortment that you have online, you called out 250,000 SKUs. Is that inclusive of your SKUs online? Or is that incremental? How large do you see this potentially going? And then on the fulfillment front, is this a drop-ship arrangement from the vendor? Or are you stocking these items now? And just really big picture, how do you think about that opportunity over the long term?
Brian Cornell:
Chris, we're going to continue to carefully curate our Target Plus assortment. I'll continue to emphasize the fact that it's an invitation-only. We're carefully working with vendors that we think meet our criteria. We will expand that selectively over time, and that is an arrangement where those vendors ship directly to our guests. So we're very pleased with the early reaction. We'll carefully build curation and assortment over time, but the reaction has been very positive.
Operator:
Our next question comes from Mike Baker with Nomura.
Michael Baker:
In terms of the comps throughout the year, should we expect any variation by quarter? It sounds like February is off to a good start. You have a tougher comparison in the first quarter on a 1-year basis, but it's not as tough when you look at it on a 2-year basis. Just anything we should think about in terms of the pace throughout the year?
Brian Cornell:
Yes. As Michael discussed during the prepared comments, we expect a very consistent level of performance throughout the year, low single-digit comps, mid-single-digit operating income expansion, high single-digit EPS. There'll be some fluctuation month-to-month, but you should expect a very consistent performance over the balance of the year. We felt very good about the start of our business in February, and we expect to deliver very consistent results throughout 2020.
Michael Baker:
Fair enough. And one follow-up if I could, and if you said this and if I missed it, I apologize, but I don't think I did. How do you expect your digital sales to grow in 2020? As you said, it's 6 straight years of 20% or even 25% or higher. What should we think about for 2020?
Brian Cornell:
Yes. I think we should see a very consistent pattern with digital as we continue to invest in our same-day fulfillment options and the guest continues to gravitate in that space. So we've got a very consistent track record over the last 6 years. I think you're going to continue to see that perform quite well as we go into 2020 and beyond.
Operator:
Our next question comes from Oliver Chen with Cowen and Company.
Oliver Chen:
Brian, Drive-Up has been a really positive and amazing process and momentum there. What are your thoughts on how that will evolve in terms of automation in-store? And what will happen as this continues to ramp up and engage the customer there? I would also love your thoughts on managing promotions and your thoughts on what you can do with promotions as well as in-store automation and what will happen over time as you look to AI and robotics as well.
Brian Cornell:
Sure. Oliver, thanks for joining us. Why don't I let John talk about some of the changes and enhancements we'll make to Drive-Up? And I'll let Michael talk about some of the changes that we have on the promotional front.
John Mulligan:
Sure. On Drive-Up, I think the big changes you're going to see this year, we talked about, we want to add fresh or temperature-controlled products. That is -- it is the #1 request from our guests, to add a little bit a selective portion of our assortment there so that they can round out their Drive-Up trip. You'll also see us add adult beverage. That is also a request directly from our guests as we continue to get feedback on that.
I would say directly on the automation, our -- we may be going in a little bit different direction than some others. I think -- we think the store experience is based on interactions with our team member. And we think the differentiation, much like we see with Shipt, is the opportunity to provide that human connection between our team and the guest. From our perspective, the value of the automation today is upstream. And so we look to take work out of the store, consolidate it upstream and then working with our distribution teams to automate some of that to make it more efficient. And the goal there is to free our teams up in-store to interact with our guests and, again, provide that human connection and that includes as it relates to Drive-Up. And so that's the direction we've gone, as you know, for many years, and we'll continue to work against that.
Michael Fiddelke:
Yes. Thanks, Oliver. On the promotion front, I think you'll see us continue to make sure we've got that right balance of great promotion and strong everyday price. And there are certain times of the year where we lean in more into promotion appropriately. But I think you'll see us consistent in trying to balance both of those, promotion and everyday price, in the right way.
I also might add, that's why I get excited about a program like Circle. That gives us a great foundation to even personalize greater -- to a greater degree of fidelity the right promotion to the right guest. And so the launch of Circle in October gives us another arrow in our quiver when it comes to getting the right promotions in front of guests.
Oliver Chen:
Okay. Our last question is on next-day. It's a question we're receiving. What are your thoughts on how that will continue to be important and how you'll competitively position your fulfillment with [ these ] in mind?
Brian Cornell:
Yes. I mean, Oliver, we've been really clear, as we talk to our guests and as we think about our strategy going forward, we'll continue to focus on same-day. And we really think that's the point of difference for Target. Whether it's order online, pick up in-store, Drive-Up or having a Shipt shopper come to your own within hours, we really think that's the most important area for us to focus on. And you'll continue to see us lean into our same-day fulfillment options in 2020 and beyond.
Oliver Chen:
Congrats, best regards.
Brian Cornell:
Oliver, thank you.
Operator:
The next question comes from Kate McShane with Goldman Sachs.
Katharine McShane:
John Mulligan, in your comments, you had said that this was the first year, I guess, 2020, where the supply chain investments were all going to come together. And I just wondered, in the gross margin guidance that you gave that was very helpful, how should we expect that supply chain investment to drive potentially better gross margin results longer term?
John Mulligan:
Yes. I think, first, I'd say there is a sequencing thing here, right? We continue to see IPC scale, our inventory planning and control, the -- where we put the inventory. As we said, we'll scale automation, the -- [ each is ] automation to about 1/4 of the stores this year. And then late this year, we'll bring -- start to bring the Perth Amboy automation together with that to get the totality of what we've been building over several years together. Our focus, like I said, has been to consolidate that work, pull it out of the stores and then use automation to improve how we do it upstream.
So I think the biggest impact you'll see, from a gross margin perspective, relates more to continuing to reduce out-of-stocks to get our -- one, improve the guest experience; but two, capture those sales and improve gross margin dollars. So I think that's by far the largest improvement. The other place where we continue to have opportunity is exactly what Brian just said. As we continue to grow same-day fulfillment, that has a positive impact or it lessens the negative impact, if you will, of continuing to grow our digital business.
Brian Cornell:
So Kate, I'd just reinforce a couple of points that John has made. As we think about the benefits of upstream automation, we'll continue to focus on improving our in-stock positions, the quality of our in-store presentation, continue to invest in that high-touch service and continue to support our same-day fulfillment option. So you'll continue to hear us repeat that again and again as we think about 2020 and beyond. But we think we've got opportunities to improve our in-stock position, improve the quality of our presentation each and every day, continue to make sure that we use our team members and that human touch as a point of differentiation and continue to invest in our same-day fulfillment options.
Katharine McShane:
And if I could just ask one follow-up question, you have made mention that you're getting some national brand wins in some of your categories. Is that something that we can expect across the whole store in 2020 over the longer term?
Brian Cornell:
Well, Kate, obviously, as we continue to invest in growth both in-store and online, we're seeing a number of new vendors knocking on our door. Certainly, we've seen that in categories like apparel with Levi's and what we've done in the space with Disney, but we're also seeing new brands knocking on our door in categories like beauty. We were really excited this week to announce the new partnership with Boar's Head in food and beverage. So I would expect that's going to continue to happen over time. And we'll carefully select those new partners that fit our brand standards and are right for our guests.
Operator:
Our next question is from Michael Lasser with UBS.
Michael Lasser:
The first question is on the coronavirus. Are you seeing any indications today from your vendor partners that you're going to have supply disruptions in the coming months? And are you altering any decisions or doing any contingency planning for an extended consumer disruption? For example, might you be even delaying share repurchases because it could impact your stock price in the coming weeks and months?
Brian Cornell:
Michael, like others, we've been carefully monitoring the situation and the impact on our business, our team and our guests. We've been working closely with our overseas vendor partners, both our own brand partners and our national brand partners, to understand the state of play. We've set up a team over the last month that's literally meeting daily to monitor POs, to understand the state of production in China, to understand the rate of workers returning to work, understanding the state of the ports. So we've been looking at this from all possible dimensions.
And certainly, from a merchandising standpoint, we know that we're going to see some periodic delays. We're out in front of that, making changes in our assortment and our promotional and presentation plans. But all that's reflected right now in our view of guidance for certainly the first quarter and the balance of the year. We've also been working very closely with some of our domestic vendors, our DSD partners, as we see some growing demand in categories like household essentials and food and beverage to make sure we are supporting that with the right level of inventory. So it's an ongoing process, and it's very dynamic. But I feel really good about the work our teams have done, the focus that our sourcing groups, our supply chain, our merchants have brought to this discussion. And our focus is going to be to continue to meet the needs of our guests during these challenging times that we're all facing.
Michael Lasser:
That's very helpful. And my follow-up question is on the gross margin. Can you give us a little bit more detail on how the gross margin by line item performed in the fourth quarter and mostly from the merchandising strategies and digital fulfillment piece? Because on -- and then as part of that, on the digital fulfillment piece, that had become less dilutive to the gross margin. Seems like based on the commentary, the headwind from that is going to pick up. Have you just reached an inflection point where you're doing as much as -- a lot of digital fulfillment through your stores, and as you do more, you don't see as much of a marginal benefit from that as you move forward?
Michael Fiddelke:
So I'll start with some of the Q4 margin piece of that, Michael. The 2 things I would call out in Q4 that really helped us on the margin side, we are really proud of the profit performance we were able to deliver in Q4. And it came in part from some of the categories where we really saw strength. Apparel grew strong and gained share, and that's always beneficial to the gross margin side, both the gross margin naturally in that business, and then we ended the season really clean. And that saves us clearance markdowns on the back end. The second callout is actually the second part of your question. The same-day service growth is healthy for our profit. Compared to shipping a box long distances, those same-day services are way closer to the economics of an in-store sale. And that's helpful on the bottom line, too.
Operator:
The next question is from Joe Feldman with Telsey Advisory Group.
Joseph Feldman:
I wanted to ask, can you share a little more color on -- like you talked about the electronics category, redesigning it. Like, what are you guys envisioning there for that department and if you've maybe tested it anywhere and if there's a significant cost to do that?
Brian Cornell:
Yes. Joe, we're still in the early stages of testing some new redesigns. You should expect that to appear in about 200 locations this year, start to envision TVs at a much lower level as you would actually see them in your home, an emphasis on more interaction with our team members to provide insights into how to bring these products home and install them in your home, certainly elevating some of the focus on the key brands in that space. And we know that brands are really important in that space, so the focus we'll place behind brands like Apple and Samsung. So really trying to make sure it's a more inviting environment where we can have better interaction with our guests, where our teams can provide the professional services that our guests are looking for in that space.
So we'll continue to test and learn and iterate as we've always done with changes in-store. But we really want to make sure that we bring the guests a much more inspiring environment within electronics where our team members can provide the expertise that they need each and every day.
Michael Fiddelke:
And the only thing I'd add, Joe, on the cost side, if you think about doing this in the context of a store remodel where we tear up a fair bit of the store through the course of that remodel, the marginal capital here is relatively modest and certainly far better than doing it on its own and going into the store and just doing this part of the store. So as Brian said, we'll bring it into the remodel program. The early testing certainly shows that there is a payback to doing so. And so we feel good about that. And as Brian said, we'll get into a few more stores and a couple of hundred stores and really have a good idea of what it brings.
Joseph Feldman:
If I could follow up with the own brands, private brands, you guys have obviously done a great job, brought in some or developed so many new ones. How should we think about it going forward? Like will you continue to bring newness and replace some of the brands that you've even launched maybe 2, 3 years ago? Or will they be all additive? Or how are you envisioning that for the next couple of years?
Brian Cornell:
Joe, I think you're going to see us spend a lot more time on brand management. And I'll use Cat & Jack as an example. Cat & Jack's been part of our collection for 4 years now. It's now a multibillion-dollar brand. But our teams will need to continue to bring newness, make sure that, that brand is on trend, make sure that we continue to bring a refreshed assortment to our guests each and every quarter and understand when we need to make changes and pivot some of these brands to make sure that we constantly stay on trend. So over the course of time, some of the brands we have introduced, they might go away and be replaced by some new brands. But I think more and more, we're going to be making sure we're managing the life cycle of those brands, bringing newness, bringing great insights, refreshing the collection, making sure the aesthetic is on trend for what our guest is looking for and continue to strengthen and invest in the brands that we have in place today.
So Cat & Jack is just one of many of examples of where we know we've got additional opportunities to build even stronger relationship with our guests and make sure those brands are even more relevant in years to come.
Operator:
Our next question comes from Peter Benedict with Baird.
Peter Benedict:
First one, just on the mix of digital fulfillment, I think for last year, it was -- 24% or so was the same-day stuff. Can you give us a flavor for how -- or a sense for how the remaining 76% breaks down between just the traditional kind of fulfillment center going to someone's home and then how much of that is kind of the stores delivering to the home but not obviously on a same-day basis? That's my first question.
John Mulligan:
Sure. Like we've said, Peter, the aggregate for Q4 and where we're running right now is about 80% of the fulfillment we do is done by the stores. If you take away the same-day portion, all of the rest of that is shipped from store. The remainder of that is our FCs, which is probably, depending on the day, in the 12% to 15% range, and then direct vendor ship is very, very small. I mean we prefer that because the service there isn't typically at our standards. But I think overall, you'll continue to see us operate in that 80% range. And as the same-day fulfillment grows, the ship from store will come down a little bit or not grow as fast really. It will continue to grow, just not grow as fast. But the stores overall, continuing that. We think that 80% range is right where we want to be.
Peter Benedict:
That's great. And then just on the inventory position, how you're feeling about it heading into the spring here. I mean obviously, it sounds like February off to a good start here, but curious about kind of the early indications around seasonal demand, whether it be in the southern markets or whatnot. How is that setting in and where you are from an inventory perspective?
And then as we think just down the road to back-to-school, are you rethinking any of the sourcing for back-to-school product? I'm not sure how much of that would be even coming out of China. But just how are you thinking about kind of your back-to-school plans here in terms of getting the product here?
Brian Cornell:
Yes. Peter, we'll start with the first big season of the year, and that was Valentine's Day in February where we saw a very strong performance and a great reaction from the guests. We expect that to continue as we go into Easter. And obviously, we're very focused on back-to-school, back-to-college, which is a very important season and life moment for Target. And I think we feel very good about our sourcing plans and our position as we get ready for that holiday season.
So off to a good start. We see a very good reaction to our assortment and our plans for Valentine's Day. We're now focused on the Easter holiday. And I think our teams have put together really strong plans for back-to-school and back-to-college this year, and we feel good about how we're positioned going into those seasons.
Operator:
Our next question is from Karen Short with Barclays.
Karen Short:
A couple of questions for you. First of all, just on the quarter-to-date sales, I guess, I'm wondering, I think your comments on coronavirus were much more limited to the supply chain as opposed to top line. But any color you could give in terms of whether there had been some positive benefit from kind of stockpiling, I guess, in the quarter-to-date trends?
Brian Cornell:
Yes. I'll start, and I'll let John and Michael jump in. But over the last few days as obviously everyone's been reporting, we've certainly seen a U.S. consumer that's starting to stock up on household essentials, disinfectants, food and beverage items. All those staple items that the CDC has recommended, they add to their pantry. And certainly, we've seen aggressive shopping across the country in our stores. So we're obviously working closely with our domestic vendors, with our DSD partners to make sure that we're elevating inventory in preparation for what we think is going to be a continued demand for stock-up items.
So certainly, we're seeing that across our network. We expect that to continue over the next few weeks, and we'll watch it carefully over time.
Karen Short:
Okay. And then just on inventory and, I guess, working capital in general, obviously, we -- it was advertised that you would have inventories down in 3Q given the year-over-year comparison. But I guess I'm wondering if you have any thoughts or color on whether you overly managed inventory in terms of losing out on some sales in the season and then thoughts on working capital and inventory specifically into next year as it relates to out-of-stock.
Brian Cornell:
Why don't I start, and then I'll let Michael continue? And I think as we look at the fourth quarter, we clearly recognize that we exited the fourth quarter at a level of inventory that was actually too clean and certainly lost some sales as a by-product of that. There were many key items where we didn't buy deep enough. We ran out before the holiday season. We had very little clearance inventory in January. And while that was a benefit to our gross margin during the period, we certainly lost some sales because of that. And our teams are actively engaged in making sure that we learn from that as we plan for the holiday of 2020.
Michael Fiddelke:
Yes. I would just add, that's the age-old balancing act of retail. And so 2 years ago, we were much heavier than we wanted to be during and coming out of the season. This year, a little light. Next year, I feel good that we've got the plans to split the middle.
Karen Short:
Okay. And just one final question is on dividend growth. How should we think about that then in terms of the growth rate going forward?
Michael Fiddelke:
Yes, sure. As I shared in my remarks, we've kind of been tracking toward a dividend payout ratio of 40%. As we get to that mark, you could expect us to increase dividends at a more aggressive pace going forward. Something in the mid-single-digit range for this year in total is probably about right. In the long run, holding that ratio would imply dividends per share growing at a similar rate as earnings per share.
Operator:
Our next question is from Robbie Ohmes with BofA Global Research.
Robert Ohmes:
Actually a follow-up on Drive-Up maybe for Prof. John Mulligan. I was wondering if we could get maybe a little more detail on the move into fresh, frozen and alcohol and the early responses that you've seen in the Twin Cities test. And maybe kind of walk us through what the barriers are to rolling that out quickly or sooner rather than later and what the profit impacts are on Drive-Up when you start including things like fresh and frozen.
John Mulligan:
Sure. Professor is probably a strong word to describe me. I think we've been testing this in the Twin Cities with team members for a few months now, several months. I think like I said, the guest feedback broadly is that they want to add a few more items to their Drive-Up basket, something like milk, eggs, whatever, bread, whatever the kind of staples are that they need or bananas. And so we feel good that that will be -- this will ultimately be adding a few more items to what is already a Drive-Up order. And from that perspective, we think ultimately, we'll get to a good place on the economics.
Clearly, we have work to do to scale the business, to work through the operating -- operations for the stores. We want to ensure that we have the chill chain wired and all of that. And I think that's where you'll see us make sure we can do it at scale. We've done the operating tests with our team members, so we understand how it should work. But then we want to get to a place where as that demand grows, as we introduce it, which we've seen with every one of the things we've introduced from a fulfillment capability perspective, the demand grows relatively rapidly, and we want to be sure we're built for it. The final piece that perhaps changes the cadence a little bit is we do need to go back in and ensure we have capacity in the store to handle the temperature-controlled. The one thing we will not trade on is the speed and efficiency with which Drive-Up occurs today. A 2- to 3-minute promise is incredibly important. We think it's a -- we know it's a differentiator in the marketplace. And so ensuring that we have frozen and refrigerated capacity close to the front of the store so that our team members can continue to deliver on that pace requires some buildout. And so you'll see us work through that as well. Put all that together, us wanting to learn, some buildout time, and that's why we get to the scaling that we're talking about for this year.
Robert Ohmes:
And then my follow-up question would just be on Target Plus. And as you're -- as Target is bringing in more brands -- national brands, what is the economics on that? Are you pursuing brands that you just think will drive traffic to your website? Or are you getting alternative profit stream benefits from bringing on those brands?
Michael Fiddelke:
Yes. Kind of to Brian's comments earlier, we're really focused on curating the right sellers to complement what we already sell in-store and online. And we feel like that's an additive benefit to the guest experience and assortment choice in total.
Operator:
Our next question is from Edward Kelly with Wells Fargo.
Edward Kelly:
I wanted to ask you about CapEx. So the 2021 and beyond CapEx guidance came up. What's driving that? And can you just provide more color around where you're going to be spending capital that's -- that wasn't anticipated prior?
Michael Fiddelke:
Sure, I can take that. Our overall expectations for the level of continued investment in the business are actually about the same. I think what you're seeing are some puts and takes by year as we've refined our expectation on the specific timing of certain projects. For example, the timing of when we bring a distribution center online can move around a year versus what we thought before, and we're continually revising those out-year plans. We'll be about $0.5 billion light of where we thought we'd be in 2019. 2020 is unchanged at $3.5 billion. 2021 is a little higher based on the retiming of some of those projects but $3 million to $3.5 billion. And the out years are still at $3 billion or just a shade less.
Edward Kelly:
Okay. And then just a quick follow-up on what you're seeing currently on coronavirus and demand. As it relates to digital fulfillment, any increased demand that you're seeing there, thoughts on how that might impact digital growth next year -- or in 2020, sorry? And are you making any adjustments on fulfillment capacity at all related to this?
Brian Cornell:
Yes. Ed, actually, as we sit here today, I think we're reminded just how important stores are to our guests during a time like this. And we've certainly seen a surge in store traffic as guests begin to stock up on those household essentials and those core food and beverage items. So it's been a reminder to all of us that stores are critically important to our guests. It's where the majority of U.S. shopping still takes place. And while our same-day fulfillment options are growing in popularity, our guests still respond to our stores first and foremost. So that's certainly what we've seen recently, and I think you're seeing that across the retail sector. But it is a reminder that our multi-category portfolio is very important during times like this, and our stores play a really important role to meet the needs of today's guests during uncertain times.
Operator:
Our next question is from Paul Lejuez with Citi.
Paul Lejuez:
I'm curious, as we look back at 2019, what were your biggest surprises? Maybe if you can maybe throw out one positive, one negative thing that really surprised you in 2019. And I'm also curious what you view as the lowest-hanging fruit for 2020 as well as how you're thinking about your biggest challenge in 2020.
Brian Cornell:
Yes. I'll start, but I think this is a great question to open up for both John and Michael. If I think about positive surprises for 2019, I think the overall consistent performance that we delivered from a top line standpoint, the exceptional growth we delivered, the market share gains we saw across so many categories, and we illustrated that during our presentation today but seeing the type of share gains that we delivered in apparel, in beauty, the continued strength in toys, the strength we saw in household essentials and food and beverage. Our multi-category portfolio performed so well throughout the year. Obviously, we were very pleased with our ability to translate that into operating income growth and obviously into expanded EPS improvement. So for me, the health of the entire portfolio, the fact that our entire multi-category portfolio performed so well and we're able to take oversized share in so many categories, translate that back to operating income and EPS growth for our shareholders, I think the quality of the results in 2019 is something we feel very good about.
If I think about an opportunity, we've talked about it many times. We were disappointed with our performance in the fourth quarter in several spaces. And we think we've got opportunities to go back into 2020 and improve performance in toys, in electronics, in parts of our home business. As we focus on key items next year, we want to make sure we're buying to the depth required to make sure that we meet the demand in the marketplace during the holiday season. So those are important lessons learned. But the combination of our strength in our portfolio, the growth we saw in same-day fulfillment options, think about the fact that order online, pick up in-store has been something we've been offering for 5 to 6 years now, the fact that during the fourth quarter, we saw growth rates of close to 50%, the expansion in the way the guest has reacted to the Drive-Up component, we feel really good about those highlights. And obviously, we're always a company that's self-critical. There's things we know we can do better and we will as we plan for 2020. John, what's on your list?
John Mulligan:
Well, you had a good list there. I think from my perspective, the 2 things I'd say from an operations perspective, one, Brian hit right on it, the way same-day -- really the guest acceptance there and the guest preference there for same-day, we certainly plan for that to grow meaningfully this year. That exceeded our expectations. And so I think that is something we will continue. As we said, build out next year, improve Drive-Up, add different categories to Drive-Up, I think, is a huge opportunity for us. And then continuing to grow Shipt both inside Target and outside Target, we think, is an opportunity.
The other highlight I would say that we haven't talked a lot about today, but the work of the stores teams and delivering the great store experience they did while we changed entirely their operating model and, as I said earlier, 300,000 team members basically all getting new job descriptions across the company; and the way they handled that change, the great job the leaders did to lead through that and, as I said, while continuing to provide a great in-store experience, one is it's a highlight for me for 2019, but it is a huge opportunity for 2020 and beyond because we're just getting started there, right? Everyone's learned their jobs. And now we have the opportunity to really improve that operating model, improve how we work with our guests and serve their needs in the store. And I think that's a great, great opportunity for us in 2020.
Brian Cornell:
Michael?
Michael Fiddelke:
You guys have covered a lot of ground. I'll try to add to it. In 2019, if you step back and look at that year compared to our long-term algorithm, low single-digit comp growth, mid-single-digit operating income growth, high single-digit EPS growth, it was a year that exceeded that algorithm meaningfully. And our ability to translate top line strength into bottom line profit is a real standout for me. And then the capper is to see ROIC at 16%. Back to the investment question and CapEx question earlier, we've got a balance sheet that we've built intentionally to afford ourselves the capacity to invest in growth. And to see those investments pay off with strong ROIC performance is always good from the chair I sit in.
In terms of opportunities, a little bit more inventory at the end of the year would have been nice. We've touched on that already. And then as I think about 2020, I'd go back to the multi-category model both in the -- through the lens of strengths and opportunities. I think we've really shown over time that model affords us the ability to lean in and be aggressive and take share across a number of categories when the opportunity presents itself. And when I think about risks, it's the stuff that we can't see coming as we sit here today that's probably going to be what we're talking about as the year progresses. But the benefit of a multi-category model is it buys us a lot of diversification of that risk. And our ability to flex within that model to overcome whatever is thrown at us is really strong.
Brian Cornell:
Yes. So Paul, I'll come back to kind of 2 other highlights as we think about the year and I think about even the fourth quarter. While we were disappointed with our comp sales in the fourth quarter, only growing by 1.5%, we were able to take market share across many categories. But importantly, because of the work that we've done in-store, the disciplined approach we've taken in our supply chain, our ability to manage category mix and the fact that on a comp growth of 1.5%, we grew operating income by 7.3%, EPS up over 10%, is something that I think our team is very proud of.
And I would end by going back to the team. And for several years now, I think our team has demonstrated that we have built a sustainable, durable financial model that -- one that's going to perform continuously over time. And I feel terrific about the talent we have at Target, the diversity of our team, the leadership that we have in place right now. And obviously, at the end of the day, it always comes down to people. And this is a fabulous team that I think is prepared to face any of the challenges in front of us but puts the guest first, is thinking about what's right for our business, right for our shareholders. And I think that's one of the things that we all feel really good about as we go into 2020.
Operator:
Our last question comes from Greg Melich with Evercore ISI.
Gregory Melich:
Great. So I got the pressure here now.
Brian Cornell:
No pressure at all, Greg.
Gregory Melich:
A lot in here. So 2 things I really wanted to follow up on. One was you mentioned inventory a lot. I guess I want to ask a little bit, it sounds like you really wish you had more. And I'm wondering what things can you do to sort of change the incentive structure for the organization or shift to have that extra $500 million of inventory because it just seems to make sense given your traffic growth and the interest rate environment that we're in.
Brian Cornell:
Yes. Greg, I'll start. And as I think about where we ended up and the choices we made, it's not about changing our incentive structure. Our incentive structure is really well connected to the overall financial objectives of this company. Next year and actually throughout the year, you're going to see us focus on fewer items in a much bolder way to make sure we're delivering a great experience for our guests. But you'll see us curate even tighter as we go into 2020, make sure that we stand behind those key items that we know are on trend, that are going to drive demand, that are going to delight our guests and bring them joy when they're shopping our stores or shopping online.
So it's not about changing an incentive structure. It's about saying, all right, here's items we're going to stand for. We're going to make sure we're bold and deep as we make those buys. And we're going to make sure that they're the right items that deliver upon our brand promise and make sure that we're delivering both a great experience and great quality and style and terrific value throughout the year.
John Mulligan:
And the other thing I'd add, Greg, I don't think this was our merchant teams, our planning teams, IM teams, inventory management teams lacking conviction. I think we finished the year before a little bit heavy. The teams looked at a calendar with 6 less days of sales in front of them and perhaps took a -- well, we did take a conservative approach, and we perhaps went a little bit further. And I think, like Brian said, we recognize where we have some opportunity, and already adjustments are in place. So we feel good about the -- of that resolving itself.
Gregory Melich:
Got it. And then secondly, of course, we see the leveraging was, you said, John, down 25% fulfillment cost [ as you ] shift in-store. I'm curious what the growth of fresh and adult beverages would do to that this year. Should we expect a similar improvement? Will that create some headwinds? Because ultimately, if digital is profitable, it sounds like it is now but not as much as the store. Something along those lines you could help us with would be great.
John Mulligan:
Yes. I think -- as I think Michael described it well in his remarks, right, digital is always going to be dilutive to rate. But from our perspective, digital is really important because as we talked about, particularly with those same-day sales, we see a lot of incrementality. We see 25% incrementality when someone brings Drive-Up into how they engage with Target. We see 100% of their Shipt sales being incremental. So these are individuals becoming more engaged with Target and that with respect to Drive-Up, as we give them the opportunity to buy a larger assortment, again, what we hear from our guests consistently is, "I want to do what I want to do. But hey, by the way, can I throw 1 or 2 more things into that basket?" And so from that perspective, we feel good about getting to a good economic place with those transactions.
And so there's much for us to learn here as -- we aren't even really doing this for guests yet in Minneapolis or we may have just started in the past week or 1.5 weeks. So there's a lot for us to learn there, but we feel really good and we feel really good especially given that consumers clearly are moving very quickly to same-day. And those economics are very beneficial to us. So we feel good about the direction, and more for us to come back and talk to you guys about as we learn more about Drive-Up.
Brian Cornell:
All right. So with that, we're going to wrap up our session today. Again, we appreciate your flexibility. Thanks for joining us today, and we look forward to seeing you throughout the year.
Operator:
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 20, 2019.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our third quarter 2019 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; and Michael Fiddelke, Chief Financial Officer.
In a few moments, Brian, John and Michael will provide their perspective on our third quarter performance and our plans and financial outlook for the fourth quarter and full year. 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, the most important of which are described in our SEC filings. Also in these remarks, we refer to non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP numbers to the most directly comparable GAAP number are included in this morning's press release, which is posted on our Investor Relations website. With that, I'll turn it over to Brian for his thoughts on our third quarter performance and our outlook for the remainder of the year. Brian?
Brian Cornell:
Thanks, John, and good morning, everybody. We are 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 1 point ahead of our guidance, driven by an acceleration of sales in our stores. This comp performance is on top of 5.1% in last year's third quarter, meaning that we've grown our comparable sales nearly 10% over the last 2 years. Third quarter profitability was also stronger than expected, driven 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 by $0.30. This reflects really strong performance, well ahead of our expectations going into 2019, and it demonstrates the power of the durable operational and financial model we've been developing over the last several years. None of these results will be possible without the amazing efforts of our team who have designed and implemented meaningful changes across multiple parts of our business, from our store service and operating model to our unmatched digital fulfillment capabilities and our inventory replenishment routines. And while 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 as our guests chose to shop with us more often, both in stores and through our digital options. Among our sales channels, store comps were up 2.8% in the quarter, more than 1 percentage point faster than the second quarter, while 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. And while these numbers add up to 80%, when you're talking about growth rates of this magnitude, the power of compounding really matters. Specifically, when you do the math, you'll see that our third quarter digital comp sales have actually grown more than 95% over the last 2 years. Within our digital sales, 80% of our third quarter growth was driven by same-day fulfillment options:
in-store pickup, Drive-Up and Shipt. Given that these same-day options rely on our store 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 of our balanced multi-category assortment, which gives us the flexibility to lean into different seasons and important moments in our guests' lives. At the beginning of the quarter, we enjoyed favorable results in our 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 in sales of our weather-sensitive categories. Beyond these seasonal moments, we continue to benefit from our frequency categories, Food and Beverage, Essentials & Beauty, which 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 with comp sales growth of more than 10%. This was driven by even stronger trends in Jewelry, accessories and Shoes, intimates and sleepwear, young contemporary and women's ready-to-wear. In the Home category, which was annualizing really strong growth a year ago, we saw a low single-digit comp increase in 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 our 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 in toys, offset by comp sales declines in electronics and Entertainment. And finally, in Food and Beverage categories, we saw a low single-digit comp increase, led by double-digit growth in adult beverages, along with strength in non-alcohol beverages and in our bakery and deli areas. In September, we were excited to launch our new Food and Beverage owned brand, Good & Gather. The idea behind the brand is simple, great food made for real life. Good & Gather incorporates simple, high-quality ingredients without any artificial flavors, synthetic colors, artificial sweeteners or high-fructose corn syrups. We saw encouraging results from our launch of 650 items during the quarter and expect that Good & Gather will become our largest owned brand once we roll out the full 2,000-item 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 at Target. We launched 25 Disney stores within select Target locations last month, featuring an immersive experience and an enhanced Disney assortment of more than 450 items, including more than 100 items that were previously available only at Disney retail locations. Beyond those markets, we offer this extended assortment to all of our guests through the Disney store on Target.com and the Target app. We'll 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 that launched nationwide last month. Even though the program is brand new, Target Circle already has more than 35 million members, making it America's fastest-growing loyalty program. During an 18-month test period, guests enrolled in Target Circle saved more, shopped more frequently and spent 2% to 5% more than guests who weren't in the program. Joining Target Circle is simple and fast. In this holiday season, members will receive a number of exclusive benefits beyond the perks they receive all year long, such as earning 1% back on future trips to Target and the opportunity to benefit their local communities by voting to direct Target's giving. Looking ahead to the holidays, our plans are designed to deliver the joy of the season, inspire guests with unique items and services and save them time and money. On November 1, we rolled out free shipping on hundreds of thousands of items available for all of our guests 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 HoliDeals, which we'll feature throughout the season; and our Black Friday 2-day preview sale, which was kicked off earlier this month. And of course, for our REDcard and Target Circle members, we'll be offering early access to select Black Friday deals beginning on the day before Thanksgiving. Throughout the season, guests will find unique items for more than 40 owned and exclusive brands, including holiday favorites like Hearth & Hand with Magnolia and Threshold. Our Home decor assortment will feature more than 2,000 new items, and 70% of those items in our holiday Wondershop will be new this year. To make gift-giving easy, we'll be offering 1,000 curated gifts and holiday essentials under $15, along with more than 10,000 new and exclusive toys. As you've seen in past years, our digital fulfillment capabilities become even more important during the fourth quarter as they help guests 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 U.S. states, encompassing more than 1,750 of our locations. Also new this holiday, same-day delivery with Shipt, which offers delivery in as little as 1 hour, will be available directly from target.com and in the Target app. Additionally, guests will have the option of pay per order, use their REDcard to get 5% off their purchases and receive Target Circle perks. Shipt is now available in more than 1,500 of our stores across 48 states. And of course, pre-Order Pickup is available in all of our stores, allowing guests to shop online or in the Target app and pick up their purchases in store, with most orders ready within an hour. For the holiday season, we have added nearly $50 million in payroll compared to last year to ensure that more team members are available to assist guests during peak times. In addition, we have doubled the number of team members dedicated to fulfillment, including same-day services, so our guest orders will continue to be ready in as soon as an hour. And to ensure our team members continue to deliver a high level of service, we have invested more than 0.5 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 Mark Tritton, both of whom stepped down from their leadership positions during the third quarter. Both Cathy and Mark have made important contributions to our business over the last few years, helping us to achieve the high level of performance that we're delivering today. While Cathy will continue with us for a time in an advisory role, we want to wish both of them well in their future pursuits. At the same time, I want to congratulate Michael Fiddelke on his new responsibilities. Michael knows our business incredibly well having worked across multiple parts of our business and operations over the last 15 years. I'd also like to thank Jill Sando and Christina Hennington for their continued leadership within merchandising. With Jill overseeing Home and apparel and Christina responsible for our Hardlines, 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 is well earned and well deserved. These 3 leaders are shining examples of the quality of the talent that Target develops. And I'm excited to see what our team will achieve together in the months and years ahead. Now I will turn the call over to John, who'll provide an update on our plan to deliver an outstanding experience for our guests in the holiday season and beyond. John?
John Mulligan:
Thanks, Brian. As we approach the peak holiday period, our stores and supply chain teams are energized and ready to deliver a unique combination of inspiration, speed and convenience for our guests. As I mentioned last quarter, our stores have now fully rolled out a new operating model across the chain.
This new model is oriented around our guests, not around 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 while accomplishing tasks but to orient team goals around guests and business outcomes rather than merely checking off a box on a to-do list. 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 are confident this new model will allow our team to provide an elevated experience for our guests throughout the holidays. Beyond experience, convenience is important to our guests all year round, but it becomes even more important during the holidays. And this year, with 6 fewer days between Thanksgiving and Christmas, our guests may find themselves with even less time than usual. These are the times that our same-day services can feel like a lifesaver. Guests can place an order and our team will have it ready at the front of the store or in the parking lot in less than an hour. Or if a guest wants their order delivered to their home, they can request same-day delivery and one of more than 100,000 Shipt shoppers will deliver their order at the front door in an hour or 2. And as Brian mentioned, we're excited that we now have Shipt's capabilities fully integrated into our website 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 and Shipt across the country for the last couple of years, and Order Pickup has been available in all of our stores for more than 5 years. But as we've been highlighting all year, the growth rate of all 3 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 Shipt 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 more than half of the growth occurred in mature locations as more and more guests in those markets tried the 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 are 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 our stores to accommodate a meaningful spike in volume of these same-day options during the holidays while still maintaining the service standards that make them so popular. But we aren't just focused on enhancing our digital capabilities. As I've 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. And 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 in line 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 1 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 7 small-format locations in the third quarter plus another 6 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 these 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 and efficiency in an increasingly complex omnichannel retail environment. One of these investments is in the development of a new inventory planning and 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 backroom 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 this 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. For the items being managed by this new system, we are seeing favorable outcomes, including lower out-of-stocks and lower levels of backroom inventory. We're also testing and rolling out distribution center automation designed to increase our speed and simultaneously reduce store backroom labor and inventory. While the new technology at our Perth Amboy facility is one example of this capability, we're also testing a complementary 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 our sales 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, in 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. The goal of this new system is 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 a holiday season, something which should translate into strong execution during our busiest time of the year. And one final note, I've spoken several times in 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. But it's always 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.target.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 and our stores, for all the work that has gotten us 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 won't be big, but when you put them all together, 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 what the team has already accomplished and equally excited about what lies ahead. Now I'll turn the call over to Michael who will share his thoughts on third quarter financial performance and our outlook for the fourth quarter and full year. Michael?
Michael Fiddelke:
Thanks, John, and good morning, everyone. I'm really excited to join you on this morning's call, and 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 $0.30 compared with the previous range. Third quarter comparable sales increased 4.5%, about 1 percentage point 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'll see that comparable sales have grown nearly 10% over the last 2 years. Among sales channels, store comparable sales increased 2.8% in the quarter, more than 1 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 comp. 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 our guests. 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 average 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 a rate benefit within that category as the business delivered a higher-than-expected mix of full price sales. Outside of category mix, we also enjoyed a favorable mix in fulfillment, which took 2 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, our buying teams continue to develop merchandising strategies that deliver strong margin performance based on our ongoing efforts to optimize costs, pricing, promotions and 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 in toy and baby inventory and 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 P&L. Our third quarter SG&A expense rate increased about 20 basis points compared with last year, in line 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 SG&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 driven by very tight labor market conditions across the country. On the depreciation and amortization expense line, we saw an increase of $45 million or 8.5% compared with last year. This increase reflects a number of factors, including base 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 pretax earnings this year combined with the impact of discrete items in last year's results, which made last year's effective tax rate unusually low. All together, our operations generated adjusted EPS of $1.36, an increase of nearly 25% compared with $1.09 last year. Third quarter GAAP EPS from continuing operations of $1.37 was up more than 18% from last year when we recorded $0.07 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 invest capital in projects that meet our strategic and financial criteria. Second, 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 use share repurchase to return any excess cash beyond those first 2 uses with the goal of maintaining our middle A credit ratings. Turning first to CapEx. We now expect to spend 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 the smaller benefit from the retiming of some project spending into next year. As we look ahead, we continue to expect to invest about $3.5 billion in 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 D&A 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 2 years ago, the year-over-year decline is largely a 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 how our capital deployment priorities have played out so far in 2019. Through the first 3 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 in dividends and repurchased about $900 million of our shares. Over time, the quality of our capital deployment is 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 a company's business model and the productivity of their investments over time. On that basis, Target's 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 of fourth quarter sales and profit drivers, many of which are distinctly different than the rest of the year. Specifically, considerations on our outlook for the fourth quarter include:
the headwind from 6 fewer holiday shopping days, the benefit from Target Circle, the rapid acceleration in fourth quarter digital penetration, a much higher sales mix of toys and electronics compared with the rest of the year and the highly promotional nature of the competitive environment. All together, based on recent trends and 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 improvement in our gross margin rate, partially offset by smaller increases in both our SG&A and D&A expense rates. This performance would translate into a mid- to high single-digit increase in operating margin dollars and an expected range for adjusted EPS of $1.54 to $1.74. And today, based on our third quarter performance and fourth quarter outlook, we raised our full year guidance range for adjusted EPS to $6.25 to $6.45. The midpoint of this new range is $0.30 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 in sales, category mix and fulfillment mix within our digital channels. At the beginning of the year, Cathy 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 EPS 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 is something we never take for granted. The last couple of years have involved an amazing amount of change in the way our team works, from merchandising to operations, from headquarters to our distribution centers and, of course, in our stores. It's been remarkable to work closely with these teams and see how they've embraced the change, believing it's the right long-term path for our business. Results like we are seeing this year are a testament to their efforts and 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.
Brian Cornell:
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 make them a great place to live and work. It's about making Target a special place for our guests when they shop in every channel, a retailer that provides inspiration while helping our guests 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 it's confirmation that our long-term plan is working. And that's what we'll continue to focus on in the months, quarters and years ahead. With that, we want to thank you for your participation in 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 15. So now John, Michael and I will be happy to take your questions.
Operator:
[Operator Instructions] Our first question comes from Chris Horvers with JPMorgan.
Christopher Horvers:
Can you talk a little more specifically about the cadence of the quarter? Do you think weather had any impact on the business given the warm September? And do you think this was fully made up for given the strong end to the quarter?
Brian Cornell:
I mean 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 comments, all of those subcategories within apparel performed really well. So we saw strength in our business throughout the 13 weeks, and I think the team saw really strong performance across all of our categories.
Christopher Horvers:
Understood. And then as you look ahead, there's some countervailing factors. So electronics and toys do go up substantially in the mix. How are you thinking about those categories into the holiday? But then on the other hand, obviously, the e-commerce stack was very impressive and -- at least back here in the fourth quarter. So how are you thinking about the holiday broadly and electronics, toys and e-commerce as you look ahead?
Brian Cornell:
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 for the holiday season. And as always, we know that during that holiday period, we're going to amplify our focus on electronics and toys. We're well prepared in those categories with a number of new and exclusive items. So I think we're in a terrific position as we get ready for the upcoming weeks. And particularly from an electronics, toy and seasonal standpoint, I think we're going to stand tall.
Operator:
The next question comes from Michael Lasser with UBS.
Michael Lasser:
One way to 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 guests, and now you have the ability to transition those guests to more regular customers and regular guests. Is that the right way to think about it? And what does the adoption look like as the guest goes from trial of these various fulfillment options to broader adoption?
Brian Cornell:
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 visits to our site. I think that's going to translate into a guest that's shopping more categories and greater relevance and a stronger relationship with that guest. 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, guests shopping more categories.
We've talked about the rapid expansion of small formats. We're moving into new neighborhoods. Those were guests that were not shopping Target on a regular basis before, they are now. And I expect, over time, they'll be using REDcard, and clearly, they're going to be using our new Target Circle loyalty program. I mentioned it in my prepared comments. While we've only been in market for a few weeks with Target Circle, we already have 35 million guests who were enrolled in the program. So I think we're going to continue to see traffic growth in our business as guests that started to visit Target and now may come in for toys that are shopping other categories in beauty and essentials begin to shop in our style categories more frequently. So those are the indicators that we look at as we plan for the future.
Michael Lasser:
That's helpful. And my follow-up question is, as you look towards next year and you think about the algorithm that you laid out, will more of 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 more SG&A leverage? And how should we think about the drivers between those 2 factors in the next couple of quarters?
Michael Fiddelke:
Well, we aren't going to get into the specifics for 2020 in today's call. But we feel really good about the gross margin strength we've seen so far this year, and we'd expect a moderate increase to gross margin rate in Q4 as well.
Operator:
The next question comes from Matt McClintock with Raymond James.
Matthew McClintock:
Congrats, Michael, and best wishes to both Cathy and Mark. Brian, you talked about apparel for a 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 -- and even if that's not the case, it's an acceleration from 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 Levi's? And then what exactly are you doing in Jewelry and accessories that's driving that growth there?
Brian Cornell:
Yes. So I appreciate the call-out, Matt. We did certainly see an oversized increase in market share during the quarter in apparel. I think our teams have done a fabulous job of curating our owned brand assortment, really having the right assortment in front of the guests. 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 guests each and every day, is really driving great results. So the combination of the work we've done with our own brand assortment, adding some new national brands like Levi's in select stores, the 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 has done there. I think it's a great example of how our strategies come together, where we remodel stores and create an inspiring in-store environment, we surround our guests with exceptionally well-trained team members who are 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 has done there, and I think it's one of the highlights of our quarter, if not for the entire year.
Matthew McClintock:
And then, John, clearly, you're 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, is it even more of a strategic competitive advantage to offer same-day options? And do you think that that's actually going to accelerate adoption by customers?
John Mulligan:
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, Shipt, all the investments we've made there to improve the efficiency 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. When people become time strapped, digital is an easy way. And being able to knock it off your list 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 we'll deliver it to your home, I think that becomes incredibly important.
And as always, I think the stores are at the center 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 stocked. We'll have a great team there, like Brian pointed out, providing service. And if you -- again, if you want to order it online, we'll have it sitting there waiting for you either to put in your car or come in and 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.
Operator:
Our next question comes from Scott Mushkin with R5 Capital.
Scott Mushkin:
So my first question is actually to Michael. I think you talked about at the end what surprised you kind of going into the -- what the performance is versus what it was going to the year. And I was wondering if you could just get in a little more detail why you were above plan and the sustainability of some of those trends.
Michael Fiddelke:
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 apparel is running at 10% comp, that's really healthy on the margin line, good gross margin rates in that category. And we sell more product at reg price versus a discount at the end of the season when our style categories do well.
The second was the stronger-than-expected store sales. That's always helped lift the margin. And then finally, to maybe piggyback on some of what John just said where our digital fulfillment growth came from. When those same-day options that the guest is responding to drive 80% of our digital growth, that's healthy from an operating margin rate perspective as well on a year-over-year basis.
Scott Mushkin:
And the sustainability of some of these trends in your mind?
Michael Fiddelke:
I think the teams worked hard to build an algorithm that's got good sustainability in the long run. When it comes to Q4, Q4 is its own animal. So we built Q4 bottoms-up, looking at how all those factors fit together. And so we'd expect, again, moderate gross margin rate expansion in Q4, but it will be modest compared to the point of expansion we saw in Q3.
Brian Cornell:
Scott, I wouldn't describe it as a surprise. But I think as you look at the third quarter, I started with the strength in traffic, up 3.1%; the strength in our stores comping at almost 3%. The continued strength in digital in our 2-year stack in the quarter rounds to 10%. So we're putting good numbers on top of good numbers. We'll continue to do that over time. But I think the balance in our portfolio where both our style and essential categories are performing, our stores are driving growth, our digital channels are continuing to accelerate, the overall composition of the quarter, to me, was a very high-quality quarter where all factors of our business were working together as one.
Scott Mushkin:
Great. And then a 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 is actually showing the same thing. So I was wondering if you could give us a reason why you think that's happening and, again, the sustainability of that.
Michael Fiddelke:
We're a few years into this now, and we have consistently seen the second year performance. We didn't expect that going into this, honestly, and we didn't model for it as we looked at the financials of the remodels, but it's certainly a pleasant 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 them 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 guests, and then we see the guests continue to engage in different parts of the store and really experience the whole -- everything we have to offer. And 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.
Brian Cornell:
And Scott, I'll give you a little additional insight. When we talk to guests who come into a newly remodeled store, and they might have been a previous Target shopper in that store, some of the feedback we get is have we added new categories, have we added new assortment. So because of the changes we've made in the core, the layout, the experience, they start to discover even more categories than they had shopped before. And I think that's a big part of what we're seeing in year 2.
So that guest might have been coming to us for household, essentials and toys. They are now shopping in apparel and Home. They're discovering additional categories, and I think that's helping us pick up market share in those remodeled stores in multiple categories.
Scott Mushkin:
All right. Perfect, guys. I was just in a remodeled SuperTarget in Houston, and it was pretty amazing.
Brian Cornell:
Thank you. Appreciate it.
Operator:
Our next question comes from Ed Yruma with KeyBanc Capital Markets.
Edward Yruma:
I guess, first, to unpack a little bit more gross margin gains, obviously very impressive. How much of it -- I know you called out apparel, but how much of it do you think broadly is from success in your investments and your process in private label? And kind of how do you see penetration moving as we think about 2020? And then second, obviously, you've seen some very strong success in 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 front of the house perspective?
Brian Cornell:
Ed, why don't we 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 years. And then John can talk about the scalability of our fulfillment models.
Michael Fiddelke:
Yes. Thanks, Ed. On the owned brand front, it really starts with providing products that we think the guests will respond to and so curated owned brand product that drives repeat purchase and loyalty over time. So we start there. And when that owned brand product does well, it translates favorably to the gross margin line. And so the strength we've seen and the growth that will bring us over time has definitely been a positive on the margin side.
John Mulligan:
So Ed, we will -- the way I'd start is we will pick, pack and deliver either in store, through pickup and Drive-Up or Shipt to guests more packages in the next 5 weeks than we did in the entire year of 2015. And so the teams have done an outstanding job of 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'd compare this to is if you look at our average store, it does a little bit over $300 a square foot. Our top quartile of stores approaches $800 a square foot. So we have huge capacity just in those boxes to move far more inventory than we do today with far more team members doing it. Now whether that goes out the front of the store or the back of 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.
Operator:
Our next question comes from Kate McShane with Goldman Sachs.
Katharine McShane:
Our question is centered around gross margin too. I wondered if you could help us understand your comments. 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 value you continue to convey to your customers?
Brian Cornell:
Yes. Kate, why don't I start. And 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 guests that every time you shop Target, we're delivering great value. And we've been talking for several quarters now about the benefits of that investment, the benefits of that communication and the fact that we're seeing a significant portion of our business move to everyday pricing, and I really describe it as everyday value. So that continued in the quarter, and I think that's going to continue for some time to come as we continue to reinforce to our guests that every time you shop our stores, we're going to deliver great value, we're going to be priced right daily on those items that we know are so important to our guests. And that's a commitment that's been in place for several quarters and will continue for years to come.
Katharine McShane:
Okay. And if I can just follow up. I know tariffs continue to be headlines at this point and nothing is certain, but could you walk us through if List 4B were put to effect, how much you've been able to or you can mitigate versus how much price you think you'll need to take?
Brian Cornell:
Yes. Kate, we've been watching the headlines as others have each and every day. And 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 in front of us. I think we've said the last couple of quarters -- in Q2, tariffs pressured us by about $50 million. In Q3, that's going to be about a $60 million pressure. But our teams, particularly our merchants and our sourcing team, have done a phenomenal job of really working through this challenging landscape and allowing us to deliver great value to our guests at a time when they need it most.
So we'll watch the next list. We'll see what happens as 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 kind of navigate this uncharted water.
Operator:
Our next question comes from Karen Short with Barclays.
Karen Short:
Congratulations on a great quarter.
Brian Cornell:
Thank you. We appreciate that.
Karen Short:
Just wanted to actually follow up on that tariff question. Taking the opposite angle, if List 4 were to not be enacted, would there maybe be a little upside to the guidance for 4Q?
Brian Cornell:
We'll watch it carefully obviously. If some of the tariffs are pulled back, there's 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, it 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 we'll decide once we have greater clarity.
I think for all of us right now, the biggest challenge is uncertainty. And as soon as 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, we'll decide how to deploy those funds.
Karen Short:
Okay. And then I wanted to just ask about -- obviously, there's so much going on in apparel that's positive, and you called out many of it, but you actually didn't mention the 20th anniversary collection. I was just wondering if you could give a little color on that. I mean we know it's not a huge comp driver, but any context you could give on that, on how it went?
Brian Cornell:
Well, I think it was incredibly well received by our guests. I think our team did a fabulous job of executing the plan. It built enormous awareness and traffic to our stores. And it's just one of those moments where we can surprise and delight our guests. And going back and thinking about the 20th anniversary and bringing some of these great collaborations back to life was well received by the guest. And obviously, these limited-time offers will be part of our playbook as we go into 2020 and beyond. But that one was incredibly well received by the guests and a lot of excitement when our guests were in the store or shopping online.
Karen Short:
Great. And just last question. Maybe a little color for me, Brian, in terms of the merchandising structure in general. I mean, obviously, you've chosen a slightly different path in terms of senior vice president and -- 2 senior vice presidents in terms of the categories. Can you maybe just elaborate a little on that decision?
Brian Cornell:
Well, I put 2 really experienced and very talented leaders in place over 2 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 Sando to oversee our apparel and Home and style categories. At the same time, we elevated Christina Hennington to lead beauty and essentials and our Hardline businesses, toys and electronics. So they've actually been in place in those roles throughout the year.
They've been with Target for many, many years. In the case of Jill, over 20; and Christina, over 15 years. So they are experienced, talented, 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 merchandise standpoint going forward. We appointed Stephanie Lundquist as our leader for Food and Beverage. So we have some top talent leading those categories, and I feel just terrific about their leadership and the plans they have in place for the fourth quarter and their plans that they are developing for 2020.
Operator:
Our next question comes from Paul Lejuez with Citi.
Paul Lejuez:
Can you talk a little bit about the Good & Gather line, just the initial response? Also curious, what percent of your Food and Beverage was private label prior to launching Good & Gather? And where do you expect that to go over the next few years?
Brian Cornell:
So we launched Good & Gather during the quarter. We started out with 650 SKUs. That will expand in 2020 with another 2,000 items. The initial response from the guests has been fantastic. Really, really excited about the offering. I talked about it being real food, not having any artificial colors, artificial ingredients, no high-fructose corn syrup. So I think it's really on trend with what the consumer is looking for in Food and Beverage from Target. Our team has 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 brand is off to a very good start.
And as we've talked about previously, despite our strength in owned brands overall, we're underpenetrated from a Food and Beverage standpoint. So low-teen development in owned brands in Food and Beverage, we think there's significant upside over time. And we think within the next year or so, Good & Gather will likely be our single largest owned brand at Target. So I'm very optimistic about the potential for the brand. It's off to a great start. The consumer really seems to be connecting with the brand proposition. And I think the best is yet to come for Good & Gather.
Paul Lejuez:
And Brian, at what point are you going to do more of a splashy marketing effort around Good & Gather?
Brian Cornell:
Yes. We've already started to feature it in our weekly circular. There's some great in-store marketing in place right now. Obviously, as we get to a point of more critical mass, you'll see a more focused marketing initiative around Good & Gather. But if you're in our stores today, it's really obvious that we've introduced this new brand. It's featured on our end caps, it's featured in our in-store marketing and it's a prominent part of our weekly circular.
Operator:
Our last question comes from Seth Sigman with Crédit Suisse.
Seth Sigman:
I did 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 holiday sales are just starting later? I just love to get your view on your inventory position heading into the holiday and into next year.
Michael Fiddelke:
Yes. John, feel free to add. The new system work, I'd say, is a small benefit so far this year. What you're really seeing is the impact 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 2-year stack basis, I think you'll see growth relatively in line with our sales over that 2-year period. And 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 in some toys and baby merchandise, on a year-over-year basis, you're seeing the benefit of cycling that.
Brian Cornell:
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.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation Second Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, August 21, 2019.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our second quarter 2019 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; Mark Tritton, Chief Merchandising Officer; and Cathy Smith, Chief Financial Officer.
In a few moments, Brian, John, Mark and Cathy will provide their perspective on our second quarter performance, our outlook and progress on our long-term strategic initiatives. 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, Cathy 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 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 our second quarter performance and our outlook for the rest of the year and beyond. Brian?
Brian Cornell:
Thanks, John. We are really pleased with our second quarter financial performance, which reflects the durable model we built over the last several years. In building this model, we focused on making changes to ensure we maintain long-term relevance with our guests while positioning our business to grow profitably over time. When we began this journey to transform our business in 2017, we said that 2019 would be the year when we'd be positioned to deliver profitable growth, and our results through the first half of this year has certainly fulfilled that expectation.
On the top line, our business delivered second quarter comparable sales growth of 3.4%, driven primarily by traffic. This growth was on top of unusually strong comp growth of 6.5% in the second quarter last year, meaning that our comp sales have increased about 10% since 2017, our best 2-year stacked performance in well over a decade. On the bottom line, our second quarter profitability was well ahead of our expectations. Our business delivered double-digit growth in operating income, which translated into record high earnings per share numbers and more than 20% EPS growth over the last year. Among our sales channels, second quarter comp sales grew 1.5% in our stores and 34% in our digital channels. Within our core merchandising categories, we saw more than a 5% comp growth in both apparel and essentials. This reflects the broad value we deliver across all of our categories and the balance we achieved between our more discretionary areas like apparel, home and beauty and our less discretionary Food and Beverage and essential categories, which delivered consistent traffic throughout the year. Beyond our frequency categories, throughout the year, we focused on important seasonal moments in our guests' lives and unique partnerships that create excitement and sustain our brand. At the beginning of the second quarter, we were really pleased with the guest response to our limited-time partnership with vineyard vines, which was one of our most successful in our history. And near the end of the quarter, we saw encouraging early results in our Back-to-School and Back-to-College categories. In our digital channels, we continue to see the most rapid growth in our same-day fulfillment options, in-store pickup, Drive-Up and Shipt, which together have more than doubled their sales in the last year. These options offer speed, convenience and reliability, and as a result, they are quickly becoming the preferred fulfillment choices for our guests. And most importantly, because these options leverage our store infrastructure, technology and teams, same-day fulfillment delivers outstanding financial performance as well. In our stores, which grew both traffic and basket in second quarter, we continue to elevate both the environment and the level of service. We completed 84 remodels in the second quarter, and we're on track to deliver approximately 300 this year. These projects transform the shopping environment, featuring end-to-end improvements in our décor, lighting and merchandise displays. In addition, they incorporate changes to optimize digital fulfillment, enabling speed and reliability for our guests and efficiency in support of our financial performance. Within our product assortment, we continue to focus on providing a unique combination of quality, fashion and value across our owned, exclusive and national brands. Just ahead of the Back-to-School season, we launched our new multi-category owned brand, More Than Magic, which our team developed to appeal to guests in their tween years. And just this month, based on encouraging results in a 20-store pilot, we expanded our test of Levi's Red Tab denim for both men and women to 50 stores near college campuses and in high-traffic urban markets. We're pleased to be partnering with Levi's to showcase this iconic product line previously reserved for department stores to more and more of our guests. In recent years, many of our competitors have begun promoting cyber summer sales in the July period, which drives consumer interest in online shopping and causes a natural spike in our digital traffic. This seasonal spike creates a natural opportunity for us to thoughtfully invest in promotions, allowing us to gain mind share and convert this traffic into additional orders and sales. At the same time, the acceleration in order volume allows us to test the agility of our operations in advance of the fourth quarter peak. I'm pleased to report, like last year, performance of our July Deal Days event was outstanding, both in terms of guest response to our promotions as well as the ability of our operations to handle the surge in demand. And while I'm on the subject of agility in operations, I want to take a moment and address the system outages, which affected our cash registers and payment systems during a busy weekend in June. These outages disappointed our guests, and once again, I want to apologize for the inconvenience they caused. While our business still delivered an outstanding quarter, these outages are a stark reminder of the need for us to continue to focus on execution across every aspect of our business every day. On the positive side, I couldn't be more proud of our store teams across the country, who put our guests first and worked tirelessly to minimize the inconvenience to our guests. And I also want to thank our headquarter teams, who scrambled quickly to assess root causes and recover our systems in a very short time. I've said this before and I see it every day, we have the best team in retail. As we step back and look at our results throughout the first half of the year, our teams have delivered really an outstanding performance, ahead of our expectations. Comparable sales have grown more than 4%. Operating income has grown more than 13%, and GAAP and adjusted EPS have each grown about 20%. This performance puts us in a strong position as we enter the back half of the year. . However, as we look ahead to the balance of the year, we're mindful of the volatility and uncertainty in the marketplace, including the timing and extent of additional China tariffs. As you know, the list of products in line for new tariffs includes a broad set of consumer categories, including apparel, electronics, toys and home. As a result, we've been following developments carefully, and we're encouraged that many items originally slated for tariff increases in September have now been delayed until later in the year. But as long as the trade situation remains fluid, it will present an additional layer of uncertainty and complexity as we plan our business. Against that backdrop, we expect to continue to benefit from our diverse, multi-category assortment, deep expertise in global sourcing and a sophisticated set of manufacturing partners around the world. As a result, we are confident in our ability to navigate this period of heightened volatility and move our business forward. And we're really excited about our plans for the balance of the year, in which we'll continue to deliver excitement, innovation, convenience and value to our guests. Beyond the Back-to-School and Back-to-College season, we're excited this quarter to be bringing back hundreds of items from 20 different designers to celebrate the 20th anniversary of Target's first designer partnership. And just this week, we announced our newest owned brand in Food and Beverage, Good & Gather, which our team designed to make it easy for families to discover the joy of food. Over the next few months, we'll be completing more than 100 additional remodels so more and more of our guests can enjoy an enhanced store shopping experience, in time for the holiday season. And of course, we'll continue expanding our rollout of Drive-Up and Shipt across the chain, bringing enhanced speed and convenience to more and more of our guests across the country. Putting this all together in both the third and the fourth quarter, we are planning to deliver comparable sales growth in line with the 3.4% pace we established in the second quarter. As we plan for the profitability of those sales, our guidance reflects the most recent announcements about the extent and timing of China tariffs. Altogether, based on our performance the first half of the year and our outlook for the back half, we expect to generate full year GAAP and adjusted earnings per share of $5.90 to $6.20, an increase of $0.15 from our prior range. While we certainly see the potential for us to outperform the midpoint of this range, we believe it strikes the appropriate balance between the outstanding trends we've been seeing so far this year and the financial flexibility we'll need to manage through a volatile environment. And finally, for the third quarter, we are planning GAAP and adjusted earnings per share of $1.04 to $1.24. So before I turn the call over to John, I want to recognize our team for their efforts to deliver such an outstanding performance in 2019, but I also want to recognize their hard work over the last few years, which has allowed us to transform nearly every aspect of our business. Without those efforts, we might have found ourselves in the unfortunate position of many of our competitors who are struggling to perform in the face of rapid changes in the consumer and the marketplace. Through the tough times, our teams stuck with us. They believed in our plan, they believed in each other and they believed in our brand. And today, I'm incredibly honored to be able to share the outstanding results of their work. With that, I'll turn the call over to John for an update on our digital fulfillment capabilities and our plan to continue to grow. John?
John Mulligan:
Thanks, Brian. This quarter provided further evidence of the payback we're realizing on the investments we've made over the last several years to transform our assets, our capabilities and our team. This work has created an operational model that can generate growth on both the top line and the bottom line as you saw in our second quarter results.
One place where it's easy to see the impact of our new model is in digital fulfillment where the mix is moving dramatically towards our same-day services, in-store pickup, Drive-Up and Shipt. In the second quarter, these 3 services accounted for more than 1/3 of our digital sales, up from about 20% last year. In other words, our same-day options are growing much faster than our digital sales. Specifically, combined sales for in-store pickup, Drive-Up and Shipt have more than doubled over the last year, accounting for nearly 3/4 of Target's 34% digital comp in the second quarter. That means that nearly 1.5 percentage points of the company's overall comp growth was driven by our same-day services. These are remarkable statistics, and they demonstrate how rapidly our guests are learning about and embracing these new convenient options. For many guests, they are becoming the go-to choice for their digital shopping because they offer unique advantages. They're immediate. They allow guests to shop and receive their order on the same day. They're convenient. Guests can choose where they receive their order, either at the front of the store, in the parking lot or at home. They're fast. Our standard is for Drive-Up guests to receive their order in less than 2 minutes, and our average is comfortably better than the standard. And finally, these services provide certainty. Guests don't have to wonder when a package will arrive at their house and what will happen to the package if they're not at home. And of course, it eliminates the need to deal with opening and recycling a stack of cardboard boxes every week. With these advantages, it's no wonder that our same-day offerings receive some of the highest Net Promoter Scores of anything we offer, which means that guests want to use these services again and again after they tried them. So if you simply apply a guest-first mentality, you quickly see the value of our investments to develop and roll out our same-day options across the country. But what's even better is that these services also make sense for our business because they leverage existing store assets and our store teams in new ways. As a result, our same-day options are also the most profitable within our digital offering. Over the last few years, we've made a concerted effort to increase the efficiency of all of our store fulfillment options, including both our same-day and ship-from-store capabilities. As a result, since the beginning of 2018, order picking efficiency for pickup and Drive-Up has increased more than 30%. And similarly, end-to-end labor efficiency for our ship-from-store capability has also improved by more than 30% over that same period. These are massive improvements, which we realized through the natural scale efficiencies we see on higher volume, which are compounded by incorporating improved processes and technology. These tactics include creating larger batches for picking orders based on the goal to balance efficiency, speed to guest and the guest experience; optimizing the path for order picking to minimize steps through the backroom and sales floor. During seasonal peaks, batches are further segmented into subsections of the store, like Back-to-School orders this time of the year. Applying new algorithms to prioritize the sequence of order picking based on a range of criteria rather than simply applying first-in, first-out system; implementing new technology to eliminate ambiguity for our store team members about which work to perform first, when work is due and the optimal box size for packing orders; and of course, enhancing data and reporting for store teams to track the unit efficiency of both pick and pack. This reporting updates constantly throughout the day and provides leaders the ability to understand the drivers of their team's performance in real time. These efforts have been focused on store fulfillment, but we been focused on every step of the guest shopping journey, including returns. We've always offered free in-store returns of digital orders, but guests sometimes prefer to ship their returns back to us. To make that process seamless, we've worked with our shipping partners to expedite the process of a return for a digital order. Under the new process, after a guest prints their return label at home and either drops it off or schedules pick up at their home, they receive credit for the return as soon as our third-party shipping partners scans the return label. This means that refunds are received in a guest's credit or debit card account days earlier than before, and our guests have noticed. And our guest survey scores have seen a meaningful improvement in the level of satisfaction for refund timeliness compared with last year. So clearly, we've done a lot to support our digital growth, but we shouldn't forget about store sales, which continue to account for more than 90% of our total volume. As we've been saying for years, we believe that in-store shopping will continue to be important and account for the vast majority of retail sales for many years to come. However, in a world where consumers have more choices than ever, inferior brick-and-mortar experiences will go away. That's why we're investing heavily both in our store assets and in the experience our team provides. Regarding the store assets themselves, we're in the middle of a 3-year period in which we plan to remodel about 300 stores each year, a more rapid pace than we've ever accomplished. As Brian mentioned, these remodels transform the entire store experience and optimize them for digital fulfillment. And as we've covered in the past quarters, we continue to see first year traffic and sales lifts in line with our original expectations and second year lifts that we didn't originally anticipate. As successful as our remodel program has been, we continue to look for ways to refine our process. We continually analyze the results of completed remodels and apply those learnings into our project plans, so next year's remodels won't look the same as the ones we completed last year. We're also finding ways to mitigate the challenges that our guests face when construction is in process, which is leading to smaller average sales disruption than we experienced last year. And while guests are enjoying the updated look and feel of their new store, they're also experiencing a change in the way our team serves them. That's because over the last few years we've been rolling out a completely new operating model for our store team. This new model is simpler and focused on our guests rather than accomplishing tasks. We've also created more specialized roles in which team members bring their expertise to categories like food, beauty, electronics and apparel. The second quarter was the first time we have the new model fully implemented across the country, and we continue to be happy with the results. For example, we're seeing improved guest survey scores on questions about their interactions with our team, both on the sales floor and at checkout. Beyond the guest experience, we're also seeing the benefit of the operating model in our financial performance. Like everyone else, we are currently experiencing meaningful wage inflation in a very tight labor market. However, because of our ongoing investments in our team and this new operating model, we're seeing strong efficiency improvements in our stores, which is helping them mitigate the impact of higher wages. Before I turn the call over to Mark, I want to talk about our longer-term vision for the supply chain. Specifically, I want to address the questions we continue to hear about the long-term prospects for our strategy of using our stores as fulfillment hubs. One form of the question is to ask if the strategy is only feasible when Target's digital sales are still small. My first reaction is to wonder if it's appropriate to consider digital sales of well over $5 billion to be small, but I'll stick to what's most important and talk about how we expect to deliver much higher volumes of store-fulfilled digital sales over time. And based on the questions we've been getting from many of you, I want to cover 3 distinct questions about our capacity to accommodate growth. The first question pertains to the ability of our stores to fulfill higher levels of digital sales within their existing square footage. On that question, our experience shows that our stores have a very long runway of capacity. Think of it this way, last year, stores-fulfilled sales accounted for an average productivity of just over $300 per square foot. And when you do the math, every additional billion dollars of store-fulfilled sales would raise that productivity by about $4 a foot. In other words, if we doubled last year's $5 billion in digital sales and fulfilled all of that extra volume in our stores, we'd see our average store sales productivity rise by just over $20 a foot. So the question is can our stores accommodate that volume in their existing space? The answer is clearly yes, and the easiest way to see that is by looking at the range of productivity of our stores across the chain. Specifically, our top quartile stores, a group consisting of more than 450 locations, delivered average per foot productivity of more than $430 last year. That's more than $100 higher than the average for the chain. So based on our success in operating that large set of stores, we believe we have a lot of room to grow our overall sales productivity through digital fulfillment. But there's a second capacity question pertaining to the mix of space in our existing stores. Specifically, we often get asked whether we'll need to expand our store backrooms as we continue to see rapid growth in store-fulfilled digital sales. On that question, our internal modeling shows that we are not going to run up against any capacity constraints in the near term because our stores already have ample backroom space. Specifically, if we continue to simply apply our existing technology and processes and maintained a rapid rate of growth in store-fulfilled sales, we wouldn't need additional store backroom capacity until well into the next decade. And as an aside, that constraint would only occur doing the 2-week long seasonal spike in the fourth quarter. However, we'll only run up against that constraint if our technology and processes stay the same as they are today, and that isn't our plan. Just as our stores have consistently delivered ever-higher productivity in their ability to fulfill conventional sales, we are investing in technology and processes that will allow our stores to continue to grow their backroom productivity as well. Beyond the capacity of our stores and backrooms, the third capacity question we hear is whether, over time, we're going to need to invest in additional upstream distribution capacity to accommodate our growth. And for this question, our answer is clearly yes. But that shouldn't surprise anybody because we've been adding capacity throughout more than 50 years of growth in our stores. In other words, when you grow any type of sales, either a conventional store sale or a digital sale, eventually, you will need to add network capacity to serve the additional volume. But that doesn't mean we're sitting on a surprise addition to the CapEx plans we outlined that this year's Financial Community Meeting. The capital plan we outlined that day already accounted for expected future investments and upstream capacity based on our plans to grow both store sales and digital sales in the years ahead. So in other words, adding network capacity isn't something beyond our plan. It's part of the plan we've already articulated. Now before I close, I want to thank the team for their work to turn theory into reality over the last few years. When we started, many people didn't think we'd be able to grow store traffic and sales ever again. When we started, many people questioned whether stores should play a central role in digital fulfillment. And when we announced our goal to move to a $15 minimum wage across the country by the end of 2020, many people didn't think we could accommodate those kinds of wage increases and generate profitable growth. But because of this team's dedication, vision and energy, we've been able to transform our business and deliver outstanding financial results. Through their efforts, our team had delivered the performance that has converted doubters into believers. Now I'll turn the call over to Mark, who will talk about our merchandising performance in the second quarter and our plans for the third quarter and beyond. Mark?
Mark Tritton:
Thanks, John. As Brian mentioned earlier, we continue to focus on ways to deepen the engagement of our guests across multiple facets of our merchandising assortment, in discretionary and frequency categories, our owned brands and national brands and different shopping occasions, including life events, holidays and everyday shopping trips. Of course, the most visible indication of our guest engagement is our traffic growth, which we continue to see across both our stores and digital channels. Engagement can also be seen in the market share data, which continues to show gains across multiple dimensions of our business.
Between our core categories, second quarter growth was strongest in Essentials & Beauty and in apparel, both of which delivered comp increases above 5%. Results within Essentials & Beauty was strongest in baby, beauty and over-the-counter. Baby has been one of our strongest share stories for the last year, and we saw continued gains in the second quarter. Beauty has also been on an amazing run as we've seen accelerating share gains for well over a year. In apparel in the second quarter, we saw broad strength across a host of categories, including intimates and sleepwear, Jewelry, accessories and shoes, baby and performance activewear. We were particularly pleased to see such strong trends at Target despite unfavorable weather trends during the quarter and soft sales conditions for the overall industry. As a result, we saw some unusually strong share gains across multiple parts of the apparel assortment in the second quarter. Among the remaining core categories, both our Food and Beverage and home assortments saw low single-digit increases in comparable sales. In food, results were led by adult beverages, which delivered another quarter of double-digit growth. In home, results were led by décor. In Hardlines this quarter, comp sales were approximately flat overall. Results were led by toys where growth continues at a more moderate pace given that we annualized the closure of Toys "R" Us during the quarter. In addition, we saw healthy growth in our mobile category during the quarter. These areas of strength were offset by comp declines in our electronics and entertainment categories, reflecting an overall lack of industry newness in their product assortments. We're expecting this performance to strengthen in the back half of the year as both of these categories will benefit from new launches and product introductions via our vendor partners. To continue to deepen guest engagement, we focused on delivering a constant drumbeat of newness and innovation elevating key life moments for our guests while making it easier than ever to fulfill their everyday needs, all at great value. We kicked off the second quarter with our blockbuster limited-time partnership with vineyard vines, and we're really pleased with the results. This was one of our biggest brand partnerships in recent history, and we're happy to see that traffic and sales came in ahead of our forecast. This partnership was also an important moment for our brand as we saw high digital engagement and an amazing amount of buzz in social media. Also in the quarter, we're pleased with the results for both Mother's Day and Father's Day holidays. Some of our strongest share gains of the quarter occurred during these holiday periods, particularly in men's and women's apparel but also in toys and kids. And as Brian mentioned, late in the quarter, we're pleased with our early results in our Back-to-School and Back-to-College program, which are second only to the fourth quarter holiday season in terms of importance. Strategically planned right before the Back-to-School season, we launched our newest owned brand, More Than Magic, which is a complete lifestyle brand spanning sportswear, dancewear and gymnastics apparel, jewelry, accessories, beauty, electronics and even stationery. Our team developed this brand to appeal to tween girls, who are looking to move beyond Cat & Jack but aren't quite ready to move up to our juniors assortment and brands like Wild Fable. Central to the More Than Magic brand is a theme of empowerment through positive messaging on products like apparel and notebooks. In addition, based on feedback we received from both tweens and their parents, all the beauty products in this new brand are made without parabens and weren't tested on animals. We're really excited to launch this new brand in a time when many mall-based alternatives are closing their doors, and we've been very pleased with the early results since the launch. And as we look ahead, we're really excited about our plans for the third quarter where we'll continue to invest in newness across both owned and national brand assortment. As Brian mentioned, earlier this month, we expanded our pilot with Levi's, in which we're offering products with the iconic Red Tab label for the first time. Based on the success of a pilot in which we offered men's Red Tab products in 20 stores, we just added another 30 stores to the test, and we've expanded the assortment to feature items for both men and women, including jeans, tops and jackets. Of course, we're now offering the entire assortment on Target.com, and given that Levi's is one of the most searched brands on our website, we're excited to offer our digital guest access to this iconic label for the first time. Also this quarter, we're preparing to celebrate the 20th anniversary of our design partnerships, which began with our friend, Michael Graves. Then, as today, our goal was to democratize the marketplace and offer incredible design at an affordable price, something we called Design For All. So after 20 years and more than 175 different partnerships, this quarter we're going to celebrate by opening the archive and bringing back nearly 300 items from 20 past design partnerships and feature them in our anniversary collection. Prices will range from $7 up to $160 with most items priced below $50. And reflecting our commitment to inclusivity, all of the women's apparel items will be available in extended sizing. We'll feature the anniversary collection in all of our stores and on Target.com beginning on September 14. And finally, the Food and Beverage team is looking forward to the upcoming launch of our new owned brand, Good & Gather, which we just announced earlier this week. We know that Food and Beverage is a big reason our guests like shopping at Target since nearly 3/4 of our baskets have at least 1 food item in them. And driven by the improvements we've implemented over the last few years, we've been seeing consistent growth and market share gains in Food and Beverage for well over a year. To build on this momentum, it's critical that our approach to every aspect of our food offering from selection to presentation brings joy to our guests' lives. So in developing this brand, the product, design and development team is focused on delivering taste, quality and ease. And importantly, the entire assortment's made without artificial flavors, synthetic colors, artificial sweeteners and high fructose corn syrup, helping our guest to feel confident they're serving their families affordable, great tasting food that doesn't cut corners on quality ingredients. Good & Gather will become Target's flagship food brand with extensions focused on kids, organic and signature product lines. We will launch with over 650 items from dairy to produce, ready-made pastas and meats to granola bars and sparkling water. And by the full set next year, it will be 2,000-plus products strong. It will launch in all Target stores and on Target.com, the same-day delivery beginning on September 15. Before I turn the call over to Cathy, I want to pause and thank our team for their energy and focus on delivering more for our guests. After all, our brand promise starts with expect more, more newness, quality, innovation and aspiration, more value, joy and everyday surprises, more of what our guests needs and more of what they want and all at an amazing value. That's how we deliver on the pay less side of our brand promise whether offering organic pasta or a fashion item from a world-class designer all delivered at an accessible price. When you come to work at Target, the first thing you notice is the quality of the team, the passion for our business and their pride in working for this world-class company and iconic brand. Across the company, the culture of innovation is infectious and the energy of the team feels limitless. I'm so proud of what we've already accomplished, and I know there is so much more we can do in the months and years ahead. So now I'll turn it over to Cathy, who'll provide more detail on our second quarter financial performance and outlook for the rest of the year. Cathy?
Catherine Smith:
Thanks, Mark. As Brian mentioned, we saw outstanding financial performance in the second quarter as our business delivered sales growth that was in line with our expectations and bottom line results that were well above our expectations. Our comp sales growth of 3.4% on top of 6.5% last year put our 2-year stacked growth at about 10%, our best performance in more than a decade. Within our sales channels, stores comparable sales grew 1.5% and our comparable digital sales grew 34% on top of 41% growth a year ago. Among the drivers of total comp growth, we saw a 2.4% increase in traffic combined with a 0.9% increase in average ticket. We have long said that we are focused on driving traffic because it is a key indicator of Target's relevance with consumers. That's why we continue to be encouraged that traffic is growing both in our stores and our digital channels. And notably, this quarter, we were facing a really strong traffic comparison of 6.4% a year ago, meaning that our business just delivered the strongest 2-year traffic performance we've ever reported.
On the gross margin line, second quarter performance exceeded our expectations as the rate expanded from 30.3% last year, up to 30.6% this year. This was the first time in nearly 3 years that we have seen a year-over-year increase in our gross margin rate. This performance reflected the ongoing work of our merchant team to optimize assortment, cost, pricing and promotions across all of our categories. In addition, we saw about 20 basis points of benefit from category sales mix, reflecting really strong apparel performance combined with a moderating growth rate in toys and baby. These tailwinds were partially offset by about 30 basis points of pressure from digital fulfillment and supply chain costs. Even though we continue to grow digital sales at a very rapid pace, we are seeing less pressure from fulfillment costs given that we're leveraging our stores' teams and assets to fulfill the vast majority of our digital volume. And as Brian and John described, we're seeing incredibly rapid growth of low-cost digital fulfillment options, like in-store pickup and Drive-Up. As a result, gross margin rate pressure from digital fulfillment and supply chain cost in this year's second quarter was about half of the amount we were seeing a year ago. Moving down to the SG&A expense line. We saw about 50 basis points of improvement in the second quarter. This performance was also better than expected and was driven by multiple factors, including favorability in asset impairments and the timing benefit of marketing and store expenses that will come back later in the year. In addition, our expense performance continues to reflect remarkable discipline across our entire organization, which is key to sustaining outstanding performance over time. As John mentioned earlier, an important example is our store teams, who are delivering meaningful productivity improvements that are helping us to offset the impact of rapidly rising wages across the country. Our second quarter depreciation and amortization expense rate was approximately flat to last year as an increase in D&A expense dollars was offset by the benefit of higher sales. Given recent changes to our investment plans, we're now planning for higher accelerated depreciation than we originally expected for the year. One example relates to investments that will allow our stores to accommodate high volumes of pickup and Drive-Up orders during the holiday season. For stores that have particularly high volumes of pickup and Drive-Up orders, we will be deploying flexible fixtures that will allow the stores to temporarily expand our holding capacity at the front of the store during periods of peak demand. This will allow the stores to maintain their high level of performance in fulfilling pickup and Drive-Up orders, a key reason we have seen such rapid adoption of these services. In total, our business saw a meaningful improvement in our second quarter operating margin rate, which expanded about 80 basis points from 6.4% last year to 7.2% this year. As Brian mentioned, this was well ahead of our expectations, putting us in a great position to deliver outstanding financial performance for the full year. Moving farther down the P&L, second quarter interest expense was up $5 million from second quarter 2018, reflecting higher average debt balances compared with a year ago. And our income tax rate was 23%, consistent with the expected range for the year. As a result, net earnings from continuing operations grew $139 million over last year, an increase of 17.4%. At the end of the quarter, our diluted share count was about 3.8% lower than a year ago, reflecting our continued disciplined approach to capital deployment. Putting all this together, our business generated GAAP earnings per share from continuing operations and adjusted EPS of $1.82, both more than 20% higher than a year ago, setting new record highs for the company. So now I want to turn to cash flow, capital deployment and return on invested capital. But first, I want to reiterate our priorities for capital deployment, which have been consistent for decades. As we look to deploy our cash, we first fully invest in capital projects that meet our strategic and financial criteria. Then we look to support our dividend and extend our record of annual dividend increases, which we've maintained every year since 1971. And finally, we deploy any excess cash beyond those 2 uses for share repurchase within the limits of our middle A credit rating. So how have these priorities played out in 2019? Through the first half of the year, our operations have generated about $2.8 billion in cash, up from about $2.7 billion in the first half of 2018. We have deployed that cash to invest about $1.4 billion in capital expenditures, pay dividends of $658 million and repurchased $618 million of our stock. For the full year, we continue to expect to invest about $3.5 billion in CapEx, driven by our remodel program, other investments in store assets, new store openings and in our supply chain and technology capabilities. Looking beyond 2019, we anticipate a similar amount of CapEx in 2020 as we expect to maintain our current remodel pace of about 300 stores for 1 additional year. Beyond 2020, we expect to moderate the pace of our remodels to a longer-term range of 150 to 200 a year. And as a result, beginning in 2021, we expect to see a moderation in the pace of annual CapEx into the $2.5 billion to $3 billion range, closer to the level of D&A on our cash flow statement. So now I want to finish my review of our second quarter results by discussing our after-tax return on invested capital, which measures the quality of both our operating results and our capital deployment decisions. For the trailing 12 months through the second quarter, excluding discrete impacts of the 2017 tax reform legislation, our business generated an after-tax return on invested capital of 15% compared with 14.2% a year ago. This is outstanding performance, and it's even more encouraging to see the year-over-year improvement, which clearly demonstrates the benefit of our consistent, disciplined approach to capital deployment. Turning to our guidance for the back half of the year, I'll start with our expectations for comparable sales growth. As Brian mentioned, we expect our business to generate comp sales increases in both the third and the fourth quarters, in line with the 3.4% comp growth we just delivered in the second quarter. This expectation recognizes recent trends now that we've fully annualized the closure of Toys "R" Us stores as well as our bottom-up plans for sales-driving initiatives in the back half of the year. On the operating income line, we are expecting our third quarter rate will be flat to up slightly, reflecting an expected improvement in our gross margin rate, offset by pressure on the SG&A expense line. Our gross margin rate expectation reflects last year's supply chain and inventory-related pressures that we don't expect to occur again this year. On the SG&A expense line, our expectation reflects the plan's retiming of spending within marketing and our store team from the second quarter into the third quarter. And as Brian mentioned, our outlook for the back half of the year includes expected costs resulting from the most recent announcement regarding China tariff. Putting together all of our expectations, we are anticipating third quarter GAAP EPS from continuing operations and adjusted EPS of $1.04 to $1.24. For the full year, our expectations reflect strong trends through the first half of the year, the retiming of marketing and store cost into the back half of the year, updated expectations for accelerated depreciation and expected costs related to tariffs, including the increases currently scheduled for September and December. Reflecting all of these considerations, we expect to deliver full year GAAP EPS from continuing operations and adjusted EPS of $5.90 to $6.20, which is $0.15 higher than our previous range. The midpoint of this new range is approximately 10% higher than last year's GAAP EPS from continuing operations and 12% higher than last year's adjusted EPS. This is outstanding performance, ahead of our original expectations for the year. So before I turn it back over to Brian, I want to thank the entire Target team for everything they are doing to drive this outstanding performance. It reflects years of work by our team to transform our business and build a durable financial model, and it reflects our team's passion for our guests and a relentless focus on strong execution every day. When we first announced our transformation plan at the beginning of 2017, we talked about the assets we had at our disposal, including well-maintained and well-located stores, powerful owned brands, an iconic Target brand, a strong balance sheet and a business that generates robust cash flow. But what was most important both in 2017 and today is the team that powers our business. As Brian said, we're lucky to have the best team in retail, and every day, I'm grateful for the opportunity to work with them and learn from them. Now I'll turn it back over to Brian for some closing remarks. Brian?
Brian Cornell:
Thanks, Cathy. Before we move to your questions, I want to take a moment and acknowledge that my first Target earnings call was almost exactly 5 years ago today. And I think we all agree that Target has changed a lot in those 5 years. During that time, we exited our Canadian segment, allowing our teams to devote all their energy to our U.S. operations. We sold our pharmacy business to CVS, a transaction that's generated value for both companies. We rejuvenated our owned brand portfolio, launching dozens of new brands across multiple categories. We went from simply selling on a website to integrating digital within every part of our business, positioning our stores at the center of the most comprehensive suite of digital fulfillment options in the U.S. We opened about 100 small format stores, reaching new neighborhoods in dense urban areas and around college campuses. And we made significant changes to our team and how we work both at headquarters and our stores.
When I came to Target, I got an inside look at why this company had such a strong reputation for hiring and developing talent. Target has a unique and outstanding team, and I am truly grateful for the opportunity to work with them. But what's most amazing is the patience and optimism that this team has shown over the last 5 years as we've handled some significant challenges together. That's why it's so rewarding to be able to share the amazing results that this team is delivering today. At the same time, we are focused on the need to stay hungry, see around corners and continually innovate and reinvent ourselves. The pace of change in our business doesn't look like it's poised to slow down anytime soon, but I'm confident this team will continue to lead Target and the industry, allowing us to deliver outstanding results both this year and well into the future. So with that, I want to thank you for your time today, and now we'll move on to your questions.
Operator:
[Operator Instructions] Our first question comes from Chris Horvers with JPMorgan.
Christopher Horvers:
This was obviously a big quarter for investors. You lapped Toys "R" Us. You had a register a glitch on Father's Day weekend that some people pegged that 50 basis point headwind to comps, you had the weather. So can you give any -- shed any light on the sort of cadence of the quarter in light of the weather? How material was the Father's Day weekend glitch and the impact to comps? And then more broadly, the gains in apparel and continued gains in baby, what would you sort of rank order the big drivers that are allowing you to gain that share?
Brian Cornell:
Yes. Chris, I'll start. And I think as we look at the quarter, we saw very consistent performance throughout the 13 weeks of the quarter. And as I've said several times now, there's not one element that we can point to. We saw a very good response from both sides of our portfolio, both our style side and our essentials. Mark called out the strength that we saw in categories like apparel, but also strength in those household essentials that drive traffic to our stores and more and more visits to our site.
So it was a very balanced quarter, strength across our entire portfolio. And I think the team's been just very focused on executing our plans both from a store standpoint and a digital standpoint, so it all added up to a very solid quarter. We think we delivered quality results throughout the quarter that led to traffic gains, up 2.4%, very strong comps, market share gains in many of our core categories, and overall, obviously, delivered very strong bottom line performance. So I can't point to one specific element. I thought we saw consistent strength and great execution each and every day. And the investments we made in store remodels, the investments we're making in new small formats continue to perform very well. As we continue to scale and mature our suite of fulfillment options, the guest is reacting, honestly, very well to those options. We continue to see a great reaction to both our owned brands and our national brand performance. But I think our team was just focused on executing our plan each and every day, and I think it ended up with a very strong quarterly success.
Christopher Horvers:
And then as a follow-up, we're hearing a lot from the apparel set that inventories in the apparel world are bloated given some of the channel shifts that they experienced and some of the weather in the second quarter. Obviously, your inventory is flat year-over-year. But could you perhaps talk about how you look at the health of your inventory, particularly in the more seasonally sensitive areas? And frankly, given the momentum in the business, do you think that you're in a good enough in-stock position to hit your guidance expectations?
Brian Cornell:
Chris, based on the health of our business right now and the momentum we have going into the back half, we feel very good about our inventory position. Obviously, the strength of our performance in categories like apparel speaks for itself. But I think as we prepare for these big seasonal moments, I think we feel like we're in a great position for Back-to-School and Back-to-College. I would actually say it's the strongest position we've had in years as we get ready for the peak of college. And as we get ready for Back-to-School to continue to surge over the next few weeks, I think we feel very good about our position. And I think it's actually the best inventory position we've had in years in both of those categories.
Operator:
The next question comes from Kate McShane with Goldman Sachs.
Katharine McShane:
The first question I had was just about the timing of the expenses that were called out and why they shifted. And Cathy, I wondered if you could quantify how much favorability the asset impairment and the shift of expenses out of the quarter into Q3 benefited Q2?
Catherine Smith:
Yes. Happy to. So first off, the magnitude of the expenses, both in marketing and our stores, as you've seen already beginning in Q2, we've got some amazing plans in Q3. So we've shifted some expenses to support those plans. And it's probably in the 40 basis points range, maybe a little lower -- sorry, $40 million range and maybe a little bit lower going from Q2 into Q3. So that's what you're seeing in the SG&A line, reflected on the SG&A line. And then you asked about -- I'm sorry, your second question was?
Brian Cornell:
Impairment.
Catherine Smith:
Oh, the impairment. Year-over-year, we did see it reflects the strength of our business actually that we had very low to no -- very little impairments this year versus what we've seen in the previous year. And so that was actually pretty significant, and you'll see that in the Q as well.
Brian Cornell:
Kate, I'm actually glad you called that out. Actually, we were talking prior to the call. While there's lots of highlights that we've already covered in the quarter, one of the things that stands out for me is the health of our assets and the performance of our stores. And I think that showed up in the change in asset impairment during the quarter.
Katharine McShane:
That's great. And then just as a follow-up, I know the tariff situation is very fluid, but if List 4 were to come to fruition on December 15, is that something that impacts 2019? Or is it really a 2020 impact?
Brian Cornell:
Yes. Again, well, we're watching this very carefully. And obviously, we know there's been a number of shifts over the last few weeks. As it sits right now, this is largely a 2020 issue. So we've had all the current tariffs built into our guidance and our plan for the balance of the year. Mark and his team have done a sensational job of scenario planning as we get ready for the balance of this year and going into 2020. But as it's stated today, the impact of List 4 would be something that we'd realize in the first quarter 2020.
Operator:
The next question comes from Robbie Ohmes with Bank of America Merrill Lynch.
Robert Ohmes:
Congrats on a great quarter in a tricky environment out there. I was hoping to get some of you to talk more about the digital growth outlook. So digital came in I think well above what a lot of people were looking for. How should we think about that growth going forward? I think you guys had pegged it around 25% for the year. Can you do a lot better than that? And maybe an update on how many store pickup locations and Drive-Up locations you're at. Are you maybe accelerating that? And are more categories coming into pickup and Drive-Up, like fresh produce, et cetera? Just any help you can give us there would be great.
Brian Cornell:
Robby, why don't we let John kind of walk through some of the highlights of our digital performance, which again was very strong during the quarter, up 34% on top of significant growth last year.
John Mulligan:
Yes. Robby, good question on the kind of the same-day fulfillment. We're really excited about what we continue to see there across pickup, Drive-Up and Shipt. About 3/4 of the digital growth was represented by same day. It's 1/3 of the business now and growing very, very quickly. So we're excited about that.
Pickup is nationwide, and it has been nationwide for several years. Drive-Up is very close to being nationwide. We'll be largely done here as we get through third quarter. And your question about fresh is a good one, something we're working hard on, piloting here in the Twin Cities and looking to understand the operational needs there a little bit more as we get through the back half of this year, and then be back to tell you more about how we plan to scale that as we get into early next year. But I think when you put those 3 together, Drive-Up, pickup and Shipt, you've got a great offering that our guest is clearly responding to. They are our cheapest fulfillment methods, so most profitable for Target. They are our fastest. And we really see guest adoption taking off. So we're excited about the combination there.
Brian Cornell:
Yes. So Robby, as we noted during our prepared remarks, they represent 1/3 of our fulfillment, and it's growing at a rate of 2x versus last year. And as we continue to build awareness through our marketing campaign, what we're doing from an in-store standpoint, our network standpoint as well as our digital communication to the guest, we're building awareness, and we're seeing continued growth in that space. So we'd expect those fulfillment channels, which obviously, are the most profitable way to fill digital orders, to continue to grow over the balance of the year.
Robert Ohmes:
And then I apologize if I missed it, but what number roughly or range should we be assuming for digital growth for the year?
Brian Cornell:
Robbie, it's something that we do not provide guidance around. But what we said for a number of years now is we expect to outgrow the overall industry by at least a rate of 2x. And as you've seen recently, we've been growing at 3x the average rate of the digital growth in the industry.
Operator:
The next question comes from Peter Benedict with Baird.
Peter Benedict:
Maybe a question for John. Can you give us a little more color on the store operating model that was kind of rolled out here? Just curious any more detail you can give us on how the operations are changing either front end or back end? Just curious what you can add there.
John Mulligan:
Yes. This is a journey the store team has been on for several years and really around raising our level of service in the stores. The biggest change is around the actual operating model itself. Historically, we kind of had a jack-of-all-trades model. You'd be a cashier one day, go do price change, go do some planogram sets. Whatever we needed, you would do in general.
Today, we've gotten far more specialized. So people in the food area actually can speak about perishable. They're doing the ordering. They're responsible for that area. They're responsible for the out of stocks. Same for beauty, they can talk to our guests about beauty. They're in that area all day long. It's the only area they work in. They're responsible for the inventory that sits in the backroom related to that area and keeping the floor full and interacting with our guests. In apparel, more style, right, digital merchandisings, people who can make the great products that the merchants are developing look great in the store. In electronics, lots of product information. So a significantly higher level of expertise across the store in the categories where we need it. And then across the rest of the store, places like essentials and some of the dry goods, just keep it full all day long. That's your job, keep the store full. And so we're excited about actually implementing that across the chain this quarter. The teams continue to work through that, but the early results are very positive.
Peter Benedict:
That's great. That's helpful. And then maybe for Mark, there's been a number of owned brand introductions over the last year or 2, a very healthy pace. How do we think about that going forward? Does that continue? Or have you guys reached the point here where you've addressed the areas and you're going to just see how a lot of these kind of play out?
Mark Tritton:
Yes, Peter, I think we addressed this last quarter as well. I mean we expect the rate of change in newness to abate, but still sustain a level of newness to create interest for our guests. I think one of the things we're most buoyed by out of this quarterly performance has been a high degree of owned brand launches specifically in our home areas last year, and we had really strong traffic in growth, yet we're anniversarying that yet another quarter. And I think it just goes to show the building blocks that these owned brands build for us in terms of preference to Target but also help us create sustainable growth and long-term value.
Brian Cornell:
Yes. So Peter, you will expect to see the rate of new brand introductions slow. But Mark and his team are very focused on bringing newness and innovation to the owned brands that we've launched over the last couple of years. So we'll continue to make sure those brands are on trend. We bring newness and freshness to those brands that have been successfully launched over the next couple of year -- over the last couple of years. And Mark and his team are really excited about some of the innovation we'll bring to those lines in 2020 and beyond.
Operator:
The next question comes from Greg Melich with Evercore ISI.
Gregory Melich:
Really 2 areas I wanted to dig into a little bit. One is on tariffs. Just to clarify, it looks to us that for List 4 for you guys might be 80% of what you import or you would have seen some experience from Lists 1 to 3. Is that the right sort of mix, 80-20, is the List 4 versus the first list? And then I had a follow-up on digital.
Brian Cornell:
Greg, why don't we follow up with you off-line? That number is overstated. We'll circle back. But as we've said before, we've got a very balanced portfolio. Our sourcing teams have been working to diversify our network for a number of years now. But we'll come back and try to address some of that off-line.
Gregory Melich:
Okay. Fair enough. On the digital, I did want to understand a little bit more just given that strength of traffic, about the nature of the customer. I see REDcard has been sort of flat, but you're -- are you getting a higher spend per trip from people using same day? Is it existing customers coming more frequently? Are you finding new customers as a result of this?
Brian Cornell:
Greg, one of the things that we've highlighted now for several quarters is the strength in our traffic growth. And Cathy talked about the fact that in this last quarter, it is a record-high 2-year stack for traffic growth. So we're seeing our Target guests visit us more frequently, shop more categories. They're enjoying the changes we've made and the store experience, but they're also taking advantage of the convenience fulfillment options that we're offering.
So as we look at the profile of our guests, they're still shopping our stores on a regular basis. But now we also gave them the convenience of ordering online and picking up in their neighborhood store. In over now 1,550 locations, they can place an order and pull into our parking lot. We have Shipt shoppers that will deliver within a couple of hours to their home. So we're seeing traffic and interaction and engagement with our brand continue to grow. And I think it's that wonderful combination of a great store experience, the suite of fulfillment capabilities that we're now offering that's driving greater engagement and greater traffic and visits to our stores and to our site.
Operator:
The next question comes from Chris Mandeville with Jefferies.
Chris Mandeville:
Just sticking with the digital conversation, since you've already referenced your performance versus expectation and gave us a little color right there from Greg's question, I guess, I was just kind of curious about how same-day specifically is contributing to the comp. It was roughly, I think, 50% last quarter, now over 80%. Is there any way of breaking down the service modalities between pickup, Drive-Up and Shipt and they're contributing there? And then, Cathy, how did the service models in aggregate influence the margin in the quarter?
Brian Cornell:
Well, I think we've said during the prepared comments that we're seeing honestly exceptional growth in our lower-cost digital fulfillment options. And one of the things that John pointed out very clearly during our last financial community conference is, as we shift our fulfillment from upstream DCs to our stores, we see our costs go down by upwards of 40%. When it moves to one of our same-day options, pickup in store, Drive-Up or Shipt, we see a 90% reduction in that cost. So obviously, as we're seeing the acceleration of our same-day convenient options, more guests opting to order online and pickup or use Drive-Up or Shipt, we're seeing the benefits of that flowing through our P&L.
Catherine Smith:
Yes. So I was going to add on, as we shared in the prepared remarks, we're seeing, because of that shift, almost half the pressure that we saw the same time a year ago on our gross margin. So we saw -- we showed 30 basis points of pressure for fulfillment and supply chain cost this quarter, and that's almost half of what it was last year. So we're seeing that movement and the adoption towards those same-day services are closer to the store.
Brian Cornell:
I think it might be helpful, John, go back and talk about some of the things we're doing from a productivity standpoint and efficiency standpoint at the store level to make sure that as we fulfill those orders, we're driving even greater productivity and efficiency throughout our system.
John Mulligan:
Yes. I think the store teams have done an outstanding job of initially getting these services up and running and providing a great guest experience. That's the place to start always and that's what they did. I think since that time, as we've begun to roll -- I mean, we have rolled these out and scaled them, the stores have done a great job going back, process re-engineering, adding tools, adding technology to make all that easier and faster for our teams. And so we talked about just the pick for Order Pickup and Drive-Up is 30% more productive this year than it was. Across the entirety of ship-from-store, it is 30% more productive than it was. And the stores, we continue to work on additional ways to be more productive, add technology, potentially add some additional automation in the back of the house to help them become more productive.
So while we love the shift to the same-day experience because that is net better economics, we're also working hard within each one of those services to optimize the unit economics. And so great progress by our stores team.
Operator:
Our last question comes from Michael Lasser with UBS.
Michael Lasser:
Could you unpack the gross margin commentary about merchandising efforts to optimize cost, pricing, promotions and assortment? And the reason why is because I think there are questions about the sustainability of those factors. It does seem like you're expecting those to continue to drive benefit given your commentary around gross margin in the third quarter.
Catherine Smith:
Yes. I'll start and Mark can add on to it. So first off, we had a terrific performance across the board by our team. So our merchant team, from assortment to cost to price to promo, they managed the business throughout the entire quarter from the beginning of the quarter with vineyard vines through Back-to-School, Back-to-College with a cyber event in the middle. So amazing performance across the border -- across the board. And by the way, we've got tremendous plans for Q3 and Q4 as well. So I would tell you that they're sustainable type of efforts that we continue to do. And then we've got a little bit of favorable mix with the strength of the apparel and the apparel categories and a little softening of the growth of toys and baby as we've now anniversaried the Toys "R" Us and Babies "R" Us exits. And so the combination of those gave us that really strong performance in gross margin this quarter.
Mark Tritton:
And Michael, I mean, clearly, our owned brand strategy is working, and the marginal contribution is a benefit there. But I think that the agility and strength that Jill Sando and team brought to the apparel business in the quarter to the inventory management, markdown management and sales and share gains is definitely one of the strong contributors in our mix. But overall, everyone pulled weight and we had a great quarter.
Brian Cornell:
So Michael, it's probably a good place for me to wrap up and really complement Mark and his entire merchandising team for the work that they've done. Now we've been talking now for multiple years about the benefits of our multi-category portfolio, and I think we're seeing that play out each and every quarter. It was a couple of years ago when we talking about the investments we made to be priced right daily, and our guest is responding to that and that's certainly flowing through into gross margin. So I think the exceptional work that the team has done to strengthen all facets of our portfolio, both our style and essential categories; the strength we're seeing across our multi-category portfolio; certainly the market share gains we're seeing in important categories like apparel; and combining that with the everyday value we're offering to our guests, being priced right daily is contributing to the margin stability and improvement we're seeing in recent quarters. So compliments to Mark and the entire merchandising team for the work that they've done. But the guest is recognizing it, and I think again, it's contributing to the traffic gains we're seeing in our stores, like increased visits to our site and the flow through that we're seeing throughout our P&L.
So it's a great way for us to wrap up this call. I appreciate everyone dialing in this morning, and we look forward to talking to you next quarter. So thank you.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation first quarter earnings release conference call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, May 22, 2019.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our first quarter 2019 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; Mark Tritton, Chief Merchandising Officer; and Cathy Smith, Chief Financial Officer.
In a few moments, Brian, John, Mark and Cathy will provide their perspective on our first quarter performance, our outlook and progress on our long-term strategic initiatives. Following their remarks, we'll open the phone lines for a question-and-answer session. This morning, we're going on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer your follow-up questions. 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 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 our first quarter performance and our outlook for the rest of the year and beyond. Brian?
Brian Cornell:
Thanks, John. We're really pleased with our first quarter financial performance, which reflects continued progress on the strategic initiatives we began rolling out more than 2 years ago. Since that time, we've seen a meaningful acceleration in our business. In fact, the first quarter marked Target's eighth consecutive quarter of comparable sales increases.
In the first quarter, comparable sales growth of 4.8% was a bit ahead of our expectations. As Mark will cover in more detail, this was driven by broad strength across all our merchandising categories, particularly in Toys and Baby. We also saw strength across channels in the first quarter. Store comparable sales were up 2.7% while comp digital sales were up 42%, adding 2.1 percentage points to the company's comp growth. As John will cover in more detail, we're seeing a really positive guest response to our same-day digital fulfillment services, which drove well over half of our digital sales growth in the quarter. Our ability to offer these same-day services, which deliver high levels of satisfaction, is a result of our strategy to put stores in the center of fulfillment. In fact, our stores handled more than 80% of our first quarter digital volume, including all of our same-day options combined with digital orders shipped directly from stores to guests' homes. Across both our stores and digital channels, sales growth continues to be driven primarily by traffic. Specifically in the first quarter, comp traffic was up a very healthy 4.3% on top of 3.7% a year ago. On the bottom line, our first quarter performance was also stronger than expected. Against an expectation for a slight rate decline, our operating margin rate increased about 20 basis points in the quarter. This performance reflected the benefit of disciplined expense control combined with a favorable mix of digital fulfillment. Altogether, the first quarter earnings per share grew more than 15% at the top end of our guidance range. In our final Financial Community Meeting in March, we talked about our work over the last few years to create a durable model for Target, one that will drive continued engagement and relevance with consumers and support a financial model based on growth on both the top line and the bottom line. In the first quarter, we saw the benefit of this new model. Early in the quarter, we experienced some choppiness in daily sales results driven by unfavorable weather conditions in different parts of the country. And towards the end of the quarter, we saw the impact of late spring weather in our seasonal businesses. Against this backdrop, our business performed really well, benefiting from multiple drivers, including strong holiday performance in the Valentine's Day and Easter periods, along with the reliable everyday traffic in our Food, Beverage and Essential categories. Beyond short-term weather fluctuations, we continue to see a healthy economic backdrop for our business, which is evident across multiple metrics, including employment, wage growth, consumer spending and overall sentiment. Against this backdrop, Target continues to grow traffic and sales more quickly than the market, resulting in share gains across all of our key merchandising categories. And while the team has accomplished an incredible amount over the last few years and we're pleased with our current performance, we are not slowing down. Our stores and supply chain teams continue to roll out and scale up an interesting leading suite of digital fulfillment options. And as John will cover in more detail, our guests are responding enthusiastically, driving rapid growth of our same-day options, including Drive-Up, in-store pickup and Shipt. At Shipt, we continue to grow the number of marketplace participants, driving scale and relevance to the platform. In the first quarter, both CVS and Petco launched nationwide on the Shipt marketplace. Our merchandising teams continue to deliver newness through existing brands while adding new brands to supplement our assortment. In the first quarter, the team launched 3 new owned brands in intimate apparel; a new natural owned brand in Essentials; innovative national brands, including Flamingo and Welly in personal care; and our new Home brand, Sun Squad, to help our guests celebrate the summer season. Our property teams continue to rapidly transform our store network. The team completed another 53 remodels across the country in the first quarter, and they're on track to deliver approximately 300 remodels this year. Guests continue to respond to these projects by shopping the remodel stores more often, driving incremental traffic and sales. And finally, our team opened 7 small formats across the country in the first quarter, allowing Target to serve new neighborhoods in metro areas like New York, Los Angeles, Chicago and Washington, D.C. and new markets like Santa Barbara, California. Before I turn to the outlook, let me comment briefly on the topic of tariffs. As you know, the trade situation has been fluid for some time, and we've been carefully monitoring negotiations to assess potential implications and our point of view has been consistent for some time. As a guest-focused retailer, we're concerned about tariffs because they lead to higher prices on everyday products for American families. Our team continues to monitor trade negotiations and develop contingency plans to help mitigate the impact of tariffs on our guests and on our business. It's important to note that Target's multi-category portfolio remains a competitive advantage. When there are external impacts to one business area or category, we're able to balance the impact across our business in ways not available to a single-category retailer. And as you see in our recent results, the teams has been able to manage through last year's tariffs with minimal impact, and we have plans in place to mitigate the impact of additional tariffs already scheduled for next month. As always, we remain focused on being priced competitively every day, delivering value for our guests while judiciously managing our margins. With that, let me turn briefly to our outlook, and Cathy will provide more details in a few minutes. For the second quarter, we're looking to deliver a low to mid-single-digit increase in our comparable sales. This expectation is a bit slower than our first quarter pace given that we're about to annualize over last year's closing of Toys "R" Us and Babies "R" Us stores across the U.S. On the bottom line, we expect to generate a mid-single-digit increase in operating income dollars, which will translate to even stronger growth in earnings per share. For the full year, we're maintaining our expectations for both comparable sales and earnings per share. The first quarter was a great first step in delivering our full year guidance, giving us continued confidence in our ability to deliver outstanding performance in 2019 and beyond. So now before I turn it over to John, I want to thank the entire Target team for their continued passion and tireless focus on delivering for our guests. It's because of their hard work that we're able to share these outstanding results with you today. Each and every day, I'm energized and grateful to work with this amazing team. Now I'll turn it over to John, who'll talk in more detail about our efforts to elevate the shopping experience for our guests regardless of how they choose to shop. John?
John Mulligan:
Thanks, Brian. As you know, for several years now, we've been focused on building and rolling out a comprehensive set of digital fulfillment capabilities, allowing us to provide our guests a convenient fulfillment option for every shopping journey. As a result of those efforts, Target now offers more digital fulfillment options across more of the country than anyone else in retail.
Think about it, when guests are planning on being out in their neighborhood, they can shop on their digital device, and we hand them their order in an hour or 2. We offer in-store pickup in every one of our 1,851 locations, and we walk the order out to the parking lot in more than 1,250 of them. There are no fees for either of these same-day options. And of course, guests in more than 1,500 stores across more than 250 markets can order from Target through our Shipt personal shopping service and have their order delivered to their front door, kitchen table even their refrigerator if they want in only an hour or 2. Shipt offers unlimited free same-day deliveries from Target and more than 50 other retailers across the country for a $99 annual fee. There are nearly 100,000 Shipt shoppers delivering orders across the country today, and it's still growing rapidly as we welcome new marketplace partners and expand into new markets. In dense urban areas where we're building small-format stores, we offer a service in which guests who shop in store can ask us to hold their basket at checkout and deliver to their front door later that same day in a time window of their choosing. For this service, we charge a flat fee of $7 with no annual fee, and our guests love it. Once we solve the problem of carrying the order home, it frees them up to shop more, a lot more. Average basket size on these orders is more than 5x bigger than the average for these locations, and they include a very strong mix of items from our Home category. Beyond all these same-day options, when guests need to replenish their pantry, they can order a 45-pound shopping cart size box of essentials, and we'll deliver it the next day. For this service, we charge an industry-leading delivery fee of only $2.99 with no annual fee. And of course, guests can shop target.com on their desktop or mobile device, and we'll deliver their order to their front door in 2 days or less. There's no annual fee, and we don't charge a delivery fee if you have a REDcard or meet a $35 order minimum. To support all of these options, same day, next day, 2 day, our strategy puts our store teams and physical assets at the center of the bull's-eye. Now of course, like everyone else, a portion of Target's digital orders are and will continue to be shipped from upstream fulfillment centers. And other items will continue to be shipped directly by our vendors. But given our strategy, assortment and the way our guests like to shop, the vast majority of our digital orders are already being handled by our store teams, whether that means shipping packages out of the back of the store, delivering orders at the front of the store or in the parking lot or having a Shipt shopper bring it to their front door.
Despite the success we're already seeing, we continue to hear questions about the long-term viability of keeping our stores at the center of fulfillment. Our answer is empathic:
We are confident that this is the best long-term solution for Target. But I also want to emphasize that this is already a highly effective strategy today. Digital accounted for more than $5 billion of Target's sales last year, and our stores fulfilled about 2/3 of that volume. This year, given our digital growth trajectory and the rapid adoption of our same-day services, we are on track to grow Target's digital sales by more than $1 billion in 2019 and fulfill an even higher percentage of this volume from our stores. So I want to emphasize that we're not talking about a theory. This is reality today, and it's a meaningful and growing part of our retail business.
We've said many times that using our stores as digital hubs enhances our speed and reduces costs. And importantly, moving to store fulfillment does not increase the frequency of split shipments. In fact, even though store fulfillment continues to grow rapidly, the rate of split shipments this year is running lower both in our stores and in total compared with last year. Let me add quickly. Like everyone else, we have a continued opportunity to realize cost savings by reducing the frequency of split shipments even more. That is one reason why we are focused today on developing an enhanced inventory planning and control system, which will deliver increased precision in our inventory allocation, reducing the number of occasions when a split shipment is needed. Importantly, from a guest perspective, moving fulfillment into stores has delivered high levels of satisfaction. Specifically, we are seeing stable to improving Net Promoter Scores on mature fulfillment capabilities like pickup and ship to home. And we're seeing unusually high Net Promoter Scores for newer same-day services like Drive-Up and Shipt. One reason for high guest satisfaction is that store fulfillment increases our reliability. At our contact centers, which handle guest questions about their digital orders, we've seen meaningful declines in our contacts per order and contacts per unit even as we have rapidly launched new services and moved the bulk of fulfillment into our stores. In fact, contacts per unit in 2019 have been running 50% lower than we were seeing only 2 years ago. Given the high level of satisfaction associated with our new fulfillment options, we're also seeing a rapid change in the mix of our digital sales. Specifically, in the first quarter, well over half of our digital growth was driven by same-day fulfillment options, in-store pickup, Drive-Up and Shipt. Put another way, these 3 services drove more than 1/4 of our total company comp growth of 4.8%. Importantly, our analysis indicates that the new services like Drive-Up and Shipt are driving incremental trips for Target rather than simply replacing other forms of shopping. Specifically, first quarter digital sales from in-store pickup increased more than 80% from a year ago even as Drive-Up and Shipt grew even faster. And let's not forget the conventional in-store shopping, which continues to account for the vast majority of our sales, continues to see increased traffic and comp sales as well. This reflects a key aspect of our strategy. While we quickly establish ourselves as a leader in terms of convenience and digital fulfillment, we are equally focused on maintaining the leadership position of our in-store shopping experience. That's why we're remodeling 300 stores a year, keeping us on track to complete 1,000 remodels by the end of next year. These projects elevate the look and feel of the store, create more compelling displays in key categories like Apparel, Home, Beauty and Food and Beverage, and reconfigure space in operations to support all of our new digital fulfillment options. Remodeled stores continue to experience incremental sales in the year following completion of the remodel, and we've been measuring another incremental growth in the second year as well. Beyond the physical environment, we're making significant changes to the operating model in our stores, finding efficiencies that reduce nonguest-facing activities and allow us to devote more hours to helping our guests. We are staffing our stores with category experts in areas like Apparel, Beauty, Electronics and Food and Beverage who can move beyond task and share their expertise with guests, providing advice and perspective to help them find the best products to meet their needs. Some of these experts were already on our team, but this new model allows them to focus on their passion rather than serving as a general athlete across multiple categories. In other cases, we're hiring category experts, who have gained experience at other retailers and who are excited to come to our team and participate in our growth. And all these changes have been enhanced by our commitment to reach a national minimum wage of $15 an hour by the end of 2020. Only a couple of years ago, Target's national minimum was $10 an hour. That has already increased to $12 today, and we announced that we're moving to $13 next month. While this decision obviously involve some cost pressure, we have successfully controlled expenses to manage the P&L impact even as we've added guest-facing hours in our stores. Looking ahead, our work on store replenishment will deliver additional cost savings as we move store backroom activities upstream into our distribution facilities and those facilities where we realize scale efficiencies and automate a portion of those tasks. Over time, this work will enhance our inventory allocation, delivering higher in stocks while reducing safety stock across the chain. And it will free up additional space in our stores to accommodate further growth in digital fulfillment. These replenishment efforts are still in the early stages, and it will take years, not quarters, to roll out this new model across the chain. But we are very encouraged with the results we are seeing in our test of this new model in Minneapolis and our Perth Amboy facility. And we'll continue to test and learn as we expand this model to more of the chain over the next several years. So before I turn the call over to Mark, I want to pause and thank our team for all the amazing results we're seeing across the business. These results were years in the making, and a lot of our teams' efforts were behind the scenes. But those efforts were necessary to create the strong foundation that's enabling everything we're seeing today. Clearly, our guests are happy with the results, which was evident in our strong performance on both the top line and bottom line in the first quarter. Mark?
Mark Tritton:
Thanks, John. As Brian mentioned earlier, we are really pleased with the quality and breadth of the growth we've been seeing across our business, and that is certainly true of our category performance. For more than a year now, we've been seeing broad sales strength and market share gains across multiple dimensions, including both our style and frequency businesses during holiday periods and in between, across both owned brands and national brands and all 5 of our core merchandising categories. Across our core categories, we saw the strongest first quarter growth in our Essentials and Beauty and Apparel categories, both of which saw comp growth of more than 5%.
In Essentials and Beauty, which comped more than 7%, results were led by Baby, over the counter and Beauty and Cosmetics. In Apparel & Accessories, we saw particular strength in intimates and sleepwear, Baby and swim. Among our other core categories, comp growth was about 3% in each of our Food and Beverage, Home and Hardlines categories. Within Food and Beverage, we saw growth in every subcategory, but it was the strongest in adult beverages, which comped mid-teens this quarter. In Home, results were led by kitchenware, storage and décor. And in Hardlines, results were led by double-digit growth in Toys.
To build on this strong performance, we continue and invest in newness and differentiation both in existing brands and by launching new ones across our curated assortment. In the first quarter, we completely transformed our assortment presentation in intimates and sleepwear and launched 3 new brands:
Auden, Stars Above and Colsie. All 3 of these new brands are size inclusive and designed to make guests at any age feel confident and comfortable.
In addition to launching these brands, we redesigned both the digital and in-store shopping experience in ways designed to make shopping easier and more inspiring. The guest response to these changes has been phenomenal. And as I already mentioned, these categories delivered standout performance in the quarter. In Essentials last month, we launched a new natural owned brand, Everspring. This entire line of more than 70 items is made from plants, renewable materials and recycled paper. The packaging includes graphic icons that allow guests to quickly understand product attributes and what ingredients are not in the formulation. In fact, all Everspring products qualify for Target Clean, a new symbol we have designed to both simplify and indicate products formulated without chemical ingredients that guests may want to avoid. Everspring products were developed by our internal design team and feature carefully selected scent profiles, including citrus and basil. Prices in the assortment range from $2.99 up to $11.99, and the entire assortment on average is priced nearly 20% below comparable products in the marketplace. This new Everspring initiative complements other strong Q1 launches that are exclusive to Target natural brands, like Flamingo and Welly that Brian mentioned earlier. In February, we announced that we were introducing toddler sizes into our art class brand, which we first launched in 2017. Art Class brings a versatile, fashion-forward aesthetic to kids' apparel, and we know that many parents are looking for a diverse range of styles and aesthetics for their younger kids as well. We're excited to feature this new toddler assortment in more than 1,100 of our stores and on target.com at a time when many competitors in this category are closing their doors. And we also recently introduced a new seasonal owned brand, Sun Squad, to help guests celebrate the pure joy of summer. Again, developed by our internal design team, this assortment features more than 600 items from pool floats to larger-than-life sprinklers, beach totes and coolers designed to encourage families to get outside, create lasting memories and make the most of the summer season. We've priced these items to deliver amazing value with some items priced below $2. And in Food and Beverage, following the wildly successful launch of our California Roots brand, we recently added The Collection to our wine assortment. The Collection brand offers high-quality wine at an affordable price, combining the very best of carefully harvested grapes featuring 5 premium varietals at $9.99 per bottle. And last week, we're excited to announce that we're introducing men's grooming items under our Goodfellow & Co brand name. This men's brand has seen an amazing response since we launched it in the fall of 2017 driving strong market share gains at our men's apparel assortment. Given that men are increasingly doing their own shopping for grooming and personal care items, we want to ensure the Target is their destination for those categories. The assortment here features more than 30 products priced between $3.99 to $16.99 and again positioned about 20% lower than comparable men's premium brands. And finally, of course, we just launched our much-anticipated limited-time collection of products from vineyard vines. This collection of more than 300 items includes apparel, accessories and swim for the whole family, along with a distinctive assortment of home and outdoor items. The style is unmistakable, and the prices are amazing, ranging from $2 to $120 with the majority of items priced below $35. We launched this collection last weekend in all our stores and on target.com, and we maximized the impact by presenting all the assortment together near the front of our stores. The response both in our stores and online exceeded our expectations, and our team did a great job accommodating the surge in traffic. Altogether, the vineyard vines launch is already one of the most successful in our history. When you combine that insight with the better-than-expected results we're seeing from our owned brand and exclusive brand launches, you gain a deep appreciation of how our guests respond to newness and inspiration in our assortment. So I want to thank my team for everything they're doing to deliver the results we've been seeing across the whole team, design, sourcing, buying, operation. And that thanks extends to all of our vendor partners, too. I'm really excited to see their alignment, their energy and their collaborative passion to inspire our guests. It's because of their work that we're so confident as we look ahead. We're ready for the upcoming holiday and seasonal events, including Memorial Day, Father's Day, the 4th of July and the beginning of Back-to-School. But we're also focused on the categories that sustain our business in between these life events, including our Essentials and Food and Beverage categories. These categories are the focus of our Target Run and Done marketing campaign and our continued work to ensure we remain priced right daily. When we incorporate our merchandising efforts into all the other initiatives that are driving our business, remodeling our stores, delivering convenience with new fulfillment options, elevating service in our stores, reaching new neighborhoods with our small format stores, something really special happens for our guests. Target becomes more relevant to them, and they choose to shop us more often. Guest traffic is the ultimate reward for our efforts. With that, I'll turn it over to Cathy, who will provide more detail on our first quarter financial performance and outlook for the rest of the year. Cathy?
Catherine Smith:
Thanks, Mark. As Brian mentioned, our first quarter financial performance was ahead of our expectations on both the top line and the bottom line. Our comparable sales growth of 4.8% was on the strong end of our expectations for a low to mid-single-digit increase, and our EPS of $1.53 was just beyond the top end of our expected range.
Store comparable sales growth of 2.7% drove just over half of the total company comp, while comparable digital growth of 42% contributed another 2.1 percentage points. Among the components of comparable sales, first quarter traffic growth of 4.3% was the primary driver, combined with an increase in average ticket of 0.5%. Our first quarter gross margin rate of 29.6% was about 20 basis points lower than last year. Among the drivers, digital fulfillment and supply chain costs accounted for about 50 basis points of pressure, which was offset by about 30 basis points of benefit from merchandising initiatives implemented by Mark and his team. Our first quarter SG&A expense rate of 20.8% was about 30 basis points better than a year ago. This rate improvement was better than expected and driven by a number of factors, including a small benefit from the timing of marketing expense compared with last year, along with cost efficiencies in our technology operations. Overall, we saw excellent cost control across the company, which allowed us to offset continued pressure from higher wages across the country. As expected, we also saw a small leverage benefit on depreciation and amortization expense in the quarter. Altogether, our first quarter operating income margin rate was about 20 basis points better than a year ago and better than our expectation for a small rate decline. As a result, first quarter operating income dollars were 9% higher than a year ago. Interest expense of $126 million was $5 million or 3.3% higher than last year, and our effective tax rate from continuing operations was essentially flat to last year. Diluted shares declined about 4% compared with a year ago, reflecting the continued benefit of our disciplined approach to capital deployment. Altogether, our GAAP earnings per share from continuing operations of $1.53 were 15.1% higher than a year ago, while adjusted earnings per share of $1.53 were 15.9% higher than last year. Turning to cash flow. Our operations generated more than $300 million of cash in the first quarter. This was down from a year ago as the benefit of higher profitability was more than offset by a decline in payables. This quarterly result was a timing issue related to our elevated inventory position at the beginning of the quarter. For the year in total, we expect to maintain payables leverage at approximately the same rate as in 2018 and generate strong cash flow from operations. We deployed first quarter cash from operations, proceeds from debt issuance and cash on hand to fund $655 million of CapEx, $330 million in dividend and the repurchase of $277 million of our shares. We were pleased with the results of our March debt transaction in which we issued $1 billion in 10-year debt ahead of our upcoming $1 billion maturity in June. This deal benefited from our strong credit ratings and the current momentum in our business, which allowed us to price the notes very attractively. And finally, I want to close my discussion on the first quarter with an update on our after-tax return on invested capital. Excluding discrete tax benefits from federal tax reform in both years, our trailing 12-month after-tax ROIC was 14.1% in the first quarter compared with 13.5% a year ago. We're pleased with both this absolute performance and the relative improvement from a year ago as we continue to focus on driving long-term value through our operating and investment decisions. Now let me turn to our guidance for the second quarter and the rest of the year. As Brian mentioned, we expect to deliver a low to mid-single-digit increase in our second quarter comparable sales. We expect this will be somewhat slower than our first quarter comp growth given that the tailwind from Toys "R" Us and Babies "R" Us will annualize in a few weeks. We expect a slight amount of leverage on our operating income margin rate driven by relatively small changes in our gross margin, SG&A and D&A expense rates. This performance would lead to a mid-single-digit increase in second quarter operating income dollars and EPS performance in a range centered around $1.62. At the midpoint of this guidance range, we would deliver high single-digit growth in GAAP EPS from continuing operations and double-digit growth in adjusted EPS. For the full year, we are maintaining our previous guidance for both comparable sales and EPS. The strength of our first quarter performance has reinforced our confidence that we can meet or exceed these full year expectations, and we are looking forward to delivering strong performance in 2019 and beyond. As I've mentioned before, we have made a lot of progress in the 2 years since we initiated a number of important changes to our operating and financial model. We made to these changes to accelerate our progress in rolling out new fulfillment options to rapidly improve our own brand assortment, transform more of our stores faster and, perhaps most importantly, accelerate investments in our team. At that time, we told you we were confident that these were the right decisions to change the pace of our near-term performance and position Target for long-term success. We also expressed confidence that an acceleration in our operating performance would translate into strong financial performance following the transition to this new model. And today, it's great to be able to go beyond expressing confidence and actually demonstrate how this new operating model is successfully delivering relevant growth and profitability. I'd like to thank our team for their work to enable this strong performance and to everyone on the call for continuing to follow us on this journey. Now I'll turn it back over to Brian for some closing remarks. Brian?
Brian Cornell:
Thanks, Cathy. In a moment, we'll move to your questions, but I want to spend a minute and wrap-up with what we covered today. And what I hope you've heard today is that we're really happy with the path we're on, a path again well over 2 years ago. And today, our business is generating strong performance across the board from traffic and sales to operating income and EPS.
To get to where we are today, we decided to make some bold changes over the last couple of years, but I want to emphasize something important about those decisions. When we made them, we explicitly focused on taking a different path than our competitors. We said we would open stores when others were closing them. We said we'd invest billions of dollars in our shopping experience and in our team when others were pulling back. We said we'd use our stores as digital hubs because it delivers speed and convenience for our guests, and it aligns with our digital strategy. We said we'd invest in differentiation when others were simply looking for scale. And we said we'd maintain our balanced, multi-category assortment, one that's unique in U.S. retail. So when we get asked today why aren't you doing what others are doing? The answer always starts with the fact that we're not trying to be like everyone else. At Target, we perform best when we're pursuing our own path, not when we are chasing someone else. And our first quarter performance is a clear example of the benefit of that approach. So with that, I want to thank you for your time today. And now we'll move to your questions.
Operator:
[Operator Instructions] Our first question comes from Edward Yruma with KeyBanc Capital Markets.
Sarah McCann:
Great. This is Sarah McCann on for Ed. Can we click down on where you saw the cost savings in the tech expense bucket that drove some of the SG&A leverage in the quarter. And then how would you score your ability to offset those digital fulfillment and supply-chain costs going forward?
Operator:
We are experiencing technical difficulties. You will hear silence until the conference resumes.
[Technical Difficulty]
Operator:
Thank you all for standing by. The call will now resume. And our first question was coming from Edward Yruma with KeyBanc Capital Markets.
Sarah McCann:
This is Sarah McCann on for Ed. We were just hoping to click down a little bit more on where you saw the cost savings and the tech expense bucket that drove some of the SG&A leverage in the quarter. And then how do you score your ability to offset those digital fulfillment and supply-chain costs going forward this year?
Catherine Smith:
Sarah, I'll quickly answer that. This is Cathy. As we said on the -- in the prepared remarks, we did see some favorability in our tech operations. As you know, they continue to be working on just the most important things and then being really effective and efficient in their work. So that's providing some benefit. We saw some general cost control across the entire company. We saw some marketing timing, and we saw that being offset by some of the wage pressure we were seeing. All of that said, plus 30 basis points improvement in year-over-year SG&A.
Brian Cornell:
And Sarah, why don't I have John Mulligan spend a few minutes talking about the benefits that we're seeing as fulfillment moves to some of our same-day services.
John Mulligan:
Yes, I think the thing we're most excited about in the digital business, Sarah, is that just guest preference, as we observe it, the fastest-growing things -- the fastest-growing services we provide are in same day, that's Order Pickup, Drive-Up and Shipt. Those are also our most profitable services that we provide through the digital channel. So as they continue to grow meaningfully faster than the rest of digital, we expect our digital profitability to improve. So we're really excited because the guest preference is meeting up with exactly the capabilities we have, and they happen to be the most economically feasible for us going forward.
Operator:
The next question comes from Chuck Grom with Gordon Haskett.
Charles Grom:
Congrats on a good quarter. Just to follow up on that. John, the digital fulfillment cost have been kind of running in the roughly 50 bps -- 70 basis points of pressure over the past few quarters. Would you expect that to begin to abate given that the penetration of the more profitable parts of the digital business are going to start to grow?
And then, Cathy, just as a follow-up, could you just review the second quarter margin assumptions again for us? I know you're saying slight leverage on the operating margin line, but I didn't hear the exact components across gross margins, SG&A and depreciation.
Catherine Smith:
Yes. Let me start. So for second quarter, we said that we would see slight leverage in our operating income margin, so just a little bit there, and relatively small changes in all 3 of the subcomponents, so think gross margin, SG&A and depreciation. So pretty much just a pretty consistent quarter where we're already expecting to be supported by that top line of low to mid-single digit. And then it'll end up in a mid-single-digit increase in op income dollars. So pretty much consistent with what we just said.
John Mulligan:
And I think, Chuck, stepping back from perhaps the basis points of gross margin. I think we've been very consistent in saying that we see great benefit in using the stores as hubs. I think that's where we see we're able to bring great speed to our consumers. Same day, we just talked about that. Next day, 2 day, whatever it is, we can do all that through the stores. It's faster and it's more efficient for us from an economic perspective. So we feel really good about the path we're on. We feel great that same day is growing much, much faster than digital and the benefits that will bring to us economically. So we think we've got a really good path forward to continue to build on what we've already built from a capabilities perspective.
Brian Cornell:
Yes. Chuck, let me add on. I think you should expect to see our Q1 performance really serve as a proxy for our performance over the balance of the year. Low to mid growth in comps, mid-single-digit improvement in operating income and high single-digit improvement in EPS, and I think that's going to be kind of the pattern for the balance of the year.
Catherine Smith:
I think to summarize there, too, we just grew digital at 42%. And we grew op income dollar and rate both expanded.
Operator:
The next question comes from Edward Kelly with Wells Fargo.
Edward Kelly:
Nice quarter. I just wanted to -- I want to start with comps. Can you just give a little bit more color on cadence of comps throughout the quarter, especially the choppy start and the better finish, what you're seeing so far in Q2?
And then I wanted to ask about second quarter guidance and how you're thinking about this comparison. Low to mid singles is an acceleration even at the low end, and you left the possibility of the high end open, which is, I guess, remarkable to know. Can you just maybe talk about the optimism behind that as well?
Brian Cornell:
Yes, and I'll start. I know we saw very consistent performance throughout the quarter. Actually, we talked about in our prepared comments some strength that we saw from a digital standpoint as we exited the quarter. But across our entire portfolio, we saw market share gains, very consistent comp performance both in-store and from a digital standpoint. And we expect that to continue in Q2. We did during -- wisely, as we talked about guidance. We're now going to lap the closures of TRU in the second quarter, so we'll see some moderation in the growth that we've experienced in Toys and Baby. But I think we have a very clear plan for the balance of the year going into the second quarter. We're very confident that we're going to continue to see market share gains and a consistent rhythm of comp increases, operating income improvement and that's going to flow through to EPS. So a very consistent set of performance drivers throughout the quarter that'll extend into Q2.
Edward Kelly:
And just one follow-up on Chuck's question about the gross margin. If we think about the impact of fulfillment on the margin relative to the dollar growth that you're seeing in digital, that relationship, I guess, seems to be improving. And I guess could you maybe just talk about the underlying efficiency in terms of what's happening with orders that are sort of filled year-over-year as well as how the mix is impacting that line item? And how we should sort of think about the opportunity for improvement going forward there?
Brian Cornell:
Well, I'll go back to some of the points that John made during our March Investor Conference. As we move digital fulfillment from upstream DCs to stores, we see a significant reduction in expense, and we talked about a 40% reduction. When we go from an upstream DC to some of our same-day fulfillment offerings, like Order Pickup and Drive-Up, we see a 90% reduction in costs. And as John talked about, those were the fastest-growing parts of our digital fulfillment during the quarter, and we expect that to continue. That's clearly where we're seeing the guest preference. We saw tremendous amount of growth in Order Pickup despite the fact that we've been offering that for almost 5 years now. We're seeing dramatic acceleration in the Drive-Up offering and very strong performance from Shipt. So those were much more favorable from a expense standpoint, and they're preferred by the guests. So as that continues to mature and grow, we're going to see some of the benefits flow through our P&L.
Operator:
Our next question comes from Robbie Ohmes with Bank of America.
Robert Ohmes:
Great quarter. I'm actually going to ask 2 questions, one was just a follow-up, Brian, on your answer there. The -- I get this question all the time. As you keep shifting digital fulfillment to the stores, how are you -- how is the store SG&A not exploding or offsetting? Just maybe a little more color on how you're getting those dramatic savings, the 40% and 90% reductions. And then I'll just tell you. The second question is on the second quarter, I'm just curious how you're -- let me say it this way. Some of your competitors are not doing as well as you might have done, and they might have a lot of excess inventory in things like apparel. I'm just curious what you think the environment is going to look like with a lot of your -- some of your large competitors not in great positions right now.
Brian Cornell:
So why don't I let John start by talking about some of the process improvements we've made in store and the way we're leveraging technology and systems to drive even greater efficiency as we fulfill those orders. And then I'll come back and talk about the competitive environment.
John Mulligan:
Yes. Robbie, I think the first thing I'd say is we are investing payroll into the stores to take care of the fulfillment that is going on. The one thing we don't want to do, and we have been clear about this, is pull payroll off the sales floor to take care of what's going on in the backroom. So we have put additional payroll in the backroom. And of course, that payroll gets reclassed to gross margins because it is part of our fulfillment expense.
But to Brian's point, I think the other thing the stores team has done an outstanding job of is continuing to refine their processes and introduce new tools that allow our teams to get more efficient, particularly in backroom operations, logistics of the store. So we're able to pull hours out of there, either let them fall to the bottom line or, more importantly, we have reinvested a significant amount of those hours back into the sales floor to create a better service environment. And we'll continue to work on that. The stores have great plans. They continue to do that. As we do more upstream and supply chain, we will continue to pull those back office, backroom logistics kinds of hours out of the store, either centralize them upstream and make them more efficient or process optimize them, bring better tools from our technology partners to the stores so that they get better and better. And that's a loop that we've been on for quite some time. So the stores teams, the technology teams have done an outstanding job of continuing to manage our overall store expense.
Brian Cornell:
And Robbie, if we turn to the overall retail environment, we're seeing a very consistent and healthy environment across the U.S. I think what we're seeing right now is the bifurcation of winners and losers, and I think our performance now speaks for itself. We're on eighth consecutive quarters of growing comps. We've seen consistent market share gains across all of our categories, and we're performing both from a store standpoint and a digital standpoint. So we feel really good about the progress Mark and his team made from a merchandising standpoint, the reaction we're seeing to our own brands and the execution that we're seeing in store. So we think we're well positioned to continue to grow share in this environment. And I think what you are just seeing is you're seeing the emergence of winners who have been investing in their business, that are adapting to this new omnichannel environment and unfortunately, those that are ceding share that have not been able to invest and evolve to the new consumer environment.
Operator:
Our next question comes from Joe Feldman with Telsey Advisory Group.
Joseph Feldman:
I wanted to ask, as you guys start to lap the Toy business, Toys 'R' Us from last year, the other -- I know it has a comp impact, but it also, if I recall correctly, had a gross margin impact negatively when it happened just because Toys are lower margin. How should we think about that sort of benefit, so to speak, as you start to cycle that this year as it relates to the gross margin?
Brian Cornell:
Mark?
Mark Tritton:
Yes. Look, I mean it does provide a high level of stability going to second and more in third and fourth quarter. I mean we've been buoyant across the board because of our healthy mix and the strength of our owned brand margins, so that's helping to [indiscernible] mix. This will be a further stabilization point. But the one real benefit that we can utilize and continue to build on is the traffic that we've been building, which has gained market share for us in critical businesses like Baby, Kids and Toys, and the halo effect of that really began last year and it's continued all the way through into this strong quarter.
Joseph Feldman:
That's great. And if I could follow up maybe on some of the newer initiatives you guys have in place and if you could -- like the Circle loyalty program test that's going on and the new e-commerce marketplace, and just things like that, that you're working on. Maybe just an update on how those performed during the quarter.
Brian Cornell:
Joe, still, again, in the early stages. We've expanded our Target Circle program to a number of new markets. We are very pleased with the way the guest is reacting, and we certainly think that it's something we're going to expand over time. Our Target Plus program off to, again, a very good start, great response from vendors. But we're in the early stages. We want to make sure we stay focused on curating the right assortment by category for our guests. So more to come going forward, but both initiatives being well received, and we'll continue to look at expanding those over time.
Operator:
The next question comes from Michael Lasser with UBS.
Michael Lasser:
Two questions. One, how will you factor in the move to 25% tariff on the current lift into your guidance? And how will your guidance change if we go to 25% tariff on an entire set of products that are imported from China?
And my second question is, given all this traffic that you're seeing from in-store fulfillment and same-day pickup and Shipt, how are you converting more items into the basket for those guests that are coming into your stores to pick up orders? And what can you do to improve that conversion?
Brian Cornell:
So Michael, I'll start with the topic of tariffs. And as I said in our prepared remarks, obviously, we've been monitoring this very carefully. It has been a fluid situation for quite some time now. Our point of view hasn't changed. And as we think about tariffs, we reflect on the impact it could have and will have on American families that are going to be paying higher prices.
But I think our teams have done a very good job of trying to mitigate the impact in the short term. And as I think about where we sit going forward, one I'll start with our multi-category portfolio is a huge advantage in this environment. And our ability to flex our focus from category to category is something that's somewhat unique to Target versus single-category retailers. We also have, Michael, a very experienced and talented sourcing team that works in over a dozen offices around the world that focuses on this each and every day. They work with some very sophisticated vendor partners that for years now have been working to diversify their manufacturing base. And those are big advantages for us going forward. I'm going to let Mark and John talk about the fact they were actually with those vendor partners just last week making sure that we're constantly looking at evolving our plans to anticipate some of the changes in the environment. So we're watching this very closely. But we have the advantage of a multi-category portfolio, a very talented and experienced sourcing team that operates around the world and sophisticated vendor partners that have been looking at ways to diversify their manufacturing footprint for years now. Mark, you were there last week, as was John. Any feedback from those meetings?
Mark Tritton:
Yes. Michael, I'll share with you. But John and I and others were in Asia last week meeting with our global vendors, not just China, our Asia-based vendors, and clearly tariffs was a point of discussion. Our current actions are not reactive. They're responsive, and we've been planning these for some time looking at the level of potential change and working with our deep vendor base, we have trusted partnerships and leveraging our current strength of performance to build opportunities to diversify, to work through price changes, and again, as Brian said, a very sophisticated and elevated team who have been anticipating change. And I think when you look at our Q1 results, where we've been able to effectively mitigate those risks from prior announcements, I think it bodes well for how we look to manage this moving forward.
Catherine Smith:
Michael, this is Cathy. Maybe I'll just answer, too, to be clear that the anticipated 25% increase that will go in place in June is contemplated in our guidance. So to be clear there. And then you had asked the question, and Brian and John should answer, too, but on converting our basket or converting those same-day services. And as we shared, we're seeing a lot of incrementality in those same-day services. And as the kind of fact that's pretty amazing is the 80% increase in Order Pickup while we're well into that journey. That just shows that we're deepening our relationship and being more relevant for our guests so that they're choosing Target more often as we provide convenience and ease.
John Mulligan:
I think Cathy hit on it, Michael, that certainly, when people come in for pickup in-store drives traffic. A percentage of them go on and buy something else in the store. But our focus really is on being true to the mission that they have. If it is Drive-Up, we give them bag and they're on their way, and we're not going to bother them with a sales pitch. If pickup, they want to get in and out, that's great, too. And then when they come to store, and they get their Starbucks and they work the whole racetrack, we'll provide a great set of experiences there. So we want to meet them wherever they are, and to Cathy's point, continue to drive that engagement with Target.
Brian Cornell:
Michael, it gets back to our focus on being America's easiest place to shop. To John's point, we want to make sure we meet the guests on their terms, make it really easy and convenient for them to shop with us. And we know some days, they're going to be pulling in our parking lot and hoping to be out of there in minutes. Other days, they're going to come in, grab that cup of Starbucks and enjoy walking the racetrack and seeing what's new and exciting this week at Target. So we've got to make sure we're playing on the guests' terms and I think our strategy right now is meeting the guests right where they want to be.
Operator:
Our next question comes from Kelly Bania with BMO Capital.
Kelly Bania:
Just maybe a quick one on the guidance for the year just given the strong start. How much of maintaining that just has to do with conservatism, conservatism in Q1, tariffs or maybe any other factors you're seeing in the business?
Brian Cornell:
Kelly, I think, again, I think we were really clear back in March that we felt very good about 2019. I think our first quarter validates our guidance for the full year. And we feel very confident about the fact that we've got guidance that's realistic. We're going to continue to focus on execution each and every quarter. So no change in our guidance. We've got confident that we're going to deliver, as we said, low to mid-single-digit comps, mid-single-digit expansion of operating income throughout the year, and that's going to flow through to high single-digit EPS with very strong return in invested capital. So we feel really confident about our outlook for the second quarter and the full year, recognizing it's still early. We're sitting here in May. But we're off to a very good start. The guest is responding incredibly well to our merchandising offerings, our owned brands, our fulfillment options. And we're going to continue to stay very focused on execution each and every week of the year.
Kelly Bania:
Okay. If I could just add one follow-up, just on your ship-to-home model. Obviously, a lot of competitors in the market moving more towards a next-day ship-to-home model. And obviously, Target, having a lot of success with the same day and pickup and Drive-Up and -- but just curious, and I guess you have seen next day with restock, but do you feel like you need to match this service more broadly on a wider assortment? And can this be done, if so, from your stores? Or does this need to be done from an FC down the road?
Brian Cornell:
I'll go back to some of the point that John Mulligan's made. Clearly, as we talk to the consumer, we talk to the guest, we know how important convenience and speed is, and that's why several years ago, we made the decision to put our stores at the center of our fulfillment strategy. And you're seeing that pay off right now. Obviously, we're seeing a growing desire for our guest to take advantage of some of our same-day services and very strong growth with order online, pickup in store, Drive-Up, take advantage of over 100,000 Shipt shoppers that can bring that order to your home within hours. But -- and as we look at the benefits of shipping from our stores, even today, on any given day, upwards of 50% of our orders are delivered next day, and it's using our stores and their proximity as that advantage in our overall strategy. So we think we're very well positioned today. We're leveraging the fact that we're so, so close to the guest with our 1,851 locations, and ease and convenience as a big part of our strategy. So John, I don't know if there's anything else you'd add. But I think our decision years ago to put our stores at the center of our fulfillment strategy is paying off with accelerated growth up over 42%, tremendous growth in order online, pickup in stores and dramatic acceleration in areas like Drive-Up.
Operator:
Our last question comes from Seth Sigman with Crédit Suisse.
Seth Sigman:
I wanted to follow up on a couple of points. I guess just first looking at the comp trends, transactions growth, very strong. Over the last couple of quarters, your ticket growth has been less of a contributor to comps. And you have a number of initiatives that you talked about throughout the call that, in theory, should be supporting bigger baskets. And I think some others in the industry have also talked about a little bit of inflation coming through. So just curious how you guys are thinking about the drivers of ticket. And how we should be thinking about that?
Brian Cornell:
As we sit here today, we're very, very pleased with the overall basket performance. But what's happening is we're seeing acceleration in traffic. The guests are simply shopping us more frequently, and we're meeting more of their needs each and every day. So I think the most important barometer is we're putting great traffic growth on top of strong traffic growth from last year. I think the 2-year stack on traffic is 8%. And we're seeing the guest engaged in more categories, shopping more often. And we're really pleased with the composition of our overall results. So we're going to continue to build off of that. Guests are responding well to the offerings that we're bringing each and every week. And we're driving more footsteps to our stores and business to our site, and we're going to continue to leverage that in the second quarter and beyond.
Seth Sigman:
And then just if I could follow up on tariffs. I'm thinking specifically about the flow of inventory. If I go back to the third quarter, I think you had some challenges maybe related to the ports and you also talked about some incremental cost at that point. What are you seeing today? And do you feel like you're more prepared to avoid some of the margin pressure that you experienced back then?
Brian Cornell:
So going back to last year, we made some very specific surgical decisions to invest in inventory, specifically in categories like Toys and Baby and holiday as we are preparing for the season. So we did incur some of those challenges you just talked about. It was very strategic, very specific to categories, and we feel like we're in a very strong position from an inventory standpoint as we go into the second quarter and the balance of the year.
Operator, with that, we're going to close our first quarter earnings call. Thank you for joining us today, and we look forward to talking to you later in the year.
John Hulbert:
Well, good morning, everybody. Thanks for coming. We're really happy to be with you here in New York again today. Brian's presentation will start in a couple of minutes. And in the meantime, there's a couple of important messages that we need to convey. The first is that 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. And the second is that in today's remarks, we refer to non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP measures to the most directly comparable GAAP measure are included in our financial press releases and SEC filings, which are posted on our Investor Relations website.
Brian Cornell:
[Audio Gap]
And I want to start by thanking you for being here today. I've seen that video a dozen times now; It's pure joy, it's pure Target, and it's why I've never been more excited to be part of this brand and to lead this great company than I am right now. This morning, we announced our most successful year-over-year performance in well over a decade. Our comp sales surged this holiday season, fueled by unprecedented traffic gains, especially in our stores. We closed out Q4 with a 5.3% comp, our strongest finish since 2004, putting Target right in the center of the winner's circle. Across the business, we're growing market share in every major category. And our guests love what they see. Our team deserves all the credit. They are more passionate and committed than ever to delivering on our purpose, which is helping every family we serve, find joy in all of life's everyday moments. So while I'm here on stage, holding up some of our strongest results in a generation, this performance isn't simply a reflection of a strong consumer environment. These results were years in the making, proof of the progress we've achieved against our multiyear strategy to transform our company; deliver strong, consistent and durable growth; and emerge as one of the industry-leading retailers for years to come. Back in 2017, we laid out an ambitious investment agenda to reimagine our stores, reinvent our supply chain and fulfillment capabilities, to reposition our own brand portfolio, invest in our team. And I think we can all agree, at that time, the plan was not met with universal applause. I won't name names, but a few of you might have pulled me aside and said, "Brian, are you sure this is the path you want to pursue? Do you really want to bet the company on stores?" At that time, people were closing stores, not opening them. They were cutting costs, not investing in their teams. But we've never been a brand that falls in line with the crowd. Our guests aren't looking for red and khaki version of someone else. They expect us to be different, they expect us to innovate and inspire. They expect us to be Target. So with our guests as our guide, we kept our stores and our people at the center of our strategy, but committed to deploy them in a radically different way. Two years later, we redefined what it means to be welcoming, inspiring and rewarding in retail. Our teams are obsessed with finding new ways to make our guests' lives just a little easier. When you look at the results and pick your metric, traffic, comps, Net Promoter Scores, guest surveys, it's clear, our strategy is working. We're delivering the right outcomes, and folks are taking notice. Take a look. [Presentation]
Brian Cornell:
I'm really proud of that work, and I'm really proud of our team. 350,000 people who get up each day dedicated to making those moments happen for our guests all across this country. Yet as much of them are encouraged by our success, I'm always the first to say we still have a lot of work left to do. You know this better than anyone. As the shakeout in our industry continues, the separation between those who can afford to invest and those who can't is real. The channel convergence between physical and digital has come full circle. And today, Target is leading the way. While we might be ahead of the pack now, this is no time to slow down, and I can promise you, we won't. As we look to the future, I think it's important to take a moment to step back and look at where we started.
So think back to this meeting in 2016, just 3 years ago. We're over at Chelsea Piers. I remember it was a beautiful day, and I started with an anecdote that was, well, at that time, an aspiration. I talked about how some day, not long in the future, a mom who works here in New York City would be able to plan a birthday party right from her office, shop for everything from her phone from the train and then pick up her order before shuttling her kids off to swimming lessons. The punchline was that in the future, the whole thing would go off without a hitch. Fast forward to today, we've got that use case down cold. We got there because we spent 2016 shoring up the fundamentals. 2017 was about laying out an investment agenda and developing new capabilities. 2018 was all about acceleration and innovation, so that in 2019, we can drive adoption and scale. Today, that same mom in the city has a multitude of choices, and the shopping experience has never been easier or more convenient. For starters, she could just make that Target run on her lunch hour. Three years ago, we didn't have one single store in Manhattan south of the park. Today, we have 4, And we've opened up 8 more across other boroughs and in Long Island. If she doesn't want to schlep the bags back to her office, we'll keep them and drop them off at her desk before she leaves for the day. With Drive-Up, she can keep the kids buckled up on their car seats. We'll put that order in her trunk at the closest store to her home. And with Shipt, she can order same day and will have everything she wants in her kitchen table within an hour or two. Her shopper will even text her before check out, see if she wants or needs a few extra candles for the cake. Whatever she wants, today, we've got her covered. In fact, as we enter the next year of our transformational strategy, we're doing so with the most comprehensive suite of fulfillment choices and also extensive coast-to-coast network of any retailer in the industry. Today, Target is, hands down, America's easiest place to shop. But ease, reach and convenience are only one part of the equation. Our teams are also making process improvements to take cost out of every single transaction. They're improving speed to greater efficiency and maximizing our last mile advantages. What used to take days is now measured in hours. Costs that were once measured in dollars can now be measured in cents. So we're focused on driving awareness and adoption and helping the guest build these options into their weekly routines. And that's just one example of success in one aspect of our strategy. But what's even more important is that every piece of our strategy is working, and it's working together. Let's start with stores. During the last 2 years, our property development teams remodeled more than 400 stores, outfitting them with new technology, fixtures, design, totally transforming how they look, feel and function. This year, we'll remodel at least 300 more and another 300 in 2020. We'll continue to add to our network. Today, we have almost 100 small format stores, and they are highly productive. Herald Square, just down 6th Avenue, does more sales per square foot than any other store of any size in the company, and we'll continue opening a couple of dozen new-format stores each year in cities and on college campuses across the country. Now of course, as you look at that map, you don't see a big red and white W hovering over Wisconsin. Yet I can assure you, John Mulligan and John Hulbert, that you know all too well, are the 2 biggest badger finance at Target, and they're all over this. This year, we also undertook our most ambitious redesign of how we operate stores ever. We're investing in technology to strengthen execution and maximize efficiencies in the back of the house so our teams can shift their focus to driving guest-facing service. We're also making industry-leading investments and wage, committed to raising our starting wage to $15 an hour by 2020. Now not only does this move further burnished Target's reputation as a top destination for great talent, it sends a clear message that we value our communities. At a recent U.S. conference of mayors in Washington, there were a long line of city leaders eager to roll out to welcome Target, because a commitment like this shows we'll be good neighbors in every single community we serve. Our digital progress continues to be a standout story. Once again, our digital sales this holiday season grew much faster than the industry, and we finished the quarter up 31%. Now it wasn't long ago that digital was a rounding error when it came to overall revenue at Target. In 2012, back in just 2012, our digital sales were just over $1 billion. Today, digital is delivering more than $5 billion in sales and still growing. In fact, this was the fifth year in a row that our comp growth topped at least 25%. And as John will show you in detail, digital growth of Target isn't coming at the expense of our stores. It's making stores more relevant, because as I said at the top, the convergence between physical and digital, well, it's closer than ever at Target. And that's because we invested to build industry-leading digital and technology teams. They've created a seamless and inspired user experience that's worthy of our Target brand. We've invested in infrastructure to support greater scale and speed and strengthen our core, and we've invested in building enterprise data and analytical capabilities to better understand our guests and make smarter decisions. Today, our engineers are using voice, AR, AI, VR, to provide greater utility for our guests and integrate richer shopping experiences into their busy lives. And now that we've established the right foundation, we're able to move to the next phase of our journey. Our team is now building out an even more holistic digital strategy that reaches deeper levels of personalization and engagement across every guest-facing part of our ecosystem. Personalization and engagement are also the cornerstones of our evolving loyalty strategy. As you all know, REDcard and Cartwheel worked really hard for Target. Guests who use these programs shop more often than our average guest, but they're also geared to our most engaged guests. So building out our loyalty strategy, we saw the opportunity that tap into a full range of shopper types, folks who visited us each week and those who might only show up once a year. Last month, we announce the expansion of our new program, Target Circle. After testing in Dallas, we're now rolling it out to 5 new markets. This program rewards guests with a 1% rebate. It allows our guests to direct their philanthropic giving and offer special offers tied to key-like moments. The largest benefit is that its guests opt-in over time, we can better understand how they prefer to shop and serve them with more meaningful offers. Now if you look back on the headlines over the last 2 years, one of the biggest news generators for Target was our plan to reinvest our own brand portfolio. We said we'd deliver more than a dozen new brands in 18 months, and true to form, our team over-delivered by a mile. We've introduced more than 20 new brands, and our teams are still growing strong. Fast company just put Target near the top of the list of the world's most innovative companies, specifically for this body of work. A few days later, we unveiled 3 new brands as part of our full reinvention of our sleepwear and intimates business. To top it off, we created a mountain of buzz with our latest partnership with vineyard vines, and the guests' response has been phenomenal. But introducing new brands month after month is not the goal. We're focused on growing market share, attracting new guest segments and finding whitespace opportunities in our portfolio. So let's take Home, for example. Threshold by every measure has performed extremely well since we introduced it back in 2013. But instead of stretching Threshold to appeal to a broad array of guest's taste to drive growth in the category, we took a different path. We launched 4 new brands, Opalhouse, Project 62, Made By Design, and Heart and Hand with Chip and Joanna Gaines, which attracted more guests with different style needs and helped drive the most successful year-over-year comp growth we've seen in Home in well over a decade. With TRU and VRU's exit, we saw an obvious opportunity to pick up market share, and our teams aggressively chase the business, making big bets on Toys and Baby. We finished 2018 with huge market share gains in each. Those guests are also looking for Target for inspiration and innovation in places like Apparel and Essentials. So we've recently launched new lines in our class in Cloud Island, and that's just a start. In the months ahead, you can expect to see a steady stream of newness and exclusivity across the assortment. New brand launches, new partnerships and a sharper focus on developing best-in-class brand management expertise across every category. Finally, while it sounds like we're pleased with the progress we've made in our priorities, we know better than anyone. We can't take our eye off the ball, not even for a second when it comes to the pursuit of flawless execution on the fundamentals. Over the last few years, we reset our pricing and promote strategy, and we'll continue to fine-tune it. And in 2018, we set up dedicated teams to tackle persistent challenges in our business like [ seesaw ] merchandise transitions and in-store signage. On a store-by-store basis, we must ensure we're spending payroll on things that add value for our guests. Because when you multiply it by 1,800, we're talking about huge opportunities to take cost out and move with greater speed and efficiency. One of the biggest changes in our operating model is in Food and Beverage, where we decided to bring the full spectrum of merchandising and operation functions in one team. Over the last several years, we made great strides insuring up our operating challenges, elevating the experience and building more specialized expertise. As a result, we've seen 6 quarters of positive comps in Food and Beverage, which translated in the market share gains in 2018. Channeling that momentum, we believe bringing our Food and Beverage supply chain, operations, merchandising teams under the leadership of Stephanie Lundquist will help us move faster and farther and consistently deliver more value for our guests. So given all this progress, it's clear our strategy is working. We built a successful durable model, and I'm confident we're well positioned to continue to deliver strong sales and traffic growth in 2019 and for many years to come. You saw that our guidance this morning, low to mid-single-digit comps, driven by increased traffic and continued market share gains. But I also know exactly what you're thinking. Brian, at what cost? Are we counting empty calories? Or are there going to be more money in the bank? So I'll head this off straight away. That way you don't have pull me aside after our presentations this morning. You want to know how we plan to continue to grow, scale and accelerate our investment agenda and deliver profitable growth and strong returns on invested capital. We said this morning to expect high single-digit growth in EPS. You want to know how we get there, and that's exactly what we want to answer for you today. In a moment, I'll turn it over to Cathy Smith, who will take you through our financial model and how we're prepared for the next phase of our strategy, how we'll continue to generate strong cash flow and the ROIC that will fuel our performance in years ahead. Then John Mulligan will share how we build on this momentum, how we'll keep scaling our strategy, innovating across every aspect of our supply chain and elevating our service model. He'll talk about how we're incentivizing greater adoption of our services and fulfillment choices, how we're driving demand, how we're getting smarter, more savvy and more efficient on the back-end, and that will strengthen profitability and grow operating income. Then I'll come back and offer our guidance on our financial performance and expectations for the future. And with that, I'll turn it over to Cathy Smith.
Catherine Smith:
Thanks, Brian. One of the great things about working in retail is that every day, 365 days a year, we get a new report card from our guests. Most of the time this real-time feedback lets us know that things are working as planned.
In contrast, 2 years ago, those report cards were clearly showing that we needed to change. And based on last year's strong performance, this latest report card shows that we've been successful. But it's worth taking a look back to see just how far we've come. Here are couple of charts I showed you in the same room 2 years ago. These 2 annual report cards clearly showed the reversal in our performance between 2015 and 2016. With that feedback, we took a hard look at ourselves and how we fit into the retail industry, including our strengths and points of differentiation. We did an in-depth assessment of how consumers are evolving and shopping differently. That work confirmed, we were already focusing on the right priorities, but we weren't moving fast enough. The greatest hockey player ever, Wayne Gretzky, referred to this as skating to where the puck is going. We were headed in the right direction, but our guests were moving faster. Fortunately, we had the resources we needed to accelerate, strong operations and well-located stores, a fiercely loyal base of guests, robust cash flow and a strong balance sheet and the best team in retail. So here in this room 2 years ago, we laid out a bold new plan. We committed to make additional investments of both capital and operating margin to help Target deliver more for our guest faster. These investments were focused on delivering an ever-improving guest experience not just for today, but for many years to come; more than 1,000 story models by the end of 2020; new technology to make shopping easier for our guests and more productive for our team; a new supply chain model designed to support an unmatched suite of digital fulfillment options; and to take labor out of the store back rooms; more than a dozen new owned and exclusive brands; simpler pricing and promotions with a focus on being priced right daily; and importantly, our renewed commitment to our team, including new training, additional hours and meaningful wage increases. All of these investments were developed through a guest lens. We focused first on the things they already love about Target like our shopping experience, our brands and our team, and we asked ourselves if we could do more. That was just the start. We also committed to becoming the easiest place to shop in America because as much as our guests continue to love us, we knew we lose relevance and trips if we didn't make shopping at Target fast and easy. Our multiyear plan was focused on building a durable model, positioned to thrive in an omni-channel world. 2017 would be an investment year, marked by a step-up in CapEx and a step-down in operating profits. In 2018, the year just ended, would be a year of transition when financial metrics would begin to stabilize, positioning Target for long-term profitable growth. How did things turn out? Even though we had planned for a transition year, last year turned out to be one of the most productive in our history as our business generated the strongest traffic and sales growth in well over a decade. This growth is even more meaningful when you realize that over the last 10 years, our average store age has nearly doubled, and yet last year, we delivered the strongest growth in that entire 10-year period. The lesson is simple, the age of the stores doesn't matter as long as they're well located and you invest to keep them fresh and relevant. On the bottom line, last year's adjusted EPS of $5.39 established a new all-time record for the company, driven by strong comp sales, operating margins that began -- operating metrics that began to stabilize and the benefits of a lower tax rate. Between the top line and bottom lines, let's look back at a few other details of our 2018 performance. Last year's gross margin rate was down about 40 basis points, and half of this decline was driven by sales mix. Even though we saw historically strong sales in our higher-margin Home, Apparel and Beauty categories, we also saw exceptionally strong growth in lower-margin categories like Baby and Toys. Beyond mix, the remainder of last year's gross margin rate decline reflected the price investments we made throughout 2017, along with the cost of rapid unit growth in digital fulfillment. As you'll hear later from John, these days, we're seeing the most rapid growth in the lower-cost fulfillment options, which we began to scale up last year. And this year, we're focused on driving efficiencies that will further reduce the unit cost of digital fulfillment. Last year's SG&A expense rate of 20.9% was about 10 basis points higher than in 2017. This performance reflected the carryover of investments in hours and training we made throughout 2017 combined with continued pressure from wage growth. Among the offsets, our SG&A rate benefited from disciplined management of expenses throughout the organization and the natural leverage benefit of strong comp sales growth. On the D&A expense lines, dollars were approximately flat last year, resulting in about 10 basis points of rate leverage. This performance was better than expected and driven by our careful work of our team to optimize the scope of our remodel projects. As a result, accelerated depreciation was lower than expected last year, even as we continued to see a 2% to 4% sales lift in our remodeled stores. Below the operating income line, interest expense was down about $200 million last year, reflecting both the onetime and ongoing impacts of our 2017 debt retirement and refinancing activities. In addition, like virtually all businesses in the U.S., we benefited from a lower federal tax rate. And finally, last year's EPS reflected a 3.1% reduction in average shares outstanding, driven by our continued disciplined approach to capital deployment. This approach has been consistent at Target for decades. First, we invest fully in opportunities that meet our strategic and financial criteria. We then support our dividend and look to grow it annually, something we've accomplished every year since 1971. And finally, we return any excess cash beyond those first 2 priorities through share repurchase within the limits of our Middle A credit ratings. Let's review how our capital deployment priorities have played out over the last couple of years. During that time, our business has generated nearly $13 billion of cash from operations. With this cash, along with some overseas cash we repatriated following tax reform, we funded CapEx of $6 billion, dividends of $2.7 billion and share repurchases of $3.2 billion. In addition, in 2017, we invested more than $500 million in acquisitions, primarily for Shipt, and reduced our long-term debt portfolio by about $1 billion. We also funded a $900 million increase in last year's ending inventory position. This investment is intended to support strong sales growth, including a continued outsized opportunity in Toys and Baby. Beyond the sales line, last year's inventory investment supported better in stocks, which ended the year in the best position since we've been measuring them. So now I want to talk -- I want to turn to after-tax ROIC, which measures our profitable -- our performance in terms of profitability and the capital required to generate that profit. Target's after-tax ROIC for the last 3 years and -- we're showing you right here, and you can see that we performed really well on this metric. But I also want to show what these numbers would have been without discrete benefits resulting from federal tax reform. With that additional context, it's really clear that our plan is working. After a temporary decline in 2017, driven by our higher investments in capital and operating margin, we saw a remarkable recovery in 2018. And given our momentum, we are positioned to improve on this already strong performance in 2019 and in the years to come. One final note regarding 2018. When you're reviewing our financial results, keep in mind that the fourth quarter of 2017 included an extra week, one in which we generated about $1.2 billion in profitable sales. So when you review our fourth quarter results, you'll see on the surface that both the sales and the operating income were essentially flat to the prior year. However, on an apples-to-apples basis, last year's fourth quarter and full year performance was much stronger on both metrics, an important fact that might not be obvious from a quick scan of those financial statements. I'd like to finish my remarks by talking further about what a durable model should look like, one that will allow Target to thrive in this new and dynamic retail environment. At the high level, the goals are straightforward. The business model has to deliver continued relevance with consumers and sustainable long-term growth, and the financial model needs to deliver outstanding returns on the capital we've invested on behalf of our shareholders. On the top line, based on the capabilities we've built at Target over the last couple of years, our business is positioned to deliver growth at or above the growth rate of the addressable market in the U.S. And based on the size and breadth of our category offering, we think nominal GDP growth is a solid benchmark for the addressable market. More specifically in a typical year for GDP growth, Target is positioned to grow total sales in the low single-digit range or better, driven by comp sales growth combined with the contribution from new stores. And of course, like you saw last year, we are positioned to grow even faster in the face of unique opportunities like the Toys "R" Us liquidation. As you'll recall in this meeting 2 years ago, we pointed out that many of our competitors' stores would likely be closing. That has certainly played out as expected, and it looks like the trend will continue. The reason is simple. In today's retail environment, those who have the resources to evolve are being -- those who don't have the resources to evolve are being left behind by their customers. And unfortunately, for them, that often means they need to close some or all of their doors. That is why 2 years ago, we explained why it's so important for Target to invent in fresh, vibrant stores, places where our guests can find fun, inspiration and genuine human interaction. The lesson of the last 2 years isn't that stores are being left behind, but the consumers have the freedom to choose only the best experiences like a Target run. On the operating income line, our business delivered a 5.5% rate last year. This will serve as a good benchmark for the years to come, given the strong foundation we've built. Specifically, we believe we reached a point in which the operating margin rate, headwinds and tailwinds will generally balance. In terms of the tailwinds, we expect to see a benefit from strong sales mix in our high-margin categories; continued cost of good savings through collaboration with our own and national brand vendors; moderation in unit fulfillment costs, as John will discuss in a few minutes; labor savings from our work to change our store replenishment; overall expense discipline across the enterprise; and the leverage benefit of continued strong top line growth. We expect the aggregate benefit from these tailwinds will enable us to offset continued cost pressures on both the gross margin and the SG&A lines, most notably driven by the growth of our digital fulfillment and continued wage increases. On the D&A line, we expect to see some moderate rate leverage in the years ahead. This is because, last year, we reached a run rate of about 300 remodels a year, which we expect to maintain through 2020. This will allow our D&A dollars to remain roughly flat as well, resulting in about 10 basis points of annual D&A leverage -- D&A rate leverage. When you put this all together, relative stability and the net of our gross margin and SG&A rates and about 10 basis points of annual D&A leverage, we are positioned to deliver about 10 basis points of operating income rate leverage per year as well. On the income tax line, based on the current rates we're facing at both the federal and state levels, we expect our annual effective tax rate will be in the 23% to 24% range beginning in 2019. Regarding capital deployment, we expect to have ample capacity to maintain CapEx at about $3.5 billion over the next couple of years, deliver low single-digit growth in our annual dividend per share and return excess cash through share repurchases while maintaining our Middle A credit rating. Based on the expected share count reductions from those repurchases, earnings per share will grow faster than operating income. These financial model -- these financial benchmarks for our new business model are reasonable and achievable over time. In fact, as I look back to 2018, our full year adjusted EPS of $5.39 was near the top end of our initial guidance range. That performance reflects -- reflected several lines of our P&L that were notably different from our expectations at the beginning of the year. On the top line, our business delivered comp sales growth of 5%, stronger than our expectation of low single-digit growth. The primary driver of this upside was Toys in Toys and Baby where we captured greater market share than we had planned. This outsized growth in Toys and Baby created unexpected mix pressure on our gross margin rate causing it to be lower than our initial expectations. And finally, as I mentioned, D&A expense was lower than expected given our team's work to optimize the remodel program. All together, our business delivered strong growth, market share gains and EPS near the high end of our expectations. This is the mark of a durable model, one that can respond to unexpected events and still deliver on both the top line and the bottom line. So while our journey to refine this new business model is ongoing, I hope you'll agree that last year served as a meaningful waypoint. And as Brian said, we're the first to say we have a lot more to do. But I hope it's also clear that we feel really good about our momentum. Many of you were here in this room with us 2 years ago as we talked about this journey for the first time. At that time, it might have been seemed hard to imagine that Target would ever deliver the kind of growth we saw this last year. So today, we want to thank you for sticking with us on this journey. And as we look ahead, we hope you'll continue with us as we embark on another promising year of profitable growth. Thank you.
John Mulligan:
Good morning, everyone. Two years ago, in this room, we laid out the major investments we're making in our business, including using our stores as fulfillment hubs to get closer to the guests. Last year in Minneapolis, we showed you the prototype for how those ideas were taking shape, and we told you we are making Target the easiest place to shop. Today, I get to show you how we've done that and how the investments you've heard about have become very real from the way we're remodeling our stores to how we pick, pack, ship and deliver out their doors.
It all starts with our store teams and the expertise and talent they have that brings new services and experiences to life for guests, and it's supported by our supply chain efforts that ease the operational workload in our stores. I'll talk more about those in detail. But I'm going to start with our fulfillment capabilities, because for our guests, that's what has really stood out this year. We scaled Shipt to nearly 1,500 stores in more than 200 markets in a matter of months, expand the Drive-Up to nearly 1,000 stores coast to coast and are delivering hundreds of thousands of items in 2 days or less. We all know that operation's presentations don't start with a fancy highlights real. And for years, our work was largely behind the scenes. And it's obvious why engineered processes and algorithms don't ever make the marketing cut. But for the past year, after launching -- both launching and expanding our fulfillment services and seeing guests' excitement for them, we've got a whole lot more sizzle to show. So here's a look at all the ways guests can get the Target run done. [Presentation]
John Mulligan:
For most of Target's history, guests have had one way to shop. They came into the store, walk to the sales shelf and essentially pick their own order and drive it home. In the late 90s, when we added an online business, we began shipping orders directly to the guest. At that time, that was a new and radical concept for Target. But today, it's a relatively mature fulfillment method for just about any retailer. Then about 5 years ago, we began offering in-store pickup. This started to change the game from the 2 extremes of guests shopping only in stores and Target shipping only from a warehouse. Guests liked placing order online and picking it up not far from their home that same day. Since then, we've quickly grown the options we offer our guests. It went next day, same day, in the car or at the door. We have a way to deliver. Whether it's same-day delivery shop by Shipt or newer service Drive-Up. Placing an order and waiting for it to ship is something consumers already know how to do. But having an order popped in your trunk just an hour after you order it is a pretty new concept.
As Drive-Up expands, we're helping guests experience a whole new kind of convenience. Take a look at how Drive-Up is making the Target run easier than ever. [Presentation]
John Mulligan:
We make close to 2 million of those parking lot deliveries last year, and nearly all of them took less than 2 minutes, many even less than 1 minute from parked car to product handoff. Guests love it. The Net Promoter Score repeat rates for Drive-Up are up -- are extremely high, and they tell us it's easier and more convenient than having a box dropped on their step.
Here's a look at an actual email we got from a guest on a cold night in January. And no, it wasn't during the week that was 30 below 0 in Minneapolis. It was just a regular night for a mom who didn't have much time. She'd been meaning to try the service and finally did, and in less than 2 minutes in our parking lot, she saw how Target really understood what she needed. And it's just one email, but it speaks to what we hear from guests whenever we enter a market. In fact, in Minneapolis, the first market to have the service, we've seen it grow more than sevenfold year-over-year. With that excitement and fast adoption in just one market, we expect to see a lot of growth in Drive-Up across the country as we continue to expand most of the chain. Each of our fulfillment option satisfies a different need and serves a different kind of shopping trip. As guests are learning about these services and experiencing how convenient they are, they're choosing them more often. For example, we're seeing guests choose pickup instead of shipping, and we expect demand for our newer service to continue growing the fastest. And what if I told you we can offer all those services in a way that makes us faster, lowers our costs and leverages existing assets to drive higher productivity and ROIC. Most of you would be pretty interested, right? That's the foundation of our stores and substrategy, using our more than 1,800 stores in neighborhoods across the country to handle online orders not far from the guest who bought them. Many retailers are just starting to talk about this concept, but we've been doing it. A few years ago when others said stores didn't matter, we doubled down on ours. We shared our plans to use them for both in-store experiences and digital fulfillment. And because of the investments we've made to put our stores at the center, Target has a delivery option to meet just about any guest need for speed and to make shopping even easier. Understanding how our stores make us faster is simple. They're already in the city neighborhoods just miles from our guests' doorsteps, so we can ship online orders at least a full day faster than we can ship from an upstream fulfillment center, and we can deliver same-day orders within hours. Managing our fulfillment cost is much more complex. We do this in several ways. First, we reduce the distance of delivering fulfilled orders in stores where we already carry the items our guests want most, just miles from their homes. It's why we're shipping millions of orders at the back of 1,400 local stores, which is more than 40% cheaper per unit on average than upstream shipping. And we offer convenient services like Order Pickup and Drive-Up, which cost nearly 90% less on average than fulfilling from a warehouse. We also manage the cost by offering different fulfillment models that add revenue and control cost. For next-day delivery of essentials, guests pay $2.99 to fill a box with items like cereals, dish soap and paper towels. And we ship from local stores which lowers the cost of delivery. Delivery From Store is similar. Guest shop the store and pay $7 to have their purchases delivered home. These orders tend to be 5x higher than the average Target basket and full of high-margin categories like Home. In the crowd-sourcing technology we acquired with Grand Junction a few years ago, it matches our orders with local couriers who can hit our delivery promises most efficiently. And there's Shipt, a same-day shopping and delivery service we acquired last year and rolled out to all major markets. For $99 a year, guests can place an order through Shipt and have it delivered in an hour or two. Shipt earns additional revenue from that annual fee, and its 80,000 shoppers across the country are shopping for a growing number of retailers onto marketplace. Finally, we find efficiency in our operations to lower overall cost to fulfillment. When we first launched Order Pickup in 2013, we were literally working from a folding table setup in the back room. It took us a number of years and lots of technology and process improvements to go from scrappy to smooth. When we had Order Pickup down cold, we took it to the parking lot, giving our guests the convenience of swinging by their local store without even getting out of their car. You saw how Drive-Up works and the technology and processes that we've built for our team to move faster and spend less time per order. Across-the-board, we've put some serious technology, equipment and automation behind our delivery methods to make us faster and more efficient. This operation could be anywhere, a warehouse in Phoenix, Colorado or Virginia, but it's a local store in Minnesota doing the work of a fulfillment center just behind the sales floor. With these kinds of investments in every delivery method, we lowered our average unit cost of fulfillment by 20%, driven by our fastest-growing fulfillment methods like ship-from-store and Drive-Up. By fulfilling closer to the store shelf, adding new delivery options and optimizing our operations, we saved hundreds of millions of dollars in fulfillment costs in 2018. Two-day shipping is what guests know best, but our newer delivery services like Drive-Up that have lower costs and are more profitable are growing the fastest, because once guests try them, they love them. Of course, the P&L is only part of the financial story. Using our stores as hub has allowed us to keep up with the incredible growth we're seeing in our digital businesses. In the past 2 years, guests bought twice as many units from Target.com, and all of that growth was fueled by stores, buildings we already own and where lights are already on. Our stores have shipped 4x the number of items out their back doors, and they managed triple the demand for Store Pickup services. This year, during our fourth quarter, stores fulfilled nearly 3 of every 4 orders, effectively doing the work of 14 fulfillment centers. That means we didn't have to spend nearly $3 billion on new warehouses over the past few years to accommodate that growth. And with our store replenishment efforts that enable stores to fulfill a growing number of digital orders, we'll continue to have capacity over the next few years. Now something you would call that capital avoidance, but as you've seen in the investments we're making across our operation, we're not avoiding investing capital where it's productive. Using our stores to do the work of additional warehouses is the most efficient way to deploy our resources. It's also important to note that while our stores are fulfilling more digital orders, it's not coming at the cost of in-store sales. Since 2016, we've made our stores more productive by using them as fulfillment centers. Our fulfillment sales per square foot have grown at an average 67% rate per year. Now, more than $14 a foot as our stores increasingly support our digital business. At the same time, our in-store sales per square foot have grown at a 4% rate per year, which means our Target stores can support incremental growth from Target.com without hurting in-store sales. So our stores as hub strategy isn't putting our core business at risk, it's simply helping us grow faster. While fulfillment refers to digital orders to guests, replenishment is all about sending store's inventory to replace what they sold. And a key part of enabling so much work in our stores is getting replenishment right. That means sending our stores only the inventory they need right when they need it and moving demanding operational work like unpacking boxes and storing up the product out of the stores and into our warehouses. To do that, the supply chain team is continuing to modernize our upstream supply chain to be fast, but precise. We're building a customer automation solution like the one you see here from our Perth Amboy facility outside New York City to better support our stores. This is the future, one warehouse doing work for a whole group of store backrooms, sorting product, organizing items by store aisle and picking an individual unit or case pack based on the store's demand. The robotics allow our warehouse teams to manage the really complex sortation of millions of units and to handle each one individually bound for different stores at different times. In the end, the warehouse team will use organized carts, stock with only the items the store needs and sort it by aisle onto a truck headed to a nearby store. Once it arrives, the store team grabs a cart, wheels it to the sales floor and fills the shelf literally in minutes. It's a far cry from the trucks we packed like a game of Tetris that take hours, if not a full shift, to unload. Instead, our team spends more time on the sales floor helping guests, using their expertise and talents in service to build the basket. And at the same time, as stores get a precise amount of product sometimes delivered several times a day, our out-of-stocks improve and will reduce working capital by cutting the amount of product just sitting around in the back. It'll take a while before we deploy this model across the country. We've prioritized the Northeast, areas like Boston and New York where our small format growth depends on it. You've seen these stores, and they're small. And with the real estate at a premium, we're using every possible square foot for selling space, leaving us with little to no backroom. So we keep the sales floor in New York and essentially move the backroom to Jersey. And for our stores, it's made all the difference. But don't just take it from me, hear it from them. [Presentation]
John Mulligan:
What we're doing in supply chain is the reason we're able to grow in dense, urban areas, where we can serve new guests. But it also makes it possible for our full-size stores to act as efficient local fulfillment hubs because the product it needs in-store guests and online orders.
In the past couple of years, we've lowered our out-of-stacks as a total company. Now we're focused on reducing out-of-stack variability between individual stores. To do that, we're improving how we transition merchandise from one season to the next and improving our direct-to-store deliveries, and we'll see even more out-of-stack improvement as we scale our replenishment model over time. It all comes down to this, investing in how we replenish stores has given us a sturdy set of rails to serve those stores. And with a strong foundation in place, our fulfillment operation glides right on top, so we can offer our guests so much more ease and convenience from their local stores. Digital fulfillment is a big platform for growth and is an enormous opportunity to serve our guests in new ways, but at the end of the day, an overwhelming majority of retail experiences still happen in the store. So make no mistake, our store teams have to nail it. Helping guests find what they need before they even ask, sharing their expertise to make recommendations, presenting merchandise in a way that's easy to shop and fun to explore. The point of our investments upstream is to put more team members on the sales floor, helping guests instead of in the backroom checking off tasks. A couple of years ago, the stores team kicked off an effort to modernize the way we run our stores from how we use our talent to the many ways we invest in our team and all against the backdrop of our commitment to reach a $15 minimum hourly wage by the end of 2020. We started training our team to be specialists so they could bring expertise to how we serve our guests in each area of the store. We improved the technology they have at their fingertips to make their service even better. Today, our team can help guests check out anywhere in the store or place an order for something not in stock all from their mobile device. It's all about continuing to elevate the guest service and experience. So here's a video we use this fall at our annual company meeting. It's our team talking to our team about what we're doing inside our stores to serve our guests better than ever. Take a look. [Presentation]
John Mulligan:
We're modernizing both inside and out as we continue remodeling hundreds of stores across the country. The biggest difference, we've enhanced our experience with updated decor, lighting and color by opening sightlines that really let the product shine. Last year, we completed more than 300 end-to-end remodels, and the most we've done at any time in our history. The reaction and complete excitement from guests doesn't get old. They tell us they love what we've done with the place. But even better, they shop us more often. We consistently see an average 2% to 4% sales lift per store after a remodel.
We've moved at an unprecedented rate to touch a majority of our stores in just a few years. We'll do another 300 this year as part of our effort to have more than 1,000 remodeled stores by the end of 2020. Beyond that, we'll continue remodeling the in-store experience across the chain but at a more moderate pace for the long term. While we're investing in existing stores, we're also finding new sites to serve new guests. Last year, we opened more than 1 million square feet of sales floor in small format stores, entering big markets like New York and new markets like Vermont. In fact, some of our most recent openings have already become our highest volume small format stores, even as the traffic in our mature small formats has continued to rise. This year, we'll open doors in growth areas like L.A. and Washington, D.C., near college campuses in Seattle and East Lansing and also in new communities for Target like Cape Cod and Santa Barbara. These stores help us enter new neighborhoods, where a full-size store wouldn't fit and where we see a need we can fill. And they continue to show strong financial performance, beating our chain average of comparable sales growth and productivity. To a building owner or a developer, Target's a strong brand and a sought-after tenant, which has positioned us well to capture great opportunities during a time when hundreds of empty retail boxes are suddenly up for sale. We'll continue to evaluate where we can meet new guests or better serve existing ones and maintain our pace of opening approximately 30 new stores a year over the next few years. Target's confidence in stores hasn't changed. It's where everything we're doing for the guest comes together, to create experiences that are differentiated, inspiring and easy. We're using our stores as stores, stores as fulfillment centers, stores as the local connection to our guests even if they don't come inside for every trip. In our more than 1,800 stores, with the passion and talent of our incredible team, we remain at the center of how we deliver, grow and differentiate for years to come. Thank you.
Brian Cornell:
So clearly, a lot of incredibly exciting work is underway, and the future is just as bright. Since you've heard from Cathy and John, we're clearly focused on harnessing this success, using it to fuel, sustain growth across the business as well as reducing costs, improving speed and efficiency. We're building a durable financial model that will propel Target forward in any economic environment. It's a model that translates top line growth to bottom line performance. So in a typical year, you should expect to see low single-digit comps leading to mid-single-digit growth in operating income and high single-digit growth in EPS. The model is also built to deliver higher after-tax ROIC, pushing us further into the mid-teens during the next few years.
So let's walk through what this means for 2019, starting on the top line. You saw the detailed numbers in the morning's press release. For the full year, we're guiding to comp sales growth in the low- to mid-single digits. That will reflect the combination of increased traffic to our physical stores, strong market share gains in digital, greater adoption of our fulfillment capabilities and market share growth in every major category across both stores and digital. Moving down to P&L. As you heard from John, we're acutely focused on controlling costs to offset increased pressure for our wage investment and fulfillment growth, generated by our growing digital business. With that discipline in 2019, we're planning to deliver moderate improvement in our operating income rate, which will translate into mid-single-digit growth and operating margin dollars. And combined with the benefit of a lower share count, this operating performance will translate into high single-digit growth in EPS. As you heard from Cathy, for many years, Target has taken a consistent, disciplined approach to capital deployment. In 2019, we expect another year of continued robust cash flow, which we'll use to fund CapEx of about $3.5 billion, which, on top of the investments from 2017 and 2018, will put our 3-year stack at nearly $10 billion. We're also positioned to deliver a low single-digit increase in our quarterly per share dividend, a commitment we've upheld nearly 50 years running. And we expect continued capacity, return cash to shareholders through share repurchase within the limits of our debt rating. Altogether, this performance will translate into strong after-tax ROIC of nearly 15%. As for the near-term guidance, for the first quarter, we expect to deliver comp sales growth in the low- to mid-single digits, perhaps just a little stronger than we'll deliver for the full year, in light of the continued opportunity in our Toy and Baby business. We also expect to see a low single-digit increase in operating margin dollars but a small decline in rate, reflecting the mix impact of the unusual strength in both Toys and Baby. And like for the full year, we expect high single-digit growth in our first quarter EPS. So we've covered a lot of ground today, but the story in my mind is actually quite simple. During the last 3 years, while the future of the industry was anything but certain, Target laid out an ambitious agenda to reimagine our stores, to reinvent our supply chain and fulfillment capabilities, to reposition our own brand portfolio and to invest in our team. We did this so that we could transform our company, build a durable model that delivers strong, consistent growth that puts Target right in the center of the winner's circle in retail. Two years later, that's exactly what we've done. Today, Target is America's easiest place to shop and one of the world's most innovative companies. As we carry into 2019, you can expect Target will continue to deliver. We'll continue to adapt, evolve, innovate, invent. We'll continue to inspire, and we'll continue to succeed so that Target will continue to lead this industry for many years to come.
2018 was a great year for Target. But I'll leave you with a new headline:
2019 will be even better. So thank you for being here this morning.
That concludes our prepared remarks, and now we want to use the remaining time to answer your questions. We're going to try to get through as many questions as we can, so I'd ask you to limit your questions to one per person. I'd appreciate if you started by introducing yourselves and the organization you represent. And while I'll be here on stage, I've got several members of our leadership team that are ready to jump in and provide expertise on the various topics we'll cover today. So we've got [ Mike Reiners ] around the floor today. All the hands just went up at once. That's great. So maybe, why don't we start right here with you?
Simeon Gutman:
Simeon Gutman, Morgan Stanley. So you're guiding to profitable growth, and you said this is the durable model going forward. I think on TV, you said, "We're getting to the path of stabilization." So I'm curious if there's anything that you're looking out that's maybe more subdued. Like, why that comment? And then second of all, given that the business now has this potential, was there any debate of guiding to flattish margin just so you have more ammunition to invest?
Brian Cornell:
Yes. It's a great place to start. And again, if you look inside of our Q4 results, we started to see that margin stabilization. And as we adjust for the 53rd or the 52nd week changes, we're starting to see that improvement, and we expect that to extend into 2019. So when you look at our focus on efficiency, on reducing costs, as you see demand shift to more profitable fulfillment measures, we expect 2019 will be a year where we deliver consistent operating margin improvement, coupled by very solid single-digit, mid-single-digit comp growth in the first quarter, single digit throughout the year, and that's going to translate into high single-digit EPS. So all the work we've been doing for the last few years is starting to come together. And I've talked about this a number of times, the great part of our strategy is it's not driven by one single element. It's all of these elements now coming together, maturing at scale. And importantly, the guest and the consumer is voting with their wallet and with their feet. So it's all starting to come together, and we're building that flywheel that will extend into 2019 and beyond.
Michael Lasser:
It's Michael Lasser from UBS. You laid out several factors that'll drive gross margin stability. How much have you assumed you're going to have to invest incrementally in promotions and price to achieve your goal of gaining market share across every category?
Brian Cornell:
Michael, I'll let Mark jump in here a second. One of the things we talked about in our prepared comments, and we've talked about it over the last couple of years, is this investment we made to enhance our pricing and promotional capabilities. And we've made tremendous progress, built real expertise. So we feel very good about our pricing position today, the value we're offering against our entire portfolio. And as we look to 2019, we'll make sure that we continue to be competitive, that we're priced right daily, that we offer great value to our guest. That's at the heart of our brand promise when you think about Expect More and Pay Less. That's going to continue, and we think that's going to be very durable as we go forward. So we're committed to being priced right daily, delivering our guests great value across all our categories, and I think we're well prepared for 2019 as we think about our pricing and promotional position. Mark?
Mark Tritton:
Yes. I'll just add that -- to reiterate what Brian said. Last 2 years has been about creating a lot of stability in terms of price and promo as well as helping with our trips and traffic, and we've been outpacing regular price sales -- [ visit ] promo sales for the last 2 years and created great stability and trust with the guest at regular price as we manage price values. It's really working for us.
Edward Yruma:
This is Eddie Yruma from Keybanc. You've made some management changes within food and beverage. It seems like you're putting some real muscle there. How do you dimensionalize the opportunity? Any kind of early findings?
Brian Cornell:
Why don't I go back to the progress we've made over the last several years? We've made major commitments to improving our Food and Beverage supply chain, our merchandising, our in-store operations. But we did make the decision earlier this year to bring all of those functions together under one leader, and Stephanie is here today. And as we looked at that business, we recognized it's very different from any -- many other parts of our portfolio. The products we sourced, the perishability of it, the cold chain environment, how we manage product from a store level. So we made the decision to bring all of those elements together under one leader. The functions will still -- were very closely with their counterparts in supply chain, in merchandising, in pricing, in marketing. But having one dedicated leader who thinks about Food and Beverage every single day and is connecting the needs in supply chain to merchandising, to store operations, I think, is going to yield significant benefits in the year to come. But we've been growing our Food and Beverage business for over 6 quarters now. 2018 was a year where we took market share gains in many of our key and essential Food categories. And I think with Steph's leadership, we're just going to continue to build on that in years to come.
Gregory Melich:
Greg Melich with Evercore ISI. So couple of years ago, you talked about investment and how that was going to invigorate traffic, and it's worked. As you look out now to the next couple of years and after that, where are we on that investment cycle in terms of in the P&L versus CapEx? So more specifically, sounds like remodels will peak the next couple of years, so maybe could CapEx start to come down again? Or will investment then go back into the P&L? And then on supply chain, do we need to now ramp up at some point in supply chain investment? Just where are we on the cycles of that would be really helpful.
Brian Cornell:
Greg, honestly, 2 years ago, we talked about the significant investments we were going to make in stores and reimagining our stores, the investments we're going to make in our brands, the investments we're going to make in fulfillment capabilities and our team. I think now we're at the point of maturing and scaling those investments. John talked about in great detail the work that we've done from a replenishment standpoint, a fulfillment standpoint. We're going to continue to build awareness and adoption of those fulfillment capabilities in 2019 and beyond. We'll continue to remodel stores, and we certainly like to see the lift and the return that we're getting with those stores. We think we've got a pathway to open up many more small formats. But many of the big investments we made are going to start to normalize over time. So I know one of the questions that's been on everyone's mind is
Peter Benedict:
Peter Benedict at Baird. You talked about the new replenishment model that's going to be rolled out to some of the smaller stores. I'm curious what's the time line for getting that to start impacting the larger stores. And related to that or somewhat related, are there any marketing or pricing plans in place to incentivize customer use of the different fulfillment options that you have for digital?
Brian Cornell:
Yes. Why -- handle the back end. And then, John, why don't you talk about some of the timing? And Rick, why don't you jump in from a marketing standpoint? One of the things that we didn't talk about specifically today is the path and the journey we've been on with our fulfillment capabilities in building awareness. While we've been working on many of these for upwards of 5 years, pickup was something we started talking about almost 5 years ago. And over the last year or so, we started talking about the fact that we've gone from testing Drive-Up to scaling to almost 1,000 locations. It was December 2017 when we acquired Shipt. In that same time period in major metro markets, we started offering our same-day courier service, leveraging our Grand Junction capabilities. But it literally wasn't until the fourth quarter of 2018 that we started talking about it to our guests, actually starting to build it into our Target Run and Done campaign. So as we said earlier today, now it's about building awareness. Because what we hear time and time again, when our guest realizes that they can place an order, drive in our parking lot, and within 2 minutes, we'll put that order in their trunk, they love it. The Net Promoter Scores are the highest we received for any service. But in many cases, they just haven't been aware of it. Because we wanted to make sure we built the processes, we had the systems in place, we had the measures that we knew our guests were looking for before we started to really talk about it. As we go into 2019 and beyond, we're going to incorporate that into our Target Run And Done campaign, make sure that America knows we are the easiest place to shop and we give you all these choices. Over 1,800 great stores to shop. You can order from your desk and come by a couple of hours later and pick up that order. If you want to drive into the parking lot on a chilly day, leave the kids in the car, we'll put it in your trunk. If you want a personal shopper from Shipt to do the shopping for you and come by in a couple of hours, we can offer that. So we're going to continue to build awareness. But as we build awareness, we're getting a great response from the guest. And one of the things I talked about earlier today is the good news is as we think about order pickup or Drive-Up, while it's more profitable for us, as John showed you, it's also preferred by the guest. They love the convenience of knowing they don't have to wait several days for something to be left on their front door. They have the reliability knowing they can pull into our parking lot or walk into our store, and we'll have that order ready for them. So it's both more profitable, but importantly, looking through the guests' lens, it's preferred by our guests. So that's a great combination for us. John, you want to talk about the time line for advancing some of our replenishment capabilities?
John Mulligan:
Sure. So I'll go back to when I talked about it. I think we're starting in the Northeast. We need to scale Perth Amboy, first of all, and service the small formats, the significant number of small formats we've opened and will open in the Northeast to start with. Right now, the team is thinking about what retrofitting an existing building looks like. We've run an iteration, probably #3 of that right now. We need to get a little bit further into the Perth before we finalize that. I would tell you the thing we think about is we move cautiously to start, and the concern is we don't get to shut down a building because we don't get to stop selling for some period of time for the stores that are served by that building, and so we will move cautiously at the beginning. We want to ensure we don't have buildings that are disrupted during Q4 because we don't want to create problems there. So I think you'll see a start, a retrofit of an existing building. Probably early next year, get one of those behind us. And then, Peter, I think we have a much better idea how that goes. We'll obviously refine it and then how quickly we can scale across the rest of the country.
Charles Grom:
Chuck Grom from Gordon Haskett. On the Target Plus initiatives, one thing you didn't discuss this morning, so I was wondering if you could shed some light on that effort. I think it's probably been 10 years since I've asked a CEO this question. But -- on the number of store opportunities ahead for -- to the small format at Target.
Brian Cornell:
Great. Rick, do you want to talk about Target Plus?
Richard Gomez:
Target Plus is a new initiative that we are very excited about because it has the opportunity to grow our dotcom business in a profitable way, and what it is about is how we can expand our online assortment into new whitespace. It's Target's version of a marketplace, but it is different than our other competitors. And it's different because we are known for a curation, and our consumers, our guests expect that. So Target Plus will be invitation-only. It's not intended to be a catalog of a list of products and products and products. Rather, we're going to go very deliberately, very intentionally after the right categories, the right brands and then offer them on Target Plus and with third parties. And for us, it's a profitable way to grow our dotcom business because the third parties deal with the supply chain components of it. And then what we offer, which I think is a competitive advantage, is you can take your product, and if you're not happy with it and you want to return it, you can take it to a Target store, which is something that our competitors can't offer. But the one point I would just say is it's still in its early stages, but we think, long term, can be a profitable growth driver for us.
Brian Cornell:
Chuck, on the new storefront, we certainly think for small formats, we've got dozens and dozens of opportunities in front of us. And we've taken a very disciplined approach. Just a few years ago, we were still testing and learning how to operate in a smaller-sized store. Our merchants were learning how to curate the right assortment store-by-store. Our store teams were learning how to operate in a different environment. From a supply chain replenishment standpoint, we had to figure out how to deliver and replenish to those stores, where you can't pull up a 40-footer. So we've taken a very disciplined approach. The great part today is we now have demand coming our way. We have local communities that are putting up their hands saying, "We'd love to have a small Target store on our college campus, in our local neighborhood." So we're seeing an abundance of opportunities, and we'll continue to be disciplined as we move forward. But we see opportunities to open dozens and dozens of stores across the country in urban settings and on more college campuses in the years to come. And as I said earlier, they're our most productive stores in America, delivering some of the highest sales per square foot that we've seen across the country, and the demand for these stores continues to grow. So we'll continue to meet that demand over time.
Christopher Horvers:
Chris Horvers, JPMorgan. Can you talk about sort of what you expect in terms of share gains within a low to mid-single-digit comp and then sales a little bit better? What categories outside Toys, which you'll annualize Toys "R" Us after the first quarter, what the driver of that is and where is the opportunity? And then specifically on gross margin, do you expect it to be flat in 2019? Given that you're scaling the fulfillment options and Toys will create some pressure on 1Q, could we see actually gross margin start to improve later in the year and then into 2020?
Brian Cornell:
Yes. So Chris, why don't I start with our approach to market share gains? And I'll let Cathy talk a little bit about gross margin. But I'll go back to our results in 2018. While we're very excited, and Mark and the entire team did a sensational job of taking advantage of the TRU closure, the BRU closures, and we took significant share in those categories, in 2018, we grew share across every one of our major categories, in Apparel, in Home. We had a very strong year in Beauty. We grew share in Food and Beverage. All of our major merchandising categories are growing share right now. We expect that to continue in 2019. We expect our growth to be driven by traffic gains, like we saw this year, equating to market share increases across both our physical and digital space. So we continue to see market share opportunities across our entire portfolio. And obviously, as we see unique opportunities, we'll lean in to take advantage of opportunities category-by-category. But for this team, they expect to take market share across every one of our major categories in 2019 and take advantage of the opportunities we see in the competitive market. Cathy, do you want to talk about gross margins?
Catherine Smith:
Yes. So let's start with operating income rate first because that's the better place to start. We said that we'll see moderate expansion there this year as we think '18, 2018 was a good waypoint as we think about going forward. So we've got enough insight into headwinds and tailwinds. It'll balance. So then when you move back up, we haven't been as specific between gross margin and SG&A, but we actually don't expect a big change, right? So we already understand where the business is at. We understand Q1 is going to be a little lighter on the margin side because of a little bit of the mix business that Brian talked about in his prepared remarks. So Q1, but then the rest of year, kind of expect the balance between gross margin and SG&A and a little bit of leverage on the op income line.
Robert Drbul:
It's Bob Drbul from Guggenheim Securities. I guess my first question is, around the new brands and the private brands that you've launched, I think 20 is the number, and you said there's more to come. Can you just talk about the rate going forward, what you've learned? Can you comp those businesses? And just how we should think about that aspect of it?
Brian Cornell:
So let me set it up, and then I'll turn it over to Mark. And I think, Bob, it's important to recognize the commitment we've made to our own brand portfolio and the work that's being done by our product development and design teams, our sourcing teams, our merchants, the role that Rick and his team play from a marketing standpoint and then the in-store execution and experience. We've made a major commitment to making sure that we use our own brands as a point of differentiation, that we bring great style and quality to our guests at a great value. But the path we've been on and the pace is going to slow. The team has made remarkable progress in a short period of time. And I've said this a few times publicly, the team has done 3 or 4 years of work in about 18 months to make sure that we took advantage of the opportunity. We're going to be more surgical now. We'll be focused much more around making sure we're managing those brands and building brand management expertise into our teams. But we'll continue to look for whitespace opportunities and the strength in our portfolio with great own brands that drive market share gains, drive traffic to our stores and more business to our site. But the team has done a remarkable job, and it's certainly been a big part of our market share gains and the change in guest perception as we bring great newness, great quality and value to our portfolio. Mark?
Mark Tritton:
Yes. Change will be a constant, but the velocity will change. So as Brian said, a compacted amount of work as we moved into a reestablished and stabilized mode of our own brand portfolio and the redefinition and curation of our total portfolio offer. And so you'll see a velocity change as we move to stabilize and optimize that assortment. The question around can we anniversary that? Yes, we can. Yes, we have. And yes, we will. So good things lie ahead, but expect the change rate to be different.
Brian Cornell:
Mark, why don't you spend a couple of seconds to talk through the performance of Cat & Jack, which, in many cases, I remember standing here actually 3 years ago with many of you talking about our commitment to Baby, the Cat & Jack brand, the progress that we expected to make in that space. And obviously, Mark, that's played a big role in attracting more moms to our stores. It's been a big part of our success story in 2018, but I also think it's a great story of a brand that's continued to build support momentum on a multiyear basis.
Mark Tritton:
Yes. It was a bold reinvent of a business in kids that was performing in low single-digit growth when the market wasn't. So we said, why change? And what we want to do is connect with our guests and deepen our relationship with them. Two years on, what we found is that that's a trusted and beloved brand across the U.S. And if you match that to the sense of authority that we want to create with moms, kids, babies, our most recent market share gains in TRU and BRU exit and the strength of our market share there, it really starts to build an ecosystem more authority with guest archetypes and relationships so we can be America's easiest place to shop. So Cat & Jack continues to build from strength to strength. We look at both category growth as well as year-on-year growth of existing space to really develop that strength. And what we see, even in the examples that Brian shared today, example in Home, where we had one brand and now we have up to 4 or 5 brands, the sense of the sum of the parts with the authority that we create in these individual spaces, Home, Baby, Kids, continues to be a key market share driver for us.
Kelly Bania:
Kelly Bania from BMO Capital. Going back to the replenishment model, can you just give some more specifics in terms of the cost of the technology that you're putting into Perth Amboy? It sounds like maybe one of these are going to be added in next year. I guess that means 2020. And just some specifics on the financial impact on the P&L as you start to really ramp implementing those longer term. And has this been tested at any of the suburban, larger stores?
Brian Cornell:
John, do you want to take that one?
John Mulligan:
I thought Brian said one question. There's about 8 there.
Brian Cornell:
John, there were only 7, but we'll try to compact it down to one.
John Mulligan:
I'll start kind of in reverse. I -- we have tested a variety of things in multiple distribution centers across the country, all of them doing different things. Some of it automation. Some of it being done manually. There's one in Minneapolis that we have used as our kind of core test, and that is providing daily replenishment to a store, a large store in Minneapolis. Two things I would say. One, this is much beyond -- we showed the automation because that's -- it's easy to see you, and you can take a video of it. There is so much more going on around this. There is a new warehouse management system. There is a new order management system. We change the way we do transportation. We change the way things physically move through that building. We changed the way things physically move for the stores. So the change here is significant when we start rolling out across the country. As far as impacts, I would tell you, it's in the guidance, the long-term guidance Brian talked about. It'll be in -- it's in our capital goals. It's in the way we're thinking about the operating margins going forward. So the balance of when we do this and the cost and the payback is all thought of within our current long-term guidance. So we feel good that that's in there. We have more work to do, like I said, to figure out the exact cadence, which will mean the exact timing of when capital comes. But we want to be thoughtful here given the magnitude of what we're changing across the supply chain.
Brian Cornell:
John, it might be helpful for us to spend a few minutes and make sure you understand the work that's going on really across the company from a replenishment standpoint. Because clearly, while, obviously, automation and robotics are part of the future, John, we're doing a lot of things changing how -- the sortation process in stores. It's driving immediate efficiency to how we replenish. It's impacting our in-stock position. It's reducing inefficient touches in our stores. So we might want to leave the group with a sense for the fact there's things happening immediately. Longer term, automation and robotics will enhance that, but we're not waiting for robotics and automation to drive efficiency in how we're operating our stores.
John Mulligan:
No, I think that's right. We've done many things much more manually. We've done things upstream in the distribution centers to help the stores. And as Brian said, even the way the stores work there, unload process today has changed almost 180 degrees from where we were a year ago. That has created significant efficiency for the stores. It has put more team members on the sales floor, which again is a big part of what we're doing here. We've done manual stuff in all the buildings, in how we load trucks, in how we sequence and where pallets are relative to case packs. So there's a lot of manual work being done, all of that headed toward walking down the path of where we ultimately want to get to as we bring the automation and the new order management and the new warehouse management and the new inventory planning system. All of that will come online as well in parallel. And so we're marching down the path. And again, it's cool to see the sexy automation, and that's just one piece of what we're doing from a replenishment standpoint.
Brian Cornell:
Yes. But the changes we're making from a process standpoint and a system standpoint, that's also fueling this operating margin income improvement that we're projecting in 2019 and beyond. So there's more to come, but some of the foundational work that we're doing more manually is also contributing to an improved operating environment. Right. Here we go.
Craig Johnson:
Craig Johnson, Customer Growth Partners. Brian, you've made great progress beginning, right here, 2 years ago in making your offerings more relevant to how people live, work, spend their money today. A generation or 2 ago, people divided up, just spending about half between goods and services. Now it's 69% service, it's 31% goods. To what extent are you all looking at the services side, which is the dominant part of the wallet, as an opportunity for you all? And if so, if you're thinking about it, are you thinking to build, buy or partner?
Brian Cornell:
Yes. And Craig, we'll also -- we'll always look at ways to meet the needs of the guest. I mean, right now, our strategy is very focused, is very centered around the initiatives we've been talking about to date. We'll look at the appropriate role that services play, and we'll continue to make sure that our brand meets the changing needs of consumers. I think we go back to some foundational components, and I go back 2 years ago. Standing here 2 years ago, there were lots of questions about the role of physical stores. I think we know today that American consumers still enjoy shopping in physical stores, and upwards of 90% of the business is still done there. So we want to make sure we leverage our store assets to provide a great in-store experience. We continue to modernize the store experience. We invest in our teams to provide great customer service. In the future, we may complement that with other services. We want to make sure that fulfillment and that digital experience is really easy, really convenient. So we want to make sure that we're focusing on the needs of today's consumer but also always looking around corners to what tomorrow brings. So 2 years ago, many people were questioning whether investing in stores was the right thing to do. In the holiday quarter, our store comps grew almost 3%, and consumers continue to enjoy that shopping experience. We'll continue to make sure we look around corners and find out what's next. But we think we're on the right path, and we've got the flexibility, and I think we've proven to be flexible and adaptable to changing consumer needs. That will be part of our future as well.
Edward Kelly:
It's Ed Kelly at Wells Fargo. Brian, you've had about, I don't know, maybe 50 basis points or so of pressure on the gross margin over the last couple of years from a fulfillment standpoint on digital. It sounds like what you're saying today is that you expect that pressure to start to ease. Could you just maybe give us a little bit more color around what drives that? How should we be thinking about the incremental margin or the margin now on an incremental e-commerce sale and how that's evolving over time? And then the second question I had for you is around wages. So I think I heard you reiterate a commitment of $15. That's expensive, I believe, right? So how does that play into the financial guidance? And particularly, how you're thinking about 2019?
Brian Cornell:
So Ed, starting with wages, that's built into the model we talked about today. We talked several years ago about the fact that we'd be on a path to get to a starting minimum wage of $15. That's built into our plans for future years. We've talked several times today about the fact that the guest is now moving to fulfillment options that are actually more profitable for us. We expect that to continue going forward. And obviously, there's always short-term anomalies. As we thought about 2018, we didn't anticipate that TRU is closing and BRU would be closing. We made big investments to make sure that we were going to garner market share in those important categories. It's going to drive long-term benefits for us as families come to Target more frequently for Toys and items for Babies and Kids. So that was a long-term investment. Those were lower-margin categories, but it was the right thing to do during 2018. That'll moderate over time. So one of the things that we didn't talk about today but I think is so important to our overall plan is the balance of our multi-category portfolio, the fact that we had this very unique portfolio where we're growing market share across all of our categories, but they're still really balanced. 20% of our business in Apparel, a very high-margin category; 20% in Home; a hardline in Toy business, that's about 20% of our business; Beauty and Essentials being 20%; and then Food and Beverage. So we have this very balanced portfolio that I think provides us a pathway during good times and bad, where we have a durable model, where we can meet the needs of consumers no matter what the economic environment. So we expect the investments we made this year to stabilize over time. And along with the changes that we're going to make and the benefits that we'll see through new fulfillment capabilities, we expect that to strengthen our gross margin, our operating income over the years to come. So it is officially double 0 here.
We didn't get to the question right upfront. Why don't we just take one more? Because your hand's been up the entire time, and I'll feel guilty if I walk off without giving you a chance to ask a question.
Michael Baker:
'
Brian, it's Mike Baker from Deutsche Bank, and it's going to be one last question in 3 parts. And it's probably -- it's a financial question maybe for Cathy. But the EPS growth, which is through the midpoint of the guidance versus the adjusted EPS. It is a little bit slower in the first quarter, a little bit faster throughout the year. And I get what you said about the gross margin, but shouldn't the better sales from Toys and the like offset it? So why does it ramp throughout the year? And maybe related to that, in the first quarter, any impact from things like tax refunds, SNAP, even the late Easter? People are going to want to know about that. And lastly, and again, related to all of it, how should we think about the comps throughout the year as your comparisons get 2% to 3% harder each quarter? So one question, 3 parts, all about the pace of the year.
Brian Cornell:
All right. You packed a lot in there to wrap this up.
Catherine Smith:
I'm happy to take it. But -- so as we said, we'll see a little bit of pressure on the op income line in the first quarter. But to Brian's -- the guidance we gave today, low to mid-single top line, and that was Q1 and full year. So you can expect -- and you guys know what our comps for this last year, so we can think about the 2-year stacks going there. But you can expect a pretty consistent -- there's -- we're not giving guidance for second, third and fourth quarter right now. But you can expect a pretty consistent pace there, if you think about low to mid in the first quarter and low to mid for the full year. It's not hard to figure that one out. And then to your point about the EPS side, same thing. If you look at the course of the year, first off, we have to start with sales. And if we expect sales to be not too big a swing in any given quarter, you should expect a similar path on the bottom line. So that's where I would go for now. Obviously, we've put that in our guidance in the first quarter and the full year. And then no, we don't actually see a big impact in our business on SNAP or tax refunds. We do always keep an eye on that, as you can imagine. But because of our multi-category assortment, because of our incredibly loyal base of guests, we see a pretty consistent business, and we don't see the impacts there typically.
Brian Cornell:
All right. Well, that wraps it up for today. Again, I really appreciate the fact that you joined us today. We got a lot of different choices. We appreciate the fact that you've been with us for the last couple of hours, and we look forward to seeing you again next year. So thank you.
Operator:
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, Tuesday, November 20, 2018.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our Third Quarter 2018 Earnings Conference Call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; Mark Tritton, Chief Merchandising Officer; and Cathy Smith, Chief Financial Officer.
In a few moments, Brian, John, Mark and Cathy will provide their perspective on our third quarter performance, outlook for the fourth quarter and progress on our long-term strategic initiatives. 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, Cathy 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 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 our third quarter performance and our outlook for the rest of the year and beyond. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. Our third quarter results are the result of superb execution by our team as they continue to drive outstanding near-term performance. In addition, the team is fully engaged in making meaningful progress as they work to transform Target and position us for sustainable, long-term success.
Third quarter adjusted EPS of $1.09 was in line with our expectations and more than 20% higher than last year. This performance also established a new all-time high for Target third quarter adjusted EPS. Our third quarter comparable sales increase of 5.1% was also in line with our expectation and slightly stronger than the pace we established in the first half of the year. This comp growth is very encouraging on its own, but we're even more excited that it's being driven by traffic in both our stores and digital channels. Comparable sales in our digital channels grew 49% in the third quarter, far outpacing the industry and the vast majority of our peers. This growth was driven by our guests' response to our team's efforts to make the digital shopping experience easy and seamless, deliver new and innovative items through our own, exclusive and national brand assortments and offer an unmatched suite of convenient fulfillment options. While digital channel sales continue to grow rapidly, we are benefiting from healthy traffic and sales growth in our stores as well. This growth reflects the capital we're investing in our remodel program, enhancements of the assortment and presentation in key categories and investments in our team, which help them provide an elevated experience and higher level of service. And finally, on top of comparable sales, new stores contributed more than 0.5 percentage point to our third quarter sales growth. This growth is being driven by new small format locations that we're opening in dense urban settings and near college campuses across the country. We refer to these stores as small because of their square footage, but they really punch above their weight because of their high sales productivity. This allows these locations to deliver strong financial returns while allowing Target to reach guest segments we couldn't serve in the past.
As we've been saying all year, when we analyze the drivers of our strong traffic and sales growth, we see the benefit of all the strategic initiatives we're pursuing, including:
Our remodel program; efforts to rejuvenate our portfolio of own and exclusive brands; the rollout of new fulfillment options focused on delivering ease and convenience, including Restock, Drive-Up and personal shopping in as little as 2 hours with Shipt; investments that allow our stores to fulfill an increasing number of target.com shipments, allowing us to deliver quickly while also controlling costs; new digital capabilities to make shopping faster, easier and more inspiring; our work to ensure we're priced right daily while delivering the appropriate number of clear, compelling promotions; and investments in hours, wages and training for our team to further differentiate the shopping experience in our stores. Rather than measuring a separate benefit from each of these efforts, we believe the impact of all of them together is well beyond the sum of the parts. From a guest perspective, it's the combination of everything we're doing that makes Target more top of mind, causing guests to choose us more often.
Beyond the impact of our efforts, we continue to benefit from a very healthy consumer and macroeconomic backdrop. In addition, as other retailers continue to close stores and liquidate in the face of rapid changes in consumer preferences and shopping behaviors, our investments position Target to capture sales and market share by serving consumers who are no longer shopping those competitors.
Now we've been clear that all of our efforts to grow and transform Target involve a commitment of resources, which explains why I've already used the word investment 5 times in these remarks. And it's also why we're fortunate to have sound operations, healthy cash flows and a balance sheet which provides the necessary flexibility to invest in our future. In addition, we continue to pursue initiatives which will help us offset incremental cost, including:
Tools and technology that deliver higher labor efficiency in our stores, allowing us to focus more of our team member hours in service of our guests; cost disciplines, beginning at headquarters but spanning all of our operations, based on relentless prioritization and a focus on what's most important; our brand development work, which helps us deliver continued strong performance in our highest-margin Home and Apparel categories; and the development, testing and rollout of automation in our supply chain, which will take work out of our store backrooms and move the bulk of replenishment activity upstream into our distribution centers. While we are already benefiting from these efforts today, we see much more potential over time. Most notably, our work to optimize and automate inventory replenishment is in the very early stages, and we expect to realize the vast majority of potential savings from these efforts over the next few years.
But even today, because of the depth of our resources, our business is thriving even as we transform our business. As we've said previously, we believe that this year we'll establish a sustainable benchmark for our operating margin rate over the longer term as we achieve a balancing point between the rate pressures and opportunities of operating an omnichannel retail business. In addition, we continue to generate a robust amount of cash, which allows us to fund:
Our current elevated level of CapEx; an attractive dividend, which we will continue to grow every year; and the return of additional cash through share repurchase, all while maintaining our debt rating.
So while we are not providing 2019 financial guidance on the call today, I will say that we are optimistic about our ability to deliver profitable growth next year and beyond. We've annualized the meaningful investments in operating income we made throughout 2017, and we're poised to benefit from far greater scale across all of our initiatives, including:
New small formats, hundreds of additional remodels, the continually expanding reach of our new fulfillment options and a comprehensive change in the way we replenish our store inventory.
But today, as the team will describe in more detail, our teams are focused and ready to deliver an outstanding holiday season in terms of both sales and profitability. Our stores are staffed and the team members are trained. They are equipped with new tools and capabilities to support an unmatched suite of fulfillment options. And we're operating an outstanding assortment of owned, exclusive and national brand items. And to support these plans, we'll deliver a compelling drumbeat of marketing and holiday promotions designed to keep Target top of mind with our guests throughout the holiday season while continuing to focus on delivering consistent value by ensuring we're priced right daily. With that, I'll turn the call over to John, who will provide an update on our rollout of new fulfillment options, investments in new and existing stores and plans to deliver outstanding service for our guests this holiday season. John?
John Mulligan:
Thanks, Brian, and good morning, everybody. As we said many times, we're in the process of making meaningful changes to Target's business and operating model, and that effort is far from complete. But last year, when we had just announced this plan at our Investor Meeting, we often spoke about how eager we were to move beyond the planning stage and get to the execution phase. That way, all of us could see what was working, what needed change and what we could accomplish faster.
Today, we have clearly reached the execution phase and there are many data points that show we are making great progress. But there is no better metric than traffic, which has been growing, in the last couple of quarters, faster than I've seen in my time at Target. As Brian said, there's no way to fully isolate the benefit of everything we're doing separately, but the one initiative that we can best measure in isolation is our remodel program since we can compare newly remodeled stores to a set of control stores both before and after the remodel is completed. When we performed that analysis, we continue to measure incremental comp sales growth in the 2% to 4% range, consistent with our goals when we launched the remodel program. And given that we completed more than 300 remodels this year, the benefit of that kind of lift in that many stores is one of the many reasons we are optimistic about the upcoming fourth quarter. A piece of unexpected good news is that we have seen a measurable incremental lift in the second year of the remodels we completed more than a year ago. This benefit was not assumed in our planning for these projects and represents another reason for our optimism about the next couple of years, when we expect to complete another 600 remodels or more. On the fulfillment side, the progress we have made this year is truly amazing. At this time a year ago, we were in the early stages of testing Drive-Up at about 50 stores here in the Twin Cities. Today, we offer this service in nearly 1,000 stores, and the ability of our team to deliver consistently outstanding service while scaling up at that pace is remarkable. Drive-Up continues to receive the highest Net Promoter Score of any service we provide. We measure it every month and it has been consistently in the mid-80s to low 90s. Early analysis show that a meaningful portion of our Drive-Up orders are either incremental or taking the place of demand that would otherwise have been shipped to guests' homes. Obviously, given the cost of last mile shipping, we like the economics of Drive-Up much better, and our guests are clearly happy as well. Shipt has rolled out even more rapidly than Drive-Up. After all, we purchased the company less than a year ago, and today, it is operating in more than 250 markets, making it accessible to nearly 2/3 of the U.S. population. As of today, Shipt shoppers are fulfilling guest orders from more than 1,400 Target stores, and a meaningful number of those orders are delivered in less than 2 hours. While our ship-from-store capability was rolled out several years ago, it also continues to grow rapidly. For the third quarter, in which overall comparable digital sales grew an impressive 49%, our ship-from-store volume more than doubled while other shipment modes were nearly flat. As we have said many times, the ability to ship from a nearby store is a win-win. Compared with shipping from farther away, shipping from store provides speed for our guests while dramatically reducing the average cost per shipment. But while Drive-Up, Shipt and ship-from-store are our newest capabilities, it's important to remember that we offer our guests several additional options. In-store pickup continues to grow rapidly and it reliably accounts for about 15% of our digital volume. We're also seeing strong growth in Restock, our next-day delivery service for household essentials. And finally, let's not forget the conventional in-store shopping, which still accounts for the vast majority of our volume, continues to grow and delivers high levels of guest satisfaction. Before I turn the call over to Mark, I want to talk about a couple of ways our team has been preparing for the upcoming holiday season. First, on inventory. As you saw in our release this morning, our inventory position was up about 18% compared with last year, consistent with our discussion on this call 3 months ago. This end of quarter increase is being driven by a few distinct factors that I want to highlight. First, and obviously, we are buying into the strong sales growth we've been seeing and expect to see in the fourth quarter. Second, from a timing perspective, this year will have the maximum number of days between Thanksgiving and Christmas that can occur on the calendar. As a result, our peak inventory position is happening relatively early this year, causing more of it to be reflected on the third quarter balance sheet. And finally, as you know, the Toy category sees a bigger-than-average holiday season peak relative to most other categories, so you're also seeing our investment to support that sales peak in Toys. Altogether, we are comfortable with our inventory position, and we feel well-prepared to support strong performance in the upcoming holiday season. Lastly, I want to talk about our seasonal hiring and our stores' readiness for the holidays. I'm happy to announce that despite very tight labor market conditions across the country, we have achieved our goal to hire 120,000 seasonal team members, which is up from a goal of 100,000 a year ago. now that we have these new team members on board and ready to help us for the holidays, we are providing them with improved training, tools and processes, allowing them to be trained and productive in about 1/2 the average time compared with a year ago. So as I turn the call over to Mark, I want to give a shout out to the team. We've asked a lot of them this last year, and I am so grateful for the way they have delivered. Because of their hard work, our stores are looking and operating better. We have new, convenient fulfillment options available in our stores coast-to-coast. We are operating hundreds of new and remodeled stores, which our guests love. And we have a supply chain that's supporting everything from behind the scenes.
I'm sure the team feels like they've already done a year's worth of work in the first 3 quarters of the year, but I also see every day that they are energized and ready for what's coming in the next few weeks. We say it a lot because we know it's true:
Target has the best team in retail.
Now I'll turn it over to Mark for his recap of our third quarter performance and our merchandising and marketing plans for the holiday. Mark?
Mark Tritton:
Thanks, John. As I mentioned in our last quarterly call, on the merchandising team, we continually focus on maintaining a sense of balance in our approach between value and inspiration, satisfying wants and needs between unique own brands and quality national brands and offering compelling deals while being priced right daily. Our third quarter performance reinforces our confidence that we are successfully maintaining that sense of balance.
From a category perspective, we were really pleased with our third quarter performance of our highest-margin Home and Apparel categories as both categories saw comp growth just below the company average. In Apparel, we saw particular strength in Baby as well as Jewelry and Accessories and Men's. Growth in Home was led by outstanding comps in our home décor assortment. Hardlines saw even stronger performance, comping in the high single digits this quarter. This was led by Toys, which saw comp growth of more than 20%. As you know, we've invested in the Toy category this year, given the recent closures of Toys "R" Us stores around the country. So far this year, our Toy results have exceeded our expectations in terms of sales and share. Beyond results in our most discretionary categories, we're also really pleased with growth rates in our less discretionary Essentials and Beauty and Food and Beverage areas. We saw particular outstanding performance in Essentials and Beauty, which grew faster than the company average. Within this category, we saw double-digit growth in Baby, which again, is also benefiting from the closures of Toys "R" Us and Babies “R” Us stores in the U.S.
In addition, we introduced 3 new innovative own and exclusive brands in the quarter:
Quip and Native in Personal Care; and our new Essentials-owned brand, Smartly, which is designed for the younger budget-conscious guest who lives in smaller spaces.
In Food and Beverage, comp sales grew about 4% in the third quarter, consistent with our second quarter performance. Within the category, we saw strong, encouraging results in our own brand assortment, along with double-digit comps again in adult Beverage. While it's important to focus on our absolute growth rates, our team also maintains a disciplined focus on market share metrics, which indicate Target's relevance against our competitive set. On these measures, we saw another quarter of consistent strong performance. Third quarter data showed we continued to gain meaningful share across every one of our core merchandising categories and nearly all of the subcategories beneath them. This reinforces what we have been saying for some time, that traffic is a key measure for us because whenever we gain a new trip from our guest, they tend to shop multiple categories, lifting performance across the board. It's also important to maintain a balance between share gains in our most discretionary and less discretionary categories. That's because while we always want to shine brightest during key seasonal moments like Back-to-School, Back-to-College and Halloween, it's the Essentials, Beauty and Food and Beverage categories that sustain our traffic and sales between the biggest seasonal events. Importantly, in the third quarter, with all of our categories doing their parts to deliver traffic, we successfully comped over several prominent own brand launches in the third quarter of last year. But now let's look ahead because even though we're really pleased with our performance so far this year, I want to share why we are even more excited about our fourth quarter and holiday seasonal plans. After all, while Target is a guest destination during holiday periods year round, we're entering, by far, the biggest holiday season of the year. As always, we're ready to deliver inspiration, convenience and unbelievable deals to our guests this season. And we'll support it all with our holiday ad campaign, and this year's theme, Gather Round, which celebrates all the ways we choose to spend time with family and friends during the season and make it easy to do so. And obviously, while Toys is important all year long, it rises to a whole new level in the holidays as we typically see 1/2 of our annual Toy sales in the fourth quarter. This year, given the opportunity I outlined earlier, we've really upped our game. In 500 stores, we've added more space for toys; and in more than 100 locations, we've completely remodeled that section of the store. Across all of our stores, we've set up new displays and deepened our inventory, adding more than 2,500 new and exclusive toys for the season, doubling the newness we introduced a year ago. In addition, we've planned for 25,000 hours of family-friendly events in our stores, and we've gone all out with this year's kids gifting catalog. At nearly 90 pages, kids of all ages will be able to find at least one must-have gift and likely many more. This year, to make the process even easier, we've added digital capabilities that simplify shopping the catalog. Using our Target app, you can simply scan any of the pages in the catalog and instantly add any of the items from the page into your shopping cart or wish list, easy. Beyond Toys, we're featuring more than 30 curated grab-and-go gifting displays in our store this season. These displays feature more than 1,400 mostly exclusive items, most at prices under $15, ranging from pops of color in cold weather accessories to everything you need to create a cozy winter escape. We'll also feature this assortment on our gifting hub on target.com, which features interactive menus to make it very easy to find the perfect gift for every one on your list. And again, based on last year's success, we're bringing back our Seasonal Wondershop again this year. This winter wonderland features unique items to trim the tree, luxe gift wrapping supplies and sweet indulgences in Food. In select stores this year, our Wondershop includes a personalized gifting station, offering guests the opportunity to create a truly unique gift for under $20 by custom-printing a recipient's name or initials on any item in a unique assortment of stockings, ornaments and gift sets. Of course, throughout the season, our guest will find more than 20 new owned and exclusive brands that we've launched over the last 2 years. This will be the first holiday season in which we feature our new Umbro, Universal Thread, Prologue, Wild Fable and Original Use brands in Apparel; our Opalhouse and Made By Design brands in Home; as well as Heyday in Electronics. So it's clear we have a lot more in store for the holidays, but guests are focused on more than the assortment at this time of the year. Everyone loves a deal, and we are more than ready to earn some of that love. After all, Black Friday is only a few days away, and we've got a killer lineup of must-have items and prices. But a key part of feeling good about a deal is also enjoying the experience. That's why we're focused on providing ease as well as excitement for our guests this Black Friday. Once again, this year, we're giving our REDcard holders early access to many of our Black Friday deals, and target.com guests will be able to shop our Black Friday deals on Thanksgiving morning. Beyond having items just shipped to their homes, online guests have the option to order items for pickup and Drive-Up as well. And of course, this holiday season will be the first one featuring free 2-day shipping with no minimum order and personal shopping with Shipt. In our stores, which open at 5 p.m. on Thanksgiving day, we'll position team members in the busiest areas of the stores equipped with our skip-the-line technology to allow guests to pay for their items anywhere on the sales floor. We've been testing this capability since earlier in the year, and we have rolled it out across the chain in time for the holiday season. But Black Friday is just the beginning. We'll be offering great deals throughout the season, including our popular Weekend Deals and Cartwheel Daily Deals. But let's not forget Cyber Week. Once again, on Cyber Monday, we'll offer 15% off the majority of our assortment. We'll follow that blockbuster offer with great deals all week, including daily offers on Apparel, Home items, personal care, Beauty and Electronics. And finally, as if the arrival of a package from Target isn't enough, we've recently rolled out new shipping boxes on target.com. These boxes are unmistakably Target and feature our iconic bull's-eye mascot. This is just one small way we're focused on making the everyday special for our guests throughout the holiday season and beyond. So I want to thank the team for everything they've done to prepare for this moment. To say it takes ability to pull off the holiday season is an understatement. It requires close coordination and alignment across all of our teams, including merchandising, marketing, stores, supply chain, technology. That's just the beginning of the list. But it's work we love during our favorite time of year, a time when everything comes together in service of our guests. And now we feel ready and can't wait to see how we deliver the holiday season. With that, I'll turn it over to Cathy, who'll provide more detail on our third quarter financial performance and outlook for the rest of the year. Cathy?
Catherine Smith:
Thanks, Mark. Our third quarter performance was right down the middle when compared to our expectations on both the top line and the bottom line. And of course, when you look at our growth compared with last year, you can see that our team continues to deliver really outstanding performance.
Third quarter comparable sales grew 5.1%, just above the 4.8% pace we established in the first half of the year. From a channel perspective, comparable sales grew more than 3% in our stores and 49% in our digital channels. This is the strongest digital comp we've ever reported, and it demonstrates the positive impact of everything we're doing to deliver convenience, speed and reliability regardless of how our guests choose to shop. From a traffic and basket perspective, third quarter comp growth was driven by a traffic increase of 5.3%, offset by a very small decline in average ticket. As we've described in prior quarters, both of these metrics reflect an increasing penetration of smaller, quick and fill-in trips, which are growing much faster at Target than for the industry overall. This trend reflects the guest response to our work over the last couple of years to enhance convenience and ensure we are priced right every day, which is reinforced by our Target Run and Done marketing campaign. Beyond comparable sales, our total sales growth of 5.7% reflects a new store contribution of about 60 basis points. As Brian mentioned, these stores deliver very high sales productivity, which allows them to make a meaningful contribution to our growth even as overall square footage is down slightly compared with last year. Our third quarter gross margin rate of 28.7% was lower than our expectations. This was the result of higher-than-expected supply chain costs, driven by digital fulfillment and the cost of receiving and processing a larger holiday inventory position compared with a year ago. Our third quarter SG&A expense rate was about flat to last year. This reflects continued investments we're making in our team, specifically hours, training and wages, which allow our teams to provide new and enhanced experiences in our stores. These investments are being offset by continued cost discipline across the enterprise as we continually work to increase efficiency and eliminate lower-priority and nonvalue-added work. Our depreciation and amortization expense rate was down about 40 basis points from last year, reflecting lower D&A dollars combined with the benefit of 5.6% total revenue growth. Below the operating income line, third quarter interest expense of $115 million was $136 million lower than last year. This decline was driven primarily by early debt retirement cost which we recognized in last year's third quarter. In addition, it reflects a lower ongoing run rate for interest expense this year, driven by last year's debt refinancing and retirement activity. And of course, our effective income tax rate was lower this year, reflecting the ongoing benefit of last year's Federal tax reform, along with the benefit of some discrete items. Altogether, this performance led to GAAP EPS of $1.16, up more than 33% compared with last year; and adjusted EPS of $1.09, up more than 20% from last year. Turning to the balance sheet. Our inventory at the end of the third quarter was nearly $1.9 billion higher than a year ago, driven by the factors John highlighted earlier. However, accounts payable were nearly $2 billion higher than a year ago, meaning this entire increase in inventories has been funded by growth in payables. Payables leverage has been a positive story for more than a year now, providing a beneficial tailwind as we invest to transform our business. Beyond investments in inventory, we continue to have ample capacity to fund robust capital investment and return cash to our shareholders. In the third quarter alone, our CapEx was just over $1 billion. We returned more than $300 million in the form of dividends and more than $500 million through share repurchase, all within the limits of our middle A credit ratings. And lastly, our after-tax return on invested capital was 15.8% for the trailing 12 months through the third quarter, up from 13.4% a year ago. As a reminder, this year's ROIC calculation reflects the discrete benefit of last year's Federal tax reform relating to the revaluation of our deferred tax liabilities. Excluding this discrete benefit, after-tax ROIC was 13.9% over the last 12 months. This is about 50 basis points higher than a year ago and demonstrates the impact of all of our initiatives combined with the benefit of a lower ongoing tax rate resulting from the passage of Federal tax reform. Now let's turn to the outlook for the fourth quarter and the implications for our full year financial results. On the comparable sales line, we are expecting fourth quarter growth of around 5%, consistent with what we have delivered year-to-date. On the operating income line, we are looking for a small rate decline compared with last year. This outlook reflects continued rate pressure on the gross margin line, although not to the same degree as we saw in third quarter. Regarding SG&A and D&A expense rates, we are expecting relative stability compared with last year. This performance supports an expected range for full year adjusted EPS of $5.30 to $5.50 and a GAAP EPS range of $5.41 to $5.61. The expected range for this year's adjusted EPS represents 13% growth at the lower end and 17% at the higher end. And of course, this range is ahead of our expectations going into the year. As we've seen better-than-expected traffic and sales so far this year, our business has delivered better-than-expected bottom line performance even as we continue to make meaningful investments in our transformation. Before I turn it back over to Brian, I want to cover one housekeeping item. Consistent with last year, we plan to issue an update on our financial performance following the holiday season. This year, we have scheduled that update for Thursday, January 10, and we look forward to speaking with many of you after that announcement. And finally, I want to thank you for your time today and your continued engagement in our story. This is an incredibly dynamic time to be in the retail business. As we look across the landscape, it's becoming clear that those of us who have the resources to invest and the ability to adapt quickly are seeing the benefit in our traffic, sales and financial performance. For us, it's a vivid reminder of the benefit of maintaining a strong balance sheet and sound operations while also maintaining a relentless focus on our guests and their expectations. With that, I'll turn it over to Brian for some final remarks. Brian?
Brian Cornell:
Thanks, Cathy. Before we move to your questions, I want to start by letting you know that we plan to host our 2019 Financial Community Meeting in New York City on Tuesday, March 5. Our Investor Relations team will send out more detailed information in January, but we wanted you to have the date as you plan for next year.
So now before we get to your questions, I want to step back and recap our journey since the Target 2017 Financial Community Meeting. At that meeting, we talked about the need to invest both capital and operating margin to transform our business and position Target as a relevant and successful retailer for decades, not months or quarters. We did so with the confidence that we were taking the right long-term steps for our business. And we had the conviction that, over time, our shareholders would look back and appreciate our long-term perspective. So today, as we're entering the fourth quarter of only our second year in this effort, I hope you are already happy with what you're seeing. Based on what we delivered this year, combined with our fourth quarter expectations, we are positioned to deliver our best comparable sales growth in more than a decade and establish a new high for Target's earnings per share. It's great to be in that position in only the second year of this effort, but there's a lot more to do. After all, when we embarked on this effort, we described 2018 as a transition year. As we get ready to move into 2019, we're ready to accelerate and scale beyond that transition period. Next year, we'll be positioned to complete our rollout of Drive-Up and Shipt, remodel and build more exciting stores, and make meaningful progress in our work to modernize our supply chain and radically change the way we replenish our stores. While the supply chain effort will take place behind the scenes, it can deliver a host of important outcomes, enhancing our reliability and reducing costs. Importantly, this effort will free up labor in our stores, providing more time for our team members to serve guests on the sales floor and support all of our different options for digital fulfillment as we continue to drive profitable growth and build even greater loyalty with our guests. So thank you for your time today. And now we'll move on to your questions.
Operator:
[Operator Instructions] Our first question comes from Seth Sigman with Crédit Suisse.
Seth Sigman:
So if we just focus on the quarter, your sales and EPS came in at about the midpoint, but your EBIT margin was below guidance. Seems like it was mostly gross margin, but just hoping that you can elaborate on what was different versus your expectations. And then as you think about the EBIT margin implied for the fourth quarter, I think you said down slightly, Cathy, so it seems to be down a lot less than the third quarter, maybe even up at the high end of the range for the year. So just curious, what is different in the fourth quarter relative to the third quarter?
Brian Cornell:
Why don't I start, and then I'll turn it over to Cathy. I think as we look at our absolute performance in the third quarter, we were right on our expectations. We continue to have another very strong quarter where traffic grew over 5%. We had very strong overall comp performance of 5.1%, an acceleration versus the first half of the year. We delivered digital growth of 49%, our strongest growth rate ever. And we did grow EPS by over 20% while growing market share in every one of our major categories. So if I look at our performance in the quarter, we're executing versus the plan we laid out in the beginning of the year. We're seeing a very strong response to our store remodels. Our new small formats are performing very well in each and every market. We continue to drive very strong performance with our new own brands. And the investments we're making in our team are driving exceptional responses from the guest. So as we look at our performance in the quarter, we're right where we expected to be and we're set up well for a very strong holiday season. Cathy?
Catherine Smith:
Yes. So Seth, as we said, we expect a small rate decline in the fourth quarter. First off, was we expect a 5% comp, so we should start there. And then a small rate decline in the quarter. And as you said, we pointed to -- we do expect continued pressure in gross margin, but not to the same extent we saw in Q3. The biggest difference is our -- while we still expect great sales, we obviously already anticipate the mix that we'll be seeing in that business, just like we did last year's fourth quarter. And we'll see strong digital sales but we would've seen strong digital sales last year's fourth quarter, so the year-over-year changes are a little less, as you can imagine. And then lastly, we're moving -- we moved a lot -- received a lot and moved a lot of inventory in the third quarter in anticipation of the fourth quarter, and so we would expect those cost to not be as strong.
Seth Sigman:
Okay, that's helpful. And then just, Brian, you highlighted a number of positives, particularly on the sales line and there are clearly cost to achieve that, right, and drive that higher share that you're seeing. So can you just help us better understand some of the initiatives to help offset those cost pressures that you alluded to earlier? I'm not sure if those are already in play, if they're already happening, but just help us better understand when that can have a more meaningful impact and support that profitable earnings growth that you were talking about earlier.
Brian Cornell:
As I mentioned in my earlier comments, we're in the very early stages of the transformation of our supply chain and replenishment systems, very early stages of testing automation and improving overall processes. Those will take place over time. We've also rolled out a number of new fulfillment options. And while we know that throughout the year, ship to home is very important to our guest, as we continue to build awareness around other fulfillment options
Operator:
The next question comes from Matt McClintock with Barclays.
Matthew McClintock:
Brian, you talked about a lot of these fulfillment initiatives and you specifically highlighted a lot of strength with Shipt and Drive-Up. And I was wondering, could you maybe give us a sense -- because you did say that Drive-Up is incremental. Can you give us a sense of how often these consumers are actually choosing to use Drive-Up or Shipt? And can you give us a sense of how many of these people are new customers? Or are they existing customers? Are you getting people who normally make 12 trips to Target a year doing a 13th or 14th? Or they are doing more like a 16th or 17th trip, 4 extra trips, because they're now using Shipt?
Brian Cornell:
Matt, it's something that we're looking at as we sit here today, but we're in the very early stages. Again, it was only 12 months ago, we had Drive-Up in 50 locations. We've been rolling that out across the country over the course of this year. We've rapidly expanded Shipt to over 200 markets, but we're still in the very early stages. So we're still building awareness. We literally just started our advertising campaign to talk to our guest, to talk to the consumer about this new suite of fulfillment options. So those are the metrics we'll be looking at over time, and they will continue to contribute to our digital growth. But it's still very, very early. And we expect to build awareness during the holiday season and throughout 2019.
Catherine Smith:
Matt, I'll pile on a little bit. John shared in the prepared remarks, too, while we're seeing 2 really positive things out of that effort, out of the Drive-Up and Shipt, specifically though in Drive-Up, and that is we're seeing incremental guests making incremental trips, to your question, and we'll continue to measure that. But secondly is we're seeing them shift what would have been a 2-day free delivery into coming by our stores because they're so well located. And we can -- they can pull right into our parking lot, we'll bring it out to their car in less than 2 minutes. And so both of those are really good back patterns as we think about the further economics longer term.
Brian Cornell:
But Matt, we'll be in a much better position 12 months from now to really understand how it's shaping guest behavior, the incrementality, how it drives additional trips. We're still in the very early stages. But as Cathy just referenced, the early indicators are quite positive.
Matthew McClintock:
Perfect. And then if I can have one follow-up. Just on SG&A, clearly, you're still making a lot of investments, but you're starting to lap a lot of investments, or an acceleration in investments that you're making, and I'm talking specific to wages. As we see comp store sales remain in pretty strong territory, especially given your very strong traffic, is it possible that as we get into early 2019, that we could start to see a little bit more of a leverage from some of the strength in comps if it stays?
Catherine Smith:
Yes. So as you said, we're continuing to invest. We think having the best team in retail is really important, so we'll keep making those investments on our path to $15 by 2020, as we said. But what you saw with us being essentially flat this quarter is that we are starting to find some of those offsets. And to your point, we'll continue. We think a lot of those benefits of removing replenishment out of the backs of our stores and back upstream and automating them will help to continue to offset some of those costs.
Brian Cornell:
But Matt, those investments that we've been making in our team are clearly one of the big drivers behind the comp store increases we're seeing in our stores, the traffic we're seeing both from a store and a digital standpoint. The team members, first and foremost, are the great ambassadors of our brand. They're helping us drive this performance and certainly contributing to the market share gains we're seeing across all of our categories.
Operator:
The next question comes from Edward Kelly with Wells Fargo.
Edward Kelly:
Could we just start with the gross margin? Could you just provide a bit more color on the gross margin performance this quarter? Cathy, you did mention that it was a bit disappointing. What was the impact of digital fulfillment, mix? How much of an impact was the growth in inventory? And just any color there, I think, would be helpful.
Catherine Smith:
Yes. So as we said, it was a little lower than we had anticipated, really driven by 2 things
Edward Kelly:
Okay. And then Brian, just a question for you. As you think about 2019, and obviously, it's early, but you sound positive about the opportunity to deliver profitable growth. Are you implying stable EBIT margins with this? And can you talk a bit more just about how you're thinking about balancing investment in the business with that goal? I mean, if you think about 2018, it was a bit harder to deliver EBIT growth despite what was very good comp growth. So what changes next year?
Brian Cornell:
Well, Ed, we're not going to give 2019 guidance today. But we are very excited about what's upcoming in 2019 and 2020. Based on the response we've seen to store remodels, and next year, you can expect us to remodel a similar number of stores. We'll continue to open up highly productive small-format stores. Mark and the team have some exciting new owned brand introductions. We'll continue to scale and build awareness around our fulfillment portfolio, which makes Target the easiest place to shop in America. So as we continue to build awareness around our new fulfillment options, begin to scale, more remodels, moving into new catchments with new small formats, the elevation of our brand portfolio, we're very excited about 2019 and beyond. And as I've said many times now, we're still in the very early stages of this journey. And while we feel great about the progress we've made in 2018, we're certainly ahead of schedule. We're certainly driving very strong traffic and market share gains. The bulk of the work is still in front of us. So that's why we're so confident about the path that we're on and excited about 2019 and 2020 and beyond.
Catherine Smith:
Ed, as I think about it, the third quarter was an important leg in this relay race that we're on because of the operational progress we made throughout the course of the business. But now we're to the point where we have our full suite of fulfillment options that we can now really start delighting our guest but really aligning that mission to closest to the store for those high-frequency things when that makes it easier for them to pull into our parking lot and pick up their diapers or their dinner to go or whatever it is. Now with that full suite of fulfillment options, we'll delight our guests, first and foremost; but secondly is we'll start to move those missions closer to the store on those times when it matters, especially in those higher-frequency, lower-margin categories.
Operator:
The next question comes from Robbie Ohmes with BofA Merrill Lynch.
Robert Ohmes:
Cathy, I wanted to just follow up on the gross margin. The -- I think the expectation was that they'd be up in the back half, and I think you guys had said stronger in the 4Q than 3Q. As we look at the fourth quarter, in the gross margin being down less than it was in the third quarter, maybe a little more color on what the -- maybe the fourth quarter digital growth assumption is. And sort of what changes? Is it basically that the pressure from bringing all the inventory into the third quarter alleviates in the fourth quarter? Maybe a little more color there would be helpful.
Catherine Smith:
Yes. So Robbie, to your point, we knew that we had a lot of cost of goods sold initiative that will start to come through the latter -- the back half of this year, which are exactly doing what we said. The strength of digital at 49% this quarter, on top of last year's in the 24% range, is a pretty big change. So that is some of the pressure you're seeing in Q3. When we move into Q4, though, we did a 29% digital comp last year in the fourth quarter, and so we're anticipating still strong fourth quarter digital comp as you would expect. Now we can offer the full suite of fulfillment options, we think guests are going to choose some of those that are a little bit more convenient, they can come by our stores and the economics are better. So that's one. But -- so one is we'll see the year-over-year digital growth isn't quite as big a change that we're expecting in the fourth quarter. But more importantly, we'll still see those merch initiatives and we are starting to see some of those, the cost of goods sold, coming through there in the fourth quarter. So those are the biggest changes. And then lastly, the amount of inventory we moved in Q3. Obviously, we're here and ready for the holidays, come shop and shop often in Target. So we're going to have a really good fourth quarter and holiday.
Robert Ohmes:
And did China tariffs play any role in bringing in more inventory in the third quarter? And maybe you could update us on how you're thinking about tariffs for the fourth quarter and for next year.
Brian Cornell:
Yes. Let me start, Robbie. We clearly were planning well ahead for a very strong fourth quarter. We wanted to make sure we had the inventory in our system to meet the very strong demand we're anticipating for the fourth quarter. And there's really no update on the overall tariff front. We continue to watch it each and every day, as I know you do. And we're looking at what levers we can pull to make sure we minimize the impact for our guest. So we'll watch it very carefully. Obviously, it's a very fluid topic right now. But our focus is on executing in the fourth quarter. And we've got the inventory and the plans in place to make sure this is a very strong fourth quarter for Target.
Operator:
The next question comes from David Schick with Consumer Edge Research.
David Schick:
Brian, a couple of times in your initial discussion and then even in Q&A, you're talking about the very early stages of these investments that the consumer is enjoying with choices, with merchandising, delivery choices, et cetera. But I guess, if you look at the history of retail, oftentimes, this high level of investment is made when there's weaker major players that you can sort of finish off and enjoy a better margin over a longer period of time. How do you think about that long-term aspect of the spending curve, given the capabilities and the competition between major players, including yourself?
Brian Cornell:
Well, in some ways, you've answered the question for me. We certainly have been talking for several years now about the opportunities that are in the market as many of our competitors shrink or liquidate and go out of business. And we think there's sizable market share opportunities as we continue to see the rationalization of the retail landscape. But the investments we're making are still in the very early stages. While it feels like we've been talking for years about remodeling stores, the fact of the matter is, over the last couple of years, we've remodeled just over 400 stores. We've got many, many more stores that we're going to touch over the next couple of years. We're excited about small format, but we've got a portfolio of new catchments that we'll be entering over the next couple of years. The work on own brands has been very well-received by the guest, but those brands are only going to build greater awareness over the next few years. And importantly, from a fulfillment standpoint, while we've been carefully testing and building platforms and capabilities, it's really just now that we're starting to extend these fulfillment options at scale. So that's going to build over the next couple of years. So as we go into 2019 and 2020, we'll have remodeled even more stores. And we know, as we remodel stores, we see a very positive lift. So stores are driving additional footsteps each and every week. It's helping us capture market share in those neighborhoods. Our small-format stores are incredibly productive right now and are being incredibly well received by the guest. So when we combine the work we're doing in-store with the progress we're making from a fulfillment standpoint to meet the needs of the guest, no matter how they want to shop, and make sure that our stores are at the center of that component, we believe there's opportunities for further market share gains; to continue to drive very strong traffic and comp store sales; and to scale these initiatives, which, over time, will reduce our cost and continue to make Target the easiest place to shop in America. So we're in the very early stages. And we'll be at a higher level of scale in 2019 and build off of that. But if this was a football game, since we're in the season, we're still in the first quarter. But I like the points that we're putting on the board.
David Schick:
I guess to continue that, good luck in the all-important drive starting...
Brian Cornell:
Thank you.
Catherine Smith:
Thank you.
Operator:
The next question comes from Edward Yruma with KeyBanc Capital Markets.
Edward Yruma:
I know that on the second quarter call, you talked about being light on inventory. Obviously ended in a different inventory position in the third quarter. Were you short of inventory intra-quarter in the third quarter? And do you think that impacted sales? And then second, you've talked a lot about how some of these urban stores are helping you reach a new consumer. Can you give us some color on the profitability over trends you're seeing on some of these locations?
Catherine Smith:
Maybe I'll start, if it's okay, Ed, with the new small formats. And then John, maybe, can add into the inventory question. So on small formats, yes, first off, we really like that we're able to access guests that haven't had access to Target in the past. And so that has been terrific. We continue to like what we're seeing out of the small stores. They have great sales productivity, as we referenced in the call earlier. And we do see really good returns. So we measure them against the same IRRs and same hurdle rates we do all of our investments, and they have really good returns. So we'll continue to see that. You'll see us continue to open new small-formats.
John Mulligan:
On inventory, we have felt good about inventory really the whole year long about where we've been on inventory. There's been some businesses we've chased into, like Toys, we have aggressively chased into; and Baby, which have the result of what's going on in the marketplace there. But I wouldn't describe our inventory ever as light. I think we were well positioned at the end of second quarter. We feel really good about our position right now. We knew we would peak inventories relatively early, given when Black Friday falls this year. And of course, you saw that on our third quarter balance sheet. But overall, we feel really good about where we've been positioned on inventory throughout the year.
Brian Cornell:
And if we go back to the new small formats, I think it's important to point out, this is allowing us to reach a guest that, in the past, we hadn't been able to serve. So when you think about recent quarter and approximately 60 bps of revenue contributed by these new small formats, that's largely incremental. These are neighborhoods and catchments where we haven't been participating before. It's a guest that wasn't able to shop with Target on a regular basis. So not only are they already contributing to our revenue, it's opening up a door for a new guest to shop at Target. And the reaction, as Cathy's referenced, has been very positive. We're seeing incredible productivity out of these stores, and we're reaching a guest in neighborhoods where we've never competed before.
Operator:
The next question comes from Peter Benedict with Baird.
Peter Benedict:
Just to circle back quickly on the gross margin. The fulfillment cost pressures, I guess, from digital in the third quarter, I mean, safe to assume that they were a little more than what you saw sequential -- or in the third quarter, which I think third quarter was around 60 basis points. Is it fair to assume it was more than that?
Catherine Smith:
Peter, you must be talking about second quarter. So we did see -- I'm not sure. So let me just address the third quarter gross margin. As we said, it was obviously lower than we had anticipated, or the deterioration was. Really, the biggest piece of that is the supply chain cost related to the digital fulfillment to support that 49% comp. The next biggest piece of it is really around the supply chain cost to process -- receive and process the inventory ahead of the holiday. And so I'm not sure if that's helping where you were going.
John Mulligan:
I might add, we've circled around this a couple of times. We did move a lot of inventory in second quarter, and we did it at a higher cost. You guys all know there's transportation pressure out there. Our first and foremost objective as it related to transportation was ensuring that we secure the supply we would need to move our goods. And so we did that, and we will find ways to offset that incremental cost through other ways as we go forward. But we're moving a lot of inventory, and it was at a higher rate than we paid last year. So both of those factors applied to what Cathy's talking about.
Peter Benedict:
That's helpful. And I guess, as we look to the fourth quarter. Again, I'm sorry to stick with the gross margin, but I guess the expectation in the fourth quarter for your gross margin, is it safe to say it's similar to what you saw in the first half of the year? I think it was down in the around 20 basis point range. I mean, is that the level or the magnitude of improvement you're expecting in the fourth quarter sequentially?
Catherine Smith:
Yes. I don't think we'd go -- specifically what we're expecting for the fourth quarter. What we said is we'll see some continued pressure, but it won't be near the extent we'd seen in the third quarter.
Peter Benedict:
Okay, that's fair. Just last question, Cathy, just in terms of the tax rate, I know it's dynamic, but maybe what your range of assumptions are for the fourth quarter in terms of tax rate.
Catherine Smith:
Yes, so I would think of more a normalized -- think about a new statutory rate with the Federal tax reform is probably a better place. So if you just take the third quarter, we obviously, on print, was 13.6% tax rate, which is incredible. I'll stop there. But if you take out the adjustment we made to the previous deferreds, we would have been closer to a 19-ish range or so. And so as you start thinking about kind of maybe a more normal, that's a better way to think about it.
Brian Cornell:
With that, operator, we've got time for one last question.
Operator:
Our last question comes from Greg Melich with MoffettNathanson.
Gregory Melich:
Wow, just getting in there on the bell. I'd love to talk about 2 things. Basically, the loyalty programs, particularly Shipt, any color there in terms of how much of the digital growth it's driving or how many members you're up to now? And I think you mentioned the number of markets. And also REDcard, it just seems like the penetration there has been sort of stable. Is there anything that you're considering to maybe reinvigorate that? Tell us how some of the tests are going on REDcard, that would be really helpful.
Catherine Smith:
Yes. So Greg, maybe I'll start and then Brian and John can pile on, too. For REDcard, as you said, penetration is about stable. As we've said in the past, we know that, that is a great program. They're our highest, most engaged guests, our most loyal guests. So we absolutely want to continue to grow that. You're seeing us do more exclusives, you'll see it this year with the fourth quarter like we did last year, and really make those a special relationship with our guest. However, we also know that, that doesn't speak to everyone. And so as you know, we've been testing a loyalty program in Dallas, we call it Target Red, which is a non-tender-based program to really have everyone be a part of the relationship with Target. So we're excited about where that's going. We'll continue to test that this next year. But all of the indications are very, very positive. We're seeing really good sign-ups and engagement with the Red program.
Brian Cornell:
John, you want to wrap this up with an update on Shipt?
John Mulligan:
Yes. With Shipt, we remain really excited, really proud of how the team has scaled that throughout this year. They have -- we're in over 250 markets now in a very short amount of time. We continue to see very strong response from consumers. I think the metric I look at that gets me most excited, if you look at mature markets, so markets that have been open for over a year, still continue to see triple-digit growth in sales, in GMV. So guests continue to engage more and more, even in markets where we've been there a long time. The other thing I'd add, Greg, to get to your question is, the impact on digital growth is relatively modest because we're not reporting GMV, we're only reporting our revenue, which, of course, is quite modest relative to the GMC -- GMV sales that go through Shipt. So the impact there is relatively modest, but we're very excited with Shipt and the opportunity now as we begin testing Shipt deliveries on target.com and the opportunity to scale that next year.
Gregory Melich:
If I could, I love just a follow-up on that. Just given the strength in traffic, have you guys been thinking about ways to monetize that traffic with digital advertising, in particular, just given what Kroger's trying to move in that direction; Amazon, certainly, with $7 billion of advertising revenue. How are you guys thinking about using all that data and traffic that you have and maybe outside the traditional avenues?
Brian Cornell:
Greg, it's something we're thinking about each and every day. And it probably leads us to wrap up today and invite all of you to join us in the spring for our updated Financial Community Day. So it's something that we're very focused on, continue to build loyalty with our guest.
But for today, I think, operator, we're going to wrap up our third quarter call and invite everyone to join us again in the spring. So thank you.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation Second Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, August 22, 2018.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our second quarter 2018 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; Mark Tritton, Chief Merchandising Officer; and Cathy Smith, Chief Financial Officer. In a few moments, Brian, John, Mark and Cathy will provide their perspective on our second quarter performance, outlook for the full year and progress on our long-term strategic initiatives. Following their remarks, we'll open the phone lines for a question-and-answer session.
As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer your follow-up questions. As a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also in these remarks, we refer to non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP numbers to the most directly comparable GAAP number are included in this morning's press release, which is posted on our Investor Relations website. With that, I'll turn it over to Brian for his thoughts on our second quarter performance and our outlook for the rest of the year and beyond. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. We are really pleased with the second quarter financial results. Comparable sales grew 6.5% in the quarter, representing Target's strongest quarterly comp performance since 2005. This increase was driven by traffic growth of more than 6%, an unprecedented number and, by far, the strongest performance since we began reporting this metric in 2008.
Total sales were up 7% from a year ago, reflecting 0.5 point of growth from our new and non-mature stores. Store comparable sales increased nearly 5%. And digital sales grew more than 40% in the second quarter as guests continue to respond to a growing menu of convenient fulfillment options, newness throughout our merchandising categories, freshly remodeled stores and a higher level of service across the chain. On top of the strong digital sales trend we've been seeing for many years, we saw a meaningful incremental lift from our 1-day sale in July, which came in far ahead of expectations. With very strong traffic, both in store and online, we saw accelerating comp sales trends in all 5 of our core merchandising categories. While there are healthy increases across the board, comp growth in our Home category was amazingly strong, up nearly 10%. Hardlines also saw high single-digit comp growth, driven by strength in both Toys and Electronics. And with stronger-than-expected sales, our business delivered stronger-than-expected profitability. Our second quarter adjusted EPS of $1.47 was near the high end of the guidance range of $1.30 to $1.50. This represents about 20% growth compared with a year ago despite the fact that our results continue to reflect significant investments in both capital and operating income to position Target for long-term success. These investments include our plan to perform wall-to-wall remodels of approximately 1,000 stores over a 3-year period; our work to completely transform Target's supply chain, placing our stores at the center of a modern network designed to deliver an unmatched combination of convenient fulfillment options; opening new small-format stores across the country, allowing us to reach guests we couldn't serve with our larger formats; last year's investment to ensure we're priced right daily in support of the Pay Less side of our brand promise; our work to deliver a constant drumbeat of new and exciting merchandise throughout our own and exclusive brand portfolio; the rollout of new convenient digital capabilities that make it easier and more inspiring for our guests to shop, save and use their REDcard; and most importantly, investments in hours, wages and training for our team members. These investments enable our team to deliver higher levels of service and productivity, and our guests are responding to the change. We embarked on this investment plan at the beginning of 2017, and our progress so far has been well ahead of our original expectations. There's no doubt that, like others, we're currently benefiting from a very strong consumer environment, perhaps the strongest I've seen in my career. But market share data demonstrates that our current results are benefiting from more than just the environment as we're seeing broad market share gains across categories we sell. The question we continue to hear from many of you is whether we can separately measure the benefit of each of these investments we're making, and the honest answer is we can't evaluate each one of them in isolation. Instead, it's the collective benefit of all these initiatives that is keeping Target more top of mind with guests, enticing them to visit our stores and our site more often. Before I turn to our outlook for the rest of the year and beyond, let me comment briefly on the topic of tariffs. Like many of you, we've been carefully monitoring recent tariff announcements, and we're aware of the potential for this situation to further escalate. As we've said many times, as a guest-focused retailer, we're concerned about tariffs because they would increase prices on everyday products for American families. In addition, a prolonged deterioration in global trade relationships could damage economic growth and vitality in the United States. Given these risks, we've been expressing our concerns to our leaders in Washington, both on our own and along with other retailers and trade association partners. However, our concern is centered on the impact of tariffs on consumers and the economy, not our ability to manage our business in the face of these challenges. As you know, when we're faced with tariffs or any other external factors, there are multiple levers we can pull to remain price competitive and maintain profitability, and we are continually developing and implementing contingency plans as we learn more and things evolve. While we always account for risks like this when we plan for the future, today, we are also focused on the multiple opportunities we see in front of us. In the first half of 2018, we delivered comparable sales growth of 4.8%, a result which is much stronger than the expectation at the beginning of the year. As a result, we've updated our comp guidance, and we are now planning for comp growth in the back half of the year in line with what we've seen in the front half. In addition, we've also updated our full year EPS expectations. Cathy will provide more details in a few minutes. These upgrades to our outlook reflect the current trends we're seeing across our business, including a very strong start to Back-to-School and Back-to-College. In addition, we continue to focus on unique opportunities in key toy and baby categories, given the recent closure of Toys "R" Us and Babies "R" Us across the country. And of course, as the year progresses, we'll continue to benefit from the broader rollout of new fulfillment capabilities like Drive-Up and Shipt, brand launches in multiple categories, the completion of additional remodels and the opening of more small-format stores. As we look beyond 2018, we have increasing confidence that we can deliver very strong results in the years ahead as we move into the next phase of our strategic plan and achieve scale across the full slate of our growth initiatives. When we move beyond testing to scaling, we'll see efficiencies and cost savings, further strengthening our guest experience and overall position in the marketplace. And importantly, by the end of 2020, we'll have a newly refreshed base of stores, reflecting our plan to complete more than 1,100 remodels in a 4-year period through 2020. So now before I turn the call over to John, I want to pause and thank the entire Target team for everything they're doing to deliver outstanding operational and financial performance. In pursuit of our plans, we're asking our team to deliver more change faster than at any time ever before. The team is responding enthusiastically to the challenge, and it is inspiring to see our vision coming to life. But I want to quickly add, while our progress feels great, we have no intention of slowing down. We'll continue to seize the opportunity ahead of us and offer our guests more inspiration and convenience than ever before. With that, I'll turn the call over to John, who'll provide an update on our rollout of new fulfillment options, investments in new and existing stores and changes in our stores to make the shopping experience easier for our guests. John?
John Mulligan:
Thanks, Brian, and good morning, everybody. As I've discussed with many of you, the operations team faces a fundamental challenge in delivering on our strategic initiatives. As we work to make changes to virtually every facet of our operations, modernizing our supply chain, delivering new fulfillment options and increasing efficiency in our stores, we need to simultaneously focus on maintaining everyday reliability in support of a $75 billion business.
In the face of this challenge, I'm really proud of how our team is performing on both priorities, particularly in light of the rapid acceleration in sales we've seen in recent quarters. As you know, our strategic plan includes significant investments in the physical infrastructure of our stores. This is because our stores will continue to be the key fulfillment node for our guests, whether that's a traditional store trip, a Drive-Up order, an in-store pickup order, a trip by a Shipt shopper or a traditional e-commerce purchase shipped from a local Target store. Our goal for the year is to deliver well over 300 remodels, and we are on track to deliver that plan. We completed remodels of 113 stores in the second quarter on top of the 56 we completed in the first quarter and many more underway. In fact, in July, we had 258 locations undergoing a remodel during at least a portion of the month, the highest at any time in our history. While our remodel project creates an optimal platform for all of our fulfillment initiatives, it also provides our guests with a more inspiring environment that's easier to shop, and our guests continue to respond by shopping more often. Specifically, consistent with our plan, we continue to see traffic-driven incremental sales lifts of 2% to 4% in our remodeled stores following completion of the remodel. And while the data is limited, we are seeing some early indications that remodeled stores continue to out-comp other stores beyond the first year after the remodel. We also continue to see encouraging performance from our new small-format stores. We opened 6 of these new locations in the second quarter on top of the 6 we opened earlier in the year. These locations deliver high sales productivity along with gross margin rates above the company average. And we continue to see strong growth as these stores mature. At the end of the second quarter, we are operating 26 mature small-format stores, and on average, this group saw high single-digit comp growth during the quarter. Beyond the physical experience in our stores, we continue to invest in hours, training and wages for our store team, allowing them to deliver a higher level of service and a better overall experience for our guests. While this modernization is focused on the guest experience, it is fueled by efficiency. In the second and third quarter this year, we are investing in key member training across every one of our stores, focusing on how our team members can be more helpful to our guests as they shop. We've rolled out new tools and technology that allow our team to find and order items on behalf of our guests and process the sale from anywhere on the sales floor. We're hiring differently, focusing on the passion and expertise of team members who can deliver more information and service in key categories like Beauty, Electronics, Apparel and Food. And in Food and Beverage, we are changing how the team accomplishes everyday tasks, allowing more opportunities for guests to interact with experts on the sales floor while also standardizing operations to ensure we have fresh and full presentations, a focus on food safety and a strong and efficient foundation for how we operate. While these investments are already helping us deliver stronger traffic and sales, we are also focused on driving efficiencies that can help us offset the cost. As a result, we have completely redesigned when and how our teams sort and stock product, reducing steps and creating more opportunity for guest interaction during key business hours. In addition, we have implemented changes to our back-room organization for store teams to more efficiently ensure our guests have what they need on the sales floor, particularly in Apparel. And of course, our work on the upstream supply chain is focused on changes that will dramatically reduce store workload associated with unloading and restocking over the next few years. Beyond store investments, I want to give you an update on our rollout of new fulfillment options across the country. The team has been moving at an amazing pace, and our guests continue to tell us that they love the new options. I'll start with Shipt, our same-day personal shopping service, which is now operating in more than 160 markets and serving more than 1,100 Target stores. Over the last year, Shipt's membership base has more than tripled while orders, revenue and GMV are 2 to 3x higher. While some of this growth is being driven by Shipt's entry into new markets, we're seeing orders and GMV in comparable markets, meaning markets in which Shipt was already operating a year ago, that are up nearly 100% year-over-year. We're also very pleased that new partners continue to sign in to the Shipt platform, attracted by the reliability and level of service that Shipt can provide. Year-to-date, the Shipt team has added to their marketplace a total of 19 new retail partners who operate under 24 unique banners across the country. This is more than double the number of new partners that Shipt added to its marketplace in all of 2017. We're also pleased with the rollout of our new service in dense urban market stores, which we call Delivery From Store. With this service, guests pay a small fee at checkout and choose a time window later that same day when their shopping basket will be delivered to their front door. This service is now available in 58 stores across 5 markets, and guests continue to love it. The average basket size for this service is more than $200, the highest of any service we provide. And last but certainly not least is our new Drive-Up service. We started the year offering Drive-Up in 50 stores, and at the end of the second quarter, it had expanded to more than 800 locations around the country. Our stores have done an excellent job training their teams to deliver this new service, and guest satisfaction is off the charts. Our most recent Net Promoter Score for Drive-Up is 88, a crazy high number, the highest of any service we provide. We expect to have this service rolled out to nearly 1,000 stores by the holiday season, and we will continue the rapid expansion next year. On top of these new services, we continue to see rapid growth and adoption of other digital fulfillment services, including Restock, in-store pickup and, of course, shipping to our guests' front doors. And you've seen that growth in our numbers for a long time now as we've seen year-over-year growth in our digital sales in the 20% to 30% range for several years. However, this quarter, we saw a step-up in the pace of growth, and a lot of that acceleration was driven by our 1-day sale in July. Among the many reasons to host a digital sale in July, it's important for our team because it gives them the opportunity to stress test our systems and processes in advance of the peak holiday season. And this year, the July sale presented a really robust test as orders and sales far exceeded our expectations. The sale created by far the biggest digital sales day we've ever experienced outside of a holiday season, driving volume nearly 3x higher than our forecast. While this was great news, of course, our store and supply chain teams had to react and recover quickly to fulfill all the unplanned demand and keep operations running smoothly. While that challenge presented some long days for our team, I'm really proud of how they responded, adding to my confidence in our ability to accommodate peak demand in the upcoming holiday season. In a way, the story of the 1-day sale is similar to the story of the second quarter as we saw stronger-than-expected volume throughout the quarter. This has caused some in-stock challenges in certain items and categories, and the team is working quickly to recover and plan for higher volumes throughout the rest of the year. As a result, our inventory position at the end of the second quarter was up about 11% from a year ago. Of course, a meaningful portion of this growth is being driven by our current and planned level of sales, which are growing faster than we've seen in the many years. In addition, the team has brought in extra inventory to recover and protect in-stocks, and we are seeing higher levels of in-transit inventory as our operations teams develop plans to accommodate the fourth quarter surge. And of course, our merchant teams have brought in extra volume to address the unique market share opportunity we're facing in Toys and Baby. Bottom line, we continue to feel very good about our overall inventory position given our plans for the rest of the year. Before I turn it over to Mark, I want to reiterate what Brian said earlier. Our current traffic and sales growth are not being driven by any single thing we're doing. They are the result of everything we're doing for our guests. And I want to thank everyone on the team for making it happen. While there's a lot of change that's visible from the outside, there's even more change happening internally. That amount of change presents a challenge so it's incredibly rewarding when we see our guests responding in such a positive way. With that, I'll turn the call over to Mark, who'll provide more detail on our second quarter performance and our upcoming plans in merchandising. Mark?
Mark Tritton:
Thanks, John. As Brian and John have mentioned, the momentum we're seeing across our business is amazing and we can't point to any one single driver. Instead, the common denominator is our guest who is thinking of us and choosing to shop with us more often. As we benefit from this momentum, our goal is to maintain this focus on our guests and push ourselves to do more even more quickly in service to them.
As we've said before at Target, we're at our best when we maintain a proper balance in our business with a focus on delivering "and," not "or." After all, we don't ask our guest to expect more or pay less, we work to consistently deliver on both sides of that brand promise. But it doesn't stop there. We feature a curated assortment that satisfies wants and needs, offers basic items and must-have style and highlights national brands and owned brands. We invest to ensure we're priced right daily and offering compelling deals, design our assortment to support both stock-up and fill-in trips, and we feature all of it in stores and online. Guest surveys give us confidence that we're achieving a proper balance in the current environment. For example, in the second quarter, our guest scores for convenience and everyday pricing increased, and our differentiation score increased as well. This is a testament to the efforts of our entire team over the last 18 months and their focus on delivering the right combination of everyday prices and compelling promotions with the right assortment of innovative national brands, alongside exciting new owned and exclusive brands. We're also seeing good balance in our category performance. Comp growth in all 5 of our core categories accelerated in the second quarter, and all of them grew faster than our first quarter comp of 3%. Among the 3 months, May benefited from the recovery of temperature-sensitive sales and July benefited from the Back-to-School, Back-to-College and some calendar shift, but comps in all 3 months were stronger than our first quarter trend.
Also of note, we saw some of our strongest market share gains around key life moments like Mother's Day, Father's Day, Memorial Day and, of course, the 4th of July. But we also saw sustained results outside of those holidays, driven by the strength of our essentials in Food and Beverage categories, which saw share gains in every week of the quarter. We saw unusually strong second quarter growth across each of our style categories:
Apparel, Beauty and Home. However, Home was the standout with a comp of nearly 10% growth, driven by even faster growth in decor and kitchen, which are benefiting from our new owned brands. Within Home, we also saw strong sales in seasonal categories, reflecting encouraging early results in the Back-to-School and Back-to-College seasons.
In Apparel, we saw high-teens growth in Baby, reflecting the benefit of the unique opportunity we're facing to gain market share in Baby and Toys, given the recent closures of Toys "R" Us and Babies "R" Us across the country. Given the strong affinity between families with young children and our brand, both Toys and Babies are key categories for us, and we expect to see traffic and share gains in both of them for the rest of the year and beyond. Outside of the style categories, our Hardlines, Food and Beverage and Essentials categories also delivered standout growth. Hardlines was particularly strong, driven by double-digit comps in both of Toys and Electronics. Now within Electronics, we saw really strong growth in video games as well as Accessories, where we successfully launched our new owned brand, Heyday, during the quarter. In Essentials, the second quarter growth was strongest in Baby and in pets, both of which saw double-digit comp growth. In Food and Beverage, we delivered our sixth straight quarter of accelerating comps. Growth continues to be led by adult beverage and produce, areas in which we have made important investments over the last couple of years. To continue supporting our frequency businesses, our successful Target Run and Done marketing campaign has begun featuring convenient fulfillment services like in-store pickup and Drive-Up, making sure our guests understand all the ways they can get their Target run done. As we look at our broad category strength, what's especially encouraging is that it isn't being driven by higher promotions. In fact, sales at our everyday price are up more than $2 billion so far this year, reflecting the continued benefit of our team's efforts to establish a better balance between meaningful promotions and everyday pricing. Even for the promotional events like our July 1-day sale, we're thinking differently about how we can provide value. More than half of our digital sales on that day were in our highly differentiated and high-margin Home category. And as John told you, we blew away our forecast for that event. As we look ahead, we have a lot more in store for the third quarter and beyond. On top of the new owned and exclusive brands we launched in 2017 and earlier this year, which continued to perform really well, we launched 4 new owned brands in the second quarter that will drive our results going forward. Three of these new brands were designed to invite young millennials and the emerging Gen Z guests to experience Target in ways that are authentic to them. Wild Fable is our newest Apparel & Accessories brand for young women. It's driven by current trends and focused on enabling guests to create their own style for their own many life moments. For young men, we just launched Original Use, a street-meets-vintage modern brand focused on enabling guests to explore fashion, culture and individuality. Both Wild Fable and Original Use feature a wide range of sizes, reflecting our commitment to inclusive sizing. As I mentioned earlier, we launched our exclusive Heyday brand of electronic accessories in June. This brand is designed to appeal to style-conscious guests at an incredible value without sacrificing quality, with trendy fun and quality tech at very affordable prices. Also in June, we launched our newest home brand, Made by Design, consisting of more than 750 items in kitchen, storage, bedding, bath and even furniture, with most items below $30. This brand is the ultimate expression of Target's DNA, a commitment to the democratization of design, offering high-quality style at affordable prices. We designed each product to intuitively go beyond the expected, delivering smart solutions that make everyday tasks easier. For example, the cookware incorporates pour spouts on the rims and built-in strainers in the lids. Glasses are stackable, and towels include hanging hooks that keep them off the floor. And items were designed to forgive minor mistakes, like silicon and nylon tools that can handle heat up to 450 degrees, in case you accidentally leave your spatula on a hot fry pan. And finally, in addition to our new owned brand, we are really pleased with the second quarter performance of our unique collaboration with Disney to celebrate Mickey's 90th anniversary. This collaboration features more than 350 exclusive items spanning multiple categories, including Toys, bedding, beach gear, Beauty, even pets, all celebrating Mickey and the pure magic of summer, bringing joy you can only find at Target. Of course, beyond new items and brands already launched, we have more newness planned for the third quarter and look forward to revealing more soon. But our differentiation doesn't just happen with new brands. We also deliver newness through our existing brand portfolio. Look at Cat & Jack. We launched this kids brand more than 2 years ago, and sales and market share continue to grow. That's because we continue to invest in delivering newness and great design through Cat & Jack every day, every season. Whether we're talking about new brand or an existing brand, it's our focus on the guest, innovation and great design at a great price that are key for Target to continue to win through differentiation, and that is not going to slow down. With that, I'll turn it over to Cathy, who'll provide more detail on our second quarter financial performance and outlook for the rest of the year. Cathy?
Catherine Smith:
Thanks, Mark. Our second quarter financial performance exceeded our expectations on both the top line and the bottom line, reflecting the benefit of our strategic initiative in a very strong consumer environment. As Brian mentioned, our second quarter comp sales increase of 6.5% is the strongest we've seen at Target in 13 years. This growth reflected a 4.9% increase in our store comparable sales combined with 41% growth in digital. These are both very healthy numbers in isolation, and they're even more powerful together.
Traffic growth of 6.4% accounted for nearly all of our comparable sales growth in the second quarter. In addition, for the first time in nearly 2 years, our comp sales grew faster than comp traffic as we saw a small 0.1% increase in basket in the quarter. In our last quarterly call, when describing our first quarter traffic increase of 3.7%, we described it as the strongest result we had ever reported since we began reporting this metric in 2008. Obviously then, this quarter's traffic growth of more than 6% is well beyond anything we've reported before, and we are really encouraged to see continued momentum in such a key metric. Our second quarter gross margin rate of 30.3% was down about 10 basis points from last year and slightly better than our guidance. Among the drivers, we continue to see meaningful pressure from fulfillment costs as guest engagement with our digital channel continues to grow and we rapidly roll out new convenient fulfillment options across the country. However, in the second quarter, this headwind was almost completely offset by the benefit of our merchandising initiatives, including ongoing cost-saving efforts and the benefit of our work on pricing and promotions. The mix of our sales was a slight headwind in the second quarter as strong sales in our high-margin Home and Apparel categories were balanced by really strong trends in lower-margin categories, including Toys, Baby and Electronics. Our second quarter SG&A expense rate was about 10 basis points higher than last year. Across the broad categories of expense, there were no large rate variances year-over-year as cost pressures were offset within categories. For example, second quarter compensation costs reflected pressure from higher wage rates, but those costs were offset by lower incentive expense compared with a year ago. Our second quarter depreciation and amortization expense rate was slightly lower than a year ago. This was better than our expectations, driven by stronger-than-expected sales and a smaller-than-expected increase in D&A expense associated with our remodel program. Altogether, our operating income margin rate was about 20 basis points lower than last year, somewhat better than our guidance for a 40 basis point decline. Notably, operating income dollars were 3.6% higher than last year as the increase in total revenue more than offset a slightly lower rate. Below the operating income line, second quarter interest expense was about 12% lower than a year ago as we can continue to benefit from last year's debt retirement and refinancing activity. Our second quarter effective tax rate was 21.8%, down nearly 10 percentage points from last year, reflecting the benefit of federal tax reform legislation. Bottom line, we reported second quarter GAAP EPS from continuing operations of $1.49, up 22.7% from last year and adjusted EPS of $1.47, 19.8% higher than a year ago. Stepping back to look at the first 2 quarters of 2018 in total. Target's comparable sales have increased 4.8% from last year, and our GAAP and adjusted EPS are both up about 15%. This year-to-date performance reflects the traffic and sales benefit of our strategic initiatives, continued significant investments in operating income and the offsetting benefit from federal tax reform. Turning briefly to the balance sheet. We ended the second quarter with about $9.1 billion of inventory. This represents an 11% increase from last year, as John covered earlier. Also notable on the balance sheet is the growth in payables, which were 20% higher than last year at about $9.1 billion as well. Payables leverage has grown substantially in the last couple of years as the team has focused on improving that metric as a source of funding for the meaningful investments we're making. Even accounting for this investment in our inventory, our business continues to generate very healthy cash flow. Specifically, through the first half of 2018, our continuing operations have generated more than $2.7 billion in cash, providing ample capacity to make meaningful investments in our business while returning capital to shareholders. In the second quarter, we made capital investments of just over $1 billion, and we remain on track for CapEx of about $3.5 billion for the year. These investments are concentrated primarily in store projects, including remodels, other presentation enhancements and new urban and college locations around the country. Beyond those capital investments, in the second quarter, we returned just over $0.75 billion to our shareholders in the form of dividends and share repurchases. And in June, our Board of Directors approved a 3.2% increase in our quarterly dividend from $0.62 to $0.64. With this increase, 2018 is on track to mark our 47th consecutive year of annual increases. Finally, I always like to close my quarterly commentary with a discussion of Target's after-tax ROIC. This is a key metric we monitor closely as it incorporates both our operating performance and the quality of our capital deployment decisions. For the trailing 12 months ending in the second quarter, we recorded after-tax ROIC of 16%, including the discrete benefits of federal tax reform that we recorded in last year's fourth quarter. However, even after we exclude those discrete benefits, our second quarter ROIC of 14.2% was up about 70 basis points from a year ago. It's encouraging that we are returning to growth in this metric as we're seeing the initial impact of last year's strategic investments in capital and operating income, which were designed to best position Target for success over time. So now let's turn to our guidance for the third quarter and the full year. As we look at the underlying drivers of our traffic and sales, there are more positive indicators than we've seen for many years. These indicators are reinforced by our comparable traffic and sales results, which have been gaining momentum over the last 1.5 years. As a result, today, we updated our guidance for both the third quarter and the back half of the year, and we are now planning for comparable sales growth in line with what we delivered in the first half of the year. As we move down the P&L to the operating income line, we continue to plan cautiously and focus on the unique opportunity we're facing to capture additional traffic and market share in key categories like Toys and Baby. In light of that opportunity, we have updated our expectation for the gross margin mix of our sales for the remainder of the year, reflecting higher sales expectations in these lower-margin categories. With this updated mix expectation, we are now planning for a gross margin rate decline of 30 to 40 basis points in the third quarter. Combining that expectation with our forecast for a slight increase in our SG&A expense rate and a small amount of rate favorability on the D&A expense line, we are planning for a 20 to 30 basis point decline in our operating income margin rate in the third quarter. These expectations translate to an expected range for both GAAP and adjusted EPS of $1 to $1.20 in the third quarter. For the full year, we are now planning for an operating income margin rate decline of 30 to 40 basis points on a higher base of expected sales. These expectations translate to a full year outlook for adjusted EPS of $5.30 to $5.50 compared with our prior range of $5.15 to $5.45. We believe this expectation achieves the appropriate balance between shorter-term and longer-term priorities. Namely, it reflects improved bottom line expectations resulting from an increase in expected sales while allowing the flexibility for our business teams to invest appropriately in the traffic and the market share opportunities we're currently facing in a number of key categories. As we enter next year, we will be well positioned to benefit from these share gains. In addition, we'll benefit from achieving much greater scale across all of the capabilities we've been testing and launching across the country. With this scale, we will realize efficiencies and cost savings, which will position us to deliver profitable growth in 2019 and beyond. Before I turn the call back over to Brian, I want to thank all of you who are listening for staying with us on the journey we began last year. At the beginning of 2017, we said that to position Target for long-term success, we needed to make some bold investments in both capital and operating margin to accelerate our transformation and deliver more relevant experiences, brand and fulfillment options to our guests faster. The momentum of our results since that announcement 18 months ago makes us more and more confident that we are making the right investments, and that affirmation is coming most strongly from our guests. We're seeing unprecedented traffic and the best comp sales trends in more than a decade. As Brian said earlier, there is no doubt that the environment is an important factor in our current success as consumer trends are the strongest they've been in some time. But market share data continues to confirm that we are growing faster than the market in the broad set of categories we sell. While this is great to see, we are just entering the next phase of our transformation, and we have much more to accomplish in the months and years ahead. With that, I'll turn the call back over to Brian for some final remarks.
Brian Cornell:
Thanks, Cathy. Before we move to your questions, I want to add to what Cathy was just saying. 18 months ago, when we were developing our plan to make additional investments in our business, so we could move faster, we considered all of our stakeholders as we evaluated our options. Obviously, we started with our guests since they are at the center of everything we do, but we also decided to increase our investments in our Target team, adding hours, training and wages to allow them to better serve our guests.
We thought about our merchandise vendors and how we can change the way we work together to deliver quality, newness, differentiation and value to our guests. We looked at our community giving and corporate responsibility efforts, focusing on the issues most important to our guests and where Target can have the most impact. And we obviously considered you, our shareholders, because your capital supports all the investments we make. So as I mentioned at our Financial Community Meeting last spring, I am very grateful for the personal comments I received from many of you in support of the commitments we've made to our business, our team, our community and creating long-term shareholder value. I hope you're as excited as we are to begin seeing the benefit of the long-term decisions we made last year, which are already driving a higher level of engagement between our guests and our brand. With that, we'll move to your questions.
Operator:
[Operator Instructions] Our first question comes from Seth Sigman with Crédit Suisse.
Seth Sigman:
My question is about the guidance. So the guidance seems to imply, I guess, slightly better operating profit growth in the second half of the year. In the second quarter, it was up, and it was up for the first time in a very long time, which is nice to see. But it was down for the full first half on similar comps to what you're assuming for the second half. So can you just remind us of some of the drivers? And Cathy, we got the margin commentary, but just help us a little bit more with some of the levers as we move into the second half of the year, some of the cost savings and other opportunities that will help support that operating profit growth.
Catherine Smith:
Yes, Seth. Thank you. As we did say, we're obviously very, very pleased with the quarter, so thank you for the comment. And as we think about updating our guidance for the remainder of the year, we expect consistent sales. So first, on the top line, we see the back half and we've got plans for consistent sales growth in that same range, which is obviously very strong, consistent with the traffic and sales we've been seeing. And then on profitability, we see a great opportunity to continue to take share and go after some categories, specifically Toys and Baby. So we baked that in into the back half of the year. So all of that said, we'll continue investing in both the fulfillment aspects, which are coming through in gross margin, and then the category mix. And then on the SG&A line, we'll continue to invest in our stores. All of that said, we expect the back half of the year for a slight deterioration in op income margin rates.
Brian Cornell:
But Seth, we feel like we're very well positioned for the back half of the year. As I've mentioned with my prepared comments, we're seeing a very strong start to Back-to-School and Back-to-College. We continue to see very strong traffic trends. And we expect to monetize that in the back half of the year. So you should expect continued strong performance from Target throughout 2018, but it also sets us up for a very strong performance as we go into '19 and beyond. So I think we're well positioned to continue to build off of the current momentum. And you should expect us to begin to grow operating income from a dollar standpoint.
Catherine Smith:
And as you've mentioned, op income dollars did grow in the second quarter.
Seth Sigman:
That's great color. If I could just follow up, Brian, on your point. I mean, clearly, there's broad-based strength here, and you highlighted that you don't think it's any single initiative. But can you maybe speak to the biggest surprises relative to your expectations? Because, obviously, the quarter turned out better than expected as well as the outlook. So just any more color on, relative to your expectations, what is outperforming?
Brian Cornell:
Seth, I'll start with each one of our key initiatives is ahead of the schedule that we had set 18 months ago. We continue to see really positive responses from our store remodels. And John mentioned that in the month of July alone, we had over 250 stores under construction. In each and every market, we're seeing really strong guest response to those reimaged stores. Our new small formats continue to impress and are driving productivity from a sales standpoint that are beyond our expectations. The reaction that the guest has had to our new brands has been spectacular in Home, in Apparel and now in electronics. And each one of the fulfillment capabilities continues to deliver a great response from the guests. John talked about the Net Promoter Scores we're getting for a service like Drive-Up that we'll bring to scale for the holiday season, the reaction we're getting in each and every market to Shipt and the quality of Shipt shoppers that are servicing their members. In urban markets like New York or Chicago, San Francisco, Boston, D.C., the ability to shop our urban small formats and then, hours later, have someone deliver that package to your doorstep for a $7 charge, very well received. And the investment that we've made in our store teams and putting more expertise in departments like Beauty and Apparel, in Food and Beverage, in technology, the reaction we're getting from our guests exceeded our expectation. So all of our key initiatives, as they're working together as one, are ahead of the schedule that we would have set 18 months ago. And now as we move into the holiday season, we'll have more of those at scale, and as we move in to '19, we'll be further ahead of the original plan that we had established back in February of 2017. So each one of the key elements is working ahead of the schedule that we had set back in February of 2017, and we expect that to continue to accelerate. And as you've heard me say numerous times, the traffic number to me is the most important measure that our strategy is connecting with the consumer both in our stores and online, and we continue to see very strong traffic as we go into the third quarter.
Operator:
Our next question comes from Mike Lasser with UBS.
Michael Lasser:
You mentioned that the remodels were -- some of that activity peaked out in July. Was there actually a drag from that, the traffic and same-store sales results would have been even better had it not been for some of the remodeling activity?
Brian Cornell:
Yes. Mike, it's certainly disruptive when we're remodeling stores. And now we're doing it at scale. So we're very focused, John and his team, on shortening the construction cycle, less disruption, rapid recovery. But you can only imagine, with over 250 stores under a construction during an important month like July, there was significant disruption in those store sales. We're going to see the recovery as we go into the third quarter, and we certainly expect to have even better response in those stores in Q4. So when we remodel, there's significant disruption in sales, but we're seeing that return very quickly once we complete the remodel.
Michael Lasser:
And is that also the case -- I mean, there was a shift with your same-store sales, and it seems like, based on your guidance, the shift has been really a meaningful story here in what either you saw in the third -- in the second quarter or what you expect for the next couple. And then I have one last follow-up.
Brian Cornell:
Yes. Mike, while we're very pleased with the rollout, at this point, it's a very, very small impact to our overall sales. So we'd certainly expect over the next few years that shift will have a more meaningful impact on our overall performance, but at this point, it's still on a very nascent stage.
Michael Lasser:
I'm sorry, Brian, that was my fault. I meant like a calendar shift rather than...
Brian Cornell:
No.
Michael Lasser:
I'm sorry, my fault, I should have spoken clearly.
Brian Cornell:
We've seen no major impact to the calendar shift throughout the season.
Michael Lasser:
Okay. And then the last question -- the follow-up is -- so it sounds like the gross margin is going to be impacted by the mix, which is a prudent strategy and totally reasonable for the back half. Is there also some effect from fulfillment costs as e-commerce becomes a bigger portion of the mix? And does that act as a continued drag beyond just the next couple of quarters?
Brian Cornell:
We're certainly going to face some headwinds from the rapid growth that we've seen online. Our digital performance is up 41% on top of 32% last year. But I think Mark and our entire team have done a sensational job of managing gross margin rate. You look at the kind of growth we drove in the second quarter, up 6.5%. You look at digital growing by 41%. And we're able to basically maintain gross margin rates equal to last year. I mean, the erosion was 10 basis points. So with that kind of explosive growth, we're managing mix very effectively. And it's where -- and again, you've heard us talk about this before -- the continued performance of our owned brands plays a very prominent role in allowing us to manage our mix. To have a category like Home grow at almost 10%, driven by some great new brand launches, led by Made by Design during the quarter, that's how we're managing to mitigate some of the gross margin rate deterioration that others are experiencing right now. So I feel really good about the efforts of the team and our ability to continue to drive store growth at almost 5%, build our online business at a rate of 41%, but use our mix management and our owned brands to deliver very strong gross margin rate performance in the quarter.
Operator:
The next question comes from Oliver Chen with Cowen.
Oliver Chen:
Our question is about pricing and promotion. What are your thoughts on managing that in the context of what you've been doing in the consumer environment? You've done a really good job with that gross margin rate. I'm just curious about value and how you'll continue to communicate that. Also, we were curious about the loyalty program. You have a very loyal customer, but what's ahead in terms of what you're thinking there just to capture that and continue to engage [ that customer ]?
Brian Cornell:
Oliver, why don't I start with loyalty, and then let Mark talk about our continued efforts to support our priced right daily positioning. I mean, the loyalty program is off to a very solid start in the Dallas market. We're watching that carefully. John Mulligan and I are actually going to be heading down there this week to assess the program, and our performance in the market, still in a very early stage. But as we think about 2019 and beyond, we certainly expect our Target loyalty program, Target Red, to play a very important role in building even greater engagement and loyalty with our guests. So lots more to come as we get into 2019 and think about loyalty. But Mark, why don't you talk about our efforts on the pricing and promo front and our continued support of being priced right daily.
Mark Tritton:
Yes. Oliver, I think that the work that we did with priced right daily beginning in 2017 and our opening price point stance, which really spans how we're pricing every day both in national brand and owned brand, has been really key to part of the traffic generation and seeing consistent flow, whether it's in stock-up or, more importantly, in fill-in trips that are changing our frequency business, but also, across the board, make it very easy for the guests to shop in-store and online with great transparency and simplicity of pricing. So we've been able to exercise great pricing, communicate simply to the guest, and we're getting credit for that. And the data that we're seeing in share in each of the categories is really reinforcing that.
Brian Cornell:
Oliver, I think one of the reasons we're so confident in our second half outlook is because we're seeing such a great response from our guests to the investments we've made in pricing to make sure that we're priced right daily on those key Food and Beverage and household essential items. Those are driving footsteps to our stores, visits to our site, and they've been a key driver behind the rapid acceleration in traffic.
Oliver Chen:
That's really helpful. Our last question was about supply chain. You made a lot of really encouraging progress in supply chain. What are your thoughts about the state of speed and stock levels? And we saw a lot of the technology and thoughts you have ahead at your Investor Day at Target lab. What are you seeing in terms of how you'll manage the bricks-and-clicks story and also how you'll manage for the smaller pack sizes? Would love an update there.
John Mulligan:
Yes, another great question. I think I talked about this a little bit in my remarks. The challenge for us is balancing changing the business while we operate the business. And as you said, we showed you a lot of what we're doing to change the business. We'll start scaling a lot of that work in 2019, and that has the opportunity to significantly move our capabilities forward as we begin to scale that work. I think, right now, we've said as the sales accelerated particularly in Q2 -- from Q1 to Q2, there are some areas where we've been spotty on in-stocks, and we're not happy with that. And you see the response in our inventories. We've -- we're flowing goods in a little bit earlier for Q4 so that we can flow them into the stores appropriately. We've taken positions in things like A&A basics, things like denim, chinos, where last year, frankly, the new brands came out and we are almost immediately out of stock. We've made investments there. And then we're working hard on Food and Beverage. And as Mark said, we're gaining share for 6 quarters in a row, so we're learning how to operate that business both differently in the store and in the supply chain. So we feel good about the progress we've made, but we are not satisfied with our current in-stock position. There's more work to do there.
Brian Cornell:
And, Oliver, I'll just build on that for you and others on the call. Well, this was a really strong quarter for the company and when we think about comps at 6.5%, the strong comps in-store, the acceleration in digital, there's a lot to be proud of, but we know we've got a lot of work to do. And we've got to make sure that we are now meeting the demand that's taking place within our system. So John is very focused on that to make sure that we improve our in-stock position. But we've seen obviously a step-function change in demand in our stores and online, accelerated growth. We're chasing some of that growth right now. And we've got to continue to make sure that we're doing a better job of replenishing our system as we go into the back half of the year and particularly as we get ready for continued strong growth in 2019.
Operator:
The next question comes from Chris Horvers with JPMorgan.
Christopher Horvers:
I wanted to -- you focused a lot on scaling in terms of 2019, the different initiatives, but also in terms of the investment base. At the Analyst Day earlier this year, you called out '18 as an investment year, and you're reiterating your view of profitable growth in '19 and beyond. Can you frame out how you think of that in terms of the margin rates in the business, including gross margin and operating income rate? Could we see flat grosses in '19 and up OI rate? Or are you thinking about profitable growth in terms of a flow-through on a flat OI rate?
Brian Cornell:
Chris, this won't to surprise you. We're not going to give 2019 guidance today.
Christopher Horvers:
I'm trying.
Brian Cornell:
I know you are, and you're trying hard. But I would refer you back to Cathy's comments earlier. When we look at our second quarter progress, really strong gross margin rate for a company that grew at our level. And for the first time in a while, operating income is growing from a dollar standpoint. So we're seeing some improvement in our performance. We expect that to continue over time. But you'll have to stick with us for another day when we're ready to give 2019 guidance.
Christopher Horvers:
Understood. And then in terms of the e-commerce growth, you called out a big lift from the 1-day sale, but at the same time, you're scaling a lot of fulfillment options into the back half. So do you think you can maintain sort of that 40% online sales growth into the back half? And how much of that contributes to the updated comp outlook versus, say, share in Baby and Toys in these key seasons coming up?
Brian Cornell:
Chris, I'll let John build on this, but we expect very strong digital growth in the back half. Obviously, we're guiding to comp sales that are going to be very consistent with our first half performance. You're going to continue to see us scale up Drive-Up and Shipt, same-day delivery in urban markets, so that's going to play a very meaningful role. But you should expect our stores to be a very important driver to our growth in the back half of the year and complemented by continued maturity in our fulfillment capabilities.
Catherine Smith:
I'll just add real quickly, Chris. Stores did almost [ 5% ] comps by themselves. And obviously, our stores are fulfilling much of that 41% digital growth, and so well over 2/3 of that -- of the digital growth is being fulfilled out of our stores. And so we're blurring those lines every single day, making sure we have a great experience for our guests and letting them choose to shop how they want to engage with Target. And so we're going to start talking less and less at some point about an actual digital comp because it is truly our entire business fueled by those stores.
Operator:
The next question comes from Matt McClintock with Barclays.
Matthew McClintock:
Brian, I was wondering if I could ask a macro question. So the broader retail industry has truly enjoyed a resurgence across the board this quarter. Target seems to standout because of the traffic, as you highlighted. But I was wondering if I could get your thoughts on what's driving this? Why did the consumer -- the American consumer all of a sudden just wake up and start going to retailers again? And then thinking forward, how should we think about Target's strength this quarter and the traffic trends this quarter, the strength everything that all throughout the year when we get to 2019 and you're up against that comparison in 2Q? Because I just want to say, in 2Q of next year, there's going to be a lot of skepticism that you can comp the comp at that point in time. So just your thoughts.
Brian Cornell:
Let me start with the macro environment. And we've talked about this a lot over the last few years, and there's been a lot of questions about the role stores would play and was everything going to shift online. And I think the one voice that was missing from that conversation was the voice of the consumer, and consumers continue to vote with their footsteps. And as we sit here today, the numbers tend to vary from week-to-week, but on any given day, 90% of retail sales are done in physical stores. And I think what you're seeing right now from a macro basis is well-run retailers with strong balance sheets that generate cash that they can invest back in their business are winning right now. And there's obviously others right now that can't afford to invest in their store experience or build capabilities or drive differentiation, and they're giving up share. So there's clearly winners and losers. We certainly think we're migrating to the winners column. And we're driving not only traffic, but as Mark and Cathy and John have talked about, we're taking market share in all of our major merchandising categories. And the investments we're making to make sure that Target is a long-term winner are being rewarded right now by the consumer and our guests. So we've got to continue to make sure we focus on executing our strategy as we go into '19, continue to take advantage of the market share opportunities that are out there. And I'll go back to our February 2017 investor conference. And one of the things we talked about in our overall management thesis is there are going to be billions of dollars of retail market share up for grabs, and we're going to position ourselves to take more than our fair share of that. We're seeing it happen. As companies like Toys "R" Us and Babies "R" Us exit the market, as others close stores, we're picking up market share in those important categories and those key geographic catchments. And we'll expect to continue to do that in '19 and beyond, and it's what gives us confidence that we're going to be able to lap these strong numbers in 2018 with continued strength in '19 and beyond.
Operator:
Our last question comes from Joe Feldman with Telsey Advisory Group.
Joseph Feldman:
I wanted to go back to something, I think, John was talking about with the labor and some of the changes maybe in the way you're hiring people and kind of the way you're allocating labor in the store and some of the transformation in the back room. Can you just give a little more detail on that and explore that issue?
John Mulligan:
Sure, Joe. I think, internally, you've probably heard us talk about the store modernization, and it's really Ken and the store team doing a great job just stepping back and saying what is it we're trying to accomplish in the store? And certainly, there's the work we have to do moving product out to the sales floor and checking people out and all the things that just happen because they have to happen in a store. And our goal there is to become more efficient and to become more efficient not just for efficiency's sake, but to provide the fuel so that we can invest in more talent and better expertise on the sales floor and in particular, in those areas where it matters the most. So think Beauty, Electronics, with our visual merchandising in both Home and Apparel and then in Food. Those are areas where we have gone out and actively hired for expertise, and that's where things like the wage investment are so critical. They've allowed us to differentiate in who and how we hire people. And so those team members, finding ways to bring that expertise in and then keep them on the floor, so that the Beauty team member is in Beauty all the time and they're able to help the guest and they also keep track of what's going on in that part of the store relative to in-stocks and inventory flow. And so rather having a team of generalists doing price change one day, checking out the next day and maybe moving freight on Wednesday, these individuals are accountable for their part of the store. They're out there, they get to know the guest and provide a very different level of experience. And then we've invested in tools and a significant amount of training to help them. And this has been a journey we've been on for a couple of years, and we will be on it for a couple of more years as the team continues to evolve and build capabilities. But we think it's something incredibly important to our long-term success.
Brian Cornell:
John, thank you. And operator, thank you. That concludes our Q2 earnings call. I appreciate everyone joining us today, and we look forward to talking to you again when we talk about our Q3 results. So thank you.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation first quarter earnings release conference call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, May 23, 2018.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our first quarter 2018 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; Mark Tritton, Chief Merchandising Officer; and Cathy Smith, Chief Financial Officer. In a few moments, Brian, John, Mark and Cathy will provide their perspective on our first quarter performance, outlook for the full year and progress on our long-term strategic initiatives. Following their remarks, we'll open the phone lines for a question-and-answer session.
As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer your follow-up questions. As a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also, in these remarks, we refer to non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP numbers to the most directly comparable GAAP number are included in this morning's press release, which is posted on our Investor Relations website. With that, I'll turn it over to Brian for his thoughts on our first quarter performance and our priorities going forward. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. We are really pleased with the performance of our business in the first quarter, which demonstrates the resilience of our multi-category portfolio.
Our traffic growth, up 3.7%, is the strongest we've seen in more than 10 years, reflecting healthy increases in both our stores and digital channels. Comparable sales growth of 3% was consistent with our guidance, driven by strength in Home, Household Essentials and Food and Beverage. This demonstrates the benefits of maintaining a balanced portfolio as strength in these categories offset the impact of a late spring on our temperature-sensitive categories, which have accelerated dramatically as we entered the second quarter. We also benefited this quarter from the launch of 3 new owned or exclusive brands in Home and Apparel and a successful limited-time partnership with Hunter. In our digital channels, we continue to see strong trends even as we compare over rapid growth in past years. For the first quarter, Target's digital channel sales grew 28%, on top of 21% a year ago. While our operating income continues to reflect some near-term headwinds driven by last year's investments to transform our business, we are benefiting from accelerated traffic and sales and federal tax reform legislation enacted late last year. As a result, our earnings per share grew more than 9% in the first quarter, and we're expecting strong EPS growth for the remainder of the year. Given all the changes we've made in our business, we are seeing multiple drivers of the recent acceleration in our performance from our investments in stores, supply chain, new brands and our team, even our ongoing partnership with CVS. Everything is contributing to our success, and our guests are responding. As a result, given our current trends and our plans going forward, we expect that our comparable sales growth will accelerate in the second quarter into the low- to mid-single-digit range, and we remain confident that our business will generate full year sales and earnings per share consistent with the guidance we provided at the beginning of the year. As we have said many times, our business performs best when we support both sides of our Expect More. Pay Less. brand promise. On the Pay Less side, we continue to see the benefit of last year's work to optimize assortment, focus on fundamentals and ensure we are priced right daily. And in support of the Expect More side of that promise, we're seeing great results from our investments to differentiate Target from everyone else in the marketplace. We have committed significant capital to remodel our stores, ensuring we continue to provide a great experience for our guests. In the first quarter, we completed more than double the number of remodels we delivered a year ago. Beyond the direct feedback we're hearing from our guests, we continue to see incremental 2% to 4% sales lifts in stores following the completion of a remodel. Beyond these wall-to-wall transformations, we continue to roll out presentation enhancements to a broader set of stores focused on key categories, like Beauty, Apparel, Home and Food and Beverage. And on the sales floor, we continue to invest in hours, tools and training that will allow our team to provide our guests a richer experience as they walk our stores, pick up their digital orders at the front of the store or now, even in the parking lot. Beyond our work in existing stores, we continue to expand the physical reach of our brand, rolling out new small formats in neighborhoods we didn't serve in the past. These stores serve as a beacon for our brand, reaching guests who have a high affinity for Target. And importantly, they continue to deliver outstanding sales productivity and compelling financial performance. Beyond a price right assortment that addresses their needs and wants, convenience is a high priority for our consumers. As a result, we're rapidly rolling out services and capabilities designed to make Target America's easiest place to shop. At the beginning of the year, we rolled out free 2-day shipping on hundreds of thousands of items on Target.com with no annual fee. We're able to make that commitment and control costs because over the last few years, we've developed the capacity to increasingly rely on our stores and serve as a shipping point for digital orders. Beyond efficient fulfillment to our guest homes, we are rapidly rolling out our new Drive-Up service to stores across the country. With this service, we typically have orders ready within an hour. And when a guest parks at a designated area, our team delivers their order to the backseat or trunk of their car, usually within 2 minutes. Guests tell us they love the convenience this service provides, and they're amazed at how easy it is. Our rollout of same-day home delivery through Shipt is also expanding rapidly, reaching nearly half our stores by the end of the first quarter. Like Drive-Up, this service is receiving very high satisfaction ratings from our guests, and we've been very pleased with the execution of the Shipt team as they rapidly scale up into new markets across the country. While Shipt is our most common way to deliver same day, we're also rapidly rolling out a distinct version of same-day delivery to stores located in dense metro areas. With this service, guests fill their own basket but don't need to worry about carrying their items home. Instead, they pay a small fee to have their order delivered via courier later that same day in a time window of their choosing. And finally, we also continue to expand our next-day delivery options for Essentials, Target Restock. In the first quarter, we expanded this service nationwide and dropped our industry-leading delivery fee even further. Beyond fulfillment, we continue to find ways to add digital capabilities that drive convenience in all channels. Last year, we integrated Cartwheel into our native Target app. And in the fourth quarter, we integrated REDcard into the app with a new wallet feature. Now at checkout, with a simple scan of a bar code, a guest can redeem cartwheel offers and redeem a gift card or pay with their REDcard and automatically save 5%. The scan is amazingly fast and easy, and we've seen increasing adoption of wallet since the rollout. With all this rapid change, our team is moving faster than ever before. At the same time, we need to execute on every task with excellence every day, and our team is rising to that challenge. To support our team in this rapidly changing environment, we are updating our operating model, providing them with new tools and training and allocating hours to support new fulfillment options and additional service on our sales floor. Beyond these investments in the guest-facing portion of our stores, we are investing to transform our entire supply chain to support stores as they provide all of these new fulfillment options to our guests. With this transformation, our team is implementing changes that will, over time, dramatically reduce store workload dedicated to replenishment, bringing up our store teams to focus on serving our guests. To support the demands of the new fulfillment model and our distribution facilities, the team is testing and rolling out cutting-edge automation that will allow our DC teams to customize and sort each shipment to match the needs of an individual store, reducing store labor without creating the need to invest in new square footage in our upstream facilities. None of these changes will be possible without the meaningful investments we're making across our business. And unlike many of our competitors, we have the financial capacity to fund these investments. Beyond CapEx, we're making additional investments to provide team members with new ways to grow and learn. And to support our team as they do more and more for our guests and our business, we're taking a leading position on wages. In the first quarter, we increased our national starting wage to $12 or more, in support of a commitment to reach a $15 national minimum by the end of 2020. With these commitments, we're already seeing the benefit in our business as we ensure Target remains an employer of choice in a very tight market. So now I want to turn it over to John, who will provide details on the team's work to transform our supply chain, enhance the experience in our stores and roll out fulfillment options across the country. John?
John Mulligan:
Thanks, Brian, and good morning, everybody. When you think about the work we're doing across the operations team, you quickly see that it's all about modernizing how we work, both our operating model and how we use our physical assets.
On the physical asset side, the good news is that we started with a strong base of well-designed, well-located and well-maintained stores and distribution facilities, but they are optimized only for store shopping.
Similarly, we already have the best team in retail, but they were trained in routines and processes focused primarily on tasks and designed exclusively for guests who are shopping our stores. Now let me be clear:
store shopping remains very important and will continue to be so in the future, but it's no longer the only way people choose to shop.
So for both our physical assets and our people, we are modernizing how we work, which includes a meaningful investment to continue providing the best of what physical shopping means today. At the same time, we are reorganizing virtually everything we do to ensure we provide convenience, speed and reliability in all the ways that our guests want to shop. Across our supply chain, we're testing and rolling out new processes designed to make us faster, more nimble, more accurate and reliable. Last year, we told you about our new facility in Perth Amboy, New Jersey, which provides a clean slate where you could develop and refine a completely new way to replenish stores, and the results have been impressive. Out-of-stocks on items in the store served by the Perth Amboy facility have been running about 40% lower than our previous benchmark. These results were accomplished by applying a new inventory positioning logic, developed by our data and analytics team that allows us to send the right quantity in the right unit measure much faster than our other facilities. While last year was about developing and testing these algorithms, this year is focused on beginning to scale up the physical movement of inventory. And by early next year, another 50 Target stores will be served by this new model. Beyond processes at the DC level, we've also made changes at headquarters to optimize inventory allocations across our network. Last year, we created a new inventory management role in the supply chain team, focused entirely on item forecast accuracy and allocation. This has led to an increased focus on inventory availability in our upstream facilities, which, historically, were associated with half of our out-of-stocks because the units simply were not in our network. With this change, we've enhanced upstream safety stock, which allows us to replenish more quickly in response to accelerating sales. In addition, this change allows the merchandising team to focus more on strategic inventory investments to better position us to gain market share. While we are still early in the process, we're already seeing the benefit in our business as our out-of-stock position is at historic lows and continuing to improve. While there's more work to be done, we're encouraged by the progress so far. And while we're on the topic of inventory, I want to address our total inventory position at the end of the quarter, which reflects the strategic positioning I just mentioned. For example, our teams in Toys and Baby have increased their inventory investment to ensure that we can meet higher demand as other competitors liquidate and exit these categories. We also ended the quarter a little heavier than expected in weather-sensitive categories, but that has already moderated as we've seen very strong sales in these categories so far in May. And finally, this year's calendar shift resulted in some early Back-to-School and Back-to-College receipts being reflected in our first quarter, which weren't recognized until second quarter last year. Bottom line, we feel very good about our inventory level, which positions us for accelerating growth and market share gains in the second quarter and beyond. All of us, both at headquarters and in the field, are focused on serving our guests as quickly and efficiently as possible. And we're placing our stores at the center of that effort. In the first quarter, more than 2/3 of our digital volume was fulfilled by our stores, up from about 50% last year. Of that store fulfilled volume, Store Pickup continued to account for about 15 percentage points, while ship-from-store volume has grown to more than 50%. We have more than 1,400 stores shipping directly to guests' homes today, and we continue to retrofit store backrooms to enable additional capacity. But there's much more to our efforts to expand our digital fulfillment capabilities and provide new, convenient options for our guests. In the first quarter, when we launched free 2-day shipping on Target.com, we saw an immediate increase in the number of orders, basket size, units and sales. The team continues to develop enhancements that will make us faster and extend the cutoff for 2-day shipping until later in the day. One of our newest services is Drive-Up, and we are rapidly rolling out this capability across the country. We added this service in more than 250 stores in the first quarter, and we'll expand into 300 more in the second quarter. For the stores added in the first quarter, guest adoption is ramping up more quickly than we saw in our Twin Cities test last fall, and the Net Promoter Score has climbed to 85 in recent weeks, the highest of any service we provide. Also new is same-day delivery through Shipt, which is now available for more than 700 stores and 80 markets in 25 states. In the second quarter, we will launch in multiple markets in the Midwest, moving our total to nearly 1,000 stores. By the holiday season, we expect to have this service available from a vast majority of our stores in well over 40 states. We are receiving really positive feedback on this service as well. As a result, other retailers continue to join the platform, which helps Shipt's gross merchandise volume reach approximately 3x last year's volume in the first quarter. In addition to Shipt, we continue to be pleased with the rollout of our other same-day delivery service in dense urban areas, which we refer to as from-store same-day delivery. As Brian explained, this is a service in which guests shop the store, and we deliver their basket later in the day. We tested this service in 5 New York stores last year. And based on the results, we've now rolled out this service to a total of 55 stores located in all 5 New York boroughs as well as Boston, Chicago, Washington, D.C., and San Francisco. Guests build much bigger baskets when they use this service, and Home continues to be the leading category in these orders, accounting for more than half of the sales dollars. And we continue to make guest-friendly improvements. In the first quarter, we simplified the fee structure in New York, moving from 3 rates to a flat $7 rate. Order volumes spiked by 75% in response to this change. And speaking of guest-friendly improvements, last week, we announced a 40% price reduction in our next-day Essentials delivery service, Target Restock. This service allows guests to shop from a selection of more than 35,000 food and essential items, which we pack into a shopping cart-sized box and deliver next day. The service is now nationwide, covering more than 75% of the U.S. population. And we reduced the delivery fee from $4.99 to $2.99, and we offer it free for REDcard holders. Oh, and I should mention, as with 2-day shipping, Drive-Up and from-store same-day delivery, we don't ask guests to pay an upfront annual fee to enjoy this service. So as you can see, we have a rapidly growing list of services that we're scaling across the chain, providing guests with a combination of convenient options, same-day, next-day, 2-day, pickup, in-store shopping and returns. That makes as unique in the marketplace. And as I said, our stores are at the center of all of them. So we're investing in tools and capabilities in our stores to ensure they can reliably fulfill in all these new ways. But the front of store still matters as well, and we're in the middle of an unprecedented remodel plan to ensure we continue to provide a differentiated in-store experience, whether you're focused on a quick Target run or coming in, grabbing a Starbucks and taking a more leisurely stroll around the sales floor. We completed 56 remodels in the first quarter, and we've already launched well over 100 more that will be completed this quarter. Unlike the past, when we plan these remodels, we partner with the local store team to customize the remodel plan to fit the needs of the neighborhood where it is located. And we know it's working. We continue to see average incremental lifts within the 2% to 4% range we've modeled for these projects. These lifts are mostly driven by additional traffic as the new environment invites guests to visit more often. And when guests visit, they find a team that's better trained and better equipped than ever before. Because we've rolled out training and ongoing product education, our guests are greeted by product experts in key areas like Food and Beverage, Beauty, Electronics and Apparel. In addition, we've allocated more hours to key shopping times, like weekends, and around key seasons, like Mother's Day, Back-to-School and Back-to-College. We started to roll out these enhancements and measure the guest response, and we're happy with what we're seeing. For example, we've seen better attachment rates and warranty sales in Electronics as guests respond to the higher level of service and expertise they're finding there. We are in the early stages of making these changes, and we will continue to monitor the guest response as we roll them out more broadly. And we can't finish without covering the new stores we're opening around the country. We opened 7 new locations in the first quarter, including one large-format location and 6 small formats in metro areas, like Los Angeles, Boston and Chicago. We are really pleased with the financial performance of these new small-format stores and even happier with how they grow. We have dozens of small formats that have been opened for more than a year. And as a group, they continue to comp in high single digits in the first quarter. So it's like Brian said, when we look at what's driving our traffic growth, we can't isolate a single driver. It's the combination of all the changes we've been making that have changed the trajectory. In fact, we continue to see the benefit of our 2015 sale of the pharmacy business to CVS as script counts in our store pharmacies increased 8% in the first quarter. While the progress feels great, we are not about to slow down. We have much more to accomplish this year, and the team is engaged and focused on delivering for our guests. With that, I'll turn the call over to Mark, who will provide more detail on our first quarter performance and our upcoming plans in merchandising. Mark?
Mark Tritton:
Thanks, John. At Target, everything we're doing is focused on our guests. You see it in our work to elevate the guest experience as we invest in our teams and remodel our stores. You see it in our new small formats where we tailor the assortment to fit the needs of the neighborhood. You see it in our work to deliver more convenience with a rapidly expanding menu of fulfillment options. And it's reflected in our work to modernize the supply chain where we are working to increase reliability and drive trust.
In merchandising, we focus on our guests by working to elevate their assortment, delivering the right balance of quality in owned brands with outstanding national brands. We differentiate Target by developing and curating new, innovative products and exciting new owned brands, which deliver an unbeatable combination of quality and price. We elevate the key moments in the lives of our guests, including holidays and seasonal moments like Back-to-School and Back-to-College. And of course, we focus on value, ensuring our assortment is priced right daily while delivering clear, impactful promotions and drive awareness through our marketing.
While there is much more ahead, I'm really pleased with the results our team is already delivering. In the first quarter, we launched 3 new owned or exclusive brands:
Universal Thread in women's denim, Apparel & Accessories; Umbro in Kids and Sporting Goods; and Opalhouse in Home. In addition, we delivered Hunter for Target, an exciting limited-time partnership with an iconic British brand. And the guest reaction to all these new brands has been fantastic.
In terms of value, multiple metrics show that last year's efforts are continuing to drive results. Across our frequency categories, where we are seeing share growth, unit share continues to grow faster than dollar share, a positive leading indicator for our future results. Already this year, regular price sales increased more than $1 billion compared with last year, reflecting the impact of our priced-right daily strategy. And both quick trips and fill-in trips are growing faster at Target than the industry overall, something that's visible in our traffic and by traffic and basket performance. Beyond these metrics, we see the benefit when we survey our guests about their perceptions of Target. In these surveys, we're receiving higher scores on convenience, reflecting the benefit of our work on fulfillment. We're also seeing rising scores on multiple measures of value, including our everyday pricing, having great sales and delivering a great deal. The data also shows we're getting high marks for our assortment across multiple dimensions, including the quality of our products, having the assortment that fits our guests' needs, being in stock and delivering an assortment of trend right. Given all of these results, it's not surprising that Target's overall Net Promoter Score has also been increasing, nor is it a surprise that we've seen an acceleration in guest traffic. Our first quarter category results reinforce the value of our balanced category mix, which sustained our traffic before warmer weather arrived. And it's clear that warm weather affects the timing of sales in some of our temperature-sensitive categories, including multiple parts of Apparel as well as outdoor living in Home, Sporting Goods in Hardlines and sun care in Essentials. In these categories, which accounted for nearly 10% of our first quarter sales, while we saw very strong growth in normal or positive temperature regions, our overall average comps were generally lower than the rest of our total assortment. However, we saw a dramatic uptick in sales and demand as weather warmed in late April into May when overall traffic accelerated and temperature-sensitive items began out-comping the rest of our assortment. Drilling into the first quarter performance of our 5 core merchandising categories, Home led the company with a mid-single-digit comp in the first quarter. This reflected broad strength, which offset the impact of delayed sales in season categories, in particular strength in owned brands with the launch of OpalHouse. Essentials and Beauty also had a strong quarter, growing well over the company average. Our Beauty area continues to benefit from our work to differentiate Target assortment, especially in areas focused on naturals and diversity in beauty, hair and body care. This is further elevated when combined with the impact of new presentation enhancements and our investment in training to increase product expertise in our stores. Beyond Beauty, in Essentials, we're seeing the continued benefit of our focused pricing and promotions work, punctuated by our Target Run and Done marketing campaign, which together are driving the trip gains I mentioned earlier. In Food and Beverage, we saw our fifth consecutive quarter accelerating growth as our first quarter comp increase was in line with the company average. This performance reflects our work on pricing and promotions, assortment, presentation and our focus on the fundamentals. Consistent with prior quarters, first quarter comps were strongest in our beverage and produce categories. In addition, we saw really strong performance around the Valentine's Day and Easter holiday, driven by strong growth in Seasonal Candy and Floral. Both Apparel and Hardlines comped positive but below the company average in the first quarter. In Apparel, which comped slightly below the company average, strength in our new brands and our positive ongoing efforts in men's offset the impact of the late spring on temperature-sensitive items. As a result, we saw positive market share gains in yet another quarter. A key standout was our Baby business, which has returned to strong growth this year. Given that having a baby is a key life moment, we have long had a focus on making life easier for new parents, and we're upping our game as others exit this space. We've done a lot of work on our assortment, quality, value and baby registry. And this year, we are seeing the broad benefits in our results, particularly in our infant basics area. In Hardlines, despite the near-term pressure caused by heavy liquidation pricing from competitors in the marketplace, we saw the strongest growth in Toys, which offset softer performance elsewhere in the category, including Electronics, where we're comping out of the very successful launch of Nintendo Switch a year ago. In the second quarter, we'll maintain our focus on newness and innovation as we continue to drive guest preference for Target. Just last week, we announced that we have partnered with Disney to launch an exclusive collection of more than 350 items in apparel, toys, bedding, beauty, food, even pet treats, all inspired by the unmistakable style and silhouette of Mickey Mouse, who happens to be celebrating his 90th birthday this year. This collection celebrates Mickey and the magic of summer in a distinctly Target way, and we will be featuring these items in both stores and Target.com all summer long. Just earlier this week, we announced that we are collaborating with the Museum of Ice Cream to bring its fun and innovative style to our Kids department, our freezer aisles and more. Once our team had visited the whimsical museum in New York, we knew we wanted to work with them to bring a little of their magic to Target guests. Beginning June 3, our art class Kids owned brand will feature a limited-time collection of summery colors, prints and patterns highlighting the museum's signature playful aesthetic. And later in the quarter, we'll be the first retailer to sell 7 premium ice cream flavors developed by the museum, including 2 of the museum's classics and 5 brand-new and exclusive flavors. And as we gear up to announce the specifics, we're planning to launch an additional 4 new owned brands later in the quarter. The first 3 will be focused on the Gen Z and millennial guests, bringing great Target style and value to all genders in multiple categories, such as Apparel, Accessories, Shoes and some exciting new areas. The fourth brand launch for the quarter will be in Home, playing to our great style credentials and Expect More. Pay Less. brand promise. This new brand will have relevance for all guests, but it's not a coincidence that we'll be launching just in time for the all-important Back-to-College season. Also, while I can't share more right now, there's more in store for the rest of the year, and I look forward to sharing those details with you soon. And finally, I want to add to John's comments on inventory. As he mentioned, we've been making some strategic investments in additional inventory as others are liquidating key categories that already represent core sales and market share strengths for us. For the remainder of the year, as other competitors close stores and exit businesses, we will use our inventory and marketing to remind consumers that we have a compelling assortment in these businesses. And in many cases, our guests will see our assortment presented in a newly remodeled store at the same time that the other stores are closing. In addition to our guests, we're also reaching out to our vendors, reminding them that Target is healthy, we're investing and growing, and we're eager to partner with them to launch exclusive items and content, helping them to grow their brand and develop a deeper relationship with the Target guests. Even though we're already seeing a lot of momentum, we see a lot more opportunity ahead of us, and we are not slowing down.
The key to driving both preference and growth is to continue to listen to our guests:
what they like, what they want and how we can deliver on our mission to bring joy to their everyday lives. If we continue this focus and move quickly to deliver more convenience, newness and inspiration, we are confident that we can create an even stronger brand and build on the meaningful progress we've already seen over the last year.
With that, I'll turn it over to Cathy, who will provide more detail on our first quarter financial performance and outlook for the rest of the year. Cathy?
Catherine Smith:
Thanks, Mark. Last year, we embarked on a multiyear journey to transform our business and position Target to generate profitable long-term growth. We said 2017 would be an investment year. And last year, our team delivered everything we planned to accomplish and more.
We've now moved into 2018, a transition year in which we expect to achieve stability and earnings from our core business. And I'm happy to say, with 1 quarter in the books, we are on track to deliver on both our strategic goals and financial guidance for this year. Our first quarter comparable sales growth of 3% compares favorably to our guidance for a low single-digit increase. This was driven by a 3.7% increase in traffic, offset by a small decline in average ticket. Our first quarter digital growth of 28%, on top of 21% last year, compounds to more than 50% over the last 2 years. Target's traffic has been accelerating for a year now. And as Brian noted, first quarter growth of 3.7% was the strongest at Target in more than 10 years. Also notable, the prior quarter's traffic growth of 3.2% was equal to the second-highest pace we've seen in the last 10 years. Traffic is a key focus for us, and seeing growth at historic highs gives us increased confidence that we're pursuing the right strategies and making the right investment to best position Target for long-term success. Our first quarter gross margin rate of 29.8% was down about 20 basis points from last year. This was a bit below our expectations as the mix impact of late spring weather caused a later-than-usual surge in higher-margin, temperature-sensitive categories. As temperatures warmed up in mid- to late April, we saw the beginning of that surge, and it has continued into this quarter. With this change, we are confident that we remain on track to deliver our previous guidance for the year, and it's one of the reasons we expect comparable sales growth to move higher in the second quarter. Our first quarter SG&A expense rate of 21.1% was about 40 basis points higher than last year. This increase was right on our expectations and was driven by planned investments in our team, including wages and other items and increased investment in stores. Our D&A expense rate was about 20 basis points higher than last year, reflecting accelerated depreciation on our remodel program as it ramps up from last year's pace. Altogether, our operating income margin rate was 6.2% in the first quarter, a little lower than our expectations because of the gross margin mix of our sales. Below the operating income line, our first quarter net interest expense was $19 million lower than last year. This reflects the impact of last year's debt refinancing and retirement activity. And finally, our effective income tax rate was 22.6% in the first quarter compared with 34.5% last year. This change was primarily driven by last year's federal tax reform legislation. Altogether, these results drove first quarter GAAP EPS from continuing operations of $1.33 and adjusted EPS of $1.32. Both of these metrics increased more than 9% compared to last year. One note. My remarks and today's press release reflect several new accounting standards that we've adopted this quarter. We provided detail on these changes in a Form 8-K filing on May 11. And in that filing, we included updated prior year numbers that reflect these new policies. So you could adjust your models to reflect the new accounting. If you haven't already, I encourage you to review the materials in that filing. And following that review, if you have any questions about these changes and how they've affected the presentation of our financials, please reach out to John Hulbert, and we will work to answer your questions. At the end of the first quarter, our inventory was up about 9% compared with a year ago. As John Mulligan mentioned, this increase reflects a couple of timing issues, along with the impact of strategic investments we've made in key categories, which will best position us to gain market share as competitors close stores or liquidate their operations. Turning now to capital deployment. We made capital investments of more than $800 million in the first quarter and returned more than $800 million of additional capital to shareholders in the form of dividends and share repurchases. We funded these investments and shareholder returns through cash from operation as well as excess cash we held on our balance sheet going into the year. We remain on track to deliver on all of our capital deployment goals for the year, including capital expenditures of approximately $3.5 billion, maintaining our quarterly dividend with a commitment to annual increases and continued share repurchase within the limits of our middle A credit ratings. As reported, our first quarter after-tax ROIC was 15.2% compared with 13.8% last year. However, this year's metric reflects the nonrecurring benefit of the remeasurement of our deferred tax liabilities that occurred as a result of federal tax reform. Excluding this benefit, our first quarter ROIC was 13.5%. While this is down from last year's result, it is still a very healthy absolute performance. And given that ROIC is a trailing measure, this decline was expected when we initiated last year's investments of both capital and operating income to best position Target for the long term. Over time, we expect ROIC to grow into the mid-teens as we see the long-term benefit from the repositioning that began last year. So now let's turn to our guidance for the second quarter and the full year. In the second quarter, beyond the momentum we're already seeing in our business, sales in May have benefited from a surge in warm weather categories. In addition, our second quarter comp sales will benefit from this year's calendar shift, which moves an extra week of the Back-to-School season into the quarter, replacing a week in early May. Given these benefits, combined with the underlying strength of our traffic, we expect our comparable sales growth to increase from our first quarter pace, moving it into the low- to mid-single-digit range. On the operating income margin rate line, we expect a decline of about 40 basis points from last year's rate. This reflects roughly equal changes on the gross margin and SG&A expense lines. In addition, we expect D&A expense to come in about $40 million higher than last year, reflecting accelerated depreciation on assets taken out of service due to our remodel program. One note. This increase in second quarter D&A is lower than we originally expected as our team has recently implemented a process improvement that reduces the time between remodel approval and project initiation. This resulted in a change in expected timing of accelerated depreciation within the year, which led to the reduction in our D&A expectation for the second quarter. Moving further down the P&L. We expect second quarter net interest expense to come in about $15 million lower than last year, and we expect an effective tax rate in the range of 22% to 25%. Altogether, our expectations lead to expected second quarter GAAP and adjusted EPS of $1.30 to $1.50. And for the full year, we are on track to deliver our previous guidance for a low-single-digit increase in comparable sales and GAAP and adjusted EPS of $5.15 to $5.45. When you look back at the last year, our team has been on quite a journey. Only 5 quarters ago, we made the decision to embark on a bold, ambitious plan to reshape our business. In the near term, we knew that decision will put pressure on our financial performance, but we were confident we were making the right long-term move. Today, a little more than a year later, our traffic is growing at historically strong rates as guests are responding to the changes we've been making. None of this could have happened without the tireless efforts of an outstanding team who have always believed in Target and what we can accomplish together. As a shareholder, I'm incredibly grateful for their efforts. And as a fellow team member, I'm incredibly proud to work by their side. Now I'll turn the call back over to Brian for some final remarks.
Brian Cornell:
Thanks, Cathy. Based on what you've heard today, I hope you can see why we are so encouraged by what we're seeing in our business. Target has always thrived by being different, by being the best version of ourselves, not another version of someone else. And we've earned the deep loyalty of our guests because we are different, because we deliver a unique assortment and experience, one that's optimistic, aspirational and full of possibilities.
But being different means always changing. Right now, we're investing to deliver differentiation that matters in today's world, focusing on convenience, digital brands, our operating model, small formats and the look and feel of existing stores. And we're investing in our greatest differentiator, our team, because human touch still matters even in a digital world. Thanks for your time today. Now John, Mark, Cathy and I will move to your questions.
Operator:
[Operator Instructions] The first question comes from Matt McClintock from Barclays.
Matthew McClintock:
I was wondering if we could start with just traffic, the best traffic that I've probably seen in my career. And it's also the best traffic -- one of the best traffic results probably across the retail industry. Could you help us parse out the strength that you're seeing there? Because you have a lot of things going on right now, is Drive-Up having a material benefit? Is Shipt having a material benefit? Or are we just -- is that traffic result really just the build of your merchandising initiatives over the last year?
Brian Cornell:
I think you've summarized it well. I think as we sit here today, we feel really good about the traffic that we've generated in the first quarter and the acceleration of that traffic as we go into Q2. And as we've said in some of our prepared remarks, it's really the combination of all of these initiatives working together. And for several years now, I've talked about the importance of traffic as a true indicator of the health of our business and the guest reaction to our key strategic initiatives. So they're all coming together well. I think the guest is reacting to our new remodels, to the new brands, to our new fulfillment options, to what we're doing from a digital standpoint. All of these elements have come together, and the guest is rewarding us with increased traffic. So we felt great about the traffic number growing by 3.7%, the best traffic growth we've seen in over a decade. And importantly, that traffic growth is continuing as we go into Q2. So it's really the culmination of all of the initiatives coming together and the guests recognizing the changes we're making at Target.
Matthew McClintock:
And then if I could have a follow-up, just on the remodels themselves. Partially why the traffic number is so impressive is you're doing some major remodels that I would assume are taking a lot of stores down and pretty much out of commission, right? So can you help me think about the negative impact from remodels this year now that you've done 50 and you're going into another 100 into this quarter? Is that in line with your expectations? Or are they -- is it a little bit more of a drag than you thought? Or are you doing those ahead of expectations?
Brian Cornell:
Matt, the remodels is performing exactly the way we had planned. Obviously, there is a disruption during the construction period. But our team is getting better and better at minimizing the disruption, accelerating the remodel time frame. And the guest is reacting very well as we complete these remodels. So the remodel initiative is working exceptionally well for us. We're generating the 2% to 4% lift that we're projecting, and the guest reaction has been superb.
Operator:
The next question comes from Oliver Chen.
Oliver Chen:
We were curious about the delivery options and becoming America's easiest place to shop. You've done a really good job with all the innovation there. How would you prioritize the options that customers have in terms of driving the financial algorithm, in terms of which ones may be more important at the top of your list for driving our models? Also, as we think about the fill-in trips and the Pay Less. part of the equation, what are your thoughts about fill-in versus stock-up, and how you're positioned with respect to the back half of the year and where you see opportunities? It sounds like the customer perception scores have gotten better with respect to value.
Brian Cornell:
Oliver, a number of different questions, so I'll try to unpack each one of them. But as we think about the overall experience and making sure that we provide ease to our guests, we're taking a very balanced approach. We want to make sure we provide a great in-store experience. It's why we're investing in remodels, investing in our team, investing in specialized services in the store. And then we recognize that from time to time, our guest is looking for alternative ways to shop. So we want to make it really easy for them to order online and conveniently pick up in one of our stores. We're seeing a great reaction, as John mentioned, to our Drive-Up service. And as we expand that service, we continue to hear the guests talk about how much they enjoy that. Obviously, with Shipt, we're now in over 70 markets, and the guest reaction has been superb. And our ability to deliver goods to their homes in now minutes is being very well-received. So we want to make sure we provide a great experience no matter how the guest wants to shop. And I think more and more of the initiatives that we're rolling out, whether it's Drive-Up or Shipt, what we're doing with the expansion of Restock, all being very well-received. But importantly, we're seeing a very positive reaction to the in-store experience. And while we feel great about the overall traffic numbers and the comp numbers, what's really encouraging is guests are coming to our stores and enjoying that experience, and they're shopping the full portfolio while they're there.
Oliver Chen:
And a quick one, Cathy. It's really encouraging that the business trends have picked up with improving weather. However, the mix impact on the gross margin wasn't quite where you wanted it to be. Just what gives you conviction on the guidance in terms of where you can be in relation to diving into some of your comments?
Catherine Smith:
Yes. As we said, clearly, every -- much of the first quarter played out exactly as we would have planned and hoped for. Other than that late temperature-sensitive category, which drove some mix pressure, we've seen that all come back into the beginning -- end of April and the beginning of this quarter, and so we're really confident. And then in addition, we have a number of initiatives we started last year that will start to cycle over about -- thinking about our price and promo reinvestments and stuff, give us confidence toward the back half of the year, and then some cost initiatives.
Operator:
The next question comes from Edward Kelly with Wells Fargo.
Edward Kelly:
Could you provide a little bit more color on the impact you think weather may have had within Q1 and the benefit that this, plus the calendar shift, will have within Q2? I'm just trying to get a better understanding of the cadence of the comp. And then as we think about progressing through the back half of the year, you've imposed, may I guess, the comparison seems like maybe it's a little bit harder. Just how should we think about the progression this year?
Catherine Smith:
Yes. So the weather, we do -- obviously, because of our multi-category assortment, we have great strength. We saw some really strong trends in Home, Essentials, Beauty, Food and Beverage, which are great. It was those really temperature-sensitive categories that we did see a little bit of challenge there in early April, which came straight back. So I would tell you the strength of that tells us, and we can see it, where weather was happening, we could see the strength and/or not. So really strong confidence around the multi-category assortment coming through throughout the year. And I'm sorry, Ed, what was the second part of your question?
Edward Kelly:
Just how we think about the calendar impact and the underlying Q2 comp?
Catherine Smith:
Yes. Yes, so we saw a little bit of benefit -- or a little bit of benefit in Q1, a little bit more benefit in Q2. But obviously, that's all contemplated into our guidance. And that gives us additional confidence into the guidance we've given.
Edward Kelly:
And then, Cathy, can I just go back to -- on the margin side? So Q1 was a bit softer, I guess, than expected and mix had something to do with that. But you expect an improvement throughout the year as we think about EBITDA margins, let's look at it like that, I guess, to try to minimize the D&A impact. But it does seem like digital will continue to ramp and be important. Wages obviously going $12 an hour, a headwind. Can you just give us a little bit more detail on, as we progress through the year, what drives the improvement in the year-over-year margin relative to sort of what we're seeing in Q1?
Catherine Smith:
Yes. So Q1 really did play out much as we would have expected. Obviously, the really strong traffic drove some great comp sales. We are investing in the SG&A that we said we were going to invest. So that was really very, very consistent. And in all fairness, gross margin played out exactly as we would have expected, except for a little different mix. And so a little bit stronger Essentials and Beauty and Food and Beverage, a little bit weaker with the temperature-sensitive categories that came back toward the end of the quarter. And so it's just literally a mixed conversation in Q1. What gives me confidence going through the rest of the year, we'll continue to invest in our business, as we've said, for the long term. That's consistent. We've got gross margin plans, obviously, as we cycle over some of those investments last year as well as those cost initiatives, which we've got planned and have planned into our guidance.
Brian Cornell:
Ed, I'll just reinforce the point, we're very confident in our full year guidance, both from a comp standpoint and an EPS standpoint. And as Mark alluded to in his comments, the reaction to our owned brands in Apparel and Home has been very strong. We've got a number of new brands we'll launch over the balance of the year, and we certainly expect that's going to influence the mix of our business as we go into Q2, Q3 and the holiday season. So we're very confident with the way the business is performing. We're seeing a very strong start to Q2, acceleration off of what we consider a very strong start to the year in Q1. And it gives us increased confidence in our full year guidance.
Operator:
The next question comes from Seth Sigman from Crédit Suisse.
Seth Sigman:
Just a couple of follow-up questions here on the margins. Aside from the mix, as we're looking at, I guess, first, the price investments you've been making, remind us when do you actually cycle fully those price investments? And regular price was up $1 billion, I think, you said year-over-year, which seems pretty meaningful. Should we interpret that as the biggest changes are done, and you feel pretty good about the value proposition, and we could see that benefit as you move through the year?
Mark Tritton:
Yes, Seth, Mark here. Thanks. What we're seeing is a cycle over our LY. We really were starting to implement price changes right at the very end of Q2 leading through Q3 and really maturing through Q4. So we're still in an evolutionary process, and we start to see that balance out by Q3. So there's some benefits again into the mix and private value to LY still in Q2 with stability going from Q3 onwards.
Seth Sigman:
Okay, that's helpful. And then on the digital and fulfillment cost, part of the outlook, I think, included the benefit from more ship-from-store to mitigate some of the cost pressures. Can you update us on that, give us a sense of the impact that fulfillment may have had on gross margin this quarter? And is that also something you expect to improve through the year?
John Mulligan:
Yes. So I think nothing new here, really. Digital fulfillment sales have put pressure on gross margin as that continues to grow faster than the rest of the business. But on the other side of that, as you pointed out, as we continue to ship more from our stores, that is the, first, the fastest way to ship for our guest; and second, it's the most efficient from a cost perspective for us. And the other thing I would point to is when we introduce things like 2-day shipping, we see lift in units as well. And so as we increase units, the cost per unit to fulfill goes down dramatically. The same is true with Shipt, where those basket sizes are almost double the average basket size that we see in the chain, and so the cost per unit to fulfill goes down meaningfully. And so that's one thing. Mike McNamara and the digital team are focused on is continuing to drive -- as we lower the actual cost to deliver, the team continues to focus on driving the average basket size to lower the cost per unit and improve the unit economics across all of our digital business.
Operator:
The next question comes from Greg Melich with MoffettNathanson.
Gregory Melich:
I really had a bigger-picture question maybe to help frame the great traffic results, but also for the cost involved. So I think if we look at EBIT dollars were down 10% in the first quarter, and you have this best traffic in years. But given the investments you made last year, it sounds like by the back half, to get to your guidance, EBIT dollar should be going up mid-single-digit. Is my -- does my math sound right, Cathy, given all the restatements that that's what we should be seeing?
Catherine Smith:
Yes. Yes, no, Greg, you're right on.
Gregory Melich:
Got it. And then sort of a housekeeping question. The week that shifts, a week that's in July or for Back-to-School versus a week in May, is that typically 20% bigger, 40% bigger? Just something there so we can do the math on the comp shift.
Catherine Smith:
Yes, Greg, so just think about it this way, we literally just map week for week. So the first 13 weeks of this quarter were the first 13 weeks and just kind of roll that out. Obviously, it does pull a little bit of Back-to-School, Back-to-College, which is why you're seeing some inventory come through as well, but we're not going to quantify that.
Gregory Melich:
Okay, great. And then just the last, maybe a bit of big-picture question on the margins. If you think about it, given this surge in traffic and you think about a few years out, if you could keep the traffic up here, would you be willing to let the margin rate continue to slip to, I guess, around 6% now to 5% if that's what it took to keep this sort of traffic number? And I'll leave it.
Brian Cornell:
Greg, I think, again, the guest is reacting to the changes we've made throughout our experience, whether it's the new brands, which I think are going to continue to deliver great results and deliver very strong margins for us. The multi-category strength we saw in the quarter is something that we feel really good about. We've been talking about this for some time. But seeing strength in Home, in Household Essentials, in Beauty, in Food and Beverage, the guest is reacting to our offerings, and they're shopping multiple categories at Target both in-store and online. So we expect that to continue. And as we remodel more stores, as we open up stores in new neighborhoods, as we continue to offer great new brands and new services, we expect traffic to continue to grow. So we think traffic was one of the highlights in the quarter, but we also feel really good about the fact that we grew comps to 3%, our digital channel grew by 28% and our EPS grew by over 9%. So we feel like all of the key initiatives are coming together, and we're delivering very solid results that are in line with our plan for 2018.
Operator:
The next question comes from Scott Mushkin from Wolfe Research.
Scott Mushkin:
So I just -- not to beat a dead horse here on the comp cadence, but I'm getting lots of e-mails, so I figured I'd do one more. As we look at the back half of the year, is it going to step down because of the calendar shift and the tough compares? Is that the expectation?
Brian Cornell:
Scott, we're expecting again low single-digit comp growth throughout the year. We're seeing really strong acceleration as we go into Q2, so we expect to see comps grow as we go into the second quarter. But our guidance is something that we got great confidence in, and we expect to see solid comp expansion throughout the year.
Scott Mushkin:
All right, perfect. Then my second question is regarding kind of the store operations. The in-stock levels, at least according to our research, are coming off, especially consumables. And I think you made some changes at the store in how you're managing it. I just wondered if you could maybe explain what's going on at the stores and why maybe we're seeing some better in-stock conditions at the store.
Brian Cornell:
Yes, why don't we let John talk about some of the changes we're making with our store operating model?
John Mulligan:
Yes. The store team has been going through a process of modernizing our store operating model. It's out in -- it's in pilot right now in what we would call 26 districts across the country. I mean, really the idea here is to get experts in the areas where they know the business. So we have food people who know the Food business, and they are accountable for the totality of that business. They do the restock. They do intraday restocking. They own price change. They own everything that goes on in that business. Similarly, in Apparel or Beauty or Electronics, and they also have expertise to help the guest understand those specialty businesses, and that's a big part of what we're doing, too. But as they own the business, and we've seen this in Beauty over the past 52 weeks for the team, we are further ahead in Beauty, we see out-of-stocks improve because the same person is in that area every single day, and they own it, and they make sure it's stocked. So some great progress there. We're a little bit further in areas like Food and Beauty than we are -- and Apparel than we are in a couple of others. But that's the focus across the entirety of the store operations. And I would say, Scott, too, that's been a big part of our out-of-stocks. There's also some things we're doing upstream as it relates to inventory positioning, improving our speed of recovery across the chain as well. So there's a lot of moving parts there as it relates to out-of-stocks, but obviously, as you know, it's something we are very, very focused on.
Scott Mushkin:
And John, how many store is it in right now? And what's your expectation as we get through the end of the year?
John Mulligan:
It depends on -- there's lots of moving parts. Beauty is across the entire chain right now, and Food and Beverage operating model is probably across most of the chain as well. Some of the other pieces, we're testing different changes across about 1/4 of the business. So it's in various stages, and we'll continue to refine it and roll that out across the chain as we move forward.
Brian Cornell:
Look, Scott, this is a part of the investments we've been making in our store teams over the last few years. It was just a few years ago we rolled out visual merchandising across the entire chain, investing in Beauty, and we're seeing great results as a by-product of that. Special resources behind Food and Beverage, and that's certainly improving both our performance, helping us grow share, but also improving the in-stock condition. So we'll continue to make those investments over the balance of the year. But importantly, the guest is responding to those changes, and they've been a very important part in driving the comp increases we saw in the first quarter.
Operator:
The last question comes from Chris Horvers from JPMorgan.
Christopher Horvers:
So I'm going to take a shot at the shift question. So as you think about the shift, does it impact as you offset come in 3Q, or does it impact in 4Q as well? And then on the e-commerce front, does Drive-Up and Shipt show up in digital comp or the store comp? It seems like they're scaling over the year, so does that mean that digital growth actually accelerates throughout the year? Because it seems like the big helper in 1Q was more the free ship versus these other fulfillment options, which are still being rolled out.
Brian Cornell:
Yes. So Chris, things like Shipt and Drive-Up show up in our digital comp, and we've talked about this a lot. From a guest standpoint, I don't think they really care how we account for it. They just care about the fact that we've got these great convenient services that we now offer them throughout the year. So that is part of our digital comp. It's part of the strong performance we're seeing in digital. And we expect that to continue over the balance of the year. Cathy, you want to talk about the shift one last time?
Catherine Smith:
Yes. With regards to the calendar, so it's again really simple, just map week for week is what we do, which means you're going to see a little bit -- we saw a little bit of benefit this quarter, a little bit more next quarter, a little less -- a little headwind in Q3 and a little bit more in Q4, and it's kind of that throughout the course of the year.
Brian Cornell:
Good. Well, we appreciate you joining us today. Hopefully, you sense the confidence we have in our business. We feel great about the start of the year in Q1, the acceleration we're seeing in Q2 and our confidence in our full year guidance. So operator, that concludes our first quarter 2018 earnings conference call, and I thank all of you for joining us.
John Hulbert:
Well, good morning, everyone. Thank you for joining us. For those of you here with us in the room, we're really excited that you joined us here in our hometown. And hopefully, you found the experience last night, the store tour, the exhibits this morning helped you get a deeper understanding of what we're working on.
Couple of housekeeping items. First, there's a couple, I'm going to just literally read the slides. First of all, 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. Second, in today's remarks, we refer to non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP measures to the most directly comparable GAAP measure are included in our financial press releases and SEC filings, which are posted on our Investor Relations website. So finally, something new this year for those of you on the webcast. You can submit questions. I'm happy to say we are already getting questions, so please submit those. The team will get those questions to us, and we will take some of those during the Q&A session after the speeches. So with that, we can get started with Brian.
Brian Cornell:
Well, thanks, John, and good morning, and thank you for joining us today in Minneapolis. John, Cathy and I really enjoyed spending time with you during last night's tours and the reception. And I hope all of you had a chance to explore even more this morning. While we can make slides or show videos, there's simply no substitute for being here live and in person, walking the sales floor, talking to our teams, touching, feeling and experiencing new products and services, seeing for the first hand the future of Target.
What's so exciting for me is that, last year at this time, all we could do was talk about the future. Most of what we could show were still renderings. Today, those things are real. The work is well under way. We've made a ton of progress against our priorities. And as you saw today, our teams are more focused than ever. And our guests are responding in kind. What a difference a year makes. Think back to this meeting 2017. The world could not have looked more different. Coming out of soft holiday sales, the headlines were all about store closures, a catastrophic border tax and a looming retail apocalypse. That morning, we had a tough message of our own. But one by one, many of you pulled me aside that day and said, "Brian, I'm glad you're investing. We believe in your strategy. I'd make the same moves if I was standing in your shoes." It was a long flight home, but let me tell you what happened as soon as we landed in Minneapolis. The very next morning, we gathered our senior leadership team from every part of the country, and we grounded them in our company purpose, making sure every decision we made from that moment forward was in service to our purpose, to help all families discover the joy of everyday life. We talked about where we were and what it would take to continue to build the love our guests have for our brand. We talked about the things that makes Target unique, playing our own game, what it means for Target to really win. We talked a lot about urgency, getting things to market, testing, learning, doing it faster than ever before and rallying the organization around our multiyear plan, committing more than $7 billion to modernize every dimension on our business and lean into the things that truly sets Target apart, blending the best of our digital and physical shopping experience, reimagining our network of more than 1,800 stores as inspiring showrooms and neighborhood fulfillment centers, moving in a new smaller markets, creating digital capabilities that bring incredible ease and convenience to our guests' lives and doing what Target does better than anyone else in the marketplace, creating great brands at scale and with style. And we talked about what it was going to take to make all of that happen, the power of our Target team, nearly 350,000 people all around the world, the connection they have to their community, the passion they have for our brand. I've been in this business now for more than 30 years, and I've never seen anything like it. Never. The people who work at Target, they love the brand. They take great pride in taking care of our guest, and our guest sees it every day. They know the people who work in their neighborhood store. They seek their expertise. They appreciate their hospitality and their friendly service. When you ask our guests why they shop at Target, more often than not, they say it's because of the people. So it should come as no surprise that given our team's drive and competitive spirit, they never consider a forecast a foregone conclusion. It's just another challenge to raise the bar even higher. So last March, we told our store teams if you post positive comps in 2017, well, we told them they could wear jeans every weekend in 2018. Sure enough, if you were in a Target store on Sunday, you saw a lot of denim because here's what happened next. [Presentation]
Brian Cornell:
I've seen that video a half dozen times now, but it still makes me smile. I couldn't be more proud of what this team has accomplished. 2017 was quite a year. We introduced 3 new billion-dollar brands; 10 new brands in all; 110 remodels; nearly 30 small formats, Herald Square, Houston, Hearth & Hand; new payment systems; new partnerships; new promotional strategies; a new mobile app; and new fulfillment capabilities, next day, same day, pickup, Drive Up and, of course, tens of thousands of new personal shoppers delivering Target products from Shipt.
Early this morning, we reported our fourth quarter and 2017 year-end results. And you don't have to get too far to the numbers to see that our strategy is working. Guests like what we're doing. The investments we're making are taking root, and they're driving results. Here are just some of the highlights. Strong Q4 traffic, not just in digital but, importantly, in our stores, which led to a 3.6% comp increase. We saw that growth come across our business as we gained market share in all 5 core merchandising categories. This was the fourth year in a row that digital grew by more than 25%. But it was our coast-to-coast network of neighborhood stores that enabled that growth, as our stores fulfilled more than half of our total digital volume. Given the strong sales performance and the benefits from the recent change in the tax code, we finished the fourth quarter with adjusted EPS of $1.37 and $4.71 for the full year. But what's most encouraging to me is that we can't hang these results on any one single aspect of our strategy. Rather, it's a sum of the parts, everything working together and everything working that carried the day. While we're obviously pleased with the results, there's no time for a victory lap because you know, and I know, we still have a lot of work left to do. So while 2017 was all about putting down a plan, getting the wheels turning in the right direction, 2018 is about acceleration, leveraging our greatest assets and leaning in to our competitive strength, all in service of making Target America's easiest place to shop.
So as many of you experienced this morning, newness and innovation are essential elements of our strategy. Our teams are exploring retail applications for just about every buzzword you can imagine, AI, CGI, machine learning. And while we're looking for future opportunities to build adjacent businesses and disruptive technology, the vast majority of our teams' time and talent is aimed at our core and advancing our investments around several key strategic categories:
creating a more inspiring and connected shopping experience; reimagining our supply chain and fulfillment capabilities by positioning our stores at the heart of our network; continuing to reinvent our own brand portfolio; and investing in what is by far our most valuable asset, our team.
These are the choices we're making to ensure Target continues to stand out from the pack and further distinguish our brand in the minds of the guests. And today, I'm happy to report we're either on pace or ahead of schedule in delivering what we laid out 1 year ago. And it's all because of our people. They are, in every sense, our greatest point of difference, and that's true across every corner of our organization. Consider for a moment what it takes to bring a shirt to market. The buyers, textile designers, sourcing managers, fabric engineers, all the planners, the pricing analysts, the marketers, the packaging experts, the global trade managers and those visual merchandisers, every one of those jobs is held by a Target team member. The talent and expertise you see at every single node in that global value chain gives us an unrivaled competitive advantage. That's what's equally important is the fact that for that shirt when it reaches the store, well, our team members who greet our guests and help them find what they're looking for, that's why we're investing in training and teaching not only to sell the shirt, but to sell the whole outfit. We're also providing new tools to manage tasks more efficiently, so we have more time for personalized service. And we're creating new pathways for advancement, developing new skills and leaning in how to manage, motivate and lead others. During the past year, we've made great strides in changing our service model and added payroll in areas where our guest expects a more human touch. And of course, I'm really proud of the leadership position we took in October, raising our starting wage to $11 and committing to $15 an hour by 2020. I will tell you that within days of that announcement, applications for seasonal positions spiked by more than 30%, and we had a much stronger pool of talent to hire from. But the benefits of that investment go much further than just the short-term seasonal boost. Our leadership position on wage establishes Target as an employer of choice and will drive preference for years to come. And now you're seeing a number of employers inside and outside of retail follow our lead. And today, I'm happy to announce, we will raise our starting wage again to $12 starting with current team members this spring. So when we talk about elevating the shopping experience, the work is all about connecting physical and digital and empowering our people to bring in all the life. Despite all the changes across the consumer landscape, one thing remains absolutely true. Our guests love to shop. Our team is laser focused on creating the kinds of experiences that are worth the trip or an extra click, and you saw that first hand last night. The before and after images of our down town store, well, they tell the whole story. It's not just about better and more modern design. It's about creating experiences based on how we want our guests to feel when they shop. It's about being welcoming. So in Beauty, this means making sure our guests see themselves in the product and the marketing, asking for what we can do to encourage them to explore even more. We want them to feel inspired. So in Apparel, it's not just presentation. It's about helpful service. Across the entire experience, we also want to make sure we continue to make it really, really easy. And by no means, we'll then experience, look the same from store to store. Each day today, 42,000 people walk past our Herald Square store during that evening commute. Not one of them wants to walk out with a 50-inch flat screen TV on one hand and try to hail a cab in the other. Every design decision, every merchandising choice has to be made with the guest experience being top of mind. Now if you haven't been to our next-generation store in Houston, I can assure you it is worth the trip. You've often heard me talk about the power of and. Our new store in Houston is really the physical manifestation of that phrase. It was designed for ease and inspiration, style and essentials, mass and specialty. And it's a glimpse into our future, not because we plan to open dozens of new stores just like it, but because we're picking and choosing elements from that prototype to create customized concepts for every store we remodel. Last year, we committed to remodeling 600 stores over 3 years, and now we're going to raise the bar. In 2017, we delivered 110. This year, we'll triple that pace and do 325 more. We'll keep going at that rate, completing over 1,000 remodels by 2020. We'll also open up more small-format stores in prime urban markets, including 3 more tomorrow. And when we put it together, the aggregate investment we're making in key markets, like Chicago, L.A. and right here in Minneapolis, will exceed several hundred million dollars across each one of those communities. We're also investing to bring the best of digital into our physical experience. Consider the stat during the holidays. Our stores fulfilled more than 2/3 of our digital orders. So now if I'm sitting at my desk and I order something from Target.com, but I pick it up on my way home, does it make sense to call it a digital transaction? If I buy a patio set with my phone, while I'm sitting on the store display model, is that a digital sale? Our finance folks would say yes. I can tell you, our guests could care less. And our technology teams, they're working hard to create new tools to completely erase that line altogether. For example, we folded our popular Cartwheel app into our flagship app to simplify the experience. And we introduced Wallet, so our guests can find deals and pay more easily and faster than ever before. On Target.com, we added a 360-degree digital shopping experience. We're investing in augmented reality. We're elevating our storytelling around key brands and key life moments. And we're finding new ways to extend our assortment and better leverage our platform. So not only are we creating better showrooms out of our stores, we're also using these buildings in a profoundly different way. They should be hubs for commerce and community. And given the fact that we're nearly 10 miles from every doorstep in America, we see a huge advantage in leveraging that proximity. We just needed to realign our network. So a few years ago, we started shipping digital orders from our back rooms. We started small, and we worked out the kinks. We focused on getting orders to our guests with greater efficiency, reducing inventory across our network and dramatically accelerating delivery times. But that was just the start. In August, we acquired Grand Junction, a technology platform that enables us to connect to third-party carriers and provide same-day delivery service. In October, here in Minneapolis, we piloted Drive Up, pull up, pop your trunk, we are out with your order in less than 2 minutes, rain or shine. Then in December, we announced the acquisition of Shipt, a technology platform, which is allowing us to provide tens of thousands of personal shoppers and closes that last mile delivery gap from days to minutes. I can tell you I've spent time with the Shipt team, talking to their network of shoppers. What really stands out for me is the people, the personal relationships they build with their customers. Think about people who love Target shopping who are out there shopping for Target lovers. It's a great combination, and John is going to share a lot more details about where we're headed, but I wanted to give you a sense for how we're moving even faster to take them to scale. Today, we're announcing how we're going to expand our same-day delivery service from Manhattan to all 5 boroughs and several other big-city markets. With Drive Up, we're taking our 50-store test nationwide to nearly 1,000 locations coast to coast. And finally, I am really excited about this, we're going to offer free 2-day delivery on hundreds of thousands of items on Target.com. No membership, no extra fees. When you think about all the bold moves we've made, none was more ambitious than our plan to reinvent our own brand portfolio. We promised 12 new brands in 18 months. Standing here today, I can tell you we're well ahead of schedule. In 2017, we brought 10 new brands to market and introduced 2 more, each one focused on replacing long existing brands or filling a whitespace in our current portfolio. Think about A New Day in ready to wear, JoyLab in active wear, Goodfellow for men, in Home Project 62 and Hearth & Hand with Magnolia, a partner with America's favorite family, Chip and Joanna Gaines. Each one of those brands delivered exceptional quality and unbeatable value. In a world where everything is increasingly commoditized, each one helps differentiate Target and build preference for our overall brand. Across the board, the results have been phenomenal. [Presentation]
Brian Cornell:
While each brand has delivered incremental sales, they're working hard across our assortment, driving traffic to other categories and inspiring cross-shopping.
For example, we were highly intentional about launching Hearth & Hand early in the holiday season. It was an invitation for our guests to explore and an opportunity for inspiration, driving results across Home, but also helping categories, like Food as well. And while our design and marketing teams would tell you we set an incredible pace in 2017, we're only going to move faster and faster in the months to come. Last month, we launched Opalhouse in Home. And last week, we debuted a limited-time-only collection with Hunter, a long admired English heritage brand. So before I turn it over to John and Cathy, I want to finish up where I started. 2017 was a big year for Target. We laid out an ambitious agenda, blending digital and physical, creating new experiences, reimagining our network of stores as hubs for commerce and community, expanding into new markets and reinventing our brands. We made bold investments, more than 100 remodels, dozens of new formats, key acquisitions, blockbuster brands, industry-leading investments in our team, and our team delivered. We're headed into 2018 with a road that couldn't be more clear. Our strategy is working. Our guests are responding. And we're accelerating the pace, pushing even harder, moving faster than ever before, 3x as many remodels, dozens of new stores, new services, new solutions, moving from concepts like Drive Up to scale and taking Shipt nationwide. And you'll see us continue to invest in our team and roll out one new brand after another all year long. Putting it all together, this is a strategy that's going to make Target America's easiest place to shop. So now let me welcome John Mulligan, our Chief Operating Officer, to the stage. Thank you.
John Mulligan:
Good morning, everyone. You just heard from Brian that the Target team delivered on the commitments we made last year and then some, from standing up new stores to remodeling existing ones, rolling out new fulfillment options and expanding capabilities to get products to our guests even faster. We're changing our operations to use our stores in new ways, while we continue to offer an exceptional in-store experience, and it's all made possible by the teams that bring those buildings to life.
We have more than 300,000 team members in our stores, face-to-face with millions of guests and tens of thousands more behind the scenes, creating, ordering, moving product and developing the technology, automation and tools that allow us to serve the guests in ways we hadn't even dreamed of just a few years ago. They're the experts, the inventors and the personalities behind every guest experience and the reason we've made meaningful progress toward putting our strategies in motion. Just about everything our team has done, and continues to do, is in service of supporting our stores as hubs, hubs that offer a great shopping experience, support our communities and fulfill digital orders. They're at the center of how we're welcoming and inspiring guests and how we're making it really easy for them to shop at Target. So here's a question I get all the time, in today's digital world, why invest in stores? And for us, the business case is simple. When a digital order comes in, we basically have 2 choices, fulfill it from one of a few fulfillment centers across the country or ship it out the back of a local store. We're fortunate to have more than 1,800 stores in really great locations, prime real estate just down the street from our guests, so we can deliver it faster, nearly 2 days faster than if we'd sent it from a regional fulfillment center, plus the inventory is already there because our stores feature a curated assortment we know our guests want. Naturally, it's the same merchandise they buy most often online. And when one store is out of an item, we have other stores nearby that could help fill the order. Even more, our stores' flexibility to ramp up when things get busy is incredibly powerful. This past Cyber Monday, our stores shipped millions of orders out their back doors. Without that capacity, we would have needed twice as many fulfillment centers as we have today. And when peak was over, the stores ramped right back down. So we avoid spending all that capital on new facilities we'd really only need a few weeks out of the year. Now that's all great, but here's the real kicker and probably the thing you all care about most. Shipping from a store is the best way to lower the total cost of digital fulfillment. We hear a lot about optimizing, picking and packing, which can help make fulfilling an online order more efficient. But step back and look at the total cost of fulfillment. There are fixed and variable costs required to run and staff the fulfillment center. But no question, shipping is, by far, the largest chunk. Going after the variable cost, while really important, only gets you so far. To lower the total cost, you can't ignore the big dog. Shipping from a local store optimizes the most dominant standalone cost by dollars per order. And because we haven't sunk capital into a massive fulfillment center, our overhead and other fixed costs essentially go away. You've all seen our strong digital growth, and we expect that to continue. So at some point, we'll need to build more upstream facilities just to manage volume, but we're not there yet. Using our stores to fulfill millions of orders lets us delay those investments or avoid some of them altogether. And because our stores are the fastest and most efficient fulfillment method, they'll continue to be our preferred shipping point in the long run. Bottom line, shipping from our stores moves product faster, and we do it at a significantly lower cost. I'm confident, none of you need a spreadsheet to see that, that's a really good thing. For a company like us with well-located assets already in place across the country, this strategy makes complete sense. But the entire supply chain operation has to support it. With everything we're asking a store to do, they need more product than ever before. We're replenishing the shelves and fulfilling digital orders, all in one building from the same pool of inventory, so product has to come fast and often. But there's already so much happening in a store, so the trick is to send them only the right amount of product at the right time and quickly. You all know our team has been building an entirely new operating model for our supply chain. Last year, I told you about our plans to become more flexible on how we move product. The goal is to be able to move inventory in any quantity, whether that's cases, pallets or individual units ,so we can replenish only what we sold. That might mean sending a truck with bottles of shampoo next to cases of ketchup and pallets of water. We send the store precisely what it needs to restock the shelf. It keeps product from clogging up the back room and makes it easier for our teams to manage the inventory. It's a model we've been testing with a distribution center in the Northeast, and it's working. The store supported by that DC have reduced their backroom inventory by more than 1/3 and cut out-of-stocks to half of what we see across the rest of the chain. Of course, we did all that with an entirely new facility, and we're expanding that operation to support more stores in Northeast. But we're also testing how to work to retrofit our existing network. And by the fourth quarter, multiple DCs will begin the journey to evolve to this model. To do it, we're scaling some of the most promising robotic solutions we've tested in the past year. That automation makes it possible for us to sort and move huge volumes of single units without putting an unsustainable burden on our DC teams or the stores. With less inventory in the back of the store, we can dedicate more room to digital fulfillment. This past holiday season, we tested a new design in the backroom, complete with more pack stations and dedicated space to sort orders for delivery, and capacity shot up. It was incredible. As orders came pouring in on Cyber Monday, the teams were picking, packing and sorting boxes, just like a fulfillment center. And with an enhanced layout and process, they did up to 6x the volume of the year before. Best of all, guests got their packages faster. Nearly every order that came into those stores that day was picked, packed and ready to ship in 24 hours. This year, to keep up with digital demand that continues to far outpace the industry, we're introducing this new backroom design to more than 150 stores ,and we're reengineering the operation in more than 1,000 others. With this additional capacity, our stores plan to shift nearly double the number of packages for Cyber Monday 2018 compared to last year. That's good news because, as I said earlier, shipping more orders from our stores reduces our costs, while allowing us to move faster. And speed is the part our guests will notice. With the changes we've been making across our operation these past few years, the average delivery time for an order was nearing 2 days. But we weren't doing it consistently enough to make that promise to our guests, until now. We're announcing today that we're offering free 2-day shipping on hundreds of thousands of items, no membership required. With more mature fulfillment capabilities, we're updating our promise and resetting our guest expectations of what's possible. It's an offer that's compelling and competitive, and it's just the start. Speaking of being competitive, one of the biggest leaps we made this past year was our swift move into same-day delivery. With our acquisition of Shipt, Target gained the ability to deliver product to our guests in hours or even minutes. We knew Shipt was a fit for Target right from the start. Here's a startup delivery company that's gone from one market in Alabama to more than 70 markets in just 3 years, so the operation is strong and proven to scale. It's a company built on speed, but focused on service, which means working with Shipt, we could jump years ahead in our fulfillment plans without sacrificing the guest experience, staying true to how we've grown for more than 50 years. Take a look. [Presentation]
John Mulligan:
Just 8 weeks after our announcement, we began offering millions of guests the ability to shop online for more than 50,000 items across Grocery, Essentials, Electronics, Baby and more, and have those products delivered that same day. Already, we brought Target same-day delivery to Shipt members across the Southeast and in the Twin Cities, and we're rolling into new markets almost every week. By holiday, we'll be the first retailer to offer same-day delivery in nearly every major market.
As you just heard, the beauty of Shipt is that it's not just a transaction. Our guests will get a personalized service and care that these shoppers offer, unlike anyone else, while also accessing a wide assortment of products, priced right daily and delivered in hours. The whole package is something no one else is offering today. At the same time, guests still like to come into our stores and shop, but for guests in urban areas, like Manhattan, they can only buy what they can carry home. Last year, our team saw a need and knew we could help. Just weeks later, they'd rolled out a service at our TriBeCa location in New York City, where guests shop the store and then play (sic) [ pay ] a flat fee, about the cost of a short cab ride, very cheap, very inexpensive, to have that order delivered that same day. Today, we're offering delivery from 4 stores in New York, and guests love it. It's quick and efficient, and it's all possible because of the technology we acquired from Grand Junction last year. The platform assigns every order to the most logical local carrier, which is what allows us to efficiently scale the service beyond a single store or a market. Starting this spring, we'll go even bigger in the city, offering the service in 25 more New York locations and reaching all 5 boroughs by Q4. And at the same time, we'll roll it out in other markets, like Boston, Chicago, San Francisco and D.C. Delivery goes a long way in making our guests lives easier, but just as meaningful as when a team member can put formula and diapers right in the back of a minivan, saving the guest from unloading the car seats to run inside. Last summer, we started testing Drive Up in the Twin Cities. It took order pickup to the parking lot, where our store teams would walk the order out to a guest car. We saw the demand for it right away, and guest feedback was overwhelmingly positive. In fact, Drive Up's Net Promoter Score is consistently over 80. And those of you who are familiar with that metric know that's incredibly high. This spring, at the same time we take Shipt across the country, we'll roll out Drive Up, putting the service in nearly 1,000 stores by the end of the year. In every fulfillment option, shipping, delivering or walking orders to the car, the store is at the center. It also continues to be a destination for millions of guests every week, while fielding much of our digital growth at the same time, so we have to be sure they are equipped to do both. Brian and I spent a lot of time visiting stores across the country. A little over a year ago, we toured a few markets together and it was clear, the stores that we lean on so heavily needed some love. Not only did the design need a refresh, and by that I mean losing the neon and the vintage signs, but many of the layouts weren't set up to handle digital fulfillment. We walked stores where the team was holding order pickup packages in the backroom meeting areas because they didn't have space upfront or boxing orders in whatever backroom cranny that could fit a pack station. So our store design team developed a new prototype that would do it all. They reimagined the entrances, sales flooring, fixtures to make shopping our stores easier and more inspiring. At the same time, they expanded the order pickup counter, built a Drive Up lane and rearranged the backroom to handle a growing number of digital orders. In November, we opened a new store in Houston with this latest generation of design. Check it out. [Presentation]
John Mulligan:
We're incorporating elements of this latest design, as we remodel more than 1,000 stores across the country over the next 3 years, including the 325 we'll do in 2018. But it won't be the same in every store. We'll adjust and evolve, applying what we learn and leaning into what works. And we'll continue to design an experience that feels relevant for each location, from cinema lights on a former theater in Brooklyn to big skylights at the store near sunny UC Irvine.
The fulfillment capabilities our stores gain are critical for our strategy, but so is the improved guest experience that comes from updating a store that hasn't been touched in years, and the difference is real. After a store has remodeled. traffic grows. And we see the 2% to 4% sales lift, on average, that we'd expected. In addition to the individual stores we're remodeling, we've made investments in key markets. Pick the Dallas-Fort Worth area. Last year, we remodeled 28 stores across the metro, and guests noticed. The refresh design is inviting guests to come back in and to shop, and the reviews have been overwhelmingly positive. We saw with Dallas and with LA25 a few years ago that we can learn a lot from putting our latest thinking into one market. So this year, we'll go big in our hometown and remodel nearly 30 stores in the Twin Cities, on our way to putting the latest design into all area stores over the next few years. Even as we reimagine our existing stores, we're continuing to find opportunities to bring an elevated experience to new guests, and we're doing that with our small format stores. The flexible design allows us to open in areas where our traditional big-box footprint simply wouldn't fit, city centers, dense neighborhoods, even college campuses. They bring us into new markets, like Vermont, which will officially put us in all 50 states and closer to new guests, like students at the University of Cincinnati and Penn State. Part of joining a new community is being a good neighbor, so our teams go deep into those neighborhoods to really know those guests and tailor the experience to what they need. It's a capability we'd built and refined over time. You can see that most easily with our assortment. And of course, we've got portable electronics and Mac & Cheese in our campus stores. But we also get specific to a neighborhood, even within the same city. Chicago is a great example. The assortment in our Lakeview Ashland store is focused on Baby and Kids products because that's what those guests buy most. While just 7 blocks away, Lakeview Belmont overindexes on top-selling categories, like home decor and liquor. Last year, we opened nearly 30 small format stores, doubling the number we'd opened up to that point. This year, we'll add another 30. In fact, we're opening a few of them tomorrow in D.C., Boston and Chicago. And we'll do another 30 in 2019, putting us on pace to operate more than 130 small formats by the end of next year, so we can meet the needs of even more guests across the country. Now all that said, it's the team inside those buildings that make us Target. And our teams work hard to deliver for our guests and serve our communities every single day. So we're continuing to invest in them. You heard our announcement of increasing our minimum wage to $12 an hour this year on our way to $15 an hour by 2020. And while pay is important, our investment goes deeper than that. We're also giving our team opportunities to develop and use new school -- skills that offer outstanding guest service, while also building the basket. Gone are the days when a team member shows up on Monday to work on Apparel and Wednesday to work in Electronics. Instead, we're placing people based on their interest and their background and providing data and paid training to help them truly be specialists in their areas. In fact, we've committed hundreds of thousands of payroll hours for training that helps them succeed in their jobs, but also in their careers. At the same time, we're giving them tools to better serve the in-store guests. Last year, we launched an application on the team member device that allow them to order something for a guest if the item they want wasn't in their store. This holiday season, it's saved the sale and extended the aisle for thousands of guests. And soon, our teams will use the same technology to save guests from standing in line. When the check lanes are full, our team can use the devices to give us more capacity at point-of-sale. They're able to ring up a guest's full order on the spot, busting lines and saving time. It's just another way they are quick to make a guest experience easier and more convenient. We've always said that the guest is at the center of everything we do, so it only makes sense that our 1,800 stores in neighborhoods across the country are at the center of how we do it. It's why you'll see our progress continue to support our stores, whether it's modernizing the supply chain, standing up new small formats, building on digital capabilities or, most importantly, investing on our team. All of it is in service of delivering a retail experience guests can't find anywhere but Target. Thank you. [Presentation]
Catherine Smith:
Wow! Like Brian said, what a difference a year makes. Coming out of this meeting a year ago, we were really confident that we were on the right path. Even so, we knew we'd be a show-me story for a while. We need to begin putting some points on the board to show that our strategy was working. And now that started to happen. But let me be clear, I know for some of you, we still remain a show-me story. And we remain confident in our path, but I'd all -- I thought -- I think we'd all agree we're in a much different place today.
Last year was the beginning of a multiyear effort to position our business for long-term profitable growth. It was an investment year, as we ramped up our capital spending and devoted a portion of our operating income to reposition Target in this new era of retail. Looking back, I'm happy to say that we made all of those investments and more. And with those investments, our business performed far ahead of our expectations, both on the top lines and the bottom lines. In particular, multiple data points either met or exceeded our expectations, including a 2% to 4% sales lift on average from our store remodels; compelling financial performance from our new small formats, including sales productivity, margins and ROIC; a strong guest response to our new brands; digital sales growth of more than 25% for the fourth year in a row; disciplined execution and a positive guest response to our new -- our tests of our new fulfillment centers -- fulfillment options; and following our investments in being priced right daily, our guests noticed, with our sales at Everyday Low Prices were up more than $4 billion compared to 2016. And finally, the most important metric, guest traffic. It accelerated as the year progressed. Last year, we said that 2018 would be a transition year, and that view is still appropriate today. Our priorities remain the same, but you'll see a rapid acceleration in our pace. To support that acceleration, we'll grow our capital investment to well over $3 billion this year. To provide a differentiated shopping experience, we'll triple the size of our remodel program. We'll open more than 30 small-format stores in new neighborhoods. We'll expand fulfillment options into new markets across the country, including Drive Up and the same-day delivery enabled by Shipt acquisition. We'll build capacity to ship more orders from our stores, increasing speed and reducing cost. We'll continue investing in our supply chain to enhance the store replenishment and digital fulfillment. We'll differentiate with more exclusive brands, combined with our curated assortment of national brands. And we'll continue to monitor and maintain the right balance of everyday prices and promotions by category. These are important investments to create the Target of tomorrow, which will position this company for growth in 2019 and beyond. In 2018, we expect that our EPS from our core business will stabilize. This reflects several profit headwinds, including accelerated depreciation resulting from our remodel program, continued cost pressure from the rapid rollout of our new fulfillment options, ongoing wage investments in the face of a tight labor market across the country and the impact of last year's price and value investments, which we'll annualize throughout 2018. However, unlike last year, we'll expect these pressures will be mostly offset by multiple tailwinds in our business, including the mix benefit of continued strength in our high-margin categories, lower unit costs for digital fulfillment driven by our supply chain, modest expense leverage from a low single-digit increase in comparable sales and of course, continued cost control across every aspect of our business. And finally, beyond operating income, we expect to benefit from the continued focus on disciplined capital deployment through lower interest expense and modest EPS leverage from share repurchase.
This highlights one of the most important aspects of our business:
its ability to generate cash year after year. Look at 2017. Even with an operating margin decline driven by our investments, we generated almost $7 billion of cash from operations. That is $1.5 billion more than 2016, nearly a 30% increase, despite the massive changes happening in our industry. So even without tax reform, we would have entered 2018 in a really strong position.
Now let me pause for a moment and talk about tax reform. As a domestic retailer, we have long had one of the highest effective tax rates around, well over 30% in recent years, so we are certainly encouraged. The tax reform has put our company, our industry on a more level playing field and made the United States more competitive globally. But the question we've heard a lot since tax reform was passed, what are you going to do with the benefits? And when you think about that question, it's important to realize we didn't wait for tax reform to make big investments in our business and our team, because we were confident they were the right long-term choices. Think back to our second quarter conference call in August, when we first announced we plan to invest more than $3 billion in our business in 2018, and then a month later, when we took decisive action in support of our single most important differentiator, our team. We announced higher investments and hours training to better equip our team to provide an outstanding guest experience. And to support our team members, we announced we would raise Target's national minimum wage to $11 an hour as part of a plan to reach $15 by the end of 2020. And again today, we made another step forward with the announcement of our national starting wage is moving to $12. Beyond investments in our team, we're accelerating our capital investments as well. Today, we're raising our CapEx guidance to a range around $3.5 billion in 2018, reflecting the incremental investments in both our stores and our supply chain in support of the priorities I outlined earlier. So for us, the question -- the answer to the question what are you going to do in light of tax reform is simple. We're investing in our business and our team to support Target's long-term sustainable growth using the same approach we always have. Now you've heard us say it so many times. We first look to invest in projects that promise to generate long-term value, then we want to support our dividend to extend the record -- our record of annual increases. And finally, we look to return any excess cash beyond those first 2 priorities within the limits of our middle A credit rating. So with that, let's cover a few details underlying our financial expectations for 2018, and then we'll talk about the first quarter. Back in January, we outlined our expectations for a low single-digit increase in comparable sales this year and a full year adjusted EPS of $5.15 to $5.45. And today, those expectations remain the same. Among the drivers, we expect our operating margin rate will be down about 20 basis points this year, reflecting the net impact of the headwinds and the tailwinds I outlined earlier. Across the lines of the P&L, we're expecting relatively small changes in gross margin and SG&A in 2018, which together should net to approximately 0. So in essence, this year's expected decline in our operating margin rate will be driven entirely by $175 million increase in depreciation and amortization. One note, this is -- this expected increase is smaller than I outlined in our last conference call. Since then we have continued to refine our outlook and expect less year-over-year D&A pressure in the year as it goes on, specifically in the third and fourth quarters. Beyond operating metrics, we expect our interest expense to decrease about $60 million this year, reflecting last year's debt retirement and refinancing activities conducted by our treasury team. And finally, we expect our consolidated tax rate to be in the low to mid-20% range, lower than in recent history in light of tax reform. Now I'll turn briefly to our expectations for the first quarter. On the top line, we're planning for a low single-digit increase in our first quarter comparable sales. We're expecting a moderate increase in our first quarter gross margin rate, which will be more than offset by an increase in our SG&A expense rate. And we're expecting an increase in our first quarter D&A expense of about $80 million, consistent with the outlook I provided on our last conference call. Altogether, this adds up to a decline in operating margin rate of 60 to 80 basis points in the first quarter. Combined with a reduction in our interest expense of about $20 million and the benefit of the lower tax rate, we're expecting first quarter adjusted EPS to be $1.25 to $1.45. One final note on our guidance. As you began seeing in our results last year, our new stores are starting to have a meaningful impact on our total sales growth. As a result, in 2018, for both the first quarter and the full year, we expect that our new stores will add approximately 50 basis points to our total sales growth. So now I want to step back and talk a minute about how our financial model is changing. While we're not going to provide long-term guidance today, we can offer a strategic view. With the changes we're making to our business model, we expect our financial model to evolve as well. Like the past, we'll continue to focus on growing traffic sales and profits, enabled by our strategic investments we've highlighted today. And our stores will be right at the center of that growth, providing an outstanding shopping experience along with fast and efficient digital fulfillment in support of a rapidly growing suite of convenient options. By placing our stores at the center, we expect our business will generate somewhat higher asset turns and somewhat lower operating margins than we've seen historically. This evolution will support continued outstanding after-tax returns on invested capital, something that's been a strength of this company for a very long time. In fact, if you think back in our history, this isn't the first time our business model and financial model have changed in service of an evolving consumer. Remember, our company began over 100 years ago as a traditional department store. It had a business model that generated higher margin rates and lower asset turns compared with Target stores. Yet, even as we completely transformed our business model from department stores to Target stores, our company has generated strong returns on capital for decades. Even in 2018, an investment year, we earned a very healthy 14% after-tax ROIC, and that's after we exclude the onetime benefits from tax reform. This is performance that many in our industry would love. And in 2018, we expect ROIC to move beyond 14% even in the face of increase in capital spending. As we look past 2018, we don't believe that margin rates are going to unsustainably low levels. And we can clearly see a path to evolve our financial model and reward investors by delivering growth and attractive returns, consistent with the long-term record of this great company. We know we serve as stewards of a company that will have a very long history, and I can assure you that this leadership team is all in, in sustaining that great legacy we've inherited. So now I want to end my remarks where Brian began, with a shout-out to our team. As soon as I came to Target, I quickly realized how special this team really is. I see it every day that I'm out in our stores, walking the sales floor or when I'm visiting our distribution centers or every day in our headquarters. No matter where they are or what they do, when you spend time with our team, you feel firsthand the pride they have in our company, our brand and the role Target serves in every community we are in. They share a common purpose to bring joy to our guests' lives, and they project an infectious sense of optimism. They see clearly that Target will succeed if we focus on the long term and make the right choices for our business, for our team, for our guests and our shareholders. So while there is no question that times were tough a year ago, our team's passion and energy never faded. Our team embraced the challenge to move faster and think bigger and begin moving Target from a show-me story to a long-term success story again. So I want to say thank you to the entire Target team for everything you do. It's a privilege to work with you as we write this new chapter in our history. So now I'm going to turn it back over to Brian for a brief wrap-up, and then we'll move to questions. Thank you.
Brian Cornell:
So I love the way Cathy just brought it all together. We have an incredibly talented team at Target, and they truly delivered in 2017. I couldn't be more proud of their ambition, their passion for the brand and the way they always do the right thing for our guest. When you think about 2017, you heard it from Cathy and John, it was in every sense an investment year. We made big bets on new brands, new experiences and capabilities. We leaned into new partnerships and empowered our people. 2017 was a year of progress. As we looked to the year ahead, 2018 is all about scale and acceleration, so we're tripling the remodel program. We'll add another 30 small formats. We'll introduce many new brands. We're rolling out new service models and game-changing fulfillment capabilities and making even deeper investments in our team. And I'm really confident about what's next.
I'll be the first to say we still have a lot of work to do. The competition is fierce, the pace of change is unrelenting, and our guest deserves the very best. But I couldn't be more bullish about Target's prospects. The strategy we're pursuing is working. Our guests are responding. And now our team is more than ready to pick up the pace and move faster than we ever have before, with one goal in mind:
to make Target America's easiest place to shop.
[Presentation]
Brian Cornell:
All right. So I'm going to ask John and Cathy to join us on stage, so we can answer some of your questions. In addition to questions in the room here today, we also have questions coming from our webcast. We're going to try to make sure we incorporate those into the approximate 30 minutes we have for Q&A today. So we've got mic runners. They'll have bull's-eyes in their hand. I would ask, as you ask your questions, if you could just pause to identify yourselves. We can see many of you, but not very well. So why don't we start with Simeon, right up front. I can see up to about the second row, so it was an advantage.
Simeon Gutman:
I want to focus on 2 items that have been pressuring margins. First, investments and capabilities, investments being a catchall, including wage. I mean -- and then the second pressure point is the shift to a lower-margin channel. And can I ask you to comment on each, where you are in terms of your spend? The SG&A guide sort of implies that we've reached some peak level, and we're going to taper off. And then second with regard to the mix shift to online, where are you in that journey? You said the customer is agnostic. Are you financially agnostic?
Brian Cornell:
Yes. So let me start, and then I'll turn it over to Cathy and John. But I think as we outlined today, we've made significant investments in the last year in our team, in new capabilities, in new brands. You're going to see that stabilize as we go into 2018. And as Cathy mentioned in our outlook, we expect to see gross margin rates stabilize, if not slightly improve, in 2018, offset by some of the investments we'll make in SG&A. So I think we've reached a point of general stability in our model. We're going to continue to invest. It's a period of, now, acceleration. But we've spent a lot of time over the last 3 years testing and validating our investments, making sure they are the right thing for our guests, the right thing for our shareholders, that we're going to be sustainable and then we're also going to provide the right return on invested capital. And I think you saw that today in our outlook. So again, we've got a lot of work to do in 2018. It is a year of acceleration. But we're accelerating based on the validation that we saw in '18 and the confidence that we're going to continue to drive great returns.
Catherine Smith:
The only thing I'd add, Simeon, is kind of longer term, that perspective of as our business model is evolving using the stores at the center of that strategy, we do expect that you'll see continued, really terrific ROIC or after-tax ROIC and so kind of probably lower operating margins than we've seen historically, not inconsistent with where we are today, but really strong continued asset efficiency, which will drive that ROIC, so growth in our ROIC.
Brian Cornell:
And your question about digital and the mix between the 2 channels. As I said several times today, we really want to make Target America's easiest place to shop; allow our guest to interface with great stores and even better store experiences as we remodel; give them a number of options for fulfillment, whether it's order online and pick up in our store, now drive up to our lot and pop that trunk, and we'll put it right in there; use Shipt to provide same-day delivering in hours, if not minutes; and convenient service right to their home. So we have to be agnostic, let the guest decide. But one of the great highlights from our fourth quarter was the fact that we saw really strong traffic and growth, both in our stores and our digital channel. And we expect as we go into 2018 to continue to drive positive growth into our stores, to drive positive comps in stores, that's critically important, and to continue to be a leader in digital growth. And I think the investments we're making in Shipt, in Drive Up, in other services positions Target uniquely, as we move into this next era of retailing.
Wayne Hood:
Just to follow-up on his question, looking at the spend rate in remodels may be peaking by 2020, the wage investment is actually peaking then as well. Why wouldn't you expect operating margins to lift in 2020, given the runoff in D&A and the spend is actually over? And then I had a question about John, if you talk a little bit about the execution on -- a lot of I heard -- what have we seen so far today is absent on improve processes, but it that didn't really address maybe the headwind in the store. And that's the modular issue that the systems will allow you to get right quantities, but the challenge is the modulars are not really set in a way that allows it to flow very -- as nice as you would like to see. So how do you address that the modular side, as the store format begins to change over time?
Brian Cornell:
So why don't I start with the first part of the question. And Wayne, you're absolutely right. As we get into the out-years, we are going to see our remodel schedule begin to normalize. Right now, we're in a catch-up state. And as we accelerate over the next 3 years, obviously, we'll touch the vast majority of our stores. So in the out-years, we do expect that to normalize. But we have a lot of work to do in these next few years. It's all about making sure we execute our plan and touch and enhance the experience in as many stores as possible before we return to a normal remodel schedule.
John Mulligan:
I'm sorry, Wayne. I didn't fully understand the second part of your question.
Wayne Hood:
I probably didn't ask it right, but I'll ask it again. So the challenge to me has always been on store replenishment side was the modulars really are not of the size that allows you to get a full case pack onto the modular. And you can do all the backroom maneuvering that you want to do that gets you so far. But those modulars over time seems to me have to change to allow for bigger quantities, what you want to do. And then you take into account how the store is changing and what modulars may or may not present there in 5 to 10 years now, you may be looking at another remodel around based on where the modulars are.
John Mulligan:
Yes, I think this goes back to why we talk about flexibility in the supply chain to address that. I think when you look where we're at today, and you're right, it will evolve over the next 10 years. Who knows what we'll have in store then? Maybe Mark does, but that will come later. 70% of that stuff doesn't sell more than 1 per store per week. So I don't need to flow case packs into that store for those items. If you think about bike helmets, the likelihood of us selling more than 1 bike helmet in a week this time of year in Minneapolis is very low. We may sell 1, and probabilistically, we will sell 1 sometime this month, but we won't sell more than that. And so that's why we go back to flexibility. There's things that are going to have to go in there in a very high-speed, high-capacity. To your point, we need to make sure a case pack fits on the floor or a case pack and half or 3 case packs in the case of Tide or 8 case packs or 20 case packs, because we move that in pallet loads. But for the majority of what we sell, much lower volumes, that needs to come in, in single units. And so it's really about having that flexibility upstream to meet the demands of whatever it is we're doing in store. And that's why we're headed down the path we are.
Brian Cornell:
Why don't we go to this side of the room? Oliver?
Matthew Fassler:
It's actually -- it's Matt Fassler from Goldman Sachs. I've got a question about the level and cadence of expense growth as you move through the year. The guidance that you gave for Q1 and then for the year as a whole would imply that the expense profile improves as you move through the year. As the wage growth piece seems like it will be persistent, are there expenses that fade as you go through the year? Are there cost-out opportunities that build? Or is there a top line acceleration implied in the guidance?
Catherine Smith:
Yes, it's a little bit of -- I talked about all of the tailwinds, and it is a little bit of all of those things. So we'll see some leverage because of the continued comp sales increase. We'll see some continued cost control, as we move throughout the year, that we have planned. So it's kind of the combination of the 4 different tailwinds and 1 of the headwinds.
Matthew Fassler:
And if I could just ask a quick follow-up. You also shared lots of top line drivers. You talked about remodels, the new brands, Shipt, free 2-day shipping for a larger array of goods. Can you talk about how those layer into the revenue forecast over the course of the year?
Catherine Smith:
Well, we gave first quarter guidance -- I can start John, I guess. We gave first quarter guidance, obviously, low single digit, and we gave full year guidance low single digit. And those all contemplate, obviously, our continued brand rollouts as well as all of our fulfillment expansion. So those are all included in that low single. Just so happens, it's Q1 and full year.
John Mulligan:
Yes. And much of that digital, absent the 2-day, which is effective today, the Shipt and Drive Up, those are the 2 big ones that we'll expand nationally. Our goal -- you'll see a pretty linear ramp-up through the end of Q3. And our goal is to have all of that done ready for Q4 to be done, and that'll all ramp up as we go along throughout the year.
John Hulbert:
Brian, we got one from the webcast participants. We got somebody that said they applaud us for the CapEx that we have, projects that are high-returning, wondered after this wave of remodels is over, the 1,000 over the next 3 years, what a more normalized level of CapEx might look like in the longer term?
Brian Cornell:
I think most of you know, we're not going to provide long-term guidance, and we're not going to provide long-term CapEx guidance. But we're going to continue to look at different projects that add value and provide great returns for our shareholders. And we'll be looking in the future to think about how we continue to provide a great physical and digital experience for our guests and make the right investments that continue to add value for our shareholders. So we don't have a long-term guidance that we're going to provide today for CapEx, John, but we're going to continue to take the same disciplined and surgical approach to CapEx that you've seen over the last few years.
Why don't we go upfront. I'll give Oliver a chance, since I jumped over him before.
Oliver Chen:
The digitization of the supply chain is likely key to unlocking the asset turns. What do you think about that with respect to algorithms as well as your relationships with vendors and as you think about robots and making sure that's on track?
John Mulligan:
Yes. So all things we're working on, Oliver, you heard me talk about we spent the last 12 months testing automation in, I think, 5 different facilities, various different forms of automation, bringing them together in different combinations in the Perth Amboy facility out in the Northeast. We're starting implementation of 1 view of that. We're implementing something different here in a DC located in Fridley. So that's a piece of it. We have a large team working on supply chain analytics, primarily located, but not exclusively located, out in the Bay Area, working with Mike's team to provide the technology and the analytics in combination. And again, if you look at Perth Amboy, Mike's team built an entirely new warehouse management system. And then there is the analytics attached to it to move how much inventory. So were moving down the path on all of those together. It is going to take all of those to deliver what we want from a supply chain perspective.
Brian Cornell:
And Oliver, we try to showcase, obviously, a lot of the initiatives today, give you a chance to interact with the team, see the work that we're doing today. What underpins so much of that is the work we're doing from a data and analytical standpoint. So our team in Sunnyvale is supporting Mark and his team to make better assortment choices, better pricing and promotional choices. Mike's team of engineers that's driving so much of the work we're doing, as we reinvent how we run our stores, how we fuel our supply chain. So the commitments and the investment we're making in our team go well beyond what you've seen today, and a lot of it is to make sure we have cutting-edge data analytics. We've got great engineer and computer scientists that are helping Mike and Mark and Rick make better decisions from a merchandising standpoint, a digital standpoint and a marketing standpoint. And that is certainly going to fuel our business as we go forward for years to come.
Oliver Chen:
Last question is about value. What are your thoughts about value in terms of making sure you communicate a clear value? And as we model comp store sales, should we continue to see your check size versus traffic? How do you think that will evolve in stocking versus fill-up?
Brian Cornell:
Yes. I think one of the great highlights this year that we really didn't cover is the work that was done between Mark's merchandising team and Rick Gomez's marketing team to make sure that as we made these investments to be priced right daily, we communicated that to our guest, both in-store from a personalized standpoint and throughout the year in our marketing and advertising campaign. And I think it was the combination of all that work that yielded the benefits that Cathy talked about today, that significant mix of $4 billion of sales from promo to Everyday. So as we go forward, we'll continue to remind our guests that we offer great value, that we're priced right daily on thousands of items across the store. And I think one of the great turning points for our business this year was the balance that we brought back to advertising Target style, but also letting our guests know every single week that we were priced right daily and there was great value within the store. And I think that's driving traffic. I think that played a significant part in the traffic increases we saw in the fourth quarter that's driving basket. And beyond some of the numbers that we've shared, it's driving an acceleration in units in those important personal and essential categories. So that commitment to value and being priced right daily, we think, is critically important to driving traffic, to leveraging our multi-category portfolio and making sure people are shopping us not only for the great style brands that our teams are bringing to market, but those household essentials that bring cars into our parking lot and clicks to our site every single week. So that commitment to value is something that you'll see throughout '18 and for years to come.
Why don't we go to the back of the room, and I'll let you pick a hand, because unfortunately, from here, we can't see. So if you can identify yourself, we'd really appreciate it,
Robert Drbul:
It's Bob Drbul from Guggenheim Securities. Brian, 2 questions I have. I guess the first one is, as you look at the full year expectation for gross margin coming off of this holiday season, can you just reiterate what you see from a gross margin and competitive perspective that gives you the confidence in a flattish or up-slightly gross margin? And the second question is on the free 2-day shipping program, will that be fulfilled out of the stores? Or is that going to be a fulfillment-center type, can you just maybe elaborate on that expectation going forward?
Brian Cornell:
Why don't I start from a margin standpoint? And as we've talked about throughout the last few quarters, our team has made significant progress, as we have shifted our business from promo to Everyday, the by-product of that commitment to being priced right daily. That's going to continue as we go forward. As you've seen over the last couple of days, we'll continue to introduce great new own brands in those signature categories that, as we all know, are higher-margin and provide a great return, both in-store, but also to our digital business. So we'll continue to see the benefits of the analytics, the science that we're placing behind our pricing and promo strategy, the shift from promotional sales to more regular-priced business, the benefits as we bring new excitement into our stores with great innovation. That's going to continue to stabilize and improve our margins over time, and it's a great point of differentiation. So whether it's Opalhouse or Umbro or some of the things you saw this morning, many new things that we'll talk about over the balance of the year, those higher-margin Home and Apparel items, those great own brands that you can only find at Target, benefit not only our store margins but also our digital margins. And we'll continue to drive efficiency over time. John, you want to talk about fulfillment?
John Mulligan:
Yes. I think you'll see -- next year at this meeting, you will see that our penetration of units delivered from stores will grow relative to 2017 and relative to 2-day, absolutely. We would expect the majority of that to be delivered from store. We know that's the fastest place it can be delivered from.
Brian Cornell:
John, should we go to the webcast?
John Hulbert:
Yes. Thanks, Brian. We've got a variety of questions about Shipt, so I'll just give you all of them. One being, are we getting new guests coming in because of Shipt yet? One, the decision to maintain the marketplace in order -- in other words, share that marketplace with other retailers on the Shipt platform. And then finally, the decision of why to acquire them versus to just become a partner on their platform.
Brian Cornell:
John, you want to lead this one off?
John Mulligan:
Sure. I think maybe I'll start with just what are we trying to do with Shipt and then hopefully, address some of those questions. We have 3 priorities for Shipt that we have been focused on since we closed the acquisition. One is scale Target nationally under Shipt app and shipt.com. And we are well down that path, we're in 455 stores. We're adding markets every single week. The second was -- is bring Shipt to target.com. Mike and his team are working hard on that to provide that option for guests who come to us directly through target.com will provide same-day delivery service for our entire assortment. And then third was expand the marketplace. And I guess, to get at a little bit of this, we think the value here is about bringing all those retailers together. That's the value of the membership. We know consumers have different reasons they go to different retailers. Often they come to Target, we really like that. Sometimes they go other places. But bringing all those retailers together on 1 marketplace is incredibly powerful to bring consumers into the Shipt app. And so we've had great conversations with other retailers. We already have great partners in H-E-B, in Publix, in Meijer, Costco, all on the app, and we'll continue to grow that. So we're very interested in continuing to grow that marketplace.
Brian Cornell:
And to the other question, Cathy, John and I, all spent quite a bit of time looking at other same-day delivery options, and we invested a lot of time getting to know the Shipt organization. We were attracted to Shipt and decided to take an ownership position because of that personal connection we saw with their member. And as we spent time and went to Birmingham, worked with some of their shoppers, saw the caliber of people that were shopping for Shipt, these moms who were shopping for moms, the approach they took to really building a relationship, we felt it was so important to own that last mile touch and that human interaction that we think really differentiates Target from anyone else in that space. So we certainly had options to partner with other last mile delivery companies, but we thought Shipt had a very different approach. It wasn't just the transaction, it was building a relationship. And we thought, owning that human touch was very consistent with what we think is our greatest asset, and that's our people that make such a different, as we talk to guests and they describe why do they shop at Target. As said earlier today, most of the time the answer is pretty simple, it's because of our team.
Peter Benedict:
Peter Benedict of Baird. Two questions. First, the cost to upgrade these fulfillment centers, the modernization, John, that you talked about. Can you give us a sense of maybe how much that is going to contribute to capital spend over the next few years? And what's the cadence? How many do you need to do? And when do we get to the endpoint there? And the second point -- question would be on inventory growth. How should we think about that as you kind of clean up the back rooms, you improve the flow of product over the supply chain? How should we think about inventory growth maybe versus sales?
John Mulligan:
Yes. I think, first on the capital. Cathy has provided the capital guidance. It's all within our capital guidance, everything we've talked about, we have planned for. If that changes, I am sure Cathy will come back and let you know that changes. I think pace, we will know more about that actually near the end of this year than I do right now. We're very focused on getting the Perth Amboy facility up and operating and -- because that's kind of the end state. This is what great will look like. Simultaneous with that, like I said, we're testing how we can start to evolve the broader network into that step-by-step-by-step, and what we're doing this year will be the first step. And we hope to have a decision about perhaps getting to 8 of those, realistically, probably very early next year and then expand from there. Meanwhile, while we're doing that, go back into the local distribution center and say okay, what's the next step we would bring to that in order to move it down the path? So that's kind of the sequence we're thinking about year-over-year. This won't happen over the next 18 months, because it can't. This is a conversation we have internally a lot. If we could like shut down for 9 months and not deliver any product to stores, we could get this done very quickly, but we don't have that ability. We need to keep producing product for the store, or shipping product to the store. So it will be a gradual evolution over time. I mean, the investments will follow that gradual evolution.
Catherine Smith:
Can I answer the inventory question real quick for you? Longer term, as we've talked many times, Peter, we do see the inventory loads, as we move product exactly where we need it, when we need it, will continue to come down. Obviously, we want to make sure we have a great guest experience and we're in stock. And so we're going to balance that as we're evolving supply chain, so -- through this transition period and then obviously, to support all of the wonderful new brands and products we're bringing in.
Brian Cornell:
So just to build on that, it is going to take time. And as you've seen over the last couple of years, with the approach we've taken to a number of initiatives, we're going to test, learn, iterate and then move forward. And it's a same model we took to own brands, starting with Cat & Jack, learning from that success, and now we're building out the portfolio. It's the same approach we took to remodels. We started with 25 stores in L.A. We continue to learn and listen and iterate. And once we saw the right response from the guest and the right return on invested capital, we moved more quickly. We're doing the same thing from a DC standpoint. We're constantly learning and updating our approach. And we think we've got a model that you can expand, but we're going to do that very, very carefully and make sure that we have a system that can be scaled. And when we get there, to Wayne's question, we will see better units of measure flowing into the stores, which will naturally improve inventory levels and working capital. But this is one that's going to take time. To John's point, we are not shutting down our system for 9 months. It's going to be a multiyear journey, but we're going to make sure that we do it right and we get the right returns and continue to provide the right experience for our guests.
We got a question upfront here.
Gregory Melich:
It's Greg Melich with MoffettNathanson. So I had a follow-up for Cathy. And then Brian, I had another question. Cathy, the $3.5 billion CapEx that is, I think, about $500 million more than what you were thinking before. Should we think about that -- I know you're not giving long-term guidance, but is that more of a pull-forward of things that you had or more of -- given what you see, there's more stuff you want to lean into this year? And then Brian, I had a follow-up.
Catherine Smith:
Yes. So consistent with our strategy Brian had laid out, we intend to remodel. We're seeing the great returns, 2% to 4% lift. We make sure we have great returns on invested capital with those. And as we've seen the remodels perform, we're going to continue to get towards that 1,000 stores that Brian talked about. But -- and by the time we get there, much of our fleet will be much younger in age. Obviously, some of the heavier needs are earlier on, which is why the capital is a little higher. But I would expect we've done -- did $2.5 billion last year, $3.5 billion this year. Obviously, we're not slowing down. We're seeing great return, and we're seeing a great response from our guests. So we're not giving long-term guidance, but you can expect that we'll continue down those stores.
Gregory Melich:
And then Brian, you talked a lot about acceleration, right, what happened last year and it's now time to really accelerate it. Could you talk a little bit more about the brand acceleration? It seems like with 12 brands in 12 months and -- is that a new run rate? I mean, can the organization really be expected to come up with that many new great brands and ideas every year? Or is there a certain amount that you -- or could that become 18 in a year? Or is there a certain amount of product that you're sort of limited on that, ultimately, we only want to change over 1/4 of the SKUs or something like that?
Brian Cornell:
So Greg, I wouldn't expect that to be the long-term run rate. But certainly, as Mark and his team have looked at the portfolio, we've seen opportunities to replace some of the existing brands that have been in our portfolio, fill new white spaces. And over the balance of 2018, we'll continue to bring newness and innovation to own brands. And then we'll continue to listen to the guests, understand category trends and bring great newness and innovation, whether it's with a new own brand or some of the great partnerships we'll continue to bring forward on a limited-time basis like we announced earlier today. So I wouldn't expect that to be the run rate, right, for Mark and his team, but we see significant opportunities to continue to strengthen our own brand portfolio in 2018, and we'll look for further opportunities in the years to come.
All right, let's go to -- all the way to the back of the room.
William Dreher:
Bill Dreher here from Susquehanna Financial Group. I have a question regarding the renovations and remodels. How do you prioritize the renovations or remodels? So are you working with the stores with the greatest opportunity, the oldest stores, or how do you work on that? And then how do you -- how much of the new store remodel program can be brought in? Not 100% of all the new modules can be brought in. Should we be expecting a similar 70%, 80% of the modules brought in? And how does that roll out?
Brian Cornell:
John, do you want to tell about the remodel strategy?
John Mulligan:
Yes. So it's a little bit of everything you said, actually. When we're choosing the stores, we have a model that helps us generate age, condition, when's the last time. Part of it that comes into it is how hard is this store shopped, how high-volume is it, what is the average basket, so do they get shopped really hard day in and day out. And then to your point, where can we have the biggest impact, where can we go in and say, look, these 10 stores or dozen stores, we know that they are in need of it and we will have a big impact. So we go through a process. The team recommends those. They have conversations with the senior store leaders as well to get their local viewpoint about what's going on in that marketplace, has somebody opened up 6 grocery stores around us or whatever it is and say, hey, this is one where we could really use the help competitively. So there's multiple pieces we come together with. The team distills that down, and then we come to a consensus about this is the list we're going to go after for this year. As you can imagine, when you're doing 100, that's a lot more difficult when you're doing -- than when you're doing 325. The list gets a lot more easy and a lot less contentious. So it's a great process. The team is already working on 2019 and actually thinking about 2020. So that all happens much further in advance. To your question about what gets put into the remodel, our goal is always to put in as many elements as we can in any individual store. The calibration though is we want to make sure that store can afford to have that much investment, and so lower volume stores get less. And the great thing is, and I've seen this happen multiple times, when we say here's where we're going to draw the line on lower volume stores, Brian challenges the team, go figure out a way to get these 2 more elements into that store. They go back, they value engineer, they find ways to do it more efficiently. Certainly, as we do more scale, that brings efficiency to it. And so we found ways to move some of the elements we really like even into those low-volume remodels.
Brian Cornell:
So I've gotten the note to say it's time wrap up this session. But before we close out, I do want to thank you for joining us in Minneapolis this week. We spent a lot of time debating where to hold this meeting. And really thought, based on the stage of our journey, it was the right time to have you here, so you could see our new renovated downtown store, spend quality time with our leadership team. This morning, we wanted to give you a sense for all of these initiatives we're working on and how they're going to help us create the Target of the future, give you a glimpse into some of the things we're doing from a technology standpoint that's going to make it easier for our guest to shop at Target and easy for our team to support that guest. And I hope, today, we were able to give you a sense for our excitement for 2018. 2017 was a year of significant progress for this team. 2018 is all about acceleration, taking all the learning that we've gathered over the last couple of years and really stepping on the accelerator. And I think we're on our way to creating long-term value for our shareholders, but most importantly, continuing to differentiate our brand and ensuring Target is one of the long-term retail winners as we move forward. So thanks again for joining us. Travel safely. And we look forward to seeing you again later in the year. So thank you.
Operator:
Ladies and gentlemen, thank you for standing by, and welcome to the Target Corporation Third Quarter Earnings Release Conference Call. [Operator Instructions]
As a reminder, this conference is being recorded, Wednesday, November 15, 2017. I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our third quarter 2017 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; Mark Triton, Chief Merchandising Officer; and Cathy Smith, Chief Financial Officer.
In a few moments, Brian, John, Mark and Cathy will provide their perspective on Target's third quarter performance and our plans and priorities going forward. Following their remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer your follow-up questions. As a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also in these remarks, we refer to non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP numbers to the most directly comparable GAAP number are included in this morning's press release, which is posted on our Investor Relations website. With that, I'll turn it over to Brian for his thoughts in our third quarter performance and our priorities going forward. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. We are really pleased with Target's third quarter performance, which reflected a continuation of the positive trends that emerged in the second quarter. We saw continued growth in both our comparable traffic and comparable sales in the face of more difficult prior year comparisons on both measures.
Digital sales grew 24%, on top of 26% a year ago. And we announced new innovative partnerships with both Google and Pinterest, that will continue to expand the digital reach of our brand. We saw a meaningful increase in the percent of our sales at regular price, reflecting the benefit of our work to communicate value more clearly and provide our guests confidence that Target assortment is priced right daily. We rolled out 4 new own brands across our Home and Apparel categories, all of which are off to a great start. And we generated an unprecedented amount of buzz when we announced an amazing new designer partnerships with Chip and Joanna Gaines called Hearth and Hand with Magnolia, which launched last week. We also remodeled 37 stores in the quarter, in support of our plan to transform 110 stores this year. And we opened 12 new stores in a single week in October. These stores are located in a diverse array of neighborhoods across the country, ranging from our new Herald Square location in New York City all the way to our newest location in Honolulu. Beyond the direct financial returns we're seeing on these investments, our guests continue to confirm for us, both through their feedback and their shopping decisions that our efforts are paying off. And finally, this quarter, we made some meaningful announcements regarding our team. In early September, we announced our intent to hire an additional 100,000 team members for the peak holiday season, up from 70,000 a year ago. And later that month, we announced we would increase our minimum wage nationally to $11 an hour in October in support of a commitment to raise our national minimum to $15 an hour by the end of 2020. These investments reflect the value of our team and our commitment to supporting them as they provide outstanding service to our guests every day. The strength of our team is never more evident than in times of need, and unfortunately, we faced several natural disasters in the quarter from hurricanes in Texas and Florida to wildfires in California. In the face of these challenges, there are countless stories of our team coming together to support each other and their communities in the face of heartbreaking devastation. While our team was focused on ensuring the safety of their own families, they also worked tirelessly to reopen stores quickly and move needed essentials from other parts of the country in support of our guests as they returned home and began the long process of rebuilding their homes. So I want to thank our teams not just for the hard work every day, but their dedication to our guests and communities in times of need. It was only last February that we walked you through a detailed plan to accelerate investments in our business that will best position Target for continued success in a rapidly changing environment. Our plan included the investment of more than $7 billion of capital over 3 years to accelerate our progress in support of several key initiatives, including blending Target's digital and physical shopping experiences, reimagining our existing stores and the labor model to operate them; rolling out new fulfillment options through enhanced convenience for our guests, opening new, small-format stores in dense urban, suburban and college campus neighborhoods; and reinventing our assortment of exclusive brands to further differentiate Target from everyone else in retail. On top of this capital commitment, we outlined an investment of $1 billion of operating margin this year. This commitment has allowed us to move fast, invest in our team and reset our value positioning in the marketplace. With 3 quarters of the year behind us, I'm pleased that we are either on track or ahead in delivering all of our goals for the year, and supported by strong execution by our team, our financial results this year have been meaningfully ahead of our expectations. A key factor in delivering our goals is the ability of our team to move faster than ever before, and nowhere is that speed more evident than in our supply chain, where we are rapidly testing and rolling out new fulfillment options for our guests. Already this year, we've taken Target Restock from only a concept to being fully operational in 11 key markets throughout the country. And we continue to expand a list of eligible items while extending the order deadline for next-day delivery. We've tested and rolled out same-day delivery in 4 locations in New York City, supported by our recent acquisition of Grand Junction, and we've rapidly tested and rolled out a new Drive Up service in 50 locations in the Twin Cities, where we're receiving positive feedback from our guests. With each of these capabilities, the team is rapidly learning and iterating as we expand our reach, and we have plans to further build out all of these fulfillment options in 2018. We've taken the same approach to our ship-from-store capabilities, which we first rolled out to approximately 140 stores only a few years ago. As we enter the holiday season this year, the count of ship-from-store locations has grown more than tenfold, and it's now in more than 1,400 locations across the country. You'll note that for each of these fulfillment options, our stores played the key role in delivering the experience. This is only one example of ways that we've been asking more from our team members than ever before, and that's why this year's investment in our team has been so important. We've invested in additional hours to support new services while continuing to be available to assist our guests. We've invested in the rollout of a new operating model with more specialized roles that support stronger execution and deliver more product expertise on the sales floor. We've invested in trainings to elevate the guest experience, moving away from task-driven models to a guest-focused mindset. And we've invested in wages to ensure we can attract and retain the right team members who consistently deliver a differentiated Target experience every day. So as we move into the busiest time of the year, I feel confident that our stores are better prepared than ever before, and in more than 100 of our stores, guests will be enjoying a newly transformed environment this holiday season, courtesy of this year's remodel program. Also, in nearly 30 local neighborhoods across the country, guests will be able to enjoy their holiday shopping at a nearby Target store for the first time. Across every store and on Target.com, guests this holiday season will be able to shop 8 new exclusive brands that we launched in 2017, in addition to our outstanding lineup of new and innovative items from our national brand partners. And of course, throughout the holiday season, we'll deliver unique and inspiring marketing intended to highlight the joy of being together during the holidays. It's important to remember the role that this year's investments have played in getting us to where we are today. We started this year with a very healthy business, one that generates lots of cash. We made a decision to ramp up the investments of that cash in both capital and operating margin to speed up our progress. Today, we have a very healthy business that generates lots of cash, a business that is seeing 2 consecutive quarters of healthy traffic growth, giving us increased confidence as we enter the holiday season. While the fourth quarter is always intensely competitive, we are entering this holiday season with lots of confidence, enabled by this year's investments and the tireless efforts of our team. We have an outstanding set of plans this year. And while it's still very early, we've been encouraged with the guest response to the launch of Hearth and Hand as well as last week's release of the Target-exclusive version of Taylor Swift's new album, Reputation. While the bulk of the season is still ahead of us, we are very happy to see how these early efforts have set the tone for the season as we are already showing our guests that Target will offer unique holiday merchandise and experiences that you can't find anywhere else. With that, I'll turn the call over to John for his comments. John?
John Mulligan:
Thanks, Brian, and good morning, everyone. As Brian mentioned earlier, a key priority of our work and operations is based on the goal to provide new and reliable fulfillment options for our guests. As of today, we have multiple new fulfillment options that are in some phase of testing or rollout across our network. We offer in-store pickup of digital orders, available in all of our store locations. We have a Drive Up service, which we just began testing at 50 locations in the Twin Cities. We now have same-day delivery, which we're testing at 4 stores in New York City. We offer next-day delivery through Target Restock, which is now available for 90 million guests in 11 markets. And we have a ship-from-store capability, which is now in more than 1,400 of our locations.
Of those 5 fulfillment options, only 2 were available as we entered the year:
in-store pickup and ship-from-store. And while both of those options are relatively mature, we continue to increase the amount of our digital volume handled by our stores.
Today, the stores are already fulfilling more than half of our total digital volumes through the pickup and ship-from-store capabilities, and that will peak at well above 80% in the days leading up to Christmas. In fact, our stores are planning to ship over 30 million units related to digital orders in the peak 4 weeks of the holiday season, up from about 18 million units last year. Among the new fulfillment capabilities we've launched this year, Target Restock has been ramping up quickly. During the third quarter, we rolled out this service to an additional 10 markets across the country. We also extended the deadline for next-day delivery to 7 p.m. and expanded the number of eligible items to more than 15,000. The average value of a restock order is about 50% larger than an average store transaction, and we're pleased that our stores have been able to fill these orders reliably and efficiently. Another capability we've just begun rolling out this year is same-day delivery, which we're now offering at 4 stores in the New York City market. For a small fee, typically between $5 and $10 depending on the address, guests can leave their basket with us at checkout and arrange for delivery later the same day, in a time window of their choosing. Guests in these stores are enthusiastically responding to this service. Basket sizes for delivery transactions are running 6x to 9x the average transaction across the 4 stores that have this service. And our Home category continues to account for more than half of the total sales on these delivery orders. And finally, our new Drive Up capability is in the earliest stage of testing. We rolled out this service to 50 stores in the Twin Cities in the third quarter, and we're pleased with the early results. Specifically, guest survey scores for this service are running well ahead of goal, and the stores are outperforming our goal for average wait time. Last week, we began offering this service at our next-generation store in Houston. As we look ahead to next year, we'll continue scaling all of our new fulfillment capabilities, including same-day and next-day delivery. Our ultimate goal is to build a supply chain that can reliably deliver any item in our network to all but the most remote areas in the U.S. in 2 days or less with most items delivered in 1 day. While a large percentage of our digital orders today are already arriving that quickly, we have more work to do before we can reliably deliver in that time frame across all of our assortment. To achieve this goal, and to be able to scale all these new fulfillment capabilities, we need to improve the speed, accuracy and reliability of our entire supply chain from end to end. While we have already made progress on all of these measures, we still have a lot more to do. And our new flow center in Perth Amboy, New Jersey will help us get there. We added this building to our network not because we needed capacity, but because it will allow our team to learn in a separate facility without the distraction of operating in tandem with the rest of our operations. It's managed by a very lean team that operates like a start-up, rapidly building solutions from scratch and iterating as they learn. They run their operations with all new systems and processes developed in-house, including their inventory planning system, order management system, warehouse management system and transportation. This facility is now serving 5 of our new small-format stores in New York City, which allows them to test these new systems under the most extreme conditions. Specifically, these stores generate very high sales per square foot and have little to nonexistent backroom storage space. As a result, they require rapid replenishment. In fact, our new Herald Square and TriBeCa locations are receiving multiple shipments a day from this facility. When these stores receive merchandise, they don't have the room or the time to unpack and store anything more than they need. To address this constraint, the Perth Amboy facility packs custom shipments for each store, which are delivered in bins organized by aisle of the store. As a result, these stores can rapidly move deliveries right onto the sales floors and quickly replenish shelves from the presorted bins. This minimizes the amount of store labor devoted to replenishment, allowing the team to devote more of their time to serving their guests. Once the new process reaches a higher level of maturity, we'll be able to scale up within the facility, incorporate automation into the process and begin replicating this model elsewhere in the network. So now while I hope it's clear that fulfillment and speed are huge areas of focus for the operations team, I want to be clear that's not our only priority. We're also investing to reach guests in new neighborhoods and elevate the experience in all of our stores. To reach new, densely populated neighborhoods, we've completely changed our approach to choosing the location for our small-format stores. In the past, we had a relatively rigid prototype for store size and layout and our real estate team focused on finding sites that would accommodate that prototype. Today, when we find space available in an attractive neighborhood, we custom design a store that can fit the available space. These stores generate high sales productivity and higher-than-average gross margin rates, driving strong returns on investment. And for the smaller group of these stores that have now been operating for more than a year, we continue to see very healthy growth in both traffic and comparable sales. Beyond new stores, our team is quickly scaling up their ability to remodel existing locations as we're rapidly growing the program from fewer than 30 stores in 2016 to more than 325 next year. Like our new small stores, we apply a custom approach to our remodel projects based on condition of each store and characteristics of the neighborhood. In all cases, when we remodel a store, we focus on convenience, including the incorporation of self-checkout and a separate area for Store Pickup. And we upgrade the shopping experience for our guests, incorporating more cross-merchandising opportunities. We carefully measure the financial performance of our remodel stores, and we continue to see an average sales acceleration of 2% to 4%, right in line with our goals for the program. But beyond our investments in the physical shopping environment, we're investing in our team and our stores. We're investing in more hours in training to elevate the level of service our teams can provide. We're also changing our operating model, creating specialized teams responsible for specific categories, so they can become category experts who can better assist our guests. And finally, we're investing in wages, so we can continue to recruit and retain an outstanding team, a team that will continue to differentiate Target from our competitors. The strength of our team was evident as we rolled out 4 new brands in our stores in the third quarter. Our team presented these new brands better than we ever have before, playing a key role in their early success. This has been an amazing year of change for our operations team. We're moving faster and thinking bigger than we ever have before as we create and implement plans to modernize nearly everything we do. So while I want to stress that our future focus isn't slowing down, I also want to make it clear that everyone across our team is laser focused on serving our guests during the holiday season. I want to thank the team for all their efforts to prepare for this season and for all their upcoming hard work during our busiest time of the year. Our team is the reason Target is a special brand and a great place to work. With that, I'll turn the call over to Mark, who will provide more detail on our third quarter performance and our holiday plans in merchandising. Mark?
Mark Tritton:
Thanks, John. Going into this year, 2 of our highest strategic priorities in merchandising were
As Brian highlighted earlier, we're encouraged by our progress on both priorities. In the third quarter alone, we launched 4 more new and exclusive own brands across Apparel & Accessories and in Home, which we then followed at the start of the fourth quarter with the blockbuster launch of Hearth and Hand with Magnolia. With this portfolio that we've rolled out this year, we are presenting our guests with new ideas and items across 8 new and exclusive own brands in readiness for the holiday season to create a unique, differentiated offer that builds preference for our guests to choose Target. Beyond the immediate strong sales growth that we've seen from these new brands, consumer survey show they are contributing to the Target brand overall. Specifically, consumer scores for Target differentiation have recently risen to a 10-year high, which will provide a benefit to traffic and sales in all of our categories over time, much like we saw when we launched Cat & Jack. To reinforce our value proposition with guests this year, our team has also moved at a rapid pace, and the response from our guests has exceeded our expectations. Specifically, we've seen a multibillion-dollar increase in sales at regular price so far this year, more than offsetting the decline in sales on discount. This clearly demonstrates that guests are increasingly confident that Target is priced right daily and are not only relying on promotions to get a great deal. Supported by our Run and Done marketing campaign, confidence in our pricing has driven a rapid increase in quick and fill-in trips, which you can see in both our traffic and basket trends. As we look back at our third quarter results from a category and market share perspective, we're driving strong relative performance in our discretionary categories. And while we're seeing steady improvement in frequency categories, these areas are facing some near-term headwinds from this year's investment to be priced right every day. As a result of this effort, which was completed late in the third quarter, we're seeing stronger unit share improvements in many frequency categories compared with dollar share. This is an important positive leading indicator for future dollar gains in these categories, which is only reinforced by our positive traffic trends. Across our 5 broad merchandising categories, Hardlines led the way in the third quarter with a strong single-digit comp increase. This growth was driven by continued double-digit comp growth in Electronics, benefiting from newness, particularly in the video game and mobile segments. Our Home category also saw a healthy comp increase in the third quarter, led by the successful launch of our new exclusive Project 62 own brand, along with the continued benefit from the consumer trend of spending on their homes. In Apparel & Accessories, we gained strong share for the quarter, in a space which consumer spending in the overall market is currently declining. Despite lean inventories in the first half of the quarter as we got ready to replace brands and unusually warm weather across most of the country during the bulk of the quarter, our overall comp was down only slightly. But following the launch of each of our 3 new exclusive Apparel & Accessory own brands mid-quarter, A New Day in women, Goodfellow & Co in men and JoyLab in activewear, we generated strong sales and traffic results, and we saw even more market improvement when cold weather finally arrived near the end of the quarter. Third quarter comp sales in Food and Beverage were up slightly despite a continued headwind from deflation in several categories combined with adjustments from our own work on pricing. We continue to measure steady progress in Food and Beverage, and most encouragingly, we're seeing the strongest results where we've been investing. This is best evidenced in produce, where we've been investing in freshness, organics, in-stocks and specialized store labor, where we saw a high single-digit comp increase in the quarter. And our beverage also continued its strength, where we saw continued double-digit comp growth, reflecting our work on assortments and in-store presentation across the country. And lastly, in Essentials, we saw a slight comp decline in the third quarter. Now this area more than any other area has seen the most change from our work on price and value. And as I mentioned upfront, because we're seeing much stronger unit share and trip growth in this category, we are very confident that this year's work will set us up for stronger performance over time. One further highlight within Beauty, which has continued to gain market share. This category is benefiting from our investments to differentiate both the assortment and the store service model as we focus on emerging trends and first-to-market brand launches, supported by an increasing number of dedicated beauty experts in our store who are available from open to close, all delivered at an unbelievable value. Before I look ahead to the holidays, our third quarter review wouldn't be complete without a recap of our key seasons. In Back-to-School, we added to our long record of logging comp growth year-after-year, and we saw the strongest result in Kids Apparel and supplies. In Back-to-College, we benefited from positive results in Electronics, reflecting all of the newness I mentioned earlier. In Halloween, we saw our strongest share results in the early part of the season as the final late-season positive sales surge moved further into the fourth quarter based on the timing of the holiday relative to our fiscal calendar. As we look ahead to this year's holiday season, we have made significant strategic changes to the quality and level of our inventory position. Our teams have reduced unproductive inventory, which has created room across our network for all the newness we are now delivering. As we ended the third quarter, we plan for our inventory position to be higher than a year ago, reflecting specific early intentional investments to support the launches of new items in Electronics, along with inventory to support Hearth and Hand with Magnolia, which launched at the beginning of the fourth quarter. Speaking of Hearth and Hand with Magnolia, we are really pleased with the initial results from the launch, which set the perfect tone for the holidays. The collection, which was cocreated with our friends, Chip and Joanna Gaines, features more than 300 items in tabletop, home decor and giftables, most for under $30. On the day the collaboration debuted, guests were shopping online in the early hours and lining up outside our stores across the country. And based on early demand, we're implementing our inventory contingency plans to quickly replenish items that are already selling through. Also new to the holidays this year, we've made a meaningful investment in our gifting program, which features more than 1,700 items curated for women, men, kids and teens. Most of the items are exclusive to Target and priced under $15, and they'll be displayed permanently in both our stores and online to make it even more easy and convenient for our guest to find the right gift this season. And of course, we'll be offering great deals on a huge assortment of new and innovative items across our Entertainment, Electronics and Toy categories. In Toys, we've added more than 1,400 new and exclusive items this year from sought-after national specialty and own brands. This season, we'll also be featuring more than 70 exclusive boardgames, building on the continued strength in this category that we've seen all year. In Electronics, we'll be featuring new and in-demand consoles across software, including the Nintendo Switch and Super Mario Odyssey game, along with a Target exclusive Xbox One S Minecraft bundle. This season will also feature our focus on a much broader assortment of voice-activated speakers like Google Home with an expanded assortment of wearable technology and accessories, and as always, we'll offer a full line of Apple products highlighting all of the recent launches. In Entertainment, we'll continue to highlight Taylor Swift's new album, Reputation, which features 2 exclusive collectible magazines available only at Target. This album broke the record for the number of preorders in advance of its launch last week, and we've continued to see strong demand in sales since the debut. Throughout the holiday season, we'll continue to offer outstanding value to our guests with meaningful deals on the items that they want the most. New this year, we've introduced Weekend Deals, which features market prices on new items every weekend based on what we know guests are looking for at different times throughout the season. In addition, we'll continue to offer a regular cadence for our Weekly Ad and Cartwheel offers, and we'll offer some of our lowest price of the year during big events like Black Friday and Cyber Monday. All of these deals are designed to reinforce the work we've done all year to show guests that we are priced right daily, and we'll continue to highlight our new lower prices with signage in our stores and online. So I hope it's clear that we feel really well positioned as we enter our peak season. Everything we've planned for this year will reinforce for our guests why they love Target during the holidays by offering unprecedented newness, convenience and meaningful deals, all wrapped up with uniquely Target marketing campaign that remind guests of the universal joy that comes from togetherness in the season. With that, I'll turn it over to Cathy, who will provide more detail on our third quarter financial performance and outlook for the rest of the year. Cathy?
Catherine Smith:
Thanks, Mark. Consistent with the second quarter, our third quarter traffic, comparable sales and overall financial performance were all stronger than our expectations.
Third quarter comparable sales increased 0.9%, driven by a traffic increase of 1.4%. Both of these numbers decelerated sequentially as we faced a tougher prior year comparison. However, on a 2-year stacked basis, both traffic and comp sales accelerated in the third quarter. Our third quarter adjusted EPS of $0.91 was near the upper end of our guidance range of $0.75 to $0.95. GAAP EPS from continuing operations was $0.87, $0.04 lower than adjusted EPS, driven by the net effect of 2 offsetting factors. The primary impact was $123 million pretax charge related to our October debt repurchase, which lowered GAAP EPS from continuing operations by $0.14. This was largely offset by a $0.10 positive impact related to income tax matters. The majority of this $0.10 benefit was driven by a decrease in our 2016 net taxes related to our global sourcing operations. The remaining benefit was related to the favorable resolution of other income tax matters in the quarter. One other note on our third quarter tax expense. In addition to the matters we've excluded from adjusted EPS, third quarter adjusted and GAAP EPS from continuing operations reflect a $0.03 benefit from our global sourcing operations related to our 2017 taxes. Our third quarter gross margin rate of 29.7% was down about 10 basis points from last year. This decline reflects continued pressure from digital fulfillment and our work on pricing and promotions, mostly offset by our cost-control effort. Merchandise mix had a roughly neutral impact on our third quarter gross margin rate as healthy performance in higher-margin categories was balanced by strength in Hardlines. Our third quarter SG&A expense rate of 21.1% was about 80 basis points higher than last year. This increase was primarily driven by compensation expense, reflecting a year-over-year increase in team member incentive combined with the impact of investments in store hours and wage rates. This was partially offset by the timing of some expenses and our cost saving efforts. The third quarter depreciation and amortization line was about $70 million higher than last year. This increase reflects the impact of accelerated depreciation related to next year's remodel program, which will transform about 3x as many stores compared with this year. We recently finalized our specific store remodel plans for next year and subsequently refined our D&A forecast by quarter. Specifically in the fourth quarter, we expect a similar or somewhat smaller year-over-year increase in the D&A expense line than we just experienced in the third quarter. And as we look ahead to 2018, our current view is that quarterly D&A will be about $80 million higher than 2017 in each of the first 3 quarters next year, reflecting the continued recognition of accelerated depreciation on next year's much larger group of remodels. At the end of the third quarter, our inventory was a little more than 5% higher than last year. This represents a change from the trend we've seen in recent quarters in which our inventory has declined, even as we've maintained a strong in-stock position. This quarter's increase reflects a year-over-year change in the timing of our holiday season inventory. One area that has increased is Electronics, in which the team has made early intentional investments in new and innovative items in the video game and mobile categories. We expect our inventory will be roughly flat to last year by the end of the fourth quarter. Over the longer term, we continue to believe we have a meaningful opportunity to increase inventory turnover as we work to speed up our supply chain, and in the near term, we believe recent favorability and payables leverage will continue into next year, providing a benefit to working capital and cash flow from operations. Our business continues to return a lot of cash. Specifically, we generated $1.5 billion of cash from operations in the third quarter. In keeping with our goals and guidance for the year, we devoted more than $800 million of capital investment to our business this quarter, bringing our year-to-date totals to just over $2 billion. In addition, we returned $339 million to our shareholders in the form of dividends and another $171 million through share repurchase. Regarding the balance sheet, as I mentioned earlier, we invested $463 million to repurchase high-coupon debt in the quarter, which was offset by the issuance of $750 million of 30-year debt at very favorable rates. In January, we have $1.1 billion in debt maturing, which we expect to retire with cash. Now let's look ahead to our expectations for fourth quarter and full year financial performance. As I have mentioned all year, we continue to plan prudently while developing the agility to adjust to changing conditions and market opportunities. And while I hope we've shown today that we have outstanding plans going into the holiday season, we enter every holiday season knowing that it will be highly competitive and promotional. Putting all of those considerations together, we believe that Target is positioned to deliver comparable sales of flat or better in the fourth quarter with an upside potential for a 2% comp increase. We expect to see continued pressure on our gross margin rate in the fourth quarter, reflecting the cost of digital fulfillment combined with the impact of our work to ensure we are priced right daily for our guests. Our SG&A outlook reflects thoughtful investments in our team and in our stores to support outstanding service for our guests during the peak holiday season. Combined with the pressure on D&A I outlined earlier, we expect EBIT will be about $290 million lower than last year's fourth quarter. This performance translates to an expectation for both GAAP EPS from continuing operations and adjusted EPS of $1.05 to $1.25 in the fourth quarter. Adding this expectation to our actual performance through the first 3 quarters, you'll see that our expected range for full year adjusted EPS is now $4.40 to $4.60, this is $0.06 higher than our guidance 3 months ago and $0.50 higher than our expectation going into the year. Regarding full year GAAP EPS from continuing operations, we expect a range of $4.38 to $4.58, $0.02 lower than adjusted EPS driven by the net impact of debt retirement cost and tax benefits we recognized throughout the year. One other note. Both our fourth quarter and full year expectations include the recognition of a 53rd accounting week this year, consistent with many other retailers. As we said before, this week is somewhat smaller than an average week in the year at about $1 billion in sales. From an operating margin standpoint, for that week, we expect to see gross margin and SG&A rates relatively similar to our annual averages. In addition, we will benefit from leverage on D&A that week as that expense is recognized on an annual basis. And one final note. Given that the holiday season plays such an important role in our fourth quarter performance, we announced today that we plan to issue a post-holiday season financial update on Tuesday, January 9. As Brian mentioned earlier, the underlying health of our business and its strong cash flow have enabled the investments that are moving our business forward today. As we look ahead to the next few years, we're planning for continued investments in our business in new and remodeled stores, our supply chain, technology, unique brands, and importantly, in our team. The good news is that our business can sustain those investments while generating enough cash to support our dividend and, when we have room within our debt ratings, share repurchase. We entered the year with a confidence that we're making the right long-term investments in our business, and our results this year have only reinforced that confidence. As we look ahead, we expect to have ample capacity to invest in our business and return capital to our shareholders, allowing us to grow into an even stronger company. Now I'll turn the call back over to Brian for some final remarks.
Brian Cornell:
Thanks, Cathy. We're going to quickly move to your questions, but I wanted to add one final note first. We are planning to host our Spring 2018 Financial Community Meeting here in Minneapolis on March 5 and 6. John Hulbert will send out more details in January. But for now, we wanted to let you know the dates so you can hold them on your calendar. We'll be scheduling the meeting to allow attendees to arrive on the afternoon of 5th, and you'll be able to return home before the end of the day on the 6th. We hope to see you at that meeting.
So with that, we'll conclude our prepared remarks. Now John, Mark, Cathy and I will be happy to take your questions.
Operator:
[Operator Instructions] David Schick from Consumer Edge Research.
David Schick:
You mentioned several times throughout the call and, frankly, throughout the year that you're trying to take a conservative approach to planning, but you also mentioned -- and you also mentioned the strength and the confidence you have as this quarter that you just reported in the prior quarter happened in the traffic and the merchandising. Can you, sort of, square that circle for us because this is -- shares are obviously reacting to guidance this morning. So help us frame conservatism versus confidence.
Brian Cornell:
David, I think sitting here today, we feel very confident that we're making very good progress against the plans that we set out earlier this year. If I think about the state of our business today, we're seeing a great response to the 8 new brands that we've launched as we've remodeled now over 100 stores, which we continue to see the list that we're projecting of 2% to 4%. We've seen a tremendous response to our new small formats that we've been opening up in new neighborhoods and on college campuses. And as you know, we opened up a number of new stores in this last quarter. And whether it was the results we've seen in Herald Square or all the way out in Hawaii, the guests have responded very, very well. We continue to see very strong performance from a digital standpoint, outpacing industry by a 2x factor. And during the quarter again, we saw very strong digital growth. And that's been underpinned by the progress we've made from a digital fulfillment standpoint and some of the things that John talked about during his prepared remarks. So sitting here today, I think we're making great progress, and I think we'll continue to see that progress extend into the fourth quarter. So we entered the quarter with a lot of confidence. We know there's a lot of business that has to be done, and we're off to a very good start led by the reaction into Hearth and Hand as well as some of the other initiatives that are in place. So I think we're taking the right approach, but we entered the quarter with a lot of confidence and making a lot of progress against literally every initiative that we set forth earlier this year.
David Schick:
Just a sort of follow-up to that, is there any -- what would be -- do you expect to backslide against any traction in key variables, comp, gross profit dollar comp? Help us understand that with this confidence in the guide.
Brian Cornell:
David, we don't expect to see any deterioration in the progress that we've been making throughout the year. So again, I think we entered the fourth quarter highly confident and a very strong position with our stores performing incredibly well, great merchandise, a terrific marketing campaign, great digital capabilities and an expanded suite of digital fulfillment capabilities. So we feel very good about how the entire business is set to perform in the fourth quarter.
Operator:
Peter Benedict from Baird.
Peter Benedict:
Just on price perception, the work you've been doing, I mean, it sounds like you're pleased with where you've gotten that now at the end of the third quarter. Just -- I mean, do you think that, that's an ongoing process that you're going to have to do? How are you -- you mentioned some of the measurements you're using on that, but just trying to understand, is that something you let ride here for the fourth quarter and then reassess where you are next year? Or do you feel like you've gotten yourself to a spot where there's going to be no further adjustments required?
Brian Cornell:
Peter, I think Mark and his team have made tremendous progress over the course of the year. And as we've talked about a number of times now, we're seeing a significant shift of our business towards everyday regular price, which is really important over the long term. So we're going to continue to make sure that we're committed to offering great value, that we're priced right daily, and during the fourth quarter, we'll provide exciting promotions to support those items that we know our guests are going to be interested in shopping for at Target. So it's an ongoing commitment. We want to make sure we deliver great value across the season. And we're going to make sure that we couple that with exciting promotions in the fourth quarter.
Peter Benedict:
Okay. And then one maybe follow-up for John. You talked about a lot of the fulfillment options that you guys are working on. Help us through -- how does that impact the store labor model as you see kind of going forward? And within that, the $15 minimum wage plan. I understand it's not a fourth quarter question, it's more just as you look out the next few years. How do you see that -- those having an impact on the labor?
John Mulligan:
Well, I think, clearly, as we do more fulfillment out of the store, we will add labor to support that. I think we've said since February, we're going to invest in the labor in our stores, invest in training, invest in having experts in the store, invest in having people on the sales floor and changing the operating model for those stores. So that's an important part of what we're doing. Almost separately and independently, we're building teams that -- so that we don't take hours away from everything else we're doing that are handling the fulfillment in the back room. So it's really a question of the operating model in the store that's evolving. And we feel really good about utilizing the stores, they're the closest, fastest and cheapest way to get merchandise to our guests. They have significant capabilities now. We're doing same-day, next-day, 2-day pickup, Drive Up, all kinds of ways to meet the guests' needs, and I think that's the important factor, all centered around using the store as the hub. And we think it's a highly efficient way to use our assets, and we have great teams that can meet the capabilities that we need for our guests.
Operator:
Our next question comes from Edward Kelley from Wells Fargo.
Edward Kelly:
Yes. So I guess, my first question really is around the fourth quarter and the comparisons that you're facing last year. So in-store comps were particularly soft, the gross margin was down a lot, there was issues around digital fulfillment. I guess -- you talk about the underlying momentum of the business not stalling at all, but can you talk about how you expect to cycle those issues from last year?
Brian Cornell:
Ed, again, as we entered this season, I think we're in much a stronger position. John underscored the fact that we've got an expanded array of digital fulfillment capabilities. Mark's talked about the progress we've made from both a brand standpoint but also a value standpoint. I think we continue to enhance our digital capabilities. So I think we entered this season in a much stronger position. And I think what's really important to recognize is the investments we've made in our team and our stores puts us in a very strong position as we enter the fourth quarter. So I feel great about the investments we've made in wages, in hours, in seasonal hiring. And I think our stores are going to drive both our digital business and our store business throughout the fourth quarter. So I think we entered the season in a very different position versus last year. And I think that's reflected in the start that we've seen to the season and the approach we're taking throughout the fourth quarter.
Edward Kelly:
Okay. And second question for you. I just want to -- I know you don't want to give guidance for next year, but I was hoping that maybe you could talk about the puts and the takes in terms of what we should be thinking about, areas that you could see outsized investment, D&A is going to be headwind next year, wages clearly seem like they'll be a headwind. Your thoughts on price investments from here, the Street's sort of looking for a modest decline in earnings, seems like something like that -- larger than that's possible. It's just -- I don't know how much at this point, Brian, you can help with that, but I think it is an area that we're all sort of wrestling with.
Brian Cornell:
Well, Ed, we're hopeful that you'll join us in March for next year's Financial Community Day. Obviously, we're not going to provide 2018 guidance today. But I'll give you a preview. You're going to hear us talk about many of the same things we've been talking about this year
Operator:
Chris Horvers from JPMorgan.
Christopher Horvers:
Two questions. So first, can you talk about how is the Essentials category? It was down slightly. You mentioned more share being taken on the unit side. Can you talk about unit growth in Essentials and how that's progressed over the past couple of quarters as you've put more muscle behind the price investments?
Brian Cornell:
Sure, Chris. Why don't we let Mark walk you through how we're approaching our investments in Essentials?
Mark Tritton:
Chris, yes, let me share with you. So we've been sharing this year that we took a journey in terms of ensuring we're priced right daily and that we were able to create and communicate to our guests the right value. And that started in April of this year and we completed that through the end of the third quarter. What we've seen with that is we had an expectation that's not an immediate just that [indiscernible] response we need to build ongoing, deeper trust with the guests and get them to connect with that priced right daily ethos, and we've seen a really fast reaction, a positive reaction to that. So we're creating in trips and traffic within our adjustment on -- to be priced right daily. And as a result, we've seen an increase in our unit velocity. We fully expected and banked in some of the short-term sales deflation that we would see as a result. But we're starting to see that equal out, and we expect that stability to continue through the fourth quarter into 2018.
Christopher Horvers:
So I think in the second quarter, I think Essentials was up slightly. So did it -- was it essentially that the price investment accelerated and the unit velocity maintained? Or maintained its positive trajectory or did it accelerate?
Brian Cornell:
Chris, I think that's exactly what we're saying, continued investment across multiple categories. And as Mark talked about, the first thing we see is an increase in units, an increase in trips and ultimately that's going to drive positive comps over time. So I think the efforts are paying off relatively quickly, and we feel really good about the guest response.
Operator:
Our next question comes from Bob Drbul from Guggenheim.
Robert Drbul:
I have two questions. The first one is on in-stocks or out-of-stocks. You look at the inventory levels that Cathy talked about, are you seeing the in-stock levels where you'd like them at this point? And then the second question that I have is around fulfillment costs. When you look at -- I think you said -- I think John said stores are fulfilling more than 50% of digital, take it to 80%. When you think about the fourth quarter and the costs around that increased fulfillment of digital by the stores, is it a one-for-one basis in terms of the level of increases there?
John Mulligan:
I'll start with the in-stock question. I think, Bob, we talked about in-stocks last year in February. It's a journey for us, we know. I think we've made a lot of progress in in-stocks given our current capabilities. But we also said, in order to really solve the problem, we need to fix some fundamental capabilities in our supply chain around speed, reliability, inventory placement. And that's where we're on the journey. So the inventory increase at the end of Q3, as Mark said, more related to us being sure we're ready for the fourth quarter in categories like Electronics, Hearth and Hand, where we took positions, intentional inventory positions to increase inventories in advance of the fourth quarter. Less to do with our management of day-to-day in-stocks/out-of-stocks. We continue to work on those. And as I said, there is the short term, working within our current capabilities and in the longer term solve that comes as we continue to improve our overall supply chain capabilities. Your second question, I'm not entirely clear, Bob, on where your -- maybe you could clarify how -- your question, the store labor related to fulfillment, I'm not -- I didn't quite understand it.
Robert Drbul:
Sorry. Just from the perspective of the expense levels, like the pressure that you saw in the third quarter versus the expectation of the pressure, fulfilling more than 80% in the stores on the expense lines specifically.
John Mulligan:
Yes, I wouldn't compare it to third quarter. Compared to last year, we are doing more fulfillment in-store. As we said, we think that's the most cost-effective way given the total P&L. So shipping plus store labor, we think that's the most cost-effective way to do it. Compared to last year, we saw significant spikes last year near the end of the quarter, approaching 80% fulfillment. And I would say, when you get into that 80% range, what really goes up is store pickup, and we'll take that model all day long, highly efficient for us, highly profitable from a digital perspective. So when our mix gets that high in store, we actually like the economics a lot.
Operator:
Matt Fassler from Goldman Sachs.
Matthew Fassler:
I've got 2 questions, and my first relates to gross margin. Just to revisit, the fact that you do have this very depressed compare from a year ago, and you're actually entering Q4 with pretty good gross margin momentum, down only very nominally in Q3 as some of your new brands are really starting to get traction. So is your thinking on the expectation of a decline in gross margin simply a factor of more business being done online each year and the cost of fulfillment associated with that? Or some of the new fulfillment options that you're introducing just somewhat more costly and you're giving yourself room to absorb that pressure?
Catherine Smith:
Matt, this is Cathy. I think I would look about it the way we -- we have all year approaching it, which is, we're trying to be prudent as we plan into the fourth quarter. We're excited about what we've seen so far, but it's early in a very important quarter. The pressure that we are anticipating is around digital fulfillment as well as all the work we continue to do around value, and we're offsetting that with cost savings continuing into the fourth quarter. So I would look at it as just doing what we said we would do all year long, which is be prudent, plan appropriately and make sure that we set the business up for success.
Brian Cornell:
Matt, I'd only build on a couple of comments that Cathy made. One, we feel very good about the performance of our own brands and from a gross margin standpoint, both short term and long term, that's going to be very beneficial to our mix. Two, we are clearly investing in digital and digital capabilities and expect that we're going to continue to see strong digital growth in the fourth quarter. So it is the mix of our business that really makes sure that our gross margin returns stay on track. But the work that Mark and his team have done with our own brands and the results that we're seeing across our 8 new brands is very beneficial, both short term and long term, to our gross margin rate performance.
Matthew Fassler:
That's super helpful. The quick follow-up relates to REDcard penetration. So we noted that the year-on-year penetration seems to have stabilized this quarter after having shown some increases for a period of time. Anything to glean from the stabilization of that trend?
Catherine Smith:
We are really excited about some of the capabilities we're adding to REDcard coming into this fourth quarter. I have to tell you, I'm one of the early users for our wallet application and it is phenomenally fast and convenient and great experience for the guests. So as we continue to ramp up some exclusives around REDcard, our guests are responding. We're seeing additional capabilities come into REDcard holders, our best guess, into the fourth quarter. So I would expect that we'll see that trend continue to be favorable.
Brian Cornell:
Yes, Matt, I think we also recognize that as a by-product of the investments we have been making in our stores, our plans moving into new neighborhoods, we're bringing in new guests to Target. So over time, we certainly want to convert them to REDcard holders. But I think what we're seeing is, as we move into new catchments, these are new guests that are shopping at Target. Over time, they'll start adapting to our REDcard. I think our new brands are bringing new guests into our stores, and I think the focus that we placed around value is also attracting a new shopper. So over time that provides us tremendous opportunities to continue to build REDcard penetration. And one of the metrics that we haven't talked about on the call is the fact that traffic was up 1.4% and as existing guests shopping more often, but it also is new guests coming to our stores and our site. So over time, those are potential new prospects for REDcard. And we certainly expect to see that conversion as we go into 2018.
Operator:
Robbie Ohmes from Bank of America Merrill Lynch.
Robert Ohmes:
Just two quick questions. Just on the fourth quarter, the sort of the breadth of the range there, can you just give us the scenarios like, sort of, what brings you to the low end of the fourth quarter range, the $1.05 versus the $1.25? And the other question I had was just -- I was wondering if you would share some of the early results on the pickup customer versus the Drive Up customer? Which is better? Whose basket is bigger? How much bigger is the basket versus the store shopper or just plain online shopper that get shipped to home? Anything you can share about the metrics and what you're excited about there?
Brian Cornell:
Robbie, why don't we let John start by talking about that pickup shopper and then we'll come back to our guidance for the quarter.
John Mulligan:
I might start up with the Drive Up shopper there. I think our guest survey scores there, NPS scores are, frankly, off the charts. We see a high utility. It's mom with 2 kids in the back, right? A core Target shopper who just doesn't -- it's raining outside and doesn't want to get out of the car. So we've seen very, very high scores there. The baskets are mixed as you'd imagine, right? Sometimes they're larger, sometimes a tiny one thing. And the same is very true for pickup in store, driven by -- it can be driven by promotional cadence, it can be driven by convenience. There's lots of different reasons people choose that option and so the basket varies. There's nothing really to glean from that other than for both of them, we see very high NPS scores for our guests, which is the most important thing from our perspective.
Brian Cornell:
Robbie, why don't I clear up the question around guidance for the quarter and, really, I'll focus on the full year. I think our fourth quarter guidance is a reflection of the performance we've been delivering throughout the year. And I'll go back and note as Cathy discussed, our full year guidance is up $0.50. I'll do the math for it. That's $500 million of improvement versus our original guidance. So we certainly approach the fourth quarter with a level of balance and conservatism, but feel good about the momentum we have. And we think the performance we've been delivering throughout the year will be reflected in our fourth quarter. So we feel confident, we're making good progress, there's a lot of business still to be done in the fourth quarter. And I think our range of comp of flat to 2 and the approach we're taking from an EPS standpoint just reflects the approach we've been taking throughout the year.
Operator:
Kate McShane from Citi.
Kate McShane:
My question was around fulfillment as well and a little bit longer term in nature. I had wondered with regards to the Drive Up and the same-day delivery, if there are any early indications of what the limitations might be in terms of where you can introduce that and then also with regards to the profitability of how those 2 fulfillment options relate to the ship-from-store?
Brian Cornell:
Yes, I'll let John talk about the profitability component. But Kate, I think one of the great things about our strategy is the important role our stores play. And as we think about Drive Up, we think about same day, those are going to be enabled by the 1,800 stores that are in neighborhoods around the country. So we should be able to continue to expand that over time and meet the needs of our guests no matter where they live and which store they shop in.
John Mulligan:
And on your question about profitability, clearly the closer we are to the store, the better we like it. When a guest comes in and picks it off the shelf, great. Only slightly disadvantaged to that would be pickup or Drive Up because there is one more touch. But really, again, economically, a great, great solution for us. As we get into shipping, same-day delivery is more expensive, there's no question about that. And at least today, our guests' research leads us to believe, guests understand that. They want it priced right, they want the convenience and they understand there may be a charge to get it to them at the time they want it during that day, and we've seen that in the 4 stores in New York, no push back at all on the delivery charge. And the great thing is, we see the baskets, as I said, 6x to 9x larger. So that ends up being a highly, highly profitable transaction for us. And so there are markets where that will work, that type of transaction will work really well. There are other markets were, as you said, there will be standard 2-day shipping. And there, we're working hard to reduce costs throughout that shipping while improving the speed. So that's on our team so that the guests gets the great service and we make that a great economic transaction for Target as well. But we feel good about our ability to make it work.
Brian Cornell:
So with that, operator, that concludes our third quarter 2017 earnings conference call. I want to thank everybody for participating and wish everyone a happy holiday season. So thank you.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation second quarter earnings release conference call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, August 16, 2017.
I would like to now turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our second quarter 2017 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; Mark Triton, Chief Merchandising Officer; and Cathy Smith, Chief Financial Officer. In a few moments, Brian, John, Mark and Cathy will provide their perspective on Target's second quarter performance and our plans and priorities going forward. Following their remarks, we'll open the phone lines for a question-and-answer session.
As a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure, and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalize operating leases. Reconciliations to our GAAP EPS from continuing operations and to our GAAP total rent expense are included in this morning's press release, which is posted on our Investor Relations website. With that, I'll turn it over to Brian for his thoughts on our second quarter performance and our priorities going forward. Brian?
Brian Cornell:
Thanks, John. Good morning, everyone. We are very pleased with our second quarter performance, which gives us increased confidence that we are focused on the right long-term strategy. Our team is energized and remains on track to deliver the ambitious agenda we laid out for the year, including the physical transformation of more than 100 stores in 2017 on the way to transforming more than 600 stores over a 3-year period; nearly doubling the number of small-format stores this year in support of our goal to open more than 100 new stores in dense urban, suburban and college campus neighborhoods over a 3-year period; development and rollout of digital capabilities that will continue to drive Target's digital sales growth in excess of the industry; completely transforming our supply chain from end-to-end; creating a smart network of stores and distribution facilities that will allow fast, reliable fulfillment regardless of how our guests choose to shop; rejuvenating our own brand portfolio by launching 12 brands over a 2-year period, replacing brands that represent more than $10 billion of our current sales volume; investing in systems, training and additional labor hours in our stores, enabling our team to provide an even better experience for our guests; and enhancing our value perception among consumers by reducing promotions and highlighting the right everyday pricing in key categories. Later in the call, John, Mark and Cathy will provide more details on our efforts to advance each of these priorities.
On our last conference call, I mentioned that beyond our focus on advancing our long-term priorities, we need to have equal focus on strong execution in every channel every day. That's why we're really proud of the execution of our team in the second quarter as they delivered better-than-expected performance in a continuing challenging environment. In particular, second quarter traffic, which was up more than 2%, was much stronger than our expectations and better than recent trends. And the strength was broad-based across the country, across categories and across channels. And while the consumer and competitive environment remains choppy, better-than-expected performance occurred throughout the quarter and wasn't limited to a short period within the quarter.
With better second quarter traffic, we saw improved performance across each of our 5 broad merchandising categories:
Apparel, Home, Food and Beverage, Essentials and Hardlines. 4 of those 5 saw comp increases in the second quarter while comp sales in Food and Beverage were flat. However, given continued competitive and deflationary pressure in Food, we're pleased that we're seeing early signs of progress. Specifically, we saw really strong positive comps in adult beverages and produce in the second quarter, both categories in which we've identified opportunities and focused on improvement. The positive response from our guests demonstrates that we're making progress and we're taking additional steps to build on that momentum over time.
I also want to call out our progress on pricing and promotions. As we mentioned in the last call, we undertook this effort with a long-term view, knowing that we might create some headwinds in the near term. Specifically, as we move towards a stronger everyday price proposition in our business and pull back on excess promotions, we can expect an adjustment period before value perception improves and consumers respond. While we continue to face the risk in future quarters as we expand the scope of this work, it's notable that in the second quarter, we saw a meaningful increase in the percent of our business done at regular price and a meaningful decline in the percent on promotion. This demonstrates the progress we've already made and gives us confidence we're on the right track. I also want to call out the team's progress on Target's digital capabilities, which continue to show up in our results. Target's digital sales grew much faster than industry in the second quarter, up 32% on top of 16% growth last year. If you do the compounding of these 2 growth rates, you'll see that this represents more than a 50% growth rate compared with 2 years ago. And importantly, as result of our comprehensive effort by our team to reduce friction and increase the reliability of our digital operations, we have seen meaningful declines in guest contact center activity related to digital. This is a tangible reflection of our work to create a stable digital platform and successful collaboration between our digital, operations and merchandising teams to create a more cohesive experience for our guests. To build on this success, the team is rapidly testing and rolling out additional fulfillment options for our guests. This includes Target Restock, our next-day delivery option for everyday essentials, that we recently rolled to Twin Cities REDcard holders. It includes same-day delivery, which we began testing in our TriBeCa store in the second quarter. It includes an early test of curbside fulfillment, which we recently began testing with Twin Cities team members and which we'll expand to a guest-facing test in the third quarter. And of course, our efforts include the expansion of ship-from-store locations, in-store pickup capabilities and our work with third-party providers to speed up ship times from our stores and distribution facilities. In each of these efforts, the team is moving quickly, more quickly than ever before, to roll out, test and iterate and expand where we see positive results. We're really excited to see the engagement of our team and the collaboration occurring across our operations, which allows these tests to move quickly. And we intend to continue moving quickly in the months ahead. Another area where we've increased our speed is in the development and rollout of new exclusive brands. With last year's rollout of Pillowfort and Cat & Jack in Kids, we've demonstrated the power of reinvention in categories that were already performing well. Specifically, both of these new brands grew double-digit comps following their launch last year. Regarding the Cat & Jack brand, we have long said that it was on pace to exceed $1 billion in sales in its year. But performance has actually exceeded those expectations. Cat & Jack just crossed the $2 billion mark only slightly more than a year after its launch. Based on the success of those brands, our team took on the ambitious goal of launching 12 additional new brands before the end of next year, and those plans are coming to life. At the end of May, we launched Cloud Island, an infant brand, which we developed in partnership with our guests. And like last year's new brands, Cloud Island has generated double-digit comp increases in the period since the launch. In July, we launched a new maternity brand, Isabel Maternity, and announced plans to launch 4 more brands in the third quarter crossing women's apparel, men's apparel and home. I also want to comment on our recently announced decision to partner with Casper in advance of the Back-to-College season. I've spent some time with the leadership of Casper, and I've been really impressed with how they think long term and focus on outstanding execution on behalf of their customers. Their brand and products are a great fit with the Target brand. And we're proud to be featuring their products online and in our stores, including a couple of exclusive items they've developed only for Target. This relationship is the most recent example of our ability to differentiate our assortment while helping outstanding brands extend their reach. During this period of rapid transformation in retail in which many others are shrinking, we'll continue to look for ways to partner and deliver incremental growth for high-quality brands while delivering differentiation and value for our guests. As we look ahead, we're committed to continued progress against our long-term goals. And we expect the environment will continue to be challenging. The pace of change in the consumer and competitive environment doesn't show any signs of slowing down. And we're well positioned to emerge as one of the winners in retail. It starts with the underlying health of our business, a business that generated profits of nearly $700 million in the second quarter. Our business is backed by amazing assets, including our team, our network of stores and distribution centers, a unique merchandise assortment and a deep relationship with our guest. Beyond those assets, we have a very strong balance sheet and operations that generate a lot of cash, providing us the flexibility to undertake the ambitious 3-year transformation we first laid out at our Analyst Meeting in February. And we continue to look for ways to move faster. In February, we announced our plans to complete 250 store transformations in 2018 on top of the 100-plus we're on track to complete this year. However, based on our success so far and the hard work of our real estate and construction teams to grow our capabilities quickly, we now believe we can accomplish more than 300 store remodels next year. While the scope of our transformation is large, we remain focused on what has made Target an outstanding retailer over the long term, all the way back to our first store in 1962. The key for us is embracing the power of and, which makes us unique among our competitive set. When we're at our best, our model delivers the best of both mass and specialty retail. We deliver inspiration and convenience. And we invite our guests to expect more and pay less. Because we've delivered on all of those dimensions over time, we have developed a unique, emotional relationship with our guest. And we believe that relationship is positioned to thrive in the new era of retail. If we continue to offer our guests inspiration and aspiration, differentiated merchandise and experiences and deliver convenience, reliability and great everyday prices, we'll continue to standout and succeed in a crowded retail environment. One way to see how the best of Target comes together is to visit one of our exciting, new small-format stores we've been opening across the country. I visited our new store that recently opened on the USC campus. And despite my loyalty as a proud UCLA graduate, I couldn't help being excited by what I saw. The store is already quite busy, even though most of the students have yet to return from summer break. Beauty, Baby, Food and Beverage are all selling well. And the store team is quickly evolving their assortment based on feedback from a diverse set of guests. It's truly inspiring to see the team interact with our new guests at an exciting, new shopping environment. And I'm proud of what they do every day. So now I'd like to turn the call over to the team, who will provide additional detail on our strategic plans and recent performance. First, John will provide detail on our work in supply chain and our stores to enhance our fulfillment capabilities and provide a more reliable and inspirational experience for our guests. Then Mark will cover category performance and provide more detail on our recent and upcoming brand launches. Finally, Cathy will provide more detail on our second quarter financial results and expectations for the rest of the year. So with that, I'll turn the call over to John for his comments. John?
John Mulligan:
Thanks, Brian. Across all the operations team, we are focused on modernizing Target's network to create a complete, seamless, efficient and reliable menu of fulfillment options for our guests. And while we are still in the early stages of a multiyear journey, the team continues to move with unprecedented speed, developing skills and processes that allows us to develop, test and iterate much more quickly than we have in the past.
Some of our fulfillment capabilities are already well developed. And in those cases, the team is focused on finding ways to increase our speed, reliability and reach. At the other end of the spectrum, we're in the early stages of testing completing new fulfillment options for our guests. In those situations, the work is fully focused on learning from our guests and vendor partners, understanding what is most important to our guests and beginning to evaluate reliable, repeatable processes that will allow Target to fulfill guests' rapidly evolving needs and expectations. Among our more developed fulfillment capabilities, we have offered in-store pickup of digital orders across all of our locations for years. But we continue to find opportunities to improve execution. And we're seeing continued momentum. Specifically, through the first half of the year, Store Pickup volume has grown more than 30% above last year. And in July, we saw more than 40% growth. As more and more of our guests respond to the convenience of order pickup, we are investing in system enhancements and store labor hours to continue to elevate the guest experience. These investments will be especially important in the fourth quarter holiday season, when guests are particularly time-pressured and rely on this fulfillment option even more frequently. Another way we can enhance the pickup experience is to offer a drive-up option, so guests don't need to leave their cars. And in the second quarter, we launched a new test of this service. Unlike the past, when we partnered with a third party to offer this service, this new test is being implemented with our own team members and internally developed technology. The offer applies to approximately 180,000 shelf-stable items currently eligible for in-store pickup. And in the early stages, we're offering it only to team members in a handful of Twin Cities stores. However, based on our early results from the test, we expect to move to a guest-facing pilot in select Twin Cities locations later in the fall. While the capability for our stores to ship digital orders directly to guests' homes was also launched years ago, we are seeing even more rapid growth in this fulfillment mode. For the first half of the year, ship-from-store sales are running about twice as high as last year, accounting for more than 40% of digital units shipped. Since the rollout of this capability, we have added new ship-from-store locations every year. And this fall, we plan to roll it out to another 350 stores in advance of the holiday season. This will bring the total number of ship-from-store locations to more than 1,400 stores. In addition, we are creating additional capacity by ramping up the order volume running through our mature ship-from-store locations. Because so many of our stores can now ship directly to guests, we have been able to increase delivery speed while still controlling costs. And that, in turn, has allowed us to offer new fulfillment options like Target Restock. This service allows guests to order a shopping cart-sized box filled with items chosen from an assortment of more than 15,000 essential items like coffee and paper towels and have it shipped to their house for a fixed $4.99 delivery fee. Because these orders are fulfilled from a nearby store location, we can promise that any Restock order placed before 2 p.m. will arrive at a guest's home on the following weekday. You'll recall that we rapidly developed this capability at a team member test in the first quarter. And we moved to the next stage of the test in the second quarter, rolling out to Twin Cities REDcard holders in late June. Operationally, this guest-facing test has gone well. And as a result, we just rolled out Restock to the Dallas and Denver markets. And we plan to expand into another 7 markets before the holidays. With Restock available in these 10 markets, we'll already be reaching 1/4 of the U.S. market less than 6 months from the day we launched the test. Beyond geographic expansion, we began offering Restock to non-REDcard holders in all 3 test markets. We'll be extending the delivery window by adding Saturday delivery. And we'll remove the cutoff for next-day delivery later, beyond the current 2 p.m. cutoff. And given the strong store execution we've seen so far, we'll begin ramping up communication and marketing efforts in Restock markets, which will increase awareness in order volume, providing visibility into the capacity of our store team to reliably process higher-order volumes. Beyond our internal fulfillment capabilities, our team is also working with transportation partners to improve the speed and cost-efficiency of last-mile delivery. To supplement these efforts, this week, we announced our decision to acquire Grand Junction, a San Francisco-based transportation technology company. Grand Junction has developed proprietary technology tools and has relationships with more than 700 carriers, allowing retailers to choose the most efficient option for last-mile delivery on an individual order. While this acquisition is not expected to have a material direct impact on our financial results, we are excited to bring Grand Junction into the Target team and believe their model will help accelerate our progress in delivery speed, efficiency and a high level of service to Target's last-mile fulfillment. We worked with the Grand Junction team on the test of same-day delivery in our TriBeCa store, which launched in the second quarter. In this test, guests at checkout can choose to have their purchased items delivered to their home on the same day in a delivery window of their choice. We've been pleased with the results of the test and have gained some useful insights from the guests' response to the offer. For example, the value of the average basket for these same-day delivery orders is more than 6x the store average at the TriBeCa store and contains nearly 4x the units compared with the store's typical basket. Also notable, Home is the most common category in same-day delivery transactions, ahead of Essentials and Food and Beverage. And importantly, Net Promoter Scores for the same-day delivery service have been higher than for the TriBeCa store overall, demonstrating the quality of execution so far. Based on these encouraging initial results, we plan to expand this same-day delivery test to several other New York City locations in the fall. Of course, the most common mode of shopping is still overwhelmingly in our stores. So while we're investing in new ways to leverage our stores for digital fulfillment, we are also interesting to bring a great store shopping experience to guests across the country. This includes our remodel program, in which we plan to transform the look and feel of more than 600 stores over a 3-year period. In support of this planned remodels in 2017, in the second quarter, we completed 42 remodels, bringing us to a total of 63 so far this year. And while we are obviously seeing a range of outcomes on an individual store level, we are continuing to see average sales lifts in line with our plan to deliver a 2% to 4% sales lift in remodeled stores. And as Brian highlighted, the team is doing a great job of scaling up our capacity, which will enable a faster pace of remodels in 2018 than we previously expected. Beyond remodels, our team is delivering on our plan to roll out more than 100 small-format stores to dense urban, suburban and college campus environments over a 3-year period. For 2017, we are still on track to deliver our plan to add nearly 30 new small-format stores. In July, we opened 9 new small stores across the country on top of the 4 we opened in the first quarter. While we have only been opened a few weeks, our July openers have been particularly strong out of the gate. And as Brian highlighted, the guest response had been phenomenal. For the set of small-format stores that have been opened for more than a year, we're continuing to see sales productivity more than double the company average. And these stores have been delivering high single-digit comp increases so far in 2017. So clearly, our team has been busy transforming our assets and developing new and more efficient ways to fulfill guest demand. But as Brian mentioned, we also need to focus on execution every day. Even though strong execution may not always grab the headlines, it has a real impact on our performance. An outstanding example is our work to improve the fundamentals of our digital business, which has dramatically reduced the number of guest-centered contacts related to digital transactions. Specifically, in 2017, guest contacts per digital order are running 30% lower than last year. This dramatic reduction is the result of concerted effort by our team, who looked end-to-end at the digital guest experience, all the way from our site and our apps to ordering, purchasing and fulfillment. Based on this foundational work, the team has worked methodically to reduce friction and pain points. And you're seeing the benefit both in our contact statistics and in our digital traffic and sales. Another example is our partnership with CVS. As we outlined last year, the conversion of pharmacies created some inevitable friction for our guests, driving an initial decline in script count in our stores. Since the conversions began, we have been working closely with the CVS team to minimize the guest impact and build awareness of the benefits CVS can provide. As a result of our joint efforts, guest experience scores in our pharmacies have been climbing since the CVS conversion and are now running well ahead of our pre-conversion levels. And we've been seeing the impact in our business. In the second quarter, comparable pharmacy script counts turned positive for the first time in more than a year. While this is encouraging, we know we have more opportunities to build on this momentum. And we are working with CVS on marketing and guest engagement plans for the fall season. Execution in our stores has been a big focus this year. And we're investing in hours, training and technology to allow our store team members to elevate the shopping experience. Depending on a store's volume and buying patterns, we're adding hours to enhance the order pickup experience and our visual merchandising teams in Apparel and Home, in Beauty and in Food and Beverage. And given all the brand launches that Mark's team is planning for the fall, we have invested in training and materials to help our store teams best present and sell these new lines to our guests. Across all of our stores, we're asking the team to increase their engagement with guests and ensure they're finding all the items on their list. To support this effort, we're rolling out a new tool that will help our store teams locate items, colors and sizes not available in their store and allow them to sell those items directly to guests right on the sales floor. We're in the very early stages of rolling out this new capability and guest awareness is still low, but we are already gaining some initial insights. Not surprisingly, over at half the activity on these devices has been related to Apparel, where the ability to find additional sizes and colors creates particular value for our guests. So now before I close, I want to give a nod to the team. I'm incredibly proud of what they've already accomplished. And I'm energized by their passion to transform our operations and our business on behalf of our guests. And while I know I keep saying that we're just getting started, it's also amazing to look back and realize how much we've already accomplished. With that, I'll turn the call over to Mark, who will provide more detail on our performance and plans in merchandising. Mark?
Mark Tritton:
Thanks, John. As you've been hearing from many of our industry peers, this continues to be a challenging competitive and consumer environment. That's why we are particularly pleased by the ongoing progress we saw in the second quarter, when we gained further momentum in the areas that we're already performing well and saw improvement in the areas where performance needed more focus. And our growth has come from both stores and digital channels, wherever our guest wants to shop us.
From a market share perspective, we saw broad-based market share gains across all our discretionary categories. In Hardlines, comparable sales grew between 3% and 4% in the second quarter, the strongest performance we have seen in 10 years. Growth in this area was broad-based, including double-digit growth in both video games, driven by Nintendo Switch, and Apple within Electronics. Toys grew more than 3% with board games continuing to be a strong highlight. This is an area where we already enjoy a leading market share position but continue to grow and take further share due to our focus on innovation and differentiation within our assortment. Our Apparel and Home categories both grew sales and market share in these tough markets. In Apparel, growth was widespread across subcategories as guests responded to fashion and newness, all underpinned by value through great priced-right daily items. We were particularly pleased with the ongoing positive performance in Kids, which continues to benefit from last year's launch of Cat & Jack and is now achieving strong year-on-year sales growth, and in our strong swim business. Like our performance in board games, we came into the year with the #1 market share in swim. And we extended our lead to become the clear destination for swim in the U.S. In Home, digital was an important growth driver. And we saw particularly strong performance from our Threshold brand. We're also very pleased with the performance of our seasonal businesses, from greeting cards to outdoor furniture. Within the Seasonal event moments, our Fourth of July holiday was strong as we quickly leveraged guests and business insights from Memorial Day. In Essentials, comp sales were up almost 1%, benefiting from the launch of our Target Run and Done campaign that began in the first quarter. We are pleased with the response from our guests, specifically with awareness and return on ad spend for this campaign, where results are higher than average. The top 2 messages guests recall from the campaign are that, "Target is convenient, and I can fulfill all of my needs at Target," which were our core campaign goals. Essentials are also seeing the early benefit from our work to improve our value perception. Specifically, when we are priced-right daily on key items in Essentials, we are seeing increased traffic and unit sales trends. As Brian mentioned earlier, comp sales in the Food and Beverage category have stabilized and were flat in the second quarter. We are seeing improvement based on our work to improve freshness and reliability as well as our work on value perception. In produce, we saw high single-digit comp increases in the second quarter, driven by even stronger growth in organics. And in our adult beverage, we saw ongoing double-digit comp growth, driven by assortment and display enhancements we've been rolling out across the country. Importantly, we continue to build Food and Beverage expertise on our team. Following the hiring of Jeff Burt to lead Food and Beverage in merchandising at the end of the first quarter, we announced that we've hired 2 members of his team earlier this week. Looking ahead, Jeff and his total team are focused on building on recent momentum. We know we need to enhance our assortment of convenient options for our guests, food that's ready-to-eat, ready-to-heat or ready-to-cook and save families time and money. In addition, we're focused on enhancing our exclusive brand assortment in Food and Beverage while ensuring we are priced-right daily on key opening price point items. While overall, we have much more accomplish in the third quarter, our work to improve value perception across all of our assortment is already beginning to have an impact. Specifically, surveys are showing that consumers are noticing Target's investment in price and value. And we saw a much stronger mix of regular-priced selling in the second quarter as we sought to simplify our promotions, clarify our voice and bring great priced-right daily items into focus. And it's working. In fact, our second quarter balance of regular and promotional sales was consistent with levels we haven't seen since 2012, well before our credit card data breach that changed our promotional cadence and stance. Also encouraging was the fact that our unit share in key categories grew more quickly than dollar share, which is a key leading indicator of the impact of this work. At a high level, our second quarter average ticket also reflects the impact of this work. At first glance, reporting a slight decline in average ticket might not sound like good news. But when it's more than offset by an increase in traffic, the picture is more positive. As we dig into the drivers, the change in basket reflected 2 key factors. The first was a reduction in general incentive offers, which were replaced better daily value pricing and more category-focused discounts. The second was a meaningful increase in the number of quick trips and fill-in trips we saw from our guests. As we mentioned last year, we saw an opportunity to more appropriately balanced between stock-up trips and these quicker, smaller trips, so we are pleased to see our strategy taking hold and generating both trips and conversion. This work on value perception is about ensuring we are priced-right daily on key items while delivering more thoughtful and effective promotions throughout our assortments. In many categories, this means we're reducing our everyday pricing and communicating with much more clarity, building confidence among our guests. We'll expand the scope of this work in the third quarter, and we will continue to measure and iterate based on the response. Another aspect of our business where we are pleased with our progress is in our inventory position. We reduced our total inventory to last year by more than 4% while improving the quality of our inventory by bringing unproductive inventory levels down to historical lows. The savings and markdowns through better sell-through rates and lower inventory levels has created the capacity for us to invest in what's new and what's working, which will position us well in the back half of the year. And we do have a lot of newness planned for the rest of the year. Perhaps most notable are the new brands that either just launched or will roll out in the next few months.
In addition to Cloud Island, which launched in May and is already comping double digits, we launched Isabel Maternity in July. This new brand features 120 key pieces designed to make every stage of maternity easy, comfortable, stylish and affordable with a focus on fit, function and fashion. And this new brand is already posting strong growth. And as we move into September, we're rolling out 2 new exclusive apparel brands. In women's, we're launching A New Day, an apparel and accessories brand featuring a strong feminine aesthetic through modern prints and patterns with a focus on building confidence through stylish, seasonal and basic items and stories that provide the ultimate wardrobe versatility. And in men's, we're launching Goodfellow & Co., which brings a new modern interpretation of classic looks focused on the strong foundation of core items based on insights our guests tell us what they want:
great quality, fit and fabric.
But there's more in store. In September, we'll also launch Project 62, a new home brand based on modern design that is thoughtful and approachable. We also built this brand from our Guest Insights to capture their growing demand for modern design with a focus on solving the challenges of urban living, including the need for easy mobility based on potential frequent moves. Items incorporate efficiency, simplicity and great design that make urban environments both highly beautiful and functional. Shortly after in October, we're excited to launch JoyLab, a new women's athletic fashion apparel brand. Items were designed based on emerging street styles that inspires fitness through fashion and building a community based on style and wellness, taking you from crunches to brunches. Given the investment in developing this portfolio of new brands, we plan to support these launched with meaningful 360-degree investments in the way only Target can, in marketing, in digital, on social media, in store experiences with fixturing, mannequins and signage and in training for our store and digital teams. It will be hard to miss the amount of newness you'll see during the third quarter. And we expect our guests will be excited to discover that there is indeed more in store. And our product design and development, manufacturing, merchandising and marketing teams have been incredibly agile, having begun their work on these new brands less than 10 months ago. It's amazing what they have been able to accomplish together in this time by keeping truly aligned to our strategic choices. It adds up to a vast body of work. And we can't wait to see all of these new items in our stores and online. Our success last year in Pillowfort and Cat & Jack provided the proof of concept and gave us the confidence to begin work on these new brands. Both of those new Kids brands saw double-digit comps in the year following their launch and they are both still growing in their second year while building trips, category growth and store basket. And as Brian shared, Cat & Jack is now a $2 billion brand based on sales volume in the last 12 months through July of this year, exceeding our initial expectations. Of course, we haven't forgotten the Back-to-School and Back-to-College key seasons, which play a huge role in our third quarter results. In Back-to-School, comps and market share have grown for 10 years straight. And we're focused on extending that record. We continue to invest in digital to support Back-to-School, including our School List Assist site that provide guests a convenient way to access their child's supply list and easily order any or all of those items to be delivered to their home. More than 1 million lists are already available on the site, well ahead of last year. And sales through the list site have been running 4x higher than a year ago. When students go back to college, mom plays a huge role in making everything happen. So we've made sure this year's marketing speaks to moms as well as students. And for those campuses that aren't lucky enough to have one of our new small-format stores, we're partnering with Barnes & Noble College, which operates nearly 800 college stores around the country, to offer the Target assortment to more than 5 million students. And finally, given our past success, our team is really excited about the upcoming release in the Star Wars series. To get things started, we're launching our latest Star Wars assortments on September 1, which is being dubbed Force Friday. And to celebrate, we'll be opening at midnight in 500 stores across the country. So okay, that's a lot of newness. I hope you see why we're so excited at Target about all of our strategies and plans coming to life. All of our work supports our long-term vision, which is to build on the strengths that have made us such a unique retailer for decades. As Brian shared, we build a brand from ands, a brand that offers the best of both mass and specialty. And we have a unique multi-category offering that allows us to drive traffic by leaning into core items and trends. And our brand is known for featuring new, exclusive and truly differentiated items from both own brands like Cat & Jack and national brands like Apple and Casper. Because we are so unique, we're hard to put in a box, and we like that. We are at our best when we connect with our DNA, unleash the potential of our brand promise to expect more and pay less, leverage our team and let Target be Tar-zhay. With that, I'll turn it over to Cathy, who'll provide more detail on our second quarter financial performance and outlook for the rest of the year. Cathy?
Catherine Smith:
Thanks, Mark. In the second quarter, our traffic sales and financial performance were all better than expected. Notably, the upside to our expectations was broad-based across the country, across channels and in all 3 months of the quarter. Second quarter comparable sales increased 1.3%, driven by a traffic increase of 2.1%. We are particularly pleased to see this growth in traffic, which reflects strong execution by our team and the early benefit of the work we are doing to transform our business.
Our second quarter adjusted EPS of $1.23 was flat to last year. GAAP EPS was $0.01 lower than adjusted EPS, reflecting some small unfavorable tax items not related to our current operations. Both the GAAP and adjusted EPS lines reflect about $0.07 of favorability, resulting from the net tax effect of our global sourcing operations. This favorability was included in the adjusted EPS calculation because it reflects a structural benefit to our tax rate resulting from our operations. The amount recorded in the second quarter reflects the year-to-date benefit of our global operations on our tax rate. And we expect to recognize an ongoing benefit in the range of $0.02 to $0.03 in both the third and fourth quarters as well. Our second quarter gross margin rate was down about 40 basis points to last year, driven by increased fulfillment cost and the impact of our efforts to improve pricing and promotions. Merchandise mix had a slightly positive impact on our gross margin rate in the quarter, reflecting healthy performance in our signature businesses, balanced by broad-based strength in Hardlines. One note, beginning this quarter in our financial reporting, we have reclassified depreciation expenses associated with our supply chain, moving them into the cost of goods line on our P&L. This elective reclassification, which resulted from an internal review of how we classify depreciation expense and discussions with the SEC during one of their routine reviews of our filings, is reflected in our second quarter 2017 reporting and we've reclassified prior year results as well. Obviously, this reclassification has no impact on our sales, EBIT, net earnings or EPS, but it results in equal and offsetting reductions to both our gross margin rate and depreciation and amortization expense rate. To provide greater clarity, this morning, we posted a document on our Investor Relations website that shows the impact of this reclassification on our quarterly gross margin and D&A rates over the last 3 years. That document shows that the reclassification impact has been either 30 or 40 basis points reduction in our quarterly gross margin and D&A rates throughout that entire 3-year period. And one final note, with this reclassification, we will no longer include EBITDA metrics in our segment table. On the SG&A expense line, we saw a year-over-year increase of about 50 basis points in the second quarter. This increase was driven by compensation costs, reflecting the store labor investments that John highlighted earlier as well as higher bonus expense, along with impairments related to anticipated store closures and our work to transform our supply chain. These costs were partially offset by the benefit of continued cost discipline throughout the organization. As I mentioned in one of our calls in 2016, for the last couple of years, we have been working to create a culture of thoughtful cost discipline. And I am really pleased to see the ongoing benefit of that effort. I want to pause and thank the team both for their passion to transform our company and for their thoughtful cost management, which is helping to fund our investments in this transformation. At the end of the second quarter, our inventory was more than 4% lower than last year. This is vivid confirmation of the benefit of the work of both the operations and merchandising teams to reduce unproductive inventory and speed up our supply chain. These efforts are driving continued strong in-stocks and sales growth on a smaller base of inventory. Compounding that benefit, we are also beginning to see the impact of our work with vendors to ensure that Target's payment terms are in line with industry norms, which drove an increase in our payables in the second quarter. The combined benefit of these two factors was an increase in our inventory leverage of more than 10 percentage points compared to last year. The working capital benefit of this leverage improvement is substantial and will provide additional cash to support our transformation. In fact, we are now forecasting 2017 cash flow from operations will be higher than last year despite the operating income reduction we have planned for the year. So now as always, I want to pause and reiterate our capital deployment priorities, which have remained consistent for decades. We first invest capital into our business on projects that support our strategic and financial objectives. Second, we support our dividend and look to extend our record of raising the dividend annually since 1971. And finally, we repurchase our shares within the limits of our current A credit rating. In the second quarter, we devoted more than $700 million to capital investment, paid dividends in excess of $300 million and repurchased just under $300 million of our shares. For the year, we continue to expect that our CapEx will be in the $2 billion to $2.5 billion range. However, with the increase in 2018 remodels Brian mentioned earlier, we now expect next year's CapEx will be $3 billion or more, somewhat higher than our previous expectations. This highlights our continued discipline regarding investment deployment. We will increase investment where we have seen solid returns to accelerate our transformation and long-term growth. Our second quarter ROIC performance also highlights the benefit of disciplined capital management. Specifically, in the 12 months through the second quarter, we generated a very healthy after-tax ROIC of 13.8%. This is about 10 basis points stronger than we reported in the second quarter a year ago if you exclude the gain from the sale of our pharmacy business. So even on lower operating income, we've seen an improvement in ROIC because we've taken working capital out of our business. Now let's turn to our expectations for the third quarter and full year. As we look ahead, we will continue to move with urgency but plan prudently. Of course, we are facing a tougher prior year comparison in the third quarter, and we continue to expand the scope of our pricing and promotion work, which may create additional headwinds for the rest of the year. As a result, we expect our third quarter and fourth quarter comps will be within the range we established across the first 2 quarters of the year. For the full year, we expect that our comp will be in the range around flat, plus or minus 1%. In the third quarter, we are planning for a decline in EBIT of approximately $230 million. More than half of this decline will be driven by D&A as we recognize accelerated depreciation related to the anticipated remodels we're planning for 2018. The remaining EBIT pressure will reflect this year's operating margin investment to support our transformation. Altogether, we are expecting GAAP and adjusted EPS in the $0.75 to $0.95 range in the third quarter. Based on our better-than-expected performance in the first half of the year, we are now raising our full year GAAP EPS expectation to the range of $4.35 to $4.55, representing an increase of about 11% from our prior guidance range. Adjusted EPS is expected to be about $0.01 lower than GAAP EPS, reflecting the tax matters excluded from adjusted EPS in the first half of the year. Before I turn the call back over to Brian, I want to step back and look at the underlying strength of our business and how it is enabling our transformation. Through the first half of the year on sales of just over $32 billion, Target's operations have generated EBIT of more than $2 billion and nearly $3 billion of cash. We have deployed that cash to fund capital investment of more than $1.2 billion. We returned nearly $1.3 billion to our shareholders through dividends and share repurchases. And we retired about $600 million of our long-term debt. As I said at our Financial Community Meeting at the beginning of the year, we are so fortunate to have such a strong business and a balance sheet which allows us to invest while many of our peers are pulling back. Not only do we have a plan to create a company that will thrive in this new era in retail, we have the financial strength to get us there. So with that, I'll turn the call back over to Brian for some final remarks.
Brian Cornell:
Thanks, Cathy. Before we move to questions, I want to thank you for your engagement and reiterate our commitment to moving quickly, thoughtfully investing in our long-term growth and strong execution every day. While we expect that the near-term environment will remain choppy, we're confident in our 3-year plan to build an even better Target. And our second quarter progress reinforces that confidence.
That concludes our prepared remarks. Now John, Mark, Cathy and I will be happy to take your questions.
Operator:
[Operator Instructions]
Brian Cornell:
Operator, before we start taking questions, I just want to make a couple of points. I recognize that our prepared comments today were rather lengthy, but we thought it would be important to give you a sense for the breadth of the work taking place at Target today, an update on our progress. And I hope we provided clarity around the key areas of focus over the balance of the year and as we go into 2018. So with that, we'd love look to open it up for your questions today.
Operator:
Our first question comes from Matt Fassler with Goldman Sachs.
Matthew Fassler:
I have two brief questions for, I think, for Cathy. The first relates to the implied fourth quarter guidance, which seems quite subdued relative to a tough fourth quarter a year ago despite the fact that I believe you have an extra week in the quarter, and correct me on that if I'm wrong. And then the follow-up to that is just that you mentioned D&A moving higher. So if you could just give us some color on the magnitude of the move you'd expect of the restated D&A numbers.
Catherine Smith:
With regards to both third quarter, fourth quarter and full year remainder guidance, as we said, we'll continue to move with urgency but plan prudently. And I think that's what you should expect from us. We are finding every time we see results coming from our investments, we're choosing to continue to invest to accelerate our transformation. And so that's how I would think about the backside of the full year. With regards to the reclassification we did on the supply chain depreciation expense, we posted a great schedule, John and the team posted today to the IR website, gives you 3 full years by quarter. You can see the bottom line, it's 30 to 40 basis points a quarter change. And you would see that -- the shift from D&A to gross margin.
Matthew Fassler:
We have that. But just in terms of the -- I think you said you expected D&A to be increasing at a faster rate as you accelerate the depreciation associated through upcoming remodels.
Catherine Smith:
Yes.
Matthew Fassler:
Can you try to contextualize the expected increase, how much the pace of D&A growth will change?
Catherine Smith:
Yes, so it is. It's related to our increasing store remodels as we accelerate some of the depreciation there. And for the full year, I was just quickly looking here, we're -- you'll see a little bit of continued pressure coming through, so it will pick up. But we'll follow up with some specifics if you need it.
Operator:
The next question comes from Chris Horvers with the JPMorgan.
Christopher Horvers:
You had a very strong Electronics quarter. The Switch, which has been a huge hit, double-digit comps in that. And then Apple iPad sounded like they're bouncing back. So it seems like there's a material contributor to same-store sales. How do you think about the sustainability of this benefit? Presumably, the Switch moderates. But do you think the Apple benefits on tablet compares and the new phone? And what other categories do you think could come in and pick up for what the Switch has provided?
Brian Cornell:
Mark, why don't you provide some insight into our view on Electronics?
Mark Tritton:
Yes. Thanks, Chris. I think, firstly, just on the Apple comments, they weren't just driven by tablet. They were all driven across the broad in categories. And we had really strong showing in Q2 on the iWatch, which we worked with Apple on clearly. And we have a lot in our plans to Q3 and Q4 with potential new launches as I've outlined. So we think that there's still room for growth and continuing the trend. In terms of Nintendo Switch, we worked really closely with those guys as well to develop not only a product but a marketing campaign that the guests really responded to. And so we've been able to secure inventory and a plan all through to the fourth quarter, so feeling positive about sustaining a trend there.
Brian Cornell:
And Chris, I think it's consistent with our focus on bringing newness to the guest, not only in Electronics but through our assortment. And I think Mark and his team have done a terrific job of working with our vendors and also building own brands that bring excitement and newness to our guests each and every day.
Christopher Horvers:
Understood. And then on the working capital CapEx side, you've seen some very nice benefits here on working capital this year. How do you think about this year, inventory outlook at the end of the year on the working capital benefit? And you raised CapEx a bit next year. Do you think that increased CapEx is largely offset by continued ongoing benefits in the working capital area?
Catherine Smith:
So Chris, as we've said, we know that we've got a multiyear journey around the supply chain transformation, which will help that working capital continue to come through the business. And we want to just make sure we keep making that progress through time, so not going to commit longer term just yet as we -- it's really going to be associated with a lot of the supply chain transformation. On the increase in CapEx next year, again we're not giving all of next year guidance but thought important to signal where we were going with our CapEx.
Operator:
Our next question comes from David Schick with Consumer Edge Research.
David Schick:
I really wanted to simplify into one question all these different tests and get at one issue, whether it's the roll -- test of curbside and same day, whether it's the rollout of in-store, all the work you are doing. Could you talk about all the new initiatives? And is it -- does it have more traction with existing customers, anything you can share, existing customers, capturing back more of their wallet? Or is it new customers that are new to Target as you go through these new initiatives?
Brian Cornell:
David, I would tell you it's a combination of both. And overall, we're very focused on improving the guest experience, whether they're shopping in store or online, making sure that we deepen the relationship with existing and new guests. And we are very pleased with the traffic increases we saw during the quarter. We're honestly very excited about the work that Mark and his team are doing around bringing new brands to our guests. And we're recognize that to move forward and to continue to execute, we've got to continue to make sure we're providing fulfillment options that our guests are looking for today. So as John talked about during our prepared comments, we're very focused right now on testing and expanding different fulfillment options. We've seen some very positive responses to things like Target Restock. And we're going to continue to ensure that we could meet the needs of our guests matter how they want to shop at Target.
David Schick:
Just as a sort of an add-on to that, one of the things over the last decade that some retailers run into with all these attempts to reengage, a lot of which are very exciting, is either overdoing it or overcomplicating it. How are you guarding against at the store level the associates not being overwhelmed by these initiatives and managing through that?
Brian Cornell:
It's a very important question. And I'm going to turn it over to John here to build on that. But we're trying to make sure we are very, very focused right now and that we have the guest in mind first, that the initiatives that we're bringing forward are guest-centered. But importantly, that we have the right focus on execution each and every day. And I think what we saw in the second quarter is a by-product of our focus on execution each and every day in our stores, online, in our supply chain. And I think you're starting to see that focus really connect with the guests.
John Mulligan:
Yes, I think the only thing I'd add, you're 100% right about the focus. I think the key challenge there for us is to continue to take work that is not guest-facing out of the store. And guest-facing work there is, like we said, the investments we're making in Food and Beverage, in Beauty, in visual merchandising. That includes things like order pickup and shipping from the store. But there are opportunities everywhere else to pull work out of the store. And I think the stores' teams have done a great job optimizing within the box. We need to continue to optimize upstream to help them take work out. And that's a lot of the testing we're doing today. Now I didn't talk a lot about it, but we have test going on in multiple parts of the company focused on taking work out of the store, so they can be focused on the guest.
Operator:
Our next question is from Robbie Ohmes with Bank of America Merrill Lynch.
Robert Ohmes:
Brian, you guys have been mentioning the environment challenges, and we're seeing the very aggressive promotions out there in categories like Apparel. Your store traffic improved a lot this quarter. I'm just curious, are there -- can you give us any color, are you picking up more share from competitors' store closings than you would have thought? And then also as you shift more to EDLP while others are getting maybe more promotional, any insights from what you've seen so far in August that you can share with us on how all this is working out? And sorry, just to add on this also, and I don't know whether John Mulligan or Mark want to jump in on this, but as you pull back on the promos more, you shift more to EDLP, can you remind us where things like Cartwheel fit into that as you move forward and also how you see REDcard penetration playing out in your strategy?
Brian Cornell:
So Robbie, there's 4 or 5 different questions there. And we'll try to unbundle each of them. But as Mark talked about during his prepared comments, during the second quarter, we saw very strong market share growth across a number of categories. We continue to see share growth in Apparel, in Home, in Hardlines. And one of the things that, I think, we felt best about in the quarter, and it's a by-product of the work we've done from a promote standpoint as we continue to see our businesses in Essentials shift back to regular-priced sales and the impact of our new marketing and advertising campaign, the Target Run and Done campaign, which has driven really positive reaction from the guests and accelerated our business in Essentials. So that was a real big highlight for us in the second quarter. And we've talked about this before. We're at our best when we balance both style and household essentials. And you're seeing that balance come to play in the second quarter. And we certainly are going to continue that over the balance of the year and into 2018. So it was a period of time where we feel good about the progress we're making as we pick up market share in many of our signature and style categories. We've seen growth in our Essentials businesses. And we'll build off of that as we go into the balance of 2017 and '18.
Mark Tritton:
Sorry, Robbie, around Cartwheel. Cartwheel remains a really viable promotional vehicle and guest engagement tool for us. And what we're doing though, in the simplification of about pricing message and creating great priced-right daily items, is we're using Cartwheel, but we're reducing the amount of stacking that's coming in. And that's really helping us to clarify and simplify our message to guests about what true everyday value is as well as what's an exceptional promotion. So the rescoping of that has been tremendous so far. And really, our regular business is shining and our promotional business is rescoped in a great way.
Robert Ohmes:
And any chance we can get you guys to comment on August?
Brian Cornell:
Obviously not.
Operator:
Our next question comes from Bob Summers with Macquarie.
Robert Summers:
Just a handful of questions. You've had some recent hires in sort of the Food umbrella. I'm just curious as to how the new individual fit into the current strategy and whether this is a catalyst for a shift and maybe something more into the prepared food sort of side of the equation. And then secondly, if you're willing to comment, I'd love to know what the trends look like, the business trends look like in and around Prime Day?
Brian Cornell:
Yes. Why don't we turn it over to Mark to talk about both Food and what we saw during that Prime period?
Mark Tritton:
Thanks, Bob. I think that we outlined in our Q1 comment around the emergence of our strategy and that we're going to be on a journey of implementation as Jeff Burt joined us in the business. And Jeff has already come in and begun start testing and iterating new ideas and concepts on top of our strategies that are creating growth vehicles, so we're excited about that. The new people entering our business are just creating new strength against those strategic intents. So firstly, Liz Nordlie will add value to our own brand growth potential there and strengthen our efforts there as well as Mark Kenny, really with his expertise in general grocery but specifically in the convenient meal area and in bakery, et cetera. I mean, that is part of our ongoing strategic intent to strengthen and focus there. So these are key investments in our strategy and in our team, balancing them against existing talent. In regards to your query around Prime, we're really happy to see ongoing trends maintained during Prime period. And we had positive comps and a really strong growth in regular price business continuing through those days both in-store and online.
Operator:
Our next question comes from Peter Benedict with Robert Baird.
Peter Benedict:
Mark, just was hoping you could expand maybe a little bit on some of the merchandising assortment changes that you're making in the consumable side of the business, the Food area, particularly in pet food. What's going on there? And anything to note there from a remodel perspective?
Mark Tritton:
Yes. Thanks, Peter. So let me start with pet. We announced this month the addition of Blue Buffalo to our assortment, which is the #1 brand in the U.S. and a really core assortment get. And so excited to add that into our mix, and we already have a lot of data from our guests who suggested they wanted to see that at Target. We also embarked on an agreement with BarkBox. So really refocusing our accessory and our total assortment of doing business inside pet. So an exciting uptick there because that brings further guest trips and conversion. Around the Food and Beverage area, in terms of general assortment, we're still working on there and more to follow.
Peter Benedict:
That's helpful. And then just leveraging on that, when you think about the private brand introductions, I mean, good color on what's coming this year. But when you think about next year, is it going to continue to be in kind of the signature categories? Or should we expect some private brand introductions to start to emerge on the consumable side of the store?
Mark Tritton:
I think that we've talked openly about a roster of more than 12 brands that we'll be bringing to life over a period of time. We've begun that journey. That continues into 2018. It highlights definitely the signature areas, but the strength, providing differentiation, exclusivity and therefore, preference that Target through this is applicable to many different areas. So we're looking at all areas and opportunities, and we have some plans in place.
Operator:
Our next question is from Brandon Fletcher with Bernstein.
Brandon Fletcher:
The only questions I have are essentially just on the pick for store concept. I just want to share a comment we had from an industrial engineer that was working for me a long time ago that it's about as efficient as a driver who takes 3 rights to take a left. There's a massive cost when you have people walk the store instead of it being your customers who walk back out on a simulated basis. I get incrementality. I get that you don't have to have the checkout cost and it offsets it a little bit. Is there something that's coming that you guys are confident on the operational side that will make pick from store the way you guys are doing it better than lots of other folks so that we don't face as much inefficiency? And similarly, will the remodels make those operational changes you think less difficult or more efficient in terms of cost structure?
John Mulligan:
I think any time you focus on just one slice of the total fulfillment, you lose picture for the whole thing, right? We're trying to optimize the total economics for Target. And those economics include investments, capital investments we might otherwise have to make if we don't utilize the existing assets. So I think we can point to any one slice and say, "This one is going to be better or worse." But again, we're optimizing total economic picture. And I'd have you think about that. I think the remodels, where they will really help us, and it's in conjunction with us taking inventory out of the backroom, is our ability to optimize that backroom more efficiently to drive more productivity as we ship from the store. And so that's the real opportunity as we go through the remodel cycle.
Brandon Fletcher:
And so the micro fulfillment in the backrooms would be one of the benefits of remodels?
John Mulligan:
For sure. And in conjunction with operating changes to reduce inventory, like I was talking about earlier, and take work out of that -- other work out of the store.
Operator:
Our next question is from Michael Lasser with UBS.
Michael Lasser:
Can you quantify how much of the $1 billion of operating profit investment you plan to make has already been deployed thus far this year?
Catherine Smith:
As you saw in the quarter, we are seeing the continued investment in both SG&A as well as gross margin. We also though are working really hard to make sure we can offset with efficiencies throughout the organization, where appropriate. And so you're seeing that -- you saw it come through in SG&A and in gross margin this first -- the second quarter, you saw in the first quarter as well to do that. So where we see the investments get the return that we expect and the results we expect, we're investing faster and heavier to accelerate the transformation. So I would say we're on path to what we said we would do. And you're seeing it come through in both Q1 and 2.
Operator:
Your final question is from Kate McShane with Citi.
Kate McShane:
I wanted to just ask about promotions a little bit more, if you don't mind. I know matching promotions are fluid. But how much more work do you need to do in moving your categories and products to EDLP? And what way are these changes impacting the second half outlook? And I know you've mentioned that there's been challenges in the past in terms of conveying value to your guests. And I just wondered how this messaging has changed.
Mark Tritton:
Yes. Okay, I'll take that one. So our promotional efforts are really a roll through the quarter event. And we began them in first quarter in April. And our second round of taking key items that comprise our guest basket and focusing on priced-right daily items really took hold and then second wave by end of July. The next round of that is through October. And that's when we'll be coming together to have a more concise in-store marketing campaign and regular cadence of new beverage to the guest to communicate value. So we think at that point that we have a strong base to maintain. And this is why in half 2, we've been prudent in how we forecasted our sales and margins based on also unit growth initially. We see trip growth initially. And we need to see that dollar growth balance out over time. But we know that we've been patient with that, hence some of our earlier discussions at the start of the year are about investing ahead of the curve.
Brian Cornell:
Kate, I think promotions, along with many of the other things we've talked about, are still obviously in the early stages. Now we're excited about the results that we've seen with remodels. But we have hundreds of stores in front of us. We've seen great responses in some of our small formats. But again, we'll open up dozens of additional stores over the next couple of years. The brands that we've launched have been well received. But we're really just getting into the heart of the brand launches as we go into the back half of '17 and '18 as well as the pricing and promo work. So we're very pleased with the progress. We know we've got much more work in front of us. But we thought today would be a great chance to give you a progress report and give you a sense for the amount of work and the scope of work that's taking place within Target. So that concludes our second quarter 2017 earnings call. I really appreciate all of you participating, so thank you.
Operator:
This concludes today's conference. Thank you for your attendance. You may disconnect your lines.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation First Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, May 17, 2017.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our first quarter 2017 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; Mark Tritton, Chief Merchandising Officer, and Cathy Smith, Chief Financial Officer. In a few moments, Brian, John, Mark and Cathy will provide their perspective on Target's first quarter performance and our plans and priorities going forward. Following their remarks, we'll open the phone lines for a question-and-answer session.
As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer your follow-up questions. As a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure, and return on invested capital, which is a ratio based on GAAP information, with the exception of adjustments made to capitalized operating leases. Reconciliations to our GAAP EPS from continuing operations and to our GAAP total rent expense are included in this morning's press release, which is posted on our Investor Relations website. With that, I'll turn it over to Brian for his comments on the first quarter and our priorities going forward. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. At our Financial Community Meeting in February, we outlined our multiyear plan to position Target to deliver consistent growth, market share gains and outstanding financial performance over the long term. This plan includes capital investments of more than $7 billion over the next 3 years, focused on continued investments in technology and our supply chain to build a smart network, a network that leverages all of our store and distribution assets to serve our guests more quickly and flexibly in every channel; investments to reimagine the shopping experience in more than 600 of our existing stores; and the addition of more than 100 new small-format locations around the country.
On top of these capital investments, we discussed our plan to invest $1 billion of operating margin this year to allow us to move faster in support of our strategic priorities. We said our biggest operating investment will be in our team, equipping them to deliver enhanced service, convenience and deeper product expertise as we prepare for the launch of 12 new and exciting brands over the next 2 years. Beyond these expense investments, we outlined our expectation for gross margin pressure resulting from the continued rapid increase in digital fulfillment, combined with the price investments to support our everyday value proposition in key categories. Among all the things we covered in detail at that meeting, one message I don't believe we emphasized enough is our continued commitment to strong execution every day in every part of our business. While we certainly need to focus intently on delivering our long-term commitments, we need to maintain an equal focus on maximizing the performance of our business every day, both in store and online, delivering for our guests and our shareholders. So I want to thank our team for very strong execution in the first quarter in a very choppy environment. They delivered sales and profitability that was meaningfully better than our expectations. In February, when we provided first quarter and full year guidance, we emphasized that our goal is to plan prudently and prepare to chase business when the opportunity arises, and that's exactly what happened in the first quarter. Following very soft trends in late January and into February, we saw an acceleration beginning in late February, which was followed by better-than-expected sales in March and April. While our comp sales were strongest in April, if we adjust for the Easter shift, we saw our best results in March. While we were pleased that our first quarter financial performance was better than expectations, our results are not where we want them to be, and we have much more work to do. Week-to-week results have been volatile since Christmas, and overall traffic declined nearly 1% in the first quarter. Along with this traffic decline, comp sales in both Essentials and Food and beverage were down as well. As we've mentioned in previous calls, we believe that consumer perception of value at Target has not reflected how low our out-the-door prices really are. As a result, we are in the early stages of implementing merchandising and marketing efforts to improve Target's value perception with guests and reestablish everyday price credibility on key items. As we implement those changes, we plan to measure carefully and adjust based on how guests respond. To support these efforts on our marketing, late in the first quarter, we launched a new ad campaign focused on our convenient and low-priced assortment of everyday items, reminding guests that they can save time and money by making a Target run to their nearby store. And for guests that prefer to get their essentials at home, we recently announced that we're testing Target Restock, which will allow guests to order a large box filled with items they choose from a selection of thousands of essential items. We've been testing this service with team members here in the Twin Cities, and we're preparing to extend this test to local REDcard holders in the near future. While some specifics of the offer have yet to be finalized, we expect to have a very competitive service compared with alternatives that are already in the marketplace. Beyond essentials, we are focused on growing the signature portion of our business, and we continue to be pleased with the performance of Cat & Jack and Pillowfort, the new Apparel and Home brands we launched for Kids last year. Based on our insights from last year's launches, Mark and his team are preparing to roll out additional brands later in the year as part of our plan to launch 12 new brands across our signature categories over the next 2 years. Beyond these efforts to reimagine our exclusive brand portfolio, we continue to find new opportunities to partner with world-class designers and brands, and deliver unique style and unbeatable value for our guests. In the first quarter, we were pleased with the results from our limited-time partnership with Victoria Beckham, which proved to be one of the single biggest partnerships in our history. In the digital channel, sales increased 22% in the first quarter, much faster than the growth rate of the industry. Mike McNamara and his team continue to work closely with both John's team and Mark's team to develop and roll out new capabilities, highlight our differentiated assortment and elevate the guest experience by providing more speed and convenience. We invested nearly $500 million of capital in the first quarter, and we're on track to invest more than $2 billion this year. Our technology and supply chain investments are focused on delivering a superior guest experience in every channel. In addition to new capabilities like Target Restock, which provide convenience, we're working to deliver a more inspirational digital experience, like the 360-degree shopping experience we just launched on our site. This capability was delivered by our CGI team, and we're investing to grow that team so we can rapidly roll out additional experiences over time. Beyond our continued investments in technology and supply chain, we're in the early stages of work to transform our existing store base and add to our portfolio of new small-format stores around the country. In the first quarter, we completed 21 existing store remodels and opened 4 new small-format locations. For the year, we're on track to deliver our goal to complete 100 remodels and add 30 small-format stores. I personally visit many of these locations, and the results look terrific. As we described in February, we are fortunate to have a strong balance sheet and a business that generates robust cash flow. Unlike many competitors, we have the resources that allow us to invest in the transformation of our business and position Target to compete in this new era in retail. Because our business is so strong, we expect to fund these long-term investments while continuing to support our dividend and annual dividend growth even during the period of transition. As we look ahead to the second quarter, we're committed to maintaining the cautious posture that served us well in the first quarter. While consumer spending growth remains strong, we're seeing a continued shift towards experiences, which is absorbing a meaningful portion of that growth. In addition to these consumer headwinds, we expect to see continued pressure from competitive closings and liquidations, which represent a long-term opportunity but divert consumer spending in the near term. And finally, our efforts to enhance value perception and regain everyday price credibility will likely create some near-term headwinds before we gain traction over time. So now I'd like to turn the call over to the team, who will provide additional detail on our performance and focus going forward. Later in the call, Mark will cover category performance and his team's efforts to support both sides of our "Expect More. Pay Less." brand promise. Then Cathy will provide more detail on our first quarter financial results and expectations for the second quarter and beyond. But first, I'm going to turn the call over to John, who will cover the team's current efforts to modernize the supply chain, invest in our store shopping experience and roll out new capabilities for our guests. John?
John Mulligan:
Thanks, Brian. This morning, I'm going to provide an update on our progress in rapidly testing and rolling out supply chain and technology innovations. These innovations are designed to provide more convenience, inspiration and faster fulfillment on behalf of our guests regardless of how they choose to shop. Then I'll highlight investments we're making in our stores to reimagine the shopping experience and roll out new capabilities that will help us drive sales in all channels.
In our supply chain and technology areas, our teams are moving quickly, testing and iterating on our ability to increase speed and offer new services for our guests. In our TriBeCa store in New York City, we are ready to begin a test in which we will offer same-day delivery to guests at that store. At checkout, guests will have the option to choose to have their orders delivered to their home later that day in a scheduled delivery window of their choice. This test presents an opportunity to gauge guest demand for this service in a high-traffic location filled with urban guests who will appreciate the convenience. Through this test, we will gain insights about potential operational challenges and determine appropriate pricing and delivery windows based on guest preferences. This will help us understand the potential to roll out a similar service more broadly over time. When I moved into my role leading operations, one of the first things I learned is that any supply chain test has to be accomplished in tandem with our current operations. As a result, we have to be very thoughtful about how we conduct a test because we don't want to make changes that might impair day-to-day reliability. In the second quarter, we plan to open a new facility in the Northeast that will allow us to test differentiated distribution capabilities, including store replenishment based on the appropriate unit of measure on every item, including pallets, case packs and eaches. By testing out of a separate facility, we can implement without disrupting day-to-day operations in any of our current facilities. This new facility will help us learn quickly about both opportunities and complexities associated with this new distribution model. I want to stress that we're opening this facility so we can test and learn quickly, not to create new capacity. In fact, given our opportunity to continue increasing the speed and flexibility of our entire supply chain and leverage our stores to enable digital fulfillment, we have ample capacity within our current network to grow for many years. As we gain insights from the test in this separate facility, we will be better informed and prepared to roll out this new model into existing facilities over time. Prior to the launch of the new East Coast facility, we have been testing daily customer replenishment based upon eaches in a single store here in the Twin Cities market. This store is much lower volume than our stores in the Northeast which provided us a much lower risk environment for this early test. Results have been encouraging as we've been able to dramatically reduce store labor dedicated to unloading trucks and stocking the sales floor, freeing up time for the team to focus on serving guests. In addition, we've been able to reduce inventory meaningfully and nearly eliminate backroom inventory of the items included in the test. And after some early bumps, we've done so without affecting out-of-stocks. With these insights, we are ready to move on to the next stage of testing with the new facility, and the team is eager to begin evaluating the results. With a faster and more reliable supply chain, we can develop new ways to leverage our stores and enhance convenience for our guests. An example is our upcoming pilot of Target Restock, which will begin rolling out to Twin Cities' REDcard holders this quarter. This service allows guests to order a restock shipping box filled with essential items like toothpaste, diapers, coffee and cereal and have them delivered to their homes quickly for a low flat fee. For the pilot, guests will have access to more than 8,000 items, and we'll continue to experiment and expand the offering based on our learnings and guest feedback. Because the items will be packaged and delivered from a nearby store, orders placed before 1:30 p.m. will be delivered on the following business day. We've built the Target Restock site and supporting back-end operations for a Twin Cities team member test in just 35 days. Based on what we learned in that test, we will launch an enhanced site for the Twin Cities pilot and continue to iterate on the experience. As we discussed at our Analyst Day, we believe that the future of retail is both digital and physical, and successful retailers will need to provide an outstanding experience in both. That's why we're moving quickly to elevate both the digital and in-store shopping experience, driving guest engagement and sales in every channel. For digital shopping, the challenge is to make it more experiential, delivering more of the inspiration you can find in a physical store. To elevate the digital experience in furniture and decor, which are already large and growing online businesses for us, we recently rolled out a 360-degree shoppable living room, which serves as a digital showroom. Seeing the products staged in rooms in relation to other products helps guests to better understand the size and style of an item, making it easier to shop. The experience will initially present about [ 120 ] products across 4 design aesthetics. As you know, more than 40% of our digital volume already runs through our stores, and we peaked at more than 80% last holiday season because we can offer both order pickup and ship orders directly from our stores. While all of our stores have offered order pickup for several years, we've worked hard to improve the experience and encourage repeat uses by our guests, and we've seen a payoff from these efforts. In the first quarter, more than 95% of in-store pickup orders were ready for guests in an hour or less, up more than 3 percentage points from a year ago. Our Net Promoter Score for the order pickup experience is improving steadily and is now actually higher than the score for our stores overall. In light of these trends, it's not surprising that repeat usage of order pickup has increased meaningfully compared with a year ago. First quarter ship-from-store volume was more than double last year's amount, accounting for 27% of our digital sales. This growth was partially driven by approximately 600 ship-from-store locations that we've added since last year. However, the increase was also driven by additional volume running through stores that had this capability for more than a year. Specifically, for the 460 stores that were shipping directly to guests in the first quarter last year, year-over-year growth in ship-from-store volume was 32% this quarter. We continue to be very pleased with the ability of our stores to accommodate these higher volumes, and our supply chain team is enhancing end-to-end processes to allow for additional volume over time. And importantly, the ability to ship directly from stores to nearby guests reduces our last-mile shipping costs dramatically. Beyond digital capabilities in our stores, we are also investing in our team in the front of the store. We're providing tools and changing processes to enhance our team's availability on the sales floor and making sure they are available during all hours the store is open. In addition, we're investing in training to equip our store team members with more product expertise in key areas like Food and beverage, Beauty, Apparel, and Electronics. And of course, we've begun investing in our existing stores to elevate the physical environment along with our level of service. Given that our 21 first quarter remodels were only completed recently, we don't yet have a statistically significant read on post-remodel performance. But early results are very encouraging. However, for the set of remodels we completed last fall, we have been measuring overall results in line with our expected 2% to 4% lift following completion. Most encouraging, for the 10 fall remodels in which the layout is most similar to the new layout we will roll out in Houston later this year, we have seen lifts near the high end of that range. It's also important to note that we have a customized approach to remodels, and we have a low-cost, high-impact model that we can bring to our lower-volume stores. Even at a lower investment, in the range of $3 million, there is a meaningful change in the look and feel of the store, and we see guests respond to that change, driving very healthy lifts in the 2% to 4% range as well. Finally, we continue to be pleased with the performance of our new small-format stores, which generate more than double the per-foot sales productivity of our larger-format stores. While we're happy with the performance of these smaller stores when they open, what's most encouraging is the continued growth we're seeing when the stores become mature. Specifically, for our 10 mature small-format stores, we are seeing double-digit comp increases on average so far this year. So I hope it's clear that our team is busy and energized, moving quickly with purpose to improve speed and agility and better serve our guests in every channel. Despite a challenging environment, I have never seen the team more focused on what we need to deliver and more confident in our path forward. Now I'll turn the call over to Mark, who will provide more detail on our performance and plans in merchandising. Mark?
Mark Tritton:
Thanks, John. As Brian mentioned earlier, we have seen very choppy trends since the end of the holiday season, and our team has moved quickly to adjust in real time. We began seeing signs of improvement in late February, and we saw the strongest performance compared with our forecast in March. We maintained solid results in April, benefiting from both our Victoria Beckham partnership and the Easter holiday.
As we've said many times, Target is a holiday destination, and we certainly saw that during the Easter season. We saw the strongest growth in candy and Easter decor, but we're also pleased with performance in Toys and Kids' Apparel in the weeks leading up to the holiday. And then there's Victoria Beckham. Given the brand she has created, we knew that our partnership with her would be big, and it delivered. More than half of our Victoria Beckham sales were made up by our most loyal guests. And in 5 cities, we hosted our best REDcard guests at exclusive events, providing early access to her products. Victoria Beckham baskets were more than twice the size of our average transaction, and they weren't just focused on her items. In fact, they were nearly balanced between Victoria Beckham items and items from our broader assortment. And not surprisingly, her items sold particularly well for us online. Overall, we are very pleased with the results of this partnership, which has proven to be one of the biggest in our history. While macro factors likely drove some of the acceleration in March and April, we also saw the impact of warmer weather on our Seasonal categories and our Electronics business leapt forward with the launch of the Nintendo Switch. Nintendo has long been aligned with our brand, given their history of delivering hardware and games orientated around activity and families. We worked closely with Nintendo team to launch the Switch, supported by a multifaceted marketing plan that was visible both inside and outside our stores. We also supported the launch online and saw great results by delivering a bundled offer for the Switch on our site. As a result of these efforts, we've enjoyed a mid-teens market share in Switch since the launch. This is a great example of the power of a successful collaboration with a national brand and why we love to partner with world-class brands to create Target-unique, differentiated experiences for consumers. Beyond video games, Electronics also benefited from healthy growth in Apple Watch and iPhone during the quarter. As a result, for the first quarter in total, Electronics delivered a mid-single-digit comp sales increase, the strongest in 3 years. In Apparel, trends have been challenging across the industry, and we saw a small decline in Apparel comps in the first quarter. However, when we compare our results to the industry, we continue to measure meaningful market share gains. Last year, our Apparel sales and market share gains were heavily concentrated in women's ready-to-wear and Kids' Apparel. This year, those categories continue to gain share, but we're also seeing gains across all of the subcategories, including Men's Apparel, intimates and Performance Activewear. Trends in activewear have improved meaningfully since the relaunch of our C9 brand after the holiday season. Swim is another big first quarter story in Apparel, and we expect that to continue all year. As you know, we already have the #1 unit share in swim, but as other retailers began closing and exiting this business, we saw a big opportunity to gain an even stronger position. Our team worked quickly to launch our new brand, Shade & Shore, which has delivered strong results since its launch. Given this momentum, we expect to see continued growth in Swim in the second quarter and beyond. For our less discretionary essentials and Food/beverage businesses, first quarter market share trends were more challenging. For the quarter, we saw low single-digit comp declines in both of these businesses, and we are taking steps to regain our value and everyday price perception in both of these. This work began in the first quarter, and we recently launched our "Target Run. And Done." marketing campaign to support that work, but we have much more to do. In the second quarter and beyond, we will continue to invest in our regular prices and reinforce our everyday positioning. An important part of that work is to adjust our promotional posture on those items and categories so they better support that everyday message. In addition, we will work to balance our promotional posture between stock-up offers and factors important for fill-in trips, including an emphasis on individual items and a low opening price point. I want to stress that this work is very detailed and surgical. There isn't a single solution across items and categories so our team will be testing and iterating at a very granular level, and they'll be expanding the scope of their work as the year progresses. Importantly, as Brian mentioned, as we are implementing these changes, we may see added pressure before we begin to see the benefit. However, we know this is the right thing to do, and we're committed to making these changes to better position our business over the long term. While value and everyday price perception are a challenge in our Food and beverage category, I want to stress that we are seeing a couple of bright spots. First, we saw a small increase in produce comps in the first quarter, reflecting the work we've done to gain credibility in this key part of the assortment. We have worked with the produce vendors to reduce the time from their fields to our network, and John's team has increased the speed of produce items into our stores once they reach that network. As a result, freshness and in-stocks have been improving. We're also benefiting from the work in our stores to hire grocery experts and organize specialized teams who now own the end-to-end process in those stores. Another great bright spot is our adult beverage business, which saw a mid-single-digit comp increase this quarter. We continue to focus on developing localized assortments and more compelling displays, and our guests are really responding. We plan to expand space for adult beverages in more than 100 additional stores in the second quarter, with more planned for the third quarter and beyond. I also want to pause and welcome Jeff Burt, who joined us in April to lead our Food and beverage team. Jeff comes to us with more than 30 years of grocery experience, most recently leading Fred Meyer. Jeff is off to a great start, and I look forward to working with him to further strengthen this business over time. At our Financial Community Meeting in February, we announced our plan to roll out 12 new exclusive brands across our signature categories through next year, and we're getting ready to launch the first of those brands later this month. It's called Cloud Island, and it's a new exclusive line of nursery décor, bedding, bath and layette products designed by our own internal design team. We've built this collection of more than 500 items to be both stylish and affordable with a focus on safety, durability and comfort. We'll roll out the décor and bedding items to all stores and our site beginning May 28, and we'll follow with the bath and layette pieces later in the summer. This new brand is a natural addition to the successful Kids brands we launched last year, Pillowfort and Cat & Jack, which continue to perform really well. The guest response to Cat & Jack, in particular, has been amazing. Among guests who purchased Kids' Apparel from Target in the months leading up to the launch of this new brand, spending on Kids' Apparel increased more than 50% in the months following the launch. This increase in spend was driven by both frequency and spend per visit. Even more encouraging, the launch brought an energy and traffic to the whole category, leading to an increase in spending on Kids' clothes at Target even among guests who didn't buy Cat & Jack. This shows why we are so excited about our plans to launch additional signature category brands later in the year and even more next year. So in closing, let me leave you with a final thought. We understand that we're in the midst of very challenging period in retail, and we're in the early stages of our plan to transform our business. That said, you wouldn't feel that way if you interacted with our team. They're energized and hungry to win, and focused on doing what it takes to get there. With that, I'll turn it over to Cathy, who will provide more detail on our first quarter financial performance, and outlook for the second quarter and full year. Cathy?
Catherine Smith:
Thanks, Mark. When we provided first quarter guidance at our Financial Community Meeting, we described the challenging results we had seen so far in February. At the time, there were theories for why things might improve, but we felt it was best to plan for those challenging trends to continue and react quickly if conditions improved. As we look ahead, we believe it's appropriate to continue to take this cautious approach as we plan for the rest of the year. After all, the environment remains volatile, and the disruption from competitor closings doesn't look like it will change anytime soon.
For the first quarter, comparable sales fell 1.3%. A little over half of this decline was driven by traffic, combined with a small decrease in average ticket. As we've said many times, traffic is the key metric for us. So we're taking steps this year to put us on the path back to growth over time. First quarter gross margin rate was down about 40 basis points to last year, driven by increased fulfillment costs resulting from the growth in our digital sales. Merchandise mix had a roughly neutral effect on our gross margin rate this quarter, reflecting the acceleration in Electronics that Mark described earlier. While gross margin dollars declined about $130 million from last year, this performance was much better than expected, driven by better-than-expected sales and fewer clearance markdowns compared with our plan. On the SG&A expense line, first quarter dollars and rate were better than expected as well. Consistent with our plan for the year, we began ramping up store labor on the sales floor. But in the first quarter, those investments in front-end labor were offset by savings in backroom logistics. In addition, we saw some timing favorability on several expense lines in the first quarter, which we now expect to see in the second quarter. Our first quarter depreciation and amortization rate was up about 20 basis points compared with last year, reflecting increased costs from our remodel program on a lower base of sales. Altogether, our EBIT rate was 7.4% in the quarter, down from a very strong 8.2% last year. At the end of the quarter, inventory was more than 5% lower than a year ago, reflecting the early impact of our work to increase the speed of our supply chain. As I've mentioned before, we believe we have a compelling opportunity to free up working capital over time by increasing the speed and accuracy of our supply chain. We're in the beginning stages of that journey, but it is encouraging to see early signs of progress. As Brian mentioned, we invested just under $500 million of capital in the first quarter. A portion of these investments was focused on our stores as we started to transform the shopping experience in existing locations. In addition, we continue to grow our portfolio of small-format stores. We also invested in supply chain and technology to support new capabilities, including those John described earlier. For the year, we will continue to focus our investments on these priorities, and we expect our full year CapEx will be in the range of $2 billion to $2.5 billion. On top of expenditures for new capital, we paid more than $330 million in dividends in the first quarter and repurchased just over $300 million of our stock, primarily through a preexisting trading plan that was put in place last year. As we consider full year capital deployment and cash flow compared with last year, higher CapEx and lower EBITDA will certainly put some downward pressure on cash flow. However, we also expect some offsetting tailwinds in 2017 as we continue to reduce working capital. Altogether, as we discussed at our Analyst Day, we expect to continue to have ample capacity to support the dividend and grow it annually, and over time, to the extent we have excess cash beyond CapEx and dividends, within the limits of our current debt ratings, we expect to have the capacity to repurchase our shares. However, given the recent change in our operating model, we will stay relatively cautious about the pace of share repurchase in the near term. My final comment on the first quarter is in reference to our return on invested capital. We earned an after-tax ROIC of 14.2% in the 12 months through the end of the first quarter. I hope you'd agree that is healthy performance in any industry and any environment, but it's also slightly better than Target's ROIC through the first quarter of last year, excluding the onetime gain from our sale of our pharmacy business. I think that's helpful perspective as we move through a year of meaningful transformation. We are blessed to have a business that continues to generate good returns and have a strong balance sheet. That powerful combination gives us the flexibility to make changes that will position our business for continued success in this rapidly changing period in retail. Now let's turn to our outlook for the second quarter and beyond. We are planning for a low single-digit decline in comparable sales in the second quarter. Just like the decision we faced in the first quarter, we could plan for a more optimistic scenario, but that would create undue risk in a very choppy environment. On the EBIT line, we are planning for a decline of just over $200 million compared with last year. We expect SG&A expense to be the primary driver of that decline as we continue to invest in store service and new capabilities, and we see the impact of the timing shift on several expense lines from the first quarter. On the EPS line, these expectations translate to a range of $0.95 to $1.15 for both GAAP and adjusted EPS in the second quarter. For the full year, we are not updating our prior guidance. As a reminder, that guidance anticipates a low single-digit decline in comparable sales for the year and adjusted EPS of $3.80 to $4.20. Clearly, given that first quarter performance exceeded our expectations, there's a higher chance that we'll finish the year in the upper end of that range. However, with most of the year still ahead of us and the prospect for continued near-term headwind, we believe these expectations are still appropriate. Before I turn the call back over to Brian, I want to thank you for your continued engagement and support. Following our Financial Community Meeting, we've heard from many of you, and as always, we appreciate your perspective. What's most encouraging is your support of our strategy and the steps we're taking to position our business for the long term. Just as we do, you clearly see the risks and challenges in this environment, so it's been very helpful to know that you also believe in our strategy and the long-term investments we are making in our business. With that, I'll turn the call back over to Brian for some final remarks.
Brian Cornell:
Before we turn to questions, I want to offer a few closing thoughts. First, while we're certainly pleased that Target's first quarter performance was better than expectations, we're not doing any high fives in the room here today. Our first quarter performance is not what we expect to deliver over time, and we're investing and moving quickly to deliver stronger, more consistent results in the future.
When we look ahead, we do so with our eyes wide open, aware of the challenges we're facing. But when I interact with our team, I see a lot of energy and optimism, a desire to deliver for our guests and win in the marketplace. What's most encouraging is the team's agility and responsiveness in a rapidly changing environment. Whether we're talking about the development of Target Restock by our technology and operations teams, the rollout of a new ad campaign like "Target Run. And Done." from our marketing team or the development and launch of a new brand like Shade & Shore from our merchandising team, everyone is focused on innovating rapidly like never before. I'm continually proud and impressed by what this team can accomplish. This concludes our prepared remarks. Now John, Mark, Cathy and I will be happy to take your questions.
Operator:
[Operator Instructions] Our first question comes from Paul Trussell with Deutsche Bank.
Paul Trussell:
Wanted to just inquire about the initial guidance given this year around the $1 billion investment. You mentioned some timing factors between SG&A in 1Q and 2Q. But even looking at the guidance provided for 2Q, the first half is certainly running at a run rate below that of $1 billion in investments. Help us just understand, have there been meaningful offsets? Or should we expect a spike perhaps in that investment pace in the second half?
Brian Cornell:
It's Brian Cornell. Paul, we're very focused on executing the plan we laid out back on February 28. So you're going to continue to see us invest in store labor, making sure our standards continue to improve, and we saw very strong progress in the first quarter; invest in value and continue to invest in the growth of our digital business. So over the course of the year, we're committed to executing against that plan. We'll see that continue over the second, third and fourth quarter. But the plan we've laid out back in February is the plan we're going to continue to focus on executing throughout the year. Our overall focus is to continue to see traffic patterns grow in our stores, improve and accelerate our digital performance. We want to make sure we're capturing market share as we did in the first quarter; continue to build and invest in our brands and, ultimately, improve our value proposition with the guest. So there's going to be no change to the plan we laid out in February. We're committed to executing and making those investments over the balance of the year.
Paul Trussell:
And just as a quick follow-up, Cathy, you gave guidance for negative low single-digit comps in 2Q. Just help us understand some more of the puts and takes from a category standpoint. How are you guys focused on improving traffic trends back into positive -- on the positive side -- yes, sorry, excuse me, on the positive standpoint. And then also, specifically, if you can speak on Food and essentials, is really what I would like to dig on, on how we get that positive as well.
Catherine Smith:
Yes. So we are working to restore positive traffic and, more importantly, preference over the long term, and I think that's everything you continue to hear us say. And so over the course of Q2, we're going to just keep doing what we said we would do, and that is we're going to make sure we're continuing to invest in a great experience for our guests, both online and in stores, and you'll see us doing that. Mark and the team have some really exciting things coming into Q2, but don't want to dismiss the positives we saw around category mix in Q1 even. So I'm just going to tell you we're just in this for the long haul. We're going to keep doing what we said we'd do, and restoring positive traffic's high on our priority list. Mark, did you want to talk about anything in particular with regards to Food and beverage?
Mark Tritton:
Yes. Paul, in terms of promotional posture and the price/value equation, we've made some rapid changes in a number of our signature categories, but probably the key areas that we're focusing on, of course, are Food and beverage and Essentials. So we've been testing and iterating quickly since Q4 and definitely in Q1, and we'll see an evolving pattern of change and evolution on how we'll roll out both the communication to the guests and the simplification of our everyday price positioning. And you'll see that evolve more deeply in Q2 and then beyond.
Operator:
Our next question comes from Simeon Gutman with Morgan Stanley.
Simeon Gutman:
So just to follow up on the guidance for the second quarter, can you just talk about the change in momentum that you experienced in March? Do you think that was the environment improving? Or was it some of your actions? You mentioned, I think, Victoria Beckham, and I don't think these things have been material, but I know that, that product line came in March. And I don't know the timing of Electronics and Switch. And then the compares, I believe, get easier -- or got easier in April and stay relatively easy for the quarter. Can you give us a sense, is the run rate deteriorating? Or is your outlook just being conservative at this point?
Brian Cornell:
Simeon, let me start by really summarizing Q1 performance. And certainly, I think we saw some changes in the overall macro environment, but I also saw -- we also saw very strong execution, both from a digital standpoint where we grew the business by 22%, but also meaningful changes in-store. And I think our store standards and our store execution continues to improve. I also think we showed great adaptability in the marketplace, and I'll let Mark talk about some of the successes we saw in categories like Apparel. But I'd highlight the efforts that we've put behind our swim business, where we started out with a #1 share position, but we saw changes in the marketplace, competitive closures, competitive exits. And as we talked about back in February, we are absolutely focused on taking advantage of market share opportunities over the next 2 or 3 years, and this was a great example where Mark and his team recognized the consumer opportunity, saw a change in the competitive environment, quickly build a brand by partnering with our vendors and introduced Shade & Shore during the first quarter, which allowed us to take even more market share in swim. And it's a great example of the work that we're going to continue to focus on over the next few years
Mark Tritton:
Yes. I think it's a great example of we're excited about our new brand launches as we've been testing, learning and constantly iterating to create new ideas, and they're really resonating with our guests. So as Brian talked about, the story here is really one about agility and market insight. So in -- where we already had a strong #1 unit market positioning in swim, we didn't rest on our laurels, similarly to our action in Kids, and we looked at this market with declining players and saw an opportunity to win even further. So we looked at deep guest insights, market insights and worked really, clearly, closely with our vendor insights to create a new brand, a new paradigm and a new service level for our guests all in a very rapid period of time. Launched in Q1, Shade & Shore gained share in hearts and minds of our guests and is creating accelerated growth and real confidence for us as we build our brand portfolio. And it's important to note, as Brian said, this was an omnichannel play. So we looked at both stores and online to meet the guest needs and get exemplary results.
Brian Cornell:
More work to do as we go into Q2. But as we talked about during our prepared comments, Q1, we remodeled 21 stores. We've got much more work to do over the balance of the year. We opened up 4 new small formats. We've started to make very surgical investments in value and simplify our value communication in-store and amplify that with a new advertising campaign that we call "Target Run. And Done." So in the early stages, we're going to continue to build off of that. We want to make progress every quarter. But we recognize it's going to take time, and we're going to stay very focused, very measured against the initiatives we've laid out. And quarter by quarter, we're going to strengthen our performance, continue to drive traffic to our stores, more visits to our site and capture market share as we improve our value perception and continue to build proprietary brands within our portfolio.
Simeon Gutman:
And then, if I can ask one follow-up on investments. You mentioned you're starting to make some value investments. Can you give us any color on time frame, on categories? Is it broad-based? And back to the earlier question, it looked like this quarter, the decline in EBIT looked commensurate with the comp decline. It didn't look like this was a big period of investment. And again, behind the scenes, there might be that we don't see. So just curious of how we should lay that out for the rest of the year.
Brian Cornell:
I mean, as Mark and Cathy have both discussed, we are making investments in value, very much focused on household essentials and Food and beverage. Those are going to continue over the balance of the year, and we're going to be very surgical. We're going to measure and iterate. We've already made some significant progress in simplifying our overall value and promo communication and now enhancing it with additional advertising dedicated to those core household essential items that drive trips to our stores. So you're going to continue to see that focus, not only over the balance of this year but over time.
Catherine Smith:
Maybe, Simeon, I'll add on just real quickly. So on -- let's look at the SG&A line, in particular, to give you an example. We invested more hours in the store, in store service and store experience, and obviously, we also invested in marketing. But it's being offset because of all of the work we're doing around -- in our supply chain and fulfillment. In the back rooms of our stores, we're starting to see some of the benefits there. Again, we're early days in a long journey, but you are seeing some of that offset. So it doesn't show up as apparently on the SG&A line. And then I'd remind you to look at -- I mean, clearly, not where we want to be with sales down slightly and EBIT down quite a bit more. So the investments are coming through as we said, and it's not going to show up in any given quarter. It's going to show up over the time.
Operator:
Our next question comes from Edward Kelly with Crédit Suisse.
Edward Kelly:
Could you talk about how your strategy in Food may evolve with the hiring of Jeff Burt from Kroger? And I guess, if you were to take a step back and really start to think about it, what are the 2 or 3 things that you really are looking for him to accomplish here?
Brian Cornell:
Let me start. First of all, Jeff has only been on board for a handful of weeks, so still in the early period of time, really trying to understand our business, assimilating to the Target environment. So we want to certainly give him plenty of time to assess our business and begin to build strategies going forward. But I think it's important to recognize he's not starting from square one. Over the last couple of years, we've been very focused on improving the quality of our fresh assortment. And the work that our merchandising team and our supply chain team have done, we've made significant progress in improving freshness, evolving our assortment to make sure we have more organic, natural, gluten-free items in our assortment in each and every category where we participate in Food and beverage. As you've heard us talk about time and time again over the last few quarters, we made significant progress in categories like adult beverages. So Jeff will build off of that work. We've certainly recognized, based on the work we've done in Los Angeles with the LA25 remodels and additional remodel activity in the Dallas-Fort Worth market, that as we change the in-store environment and elevate the presentation, the guest is responding very, very well. So we want to give Jeff plenty of time to take his own inventory, begin to build his own strategy that will enhance the work that we've been doing over the last couple of years. And we're very confident that over time, Jeff's going to build a plan that will allow us to continue to accelerate our performance in those important Food and beverage categories.
Edward Kelly:
Just a follow-up related to Food. On Monday, there was an article on -- in The Journal about you guys. I'm sure you saw. There was a mention in there about maybe your interest in Sprouts last year. I'm just curious as to -- how do you think about acquisitions generally? And are you interested, willing and thinking about out-of-the-box alternatives through maybe like M&A to reposition this business?
Brian Cornell:
Ed, we look at M&A opportunities all the time, but we look at them through a filter of what's going to really enhance our current business initiatives. So I would put out-of-the-box on the side and really think about M&A as something that's going to complement and strengthen our core strategy, help us accelerate, complement the interaction we have with the Target guest, and we'll continue to look strategically at M&A opportunities over time.
Operator:
Our next question comes from Michael Lasser with UBS.
Michael Lasser:
It's on the investments you're making this year. To what degree are you moderating and altering them based on the week-to-week and the sales trends that you're seeing? So if sales are better than expected, are you actually pulling back on some of those investments?
Brian Cornell:
Michael, we are very focused on executing against the initiatives and investments we outlined earlier in the year. So we'll continue to iterate as we learn through our remodel experience, as we continue to open up new small formats. We learn every day as we develop new brands. But our focus remains the same, so you shouldn't expect to see any drastic changes. And we'll continue to mature those initiatives over time.
Catherine Smith:
If anything, what I would say, Michael, is we're accelerating. When we test and learn and validate, we accelerate our investment into that area. And so that's where we're looking across the company. When we see an opportunity to accelerate something that's working along our strategies, that's what we're doing.
Brian Cornell:
Look, Michael, over the next couple of years, you should expect us to continue to focus on reimagining our existing stores. Adding new small formats that bring us into urban markets and on to college campuses, our continued investment in supply chain and technology, the support of our new brands that we'll be launching over the next 18 months, those commitments will not change. And our focus is on execution. And I think what we saw in the first quarter is a company that's making progress, we still have a long way to go, but continuing to focus on executing each and every day, both in our physical and digital channels. And that's not going to change over the next few years.
Michael Lasser:
Brian, within the grocery and essentials category, can you give us a sense where you think your pricing gap is to the market today and where you think it needs to be over time?
Mark Tritton:
Yes. I'm happy to take that, Michael. I think that -- we started work here in earnest in Q4 and continuing with healthy work in Q1. We actually show our indices are actually closer than the guest gives us credit for, and that's an issue for us because we know that's a bigger message that we need to convey. So we're continuing to sharpen our price and our value messaging at the same time and make sure that we move to a more regional-based pricing, localized pricing so we're more relevant to the guest and the competitive set, which is not what we're doing during '16 and we've rapidly iterated on in '17. So you'd see more of that activity and more of that benefit as we move through 2017.
Operator:
Our next question comes from Kate McShane with Citi.
Kate McShane:
With regards to moving to EDLP and the value messaging, I just wondered how much that move weighed on margins in Q1 and where you're seeing more success in that move and where you think you have more work to do. And then, in that same context, I think you've noted before that there's been fits and starts with how you've communicated your value message. Can you explain how and what you did during Q1 to convey that better to your customer?
Catherine Smith:
Yes. So I'm happy to start, Kate, and then Mark can amplify as well. So on the impact that we saw coming through gross margin, as Mark shared and we've shared actually for a couple of quarters, our biggest work has got to be around making sure that the value we're delivering is really clear. And it's going to take a while for our guest to give us credit for that, and so that's the work that we're going to continue to do. So while we're sharpening and making it more regionalized, you'll see that come through slightly. But the bigger effort is all of the work we're doing like the "Target Run. And Done." campaign that we launched this last quarter and making sure that our guests recognize the value we are delivering.
Mark Tritton:
Yes. I'd just add into that, Kate. Our efforts, as we've discussed, are quite surgical. So we're doing this area by area, classification by classification as an evolving transfer. And we've really begun those efforts through Q1 but more in the back end as we matched to the "Target Run. And Done." campaign. So what we're seeing here is, on the handle side, we've been clear that we've had up to 28 different handles that we've been using to resonate value across all our classifications. So rationalizing the voice and the nomenclature down is part of that. So we -- that's why we've come into Q2 with an evolving position, and we'll assess its impact and its opportunity.
Operator:
Our next question comes from Greg Melich with Evercore ISI.
Gregory Melich:
I had a couple of questions. One, Cathy, sort of a housekeeping. You mentioned there was a timing issue in SG&A. Could you quantify how much that helped SG&A or how much we should expect it to come in, in the second quarter?
Catherine Smith:
Yes. As we said in our Q2 remarks and guidance, that we expect a couple hundred million dollars of EBIT decrease, and we also said that the majority of that would be in SG&A. So it's pretty -- I think it's pretty safe to assume that, that would be how I'd quantify the shift from Q1 into Q2.
Gregory Melich:
Got it. That's helpful. And then a bigger-picture question. We've talked a lot about traffic, but I don't think we've touched yet on the loyalty programs and the frequency you could drive from REDcard and Cartwheel. And been a lot of change in the market, whether it's Amazon Prime or Costco with their new credit card or Walmart with free shipping thresholds lowering. How are you guys thinking about integrating those programs to really help drive traffic? And is there a time this year we should expect to see that maybe enhanced or rolled out?
Brian Cornell:
Greg, we'll talk more about that in the second half of the year. We're spending a lot of time right now with Rick Gomez, who's now our Chief Marketing Officer, really stepping back and thinking about loyalty and, importantly, as you just said, the integration of the REDcard into that loyalty program. And one of the other highlights from the first quarter is the continued penetration growth of our REDcard. So we recognize that's a very important asset that we need to leverage going forward, and Rick and his team are working right now to think about the next phase of loyalty and how we continue to leverage the REDcard to build even a stronger relationship with our guests. So you're spot on, and we'll talk about that much more in the second half of the year.
Gregory Melich:
And on sales, if I could just follow up, it sounds like sales improved in March and April, but we're still negative. I just want to make sure that's right.
Brian Cornell:
Greg, you know we don't break out monthly sales. As we said, we saw strengthening in the latter half of February, into March and April. But obviously, our comps were still down for the quarter, so we've got work to do. We're not satisfied with where we ended up. But we certainly feel good about the progress we made in the quarter and, importantly, the market share gains that we saw in very important signature categories. So we're focused on driving traffic. We are certainly committed to restoring positive comps throughout our system. But one of the other important metrics that we're going to be looking at every single quarter is how we're performing from a market share standpoint, and I feel very good about some of the market share gains that our team achieved in Q1. We're going to continue to focus on market share opportunities throughout the year.
Operator:
Our next question -- or final question comes from John Zolidis with Buckingham Research.
John Zolidis:
A question on the performance of the smaller-format stores. You mentioned that they had sales productivity roughly 2x that of the larger, more suburban-based stores. Aside from the difference in either being an urban or suburban location, what do you attribute -- or what can you tell us about why the productivity of those boxes is so much better? And is there any learnings you can take from the small-format stores to extend to the balance of the chain?
Brian Cornell:
John, there's a lot of learnings that we're bringing forward from those small stores, not only as we expand into new markets but as we think about application to our traditional stores. I think the biggest learning is, as we move into these new neighborhoods, consumers love Target and they love the brand. And the response we're seeing has been really outstanding. So we feel very good about our small-format strategy. As we move into new neighborhoods, we're getting better and better at curating and localizing assortments, understanding how to operate in various markets. And we're also encouraged to see the early comp results as we lap some of the new small formats we opened up last year. So encouraging signs, and we're going to build off of that as we go forward. So we feel good about the progress we made in Q1. But as a team, we're not doing high fives. We know we've got a lot of work to do. But I think it's important, as we end, to recognize, as a company, we have a very strong foundation. If you look at our results in the first quarter, we generated $16 billion of revenue. Our operating income was almost $1.2 billion. We were able to invest $500 million of CapEx and still see a very strong return on invested capital of over 14%. And as we did that, we were able to reduce inventories by over 5%. So we know we've got a lot of additional work to do, but I think it's important to recognize we're a fundamentally sound company. We've got a very clear strategy in place, and now our focus over the balance of the next 3 years is week-to-week execution, both from a physical and digital standpoint.
So we appreciate you dialing in today. We look forward to talking to you at the end of Q2. And operator, that concludes our call. Thank you.
John Hulbert:
Good morning, everyone. It's really nice to see you all out there today. Thank you very much for coming. We have a lot to cover today, so we're going to get started in just a minute, but we have a couple of important disclosures up front that I'm just going to read verbatim to you.
Any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described on our SEC filings. And the second one is our earnings press releases and SEC filings available on target.com/investors provide reconciliations of adjusted EPS to our GAAP results and a reconciliation of the non-GAAP components of ROIC. With that, we'll get on with the show.
Brian Cornell:
Well, thank you, John. Welcome, and thanks for joining us this morning. Today, I'm going to provide an overview of our strategy. I'll talk about where we've been, and more importantly, what's next. John will share more details about what we're doing to get there. And then Cathy will walk through our financial model. At the end of that, we'll spend the balance of the program taking your questions.
As you all know, we've been on a multiyear journey to redefine the future of our company, to compete and ultimately win in this new era of retail. For the past several years, we've been watching several key consumer trends emerge. People are placing greater value on experiences. Often, they'd rather live it than own it, especially young people. When they buy, they want to buy into a greater purpose, not just a product. Taken together, these changes can only be described as a profound shift in the consumer mindset. Then combine that with the different behaviors around how and where consumers are choosing to shop. Today, there's total transparency. Ease and speed are paramount. The shift in channel preference is real and only gaining momentum. Our industry is in a midst of a seismic shift. And of course, you read the headlines. In fact, many of you write the reports. We're operating in an incredibly challenging environment. All across the retail industry, many of our competitors are aggressively rationalizing our assets. They're closing stores, exiting markets. They're cutting costs just to keep their heads above water. We've not seen this number of distressed retailers since 2009 in the Great Recession. This contraction will create opportunities for Target to pick up market share over the long term, but aggressive promotional activity will create pressure on our business in the near term. At the same time, there are others who are thriving in this new environment, so the changes we're making are aimed squarely at moving Target into the retail winners circle. Now I stood before you a year ago, and I laid out 5 key priorities. I talked about on-demand shopping, establishing category roles, localization and personalization. I talked about small formats. And I talked about simplifying and controlling our costs. And we've made good progress executing against these priorities. But it's become very clear that our efforts were not enough to win in this changing and challenging environment. And you've seen that in our recent results. We'll continue to have these same priorities, but today, we'll tell you what's going to be different. We all know the industry shift has begun to accelerate, and we believe that rate of acceleration will only continue to increase. You see it. Our competitors see it. John, Cathy and I, well, we live it every single day. But what I want to talk about today is how, at Target, we're embracing this new reality, how we're building a company that's poised to lead and grow market share in digital and in our stores and how we're laser-focused on mastering execution and accelerating our efforts to become an even stronger competitor. Let's go back to 2014, the Black Friday weekend. In 2014, more than 93% of our transactions took place in stores, less than 7% digital. That season, we had just started shipping from a small number of stores. 2015 that same time frame. Digital sales reached almost 10% of our total sales. We more than doubled our ship-from-store capability to nearly 500 stores. We fulfilled 41% of all of our digital orders inside of a store. 2016, just a few months ago, just last year. Digital sales climbed to 14%, more than twice what we did 2 years earlier. We doubled ship-from-store again, more than 1,000 stores. Our stores were fulfilling 68% of our digital orders. We finished December with record digital growth, including record-breaking days on both Thanksgiving and Cyber Monday. We realized, on more and more shopping journeys, our guests are looking to save time by using digital, and we only expect that trend to continue. But I know and you know this channel shift comes with additional challenges. Today, that essential base Target run doesn't completely translate to the new digital world. Traffic drivers are fundamentally different. And guests behave differently, too. Put a guest in a store, they're looking for inspiration, they enjoy discovery, they enjoy shopping. But very often, a visit to target.com, it's far more transactional. One item at a time, log on, check out as fast as possible, friction-free. Now we've proven we can build baskets with more storytelling and inspiring site merchandising, like we've done in Kids with Cat & Jack. So there's an incredible opportunity for us to do more, but we also need to make sure we don't impede efficiency or complicate the overall experience in the process.
So this combination of changing behaviors and expectation, it's certainly causing stress in our model. But the reality is, this is where the guest wants to be. We will never be successful if we dig in and insist they shop the way their parents did. So as I said before, given these realities, we're embracing the change. We're reimagining and repositioning our assets to deliver even greater competitive advantage going forward. It's moving from a very linear model:
Supplier, distribution center, store to guest, to creating a smart network where distribution centers, stores, digital channels, they become guest-facing access points where Target's always on, where Target is always within reach, down the street, on your doorstep or simply in the palm of your hand.
So the challenge ahead is really about continuing to understand how consumer preference and expectations are evolving, anticipating where they're going, what they'll want before they have to tell us, finding new ways to engage at every stage, in every occasion, offering and clearly communicating compelling value in every interaction at every touch point. And building a new Target that's uniquely positioned to compete and win, delivering on 2 pillars of market share growth:
1 digital and 1 physical.
So this morning, I want to talk about what that looks like, the capabilities we're building, the investments we're making to emerge as a stronger competitor and ultimately grow. But I don't want to gloss over the important point. This isn't work we just started. These aren't things we'll eventually do. These are initiatives that are well underway, and we're making progress. What is changing is our speed. Maintaining our current margin rate will not allow us to go fast enough. We're aggressively investing in the business to make sure we're highly competitive on price across our assortment all day and every day. We're making significant capital investments that will position Target for the long run, long-term sustainable growth. And all the while as the investments take root, you'll see a much sharper focus on execution every day in our stores, every day online, every day throughout our enterprise. So let's start with some of those foundational capabilities we've been testing, building and beginning to scale. These are nonnegotiables for any retailer that's going to win in this new era. These initiatives represent significant investments in terms of capital and talent, and they'll continue to be among our highest priorities in the years ahead. In the last 3 years, we've more than doubled our digital sales, from $1.4 billion in 2013 to more than $3.4 billion last year. And we did that in large part because the investments we made to re-platform our sites and mobile channels. Today, we have an entirely new engine under the hood. It gives us vastly more power in terms of speed, stability, performance and capability. We set up new functions, investing in top engineering and data science talent and trained them to make sure their scope impacted the entire enterprise. Now not long ago at Target, this was a new function. Today, it's one of our core strengths.
When I think about stores, when you look at our store base, you can see that we've been highly intentional with our real estate strategies:
Prime first- and second-ring suburban locations. By and large, we're not tethered to shopping malls or isolated on some interstate far from guests.
But as you move from coast to coast, this experience is uneven at best. In L.A, Chicago, Boston, we have some beautiful stores, but we also have a large percentage of the portfolio where the buildings just don't match the brand. They're old, they're tired and they haven't been updated in years. As you know, we spent 2016 testing the best of our enhancements from our store prototype pilot in L.A. And now we're rolling the best of the best as well as the new features, to hundreds of stores across the country. Each store is going to look and feel like a totally new Target. We also see tremendous opportunity expanding our footprint in the key urban neighborhoods and on major college campuses. The store functions in every respect as a store, you can place shop, but they're also just as much hyper-local fulfillment centers. Take a look at what we're doing right here in New York. Until now, we left this massive opportunity on the table because we didn't have a solution to literally fitting Target into Manhattan. I can tell you those days are gone. And just during the last 6 months, we've opened up 3 new stores in TriBeCa, downtown in Brooklyn and Forest Hills, Queens. 3 very different sites, 3 different neighborhoods, 3 completely different experiences, each one customized to fit the neighborhood. And I can tell you, you can expect to see more and more of these across the city. In New York and beyond, we've been purposely very disciplined in our approach, but now I can tell you it's time for us to accelerate this new format. Behind the scenes, our supply chain is in the midst of a total transformation aimed at leveraging our proximity to the guest to unlock even greater value. How do we get just the right amount of product to exactly the right place at exactly the right time? The work underway is game-changing for Target. It will significantly reduce cost and dramatically improved speed, efficiency and the reliability across our network. Target's scale and commitment to operational excellence has long been one of our true competitive advantages, but in this new era, size is not the endpoint. How we leverage our size and scale not just in supply chain but the entire enterprise is supremely important, but size is only an advantage if we use it the right way. In football, a lineman who's big and strong but slow is easily outmaneuvered, but a player who's big, strong, quick on his feet, virtually unstoppable. The key to our future success is to focus on greater agility, so you'll see that in the way we're leveraging this network. But it goes deeper than that. You see the advantages we have in our multi-category portfolio and how it allows us to flex and manage trends in the marketplace. You see that in our balance sheet, which gives us the ability to invest, to grow even during challenging times. The third and final piece of our strategy is about standing proud and being confident about who we are, holding up the power and the potential of our brand as a beacon and leaning into all the reasons guest fell for Target in the first place. So at the start this morning, I talked about how we're looking at this seismic and accelerating shift in our industry, and that's true. But you know better than anyone that these inflection points come around any every generation or so. And strong retailers endure, well others -- well, they don't. Pick your era-defining change throughout history. From downtown department stores to suburban malls, catalogs, e-commerce, Target not only weathered the storm, we emerged better positioned as a result. And that's for many reasons.
One, we know our guest, and we're making sure the changes we make continue to build guest love for our brand. We know our guests are rooting for Target to win and those reasons are embedded in our DNA:
Our differentiated assortment, an easy and inspiring shopping experience, engaging marketing, a deep commitment to investing in the communities we serve, giving back 5% of our profit, a promise we've kept for more than 70 years.
But as guest expectations evolve over time, we have to evolve the way we deliver the things that are most important:
Ease, value and inspiration. So today, we're redoubling our efforts. One example is work underway to reinvent our portfolio of exclusive brands. Cat & Jack and Pillowfort was just the toe in the water for us. Our teams right now are busy building brand after brand, and they're prepared to unveil them one after another, season after season.
In a moment, John will provide a lot more color and content, where we are today and what's to come. But before I close out, I want to make sure one thing is really clear, that underlying all this work is an unbending commitment to continued operational efficiency, a commitment to invest in our core business, constantly elevating the in-store shopping experience and a commitment to learn and innovate. To get where we want to go, we know we can't fixate on short-term opportunity. Target is taking the long view, and we can either bemoan the changing conditions in the marketplace or we can embrace them and double down on our strengths. Now in all candor, 2016 was not our best year and we're facing some headwinds as we begin 2017. But we're asking shareholders to make a meaningful investment to build a stronger, growing company for the future. The good news is that we've been working on this for a while, and we know how to align around the change rather than run from it. Our goal today is to demonstrate that the investments we're making are the right investments for the future, are the right decisions for the long term and will create greater shareholder value. John and Cathy will address this in more detail in a few minutes. But in addition to making the capital investments, we're also investing $1 billion in operating margins this year. It'll allow us faster growth over time and ensure we're competitively priced every day starting right now. Now clearly, this is a significant change in our financial model, but it reflects the new realities of the seismic shift that's occurring across our industry. Combine these investments with our unique asset base, and we believe Target's opportunity is fundamentally different for many of our competitors. No one has our stores. No one has our assortment. No one has our brands. No one is closer to the guest. And no one's better positioned to compete in this next generation of retail like Target. So while others are pulling back, Target is investing to compete and investing to grow. We're investing in stores. We're investing in our supply chain and in digital to fuel our business growth. We're investing to win share, not surrender it. There will be winners and losers in this new era of retail. This plan is all about how we emerge on top. It's how we strengthen Target's value proposition to our guests and for our shareholders. It's how we build a company that will deliver strong returns for many, many years to come. So thank you.
John Mulligan:
Good morning, everyone. Well, you just heard from Brian. Our brands, our smart network, the incredible value we offer our guests, put together, give us a unique position as we move into this next generation of retail.
And over the past few years, we've made significant investments to make our assets work even harder. While we're seeing progress, we're nowhere near done. Brian just talked about the record number of days this season when we saw all-time high digital sales. Make no mistake, we're proud of that performance, but what he didn't say and what's just as important is that behind the scenes, our platform functioned flawlessly. Record online sales, record traffic and more than enough capacity in the system to keep things humming right along. A year ago, as you well know, it was a different story. Back in 2015, we introduced a general incentive offer for Cyber Monday, 15% off everything on our site, and our guests went crazy, which was great right up until it wasn't. Demand was so high that, quite candidly, we had to throttle traffic to keep our site from crashing, frustrating guests and leaving millions of dollars on the table. Not good. But the message was clear. Put together a compelling offer, straightforward, easy to understand with really clear value, and our guest will respond. But we also needed to really -- significantly increase our capacity to support the demand. So this year, our Chief Information and Digital officer, Mike McNamara, and his team, accelerated their efforts to deliver a new adaptive platform that gave us much more capacity, flexibility and stability. And when we put up record numbers this season, our site didn't fall through once for our guests. In fact, the new platform allowed us to adjust the site experience in real time and drive additional sales, and still our site had 100% availability all season long. We invested in going well beyond what would simply help us manage through the next year. We've built for the long haul, allowing us to imagine our business far down the road. This is what we mean when we say we're investing to compete and grow. It's what we're doing across our business. We're sharpening our operational performance so we can execute on our plans quickly, while at the same time, we're making investments that set us up to compete in an increasingly fierce environment. We see enormous potential out in front of us, and we're seizing every opportunity to capture it. First, let's talk stores, our key competitive advantage. They're at the center of everything we do for our guests regardless of how we deliver. The 40% digital growth we saw in December, they enabled it. In the 2 days that followed our record-setting Cyber Monday, our store shipped more than 1 million orders to fulfill that demand. The week before Christmas, our stores fulfilled nearly 70% of our target.com orders. And on Christmas Eve, they fulfilled more than 80%, shipping about half of those to our guests and packing the other half for in-store pickup. Our stores are a center for inspiration and discovery. They always have been, and that's not changing. But when we look at them as buildings stocked with product, they're also local fulfillment centers. Now when you take the products our guests already love and add in our store network, we have the unique potential to be incredibly competitive against both digital and traditional retailers. Because for digital sales to work, you have to be able to deliver quickly and with as little cost as possible. That's why getting near the consumer has become the holy grail in retail. Online-only competitors are investing rapidly to stand up warehouses or storefronts that cut the distance between their products and the consumer, but we're already there. In fact, we're practically neighbors. 85% of our demand and 3/4 of all Americans are about 10 miles or less from our 1,800 stores. So if we're talking about proximity, we already have it. No question. Brian mentioned that we're making investments to let us really exploit that advantage, to compete on a whole new level. So let me show you what we mean. So here are those 1,800 stores. We were really intentional about where we put these years ago, most in the suburbs, some in the exurbs and a few in the city. But now here are the 32 small-format stores we opened in the last few years, prime urban neighborhoods, college campuses, places where the suburban format just didn't fit. These sites are unlocking tremendous value. They have more than 2x the sales productivity of our average store. So even higher operating costs, they generate healthy returns. They also serve as fulfillment hubs and a convenient pickup point for guests who'd rather not have items delivered to the front step of their high-rise condo. In 3 years, we'll add more than 100 to where we are today. To get there, we'll open nearly 30 small-format stores this year, doubling the number we have now. And we'll open about 40 a year by 2019, with a potential for many more down the road. Now this map doesn't outline every specific location, but it's representative of where we'll focus. This will add fulfillment points in dense neighborhoods in cities like New York, L.A. and Chicago and near more college campuses, where lifelong shopping habits and brand affinities begin to take hold. As we expand, we will continue our hyper-local approach. Before we plan a store, we get to know the neighbors, who they are and what they need. Then we design experience from the store's layout to the merchandise inside that fits. It's localization at its core. Take a look. [Presentation]
John Mulligan:
So I showed you how we're expanding our footprint with more than 100 small-format [indiscernible] good look and feel for our guests and where we are today. We know that to really compete in the local market, we need to make some big investments in those buildings, and so we are.
Starting in 2017, we'll reimagine 100 of our existing locations. We'll pull elements from our new store prototype, which we designed based on how guests responded to a multitude of tests we've run over the past few years, like our LA25 pilot. For this prototype, we took a fresh look at everything, from the front of store to the back room layout, the entrance displays to the product presentation, food and beverage to apparel. As we build on what worked in LA25 and add even more enhancements with this new prototype, we expect to see a 2% to 4% sales lift per store. Not only will they feel like the brand-new stores, they'll do even more than they can do today. The design will be flexible so the store can be configured to reflect the needs of each community. We'll have more space dedicated to visual storytelling, inspiring guests by showing products together, like entire outfits or table settings. And we'll re-allocate space to support digital [indiscernible] and designing backrooms to grow our ship-from-store capabilities. In 2018, we'll touch more than 250 stores and do that once again the next year [Audio Gap] stores, and that's just the beginning. We'll continue to make these investments so our stores can deliver the very best to our guests no matter the channel. With these enhancements, we'll be able to expand ship-from-store capabilities beyond the 1,000-plus stores shipping today. Just as every store already serves as an order pickup location, by 2019, most stores will be shipping orders from the back room. And because we're proving how we flow a product across our network, which I'll talk about in a few minutes, each store will have even more of our assortment available to ship. You can see how this map gets really rich over the next year and into the next 3 years. We continue getting closer to the guests, shipping from more of our assets and improving the in-store experience across the country. We're also doing work in all stores to make it easier for guests to shop, no matter if their trip starts online or in-store. Take order pickup, which after nearly 3 years, we still see growing rapidly. Guests chose to have nearly 50% more items picked up in store this year than last, and they love that we'll have it ready for them within an hour or 2. We're making it easier and faster by separating the pickup and return areas. And we're moving toward a future where we'll use technology to alert the team when guests arrive. We're also continuing to fold digital into the physical shopping experience. Today, guests use Cartwheel, our digital savings app, nearly 5 million times every week. They use it to plan their trips and shop the store. Later this year, we'll combine Cartwheel and our Target app to make shopping at Target even more easier and convenient. Guests will be able to make their list, find items in stores, take advantage of great offers and pay for their orders, all with a single app. And in our refresh stores, we'll test technology that gives the guest the ability to opt in and see what products around them are on sale with Cartwheel, so it'll be simple for them to be finding great value while checking things off their list. At the same time, we're making the shopping trip even more inspirational. For the past year or 2, we've been testing new visual merchandising strategies and watching how our guests respond. Now we're taking those learnings and cross-merchandising even more product categories. We're rearranging floor pads and standing up more compelling displays to help guests imagine how products work together and fit in into their own lives. We're taking a similar approach to how we're featuring products on our site so it's easier for guests to explore and find what they need while discovering a few extra items along the way. In our stores, we know the human interaction plays a big role in the guest experience. It's why our talented store team is such an asset. Our expectation of store team leaders is a good example. Gone are the days when we send a playbook from HQ and ask the teams to execute word for word. We're empowering and expecting store leaders to know their communities, know their guests and do what's right. Let me tell you about a store leader in Orange County, California named Carrie Keiper [ph]. She has a guest base that is very passionate about beer, not wine and not just the domestic big guys. Her guests love craft beer. But instead of just stocking what our buyers in Minneapolis sent her way, she asked around, listened to her guests, shopped the competition and selected an assortment with the buying team that reflected what her guests want. And guess what? Just like that Cyber Monday sale, give the guest what they want, and they respond. And at Carrie's store, they [indiscernible] big time. Her micro beer sales shot up 60%. In fact, she saw a lift across her whole adult beverage business. As a result, we built a process at headquarters to capture those insights from the front lines so our teams can work together to localize assortments across the country. [indiscernible] Carrie is one example of how we're driving a cultural shift across the company. And we're seeing what happens when we clear the way for the experts to do their jobs. But we're not asking our store leaders to act on gut alone. We're giving store teams far more data, metrics and training to help make smart decisions. We're also giving the teams technology to improve a guest's experience and save the sale. This summer, we're implementing a program where when a guest wants a different size or color, our team members will take care of everything. They'll be able to search our network's inventory, take payment from a mobile point-of-sale system and arrange home delivery right from the sales floor. We expect to offer this level of service in all stores by holiday. Finally, we're simplifying operational tasks so our store teams can focus more of their energy on helping the guest. To make all of that work, we're leveraging the skills of our team members. We've always cross-trained our teams they can so perform almost any task in the store. Now we're also standing up specialized teams, like the crews that handle digital fulfillment or food, and giving them more focused training so they can use their expertise to best serve the guest. Improving the store experience is an enormous body of work, but it's no secret that investing in our stores is only part of the equation, and you know that our supply chain has been a major focus for our team. This past year, we hired a lot of talent with deep expertise and set wheels in motion for a major revolution of how we operate. We've homed in on 2 points we have to fix. To put it bluntly, we are slow and we have too much inventory. And I can't tell you how painful it used to be to say that out loud. But now I'm actually eager to share it because I'm so confident the work we're doing will position us to compete on a whole new level. Fundamentally, we're moving -- changing how we move product. For the last 50 years, our supply chain has moved big case packs of product, and we've done it slowly. In the future, we know we'll still have to move cases. But to replenish our stores faster and manage the growing digital demand, we have to start moving individual items, too. The concept is really, pretty simple. When a store sells 1 bottle of a certain shampoo, we put 1 of those bottles on the next store truck within hours. It's replenishing the actual guest demand and doing it fast. Now to someone not familiar with supply chains, that might not seem like a big deal, but here's why it is. When we move with that much speed and precision, all product that comes into a store can go straight to the sales floor. Nothing sticks around in the back room. Out of stock goes down, safety stock goes down and our speed goes up, way up. Plus, it's exactly how we need to move product to fulfill an increasing number of individual target.com orders. Above all, we get faster and more reliable, and the guest wins. Then we can dedicate that back room space to more productive activities, like storing online-only product for order pickup or shipping digital orders. And there's no extra product at 1 store when it can be used as another. I just talked about scaling our small-format stores. This operating model is absolutely key to pulling that off. In those stores where back rooms are typically tight or almost nonexistent, we'll be better equipped to send product needed in real time instead of relying on back room storage. Today, we have several pilots already underway, and we'll start transitioning to this model this spring, starting in the Northeast. The opportunities these changes open up in terms of last mile delivery speed are really exciting. We'll ship faster and at a lower cost, improving guest satisfaction and digital profitability. It has the potential to give guests more options for how to shop and how to truly get it whenever they want it. I'm very encouraged by the work already underway, and by what our team expects we'll do in the next few years. We've set out to completely transform how we deliver for our guests, and I can't wait to share more as we make progress.
As we're investing in our stores and our supply chain, we're also undertaking an enormous effort to strengthen what our guests already love about us:
Our products. Target's assortment has always been the star of the show. It's why we hear about the guest who comes in for one thing and leaves with a full cart.
We know our style categories are typically at the heart of those stories. Home and Apparel delivered [indiscernible] results. Our team has seen the opportunities [indiscernible] last year. Our research told us we can capture even more of the market. So we retired 2 pretty successful brands and developed something new to reflect the needs of both parents and kids. Since it rolled out in July, Cat & Jack has consistently delivered double-digit comp growth. It's on track to become a $1 billion brand in its first year [indiscernible] with the brand whether in-store or online was compelling, inspiring and easy to shop. While our stores featured product on mannequins and kid-sized fixtures, our site had a dedicated page [indiscernible] list of products and make it easy to shop by item. Both channels put the product front and center, and our guests responded. Store traffic increased. Digital conversion rate shot up. Baskets grew. We saw strong sales across the business. In fact, the Digital brand pages were so successful, it's how we'll present our products online going forward. We learned a lot about our guests, the potential in the market and how we could use our platforms together to drive growth. And how many companies rolled out a new $1 billion brand last year? I don't have a clue what the answer to that is, but I know it's not many. And now we're looking to do more. When our new Chief Merchandising Officer, Mark Tritton, came on board last summer, he challenged the team to take the learnings from Cat & Jack and go further. They've been looking at everything, all of our brands, and seeing where we have a lot of value and where we don't. They're talking to our guest to really understand what they want and matching that up with where Target has a unique opportunity to stand out. Now we're applying all of that in a really big way. In the next 2 years, we will introduce more than a dozen new brands that Target guests will find only at Target. We'll touch more than $10 billion of current volume with the expectation that we'll accelerate growth within our most differentiated and profitable categories. And of course, our marketing team will bring them all to life in the magical way that only Target does. Mark can give you plenty more color during Q&A, but I'll say that we're confident we'll appeal to current guests and attract new ones. So much of what we offer will feel completely fresh, and it'll be grounded in what our guests expect from Target while helping them discover new styles and trends we know they'll love. Our exclusive brands have always been a huge differentiator. They're part of Target's DNA. This investment shows our commitment to making sure what has always driven guests to Target, like our great product at an incredible value, will only keep getting better. As you've seen, nothing we're doing is specific to a channel, stores or digital. Everything we're building is a combination of the best of each channel working together to provide a wholly seamless experience for our guest. We're transforming stores to help support our digital growth. We're building our supply chain to better -- to enable better experience in-store and online. And we're thinking about our assortment from every angle so guests are inspired no matter how the shop. And we recognize that given our current results, where we are today simply isn't good enough. And as we put in the work over the next few years, it's going to be a difficult journey. The investments we're making aren't simple and they aren't going to all pay off right away, but they're significant and they're ambitious because we know that being successful requires playing the long game, and that's the game we fully expect to win.
Catherine Smith:
John's last point is spot on. Our current performance is not where we need it to be. So I want to start today with a progress report on the last couple of years that will provide important context for where we are today.
We have made significant progress on many of our strategies signature categories have grown much faster than our overall sales, consistently gaining market share. Target's digital performance has outpaced the industry, averaging 29% over the last 2 years. We've seen outstanding results in our new small formats, which generate much stronger sales productivity, healthy profit margins and return on investment. We've started investing to transform our supply chain. 2 years ago, fewer than 150 stores were shipping directly to guests. Today, that's grown to more than 1,000 stores and counting. We've made changes to allow our team to focus on our core business in the United States with our decisions to exit Canada and sell our pharmacy business. And the team has done an outstanding job of controlling costs. We beat our goal to take out a combined $2 billion of SG&A and cost of goods these last 2 years. And when you look back at our bottom line results, it's been a pretty good couple of years. In 2014, we earned an adjusted EPS of $4.22. It grew to $5.01 in 2016. That amounts to an average annual growth of 9%. Over that same time period, we returned nearly $10 billion to our shareholders through dividends and share repurchase. That solid performance, better than many others have seen. Despite that progress, we haven't seen the growth we expected. On average, our comp sales have grown less than 1% over the last 2 years. More importantly, instead of building momentum, we've been seeing a slowdown. Specifically, our comp sales and our traffic have moved from growth in 2015 to declines this last year. Given these results and the rapidly changing environment, we must evolve our business model faster. By investing more aggressively, we can create a growth engine that will drive consistent, sustainable and profitable growth and market share gains.
The good news:
We're not starting from scratch. We've been investing in the right things, but it's clear we need to pick up the pace, and that will affect our financial model. As always, our first priority is to invest in our business with a long view. As we look ahead, we have a big opportunity to grow share in a world where others will be scaling back.
Today, you've heard in detail about the investments we're making to transform all aspects of our business, including our digital capabilities, small format, existing stores, supply chain, exclusive brands and core capabilities like data and analytics. To support these changes, we're planning to invest more than $2 billion of capital in 2017 and more than $7 billion over the next 3 years. In addition, we'll invest about $1 billion of our operating profits this year. This will position us for faster growth over time. Our investments will include enhancing store service. We know it's critically important to provide a distinctive service in a world where consumers have more choices than ever. We'll also see continued cost pressure from the rapid shift to digital. We'll invest to develop and launch new brands with marketing support to make sure that they're top-of-mind for our consumers. And finally, we'll make gross margin investments to ensure we're always competitively priced everywhere and every day. Unlike the last couple of years, we don't expect the margin headwinds and tailwinds to balance out this year. As we all know, we could make changes to maintain our margins through this transition. We could cut stores service and cleanliness standards. We could pull back on marketing. We could stop investing in brands and cut back on their quality. And we could stop investing in our stores. Those changes would help our P&L in the short term, but they are absolutely the wrong long-term decisions. Of course, we'll continue to reduce cost on those noncritical efforts, but the right path is to invest in lower margins. This will allow us to grow and gain market share in the future. Target's in a really unique position. We have a strong balance sheet and robust cash generation. Both provide us the flexibility to evolve our business model rapidly. In addition to our assets, we are well positioned for these -- for this change. First, consider our team, which has always been our greatest asset. We have long focused on hiring, training and retaining a [indiscernible]. So today, as we take our new store experience to a higher level, our team is ready and excited to do more. We'll continue to give them new tools and empower them to manage their local businesses. Beyond our team, our unique assortment has always been an asset. It's gives us the flexibility to present and curate all that our guests desire. And finally, consider our stores, they are more than 1,800 strong and a key competitive advantage. They're usually off-mall. They're very close to consumers, and they universally [Audio Gap] We have long applied a rigorous process to decide where to build our stores and we have an equally rigorous process to decide when it's time to close them. Every year, we conducted a close/continue analysis on the entire store base individually for each location. As a result, we have closed hundreds of locations over time. The key is discipline. It's the reason we have a very healthy portfolio of stores. Looking ahead, our stores will still be the center of our business, but their roles will evolve. Within our smart network, stores will fulfill many roles. In addition to serving as a place where guests can shop and return, they'll also be a digital hub. They'll provide online order pickup and deliver directly to guests. And importantly, they'll continue to offer genuine human interaction and engage in their local communities. As we navigate this transition, we'll continue to apply a disciplined, returns-based approach to all of our investments. At the highest level, we're focused on sales growth with a relatively stable base of invested capital. We're focused on growing sales in all channels by transforming our assets, both our distribution centers and our stores. In addition, we'll look for ways to streamline our asset base as our business evolves. For example, as we increase the speed of our supply chain, we have a significant opportunity to reduce inventory without hurting our in-stocks. In the last 2 quarters, you've seen the earliest signs of this trend, but we have a lot of opportunity to take inventory out of our network.
And finally, I want to emphasize that our priorities for capital deployment remain the same as they've been for many years:
First, we invest in our business with a long-term view; second, we support our dividend. This year, we're on track to deliver our 46th straight year of annual dividend growth. And finally, we engage in share repurchase when we have excess cash beyond those first 2 uses. We'll manage our repurchase program within the limits of our credit rating. We may have some capacity during this transition period, but we won't be close to last year's pace, given the changes to our financial model. As I mentioned earlier, our strong balance sheet is providing valuable flexibility, especially during this key inflection point in our history. Looking ahead, maintaining the flexibility will be essential.
Now let's turn briefly to our 2017 expectations, which were included in this morning's press release. At a high level, our guidance reflects a prudent view based on current trends and what we need to accomplish. Let's start with sales. We are planning for a low single-digit decline in comp sales this year. While this may not -- while this is not where we want to be, we believe it's prudent based on a couple of key factors. First, it reflects strong digital growth that has not fully offset declines in our stores, and it reflects the view that our investments will not have an immediate impact on our near-term performance. As I've said many times, we stand ready to chase stronger comps when we have the opportunity. In the meantime, we will plan our business prudently. On the EBIT line this year, we're planning to generate about $1 billion less than last year. This reduction reflects investments in enhanced store service; the continued shift into digital; support to develop, launch and market new, exclusive brands; gross margin investment to ensure we're competitively priced and additional D&A from investments in existing stores. Now I'll give you some insights on how this will play out in our P&L this year. About half of the $1 billion investment will be on the SG&A line, approximately $400 million will be on the gross margin line and the remaining pressure will be in D&A. Obviously, D&A is a noncash expense, but this pressure will show up in the P&L. All together, we're planning for GAAP and adjusted EPS of $3.80 to $4.20. We know this is a meaningful departure from both our prior performance and expectations, but this change is essential to position our business for faster growth. Now let's turn briefly to our expectations for the first quarter. In February, we faced a challenging and choppy environment. We saw some improving trends near the end of the month. While that's encouraging, we believe it's prudent to plan for the challenging trends to continue for the rest of the quarter. As a result, we're planning for a low- to mid-single-digit comp decline in the first quarter. This is the softest quarter comp that we're planning for the whole year. As a reminder, we're comping over our strongest quarter last year, and our full year outlook includes the benefit of store remodels and brand launches. On the EBIT line, we're planning for a decline of about $400 million from last year. The majority of this decline will be on the gross margin line. All together, we're planning for both GAAP and adjusted EPS of $0.80 to $1. I know the magnitude of this change to our outlook is unexpected, but we must make these changes to position our business for the long term. Brian began the day by outlining the seismic shift we're seeing in the consumer and retail landscape. Our leadership team has spent a great deal of time studying what this shift means for Target. Because of that analysis, we are confident [indiscernible] now it's time to accelerate the transformation of our business model. Our goal today has been to clearly show you where we're investing in that new model. We're building a smart network that's more agile and reliable than ever before, a network that will be equally capable of inspiring and fulfilling physical and digital shopping. We're investing in stores that will look different and function differently than they do today. We're completely transforming our supply chain, becoming meaningfully faster, more efficient and more accurate. And finally, we're delivering an even stronger portfolio of exclusive brands.
So now before I turn it back over to Brian, I want to spend a minute talking about what makes our approach different. We anticipate a lot of disruption in the retail landscape. We want to position ourselves to gain share as those changes occur. We've seen a lot of stories this year. You've seen a lot of stories this year. Retailers are closing stores and closing businesses across the country. We are positioning ourselves to play offense. We're going after that share market-by-market, but it's going to be a little noisy in the near term. So at a time when many others are shrinking, we are investing. We're investing in 2 pillars of growth:
Our stores as multipurpose assets within a smart network and our digital capabilities as we continue to gain shares in e-commerce.
Unlike the past, we're not providing explicit guidance beyond this year. I understand you have a desire for us to provide detailed longer-term guidance. However, given the amount of uncertainty we're facing, providing multiyear guidance would be a case of false precision. And given the transition we're planning, we believe it's important to focus on the company we will become. With the investments we're making, we'll be best positioned to deliver positive in-store comp sales and a rapid and profitable growing digital channel, stable to growing enterprise profit margins, continued strong cash flow and the ability to return capital to shareholders and superior ROIC over time. But let me be clear. This will be a multi-phase, multiyear journey. This year will be an investment phase. We'll move to lower margins to enable faster growth in the future. Beyond this year, we'll continue into a transition phase. We'll invest capital to transform our supply chain, digital capabilities, new stores and existing stores. As we move past the transition, our new business and financial model will stabilize, and we'll deliver sustainable, reliable growth over time.
During the entire transition period, we will commit to transparency. Insights on our investments will serve as leading indicators of our future performance:
Digital growth and the role of stores in fulfilling that demand; our pace of opening new stores with continued insight on their performance; investments in existing stores and how those stores respond to those investments; insight on how we're reducing delivery times and removing inventory from our supply chain; and finally, timing of new brand launches and how those brands perform.
Our company was founded over 100 years ago, and the first Target store opened more than 50 years ago. We are investing to position this company for success over the next 50 years. That's what we mean when we say we're taking the long view. Thank you.
Brian Cornell:
Well, thank you, Cathy. So I know we've covered a lot of ground this morning, but I'd like to build on what Cathy just said. Target's been a great American retailer for more than 50 years, but our roots stretch back even further than that. As many of you know, our company started out as Dayton's Dry Goods just around the turn of the last century. That business evolving into a prominent chain of department stores, which led to a string of retail firsts, including the first indoor shopping mall, the first discount mass retailer, and later, the acquisition of Mervyn's and Marshall Field.
You know the story from there. Evolution is in our blood. And out of every period of disruption, our company has always forged ahead into the next era. So when you think about what's in front of us, the seismic shift in consumer behavior that's disrupting our industry, we're doing what we've always done. We're taking the long view, investing to compete, investing to grow. And we have the financial strength and the resources to build a new company, one that's poised to lead, positioned to win in this next generation of retail.
So look ahead 3 years from now. We talked about what we'll deliver:
New stores, new formats, more than a dozen new brands, a coast-to-coast smart network [indiscernible] digital capabilities. To our guests, the entire experience will look and feel like a completely new Target.
While many of our competitors are cutting costs and just trying to survive, we're doubling down. We know there'll be meaningful opportunities to capture additional market share now and in the long term, so we're aggressively deploying capital to expand our reach, reimagine our physical stores and transform our supply chain. We're investing in margin to accelerate and unlock even greater digital growth. We're investing in price to ensure we're competitive across our assortment every day, both online and in-store. And we're investing in speed to move faster than we ever have before. This is the plan that will produce the Target of the future. This is the plan that puts Target back on the path to profitable growth. This is the plan that will create shareholder value and deliver guest love and loyalty for many, many years to come. So I want to close by thanking you for joining us this morning. And now I'm going to invite John and Cathy as well as Mark Tritton, our Chief Merchant; and Mike McNamara, our Chief Digital and Information Officer, to join me on stage so we can spend time taking your questions.
Brian Cornell:
We've got lots of mics, we've got lots of time, so we'll try and work our way around the room. If you could introduce yourselves this morning, I'd appreciate that. And we're happy to take your questions. So why don't we start right up front?
Christopher Horvers:
Chris Horvers, JPMorgan. Trying to dig in a little bit into the gross margin pressure. Understand that first quarter, you're going to have some pressure from markdowns and clearance, but then over the balance of the year, some channel shift pressure as well as price investments. Can you talk about the latter? What are you expecting in terms of gross margin pressure from the digital and pricing pressures? Will pricing largely be a reset in '17 and then we sort of neutralize from there? And is it your expectation that, over time, supply chain improvements ultimately stabilize the gross margin? And is that an '18 event?
Brian Cornell:
Yes. Chris, let me talk about the pricing investments we're making. And I think as most of you know, coming out of the data breach, we invested heavily in promotions. As we go forward, we're going back to our roots and reestablishing our everyday low price commitment. So that's going to take some time. It's starting today. We're going to make sure that we re-establish our value with the guest. So there's an investment we have to make. And we also recognize we have to continue to invest in digital to grow that channel, to continue to make sure we're accelerating market share. So you're going to see us invest in 2017. As John talked about, we expect greater efficiencies over time, one, as we continue to optimize our digital performance, but importantly, as we transform our supply chain. But in the short term, we have to compete, we have to invest to make sure we're delivering the value the guest is looking for. We want to make sure we're taking market share both in-store and online. And we think those are 2 very important investments in the near term that provide long-term benefits for the company.
Michael Lasser:
It's Michael Lasser from UBS.
Brian Cornell:
Thank you.
Michael Lasser:
I think the key question is, we all appreciate that you don't want to provide long-term guidance, but how long are you anticipating it's going to take for you to see you to see a return on all the investments that you're making? Is it reasonable to expect that you're going to return to earnings growth in 2018, 2019? When should we expect that?
Brian Cornell:
I'll go back to what Cathy talked about just a few minutes ago. We certainly view 2017 as a year of investment. In '18, we'll continue to transition as these different initiatives begin to mature. As we get into '19 and beyond, we certainly expect stability and return to growth. So that's the model we're looking at. We can't lay it out for you quarter-by-quarter. We want to make sure we're properly investing and accelerating these initiatives. And if there's a message I want everyone to walk away with today, these aren't new initiatives. We've been working on these for several years. Now is the time for us to grow faster. And this is about accelerating at the right pace for our business. But whether it's our digital channel, the work John talked about in supply chain, the acceleration of remodeling our existing stores and reimagining that experience, we're opening up these new smaller formats. We've got to step on the accelerator. And as they mature, we're going to return to growth, we're going to capture market share, and we're certainly going to see the benefits that our shareholders are looking for.
Craig Johnson:
Craig Johnson at Customer Growth Partners. Brian, I understand the importance and necessity of the reset you've talked about doing here today. And I want to look forward to how do you get back to growth. And one pillar of growth, of course, is traffic growth. Hallmark of all great retailers is consistent traffic growth. You showed 2 of them earlier Costco and TJMaxx. It applies to Wegmans and Home Depot. Question is, could you get more granular on how you're going to actually rebuild share of trip missions as a way of getting share of traffic?
Brian Cornell:
Craig it's a great question, and it's embedded in everything we've talked about today. So the reinvestment in our stores, reimagining over the next few years hundreds and hundreds of stores. We've certainly learned in our tests in both Los Angeles and as we've remodeled stores in Texas, that as we bring in new experience, that drives traffic to our stores. As Mark and his team continue to roll out these new proprietary brands that are unique to Target that drives traffic to both our stores and our site. And we've seen that with Cat & Jack. [indiscernible] and our site. As we move into these new urban neighborhoods, it's driving foot traffic every single day. So as we think about how this smart network comes together, brands play an important role, that in-store experience is critically important, being in the right neighborhoods. But then we also know from a digital standpoint, more and more, our guests are ordering online and conveniently coming to our stores to pick up that order. That allows us to really make sure that once they're in our store, they continue to shop. So all of these elements are all about driving traffic to our stores and more visits to our site. And as they mature, that's certainly going to be one of the key metrics that we'll all be tracking.
Robert Ohmes:
Robbie Ohmes at Bank of America Merrill Lynch. As a follow-up to that question, can we get you guys to talk a little bit more about the category outlooks? So how you're thinking about price investment in terms of Food and Consumables versus Apparel and Electronics, et cetera? And also, for the new brands, maybe some more insight, what categories you're thinking about launching, some of these 12 new brands? And then just a quick for Cathy, I guess I might have missed it, I didn't understand. Are you -- you've been disciplined about store closings, but is there a change in your pace of store closings?
Brian Cornell:
So let me start with price, let Mark talk about brands, and then Cathy can talk about our real estate portfolio. And I think you answered the question for us. As we think about the investments we're making in price,
[Audio Gap] referred to, we've got to make sure that we move from a promotional cadence back to our traditional, everyday low price and great value every time they guest shops in those core, personal care, household essential and food categories. We'll certainly make sure we're revisiting price across the box, but it certainly starts with making sure we're price-right on those trip-driving items that our guests depend on Target for every day. Mark, why don't you talk about some of the brand work?
Mark Tritton:
Yes. As we roll out the new brand work, we've been -- we're looking at Guest Insights about what brands and what spaces we should play in. But more importantly, what is the sweet spot on pricing for regular everyday pricing? So as we reset these brands, we're going to be defining great value every day for our guest as we introduce in every niche in the business.
Catherine Smith:
Robbie, I'll quickly address store portfolio. As we said, we've had a very disciplined process forever. The team has done a great job. And so our pace doesn't change. We've been closing about 10 to 15 stores a year. That's been consistent year in and year out. We'll continue to do that. But that's just normal course for us. We look at every store every year and say, "Does it make sense to keep open?" And today, the answer is, yes, universally generating positive cash.
Brian Cornell:
Yes. Cathy, on the store front, just to close that out. And I know we talked about it during our prepared remarks, but our store portfolio is mall-based. We're in some of the centers where most of the retailers are trying to migrate to. So we're very fortunate that over time, we built 1,800 stores that are effectively located. They're in the right neighborhoods. They're not off remotely on interstates. They're not tied to dying malls. So we have an obligation to revitalize some of those stores and reimage those stores. But one of the things that we're most confident about is we have an exceptional store portfolio. So as we invest, as we bring those stores up to the expectation that our guest has for Target, we expect those to drive traffic and continue to flourish in the years to come.
Matthew McClintock:
Matt McClintock from Barclays. So clearly, the story today is about investment, right, you need make substantial investments. And as I look back at the past 2 years, you've fallen shy of your capital plan by a significant amount, right? So as I look forward, one, can you help me understand where the shortfall to the capital plan was this past year? Two, would you attribute some of the weakness today that you're seeing to some of the lack of investment or shortfall to your prior capital plans? And then three, is the $2 billion enough for 2017, given that it falls to the low end of your prior long-term guidance of $2 billion to $2.5 billion?
Brian Cornell:
Matt, I'd start out by talking about the last couple of years as being a time of very disciplined capital allocation. We've taken a very surgical approach to some of these initiatives. We remodeled 25 stores in Los Angeles. We've been testing and learning and iterating improving the expectation that the guest has, making sure we deliver against that. Now that we've gotten the feedback, we're ready to accelerate. John talked about we've opened up 32 small formats, not 300. We study each one of those very carefully to make sure we understood how to customize them for the local neighborhoods. Now that we understand the expectation, we're ready to accelerate. From a capital standpoint, we've actually benefited from the fact that Mike's taken a very disciplined approach to setting priorities within technology. And we've seen phenomenal improvement in our platforms, our capabilities at a lower cost. So our approach to capital has been very disciplined. We've been testing and validating and learning. Now that the learning is complete, we're ready to accelerate those investments. But we have been very disciplined. John talked about supply chain. We know the changes that we need to make, but we've been very surgical, very disciplined in putting together that playbook. Now that it's in place, we'll begin to accelerate. So from a capital standpoint, we'll continue to make sure we're very thorough, we test and validate. But once we've completed the learning, we'll be ready to accelerate. And that's what you're seeing as we think about the next 3 years.
Peter Benedict:
Peter Benedict of Robert Baird. I was hoping you could maybe speak a little bit more detail about your view of Grocery, that side of store, what -- how's that going to look in the reimagined store? And then, Cathy, maybe a little view as to how much it costs to do the remodels and how long it takes.
Brian Cornell:
Yes. Why don't I start, and I'll let Mark talk about some of the progress we've seen on Grocery. And while we didn't spend a lot of time on it today, I want to make sure it's very clear. We're very focused on improving our Grocery performance. But we haven't just been standing still. We made significant progress in procurement, in supply chain, in making sure we've improved our assortment, in making sure, in those tests stores in Los Angeles and Dallas, we understand the changes that need to be made in the in-store experience. We're going to follow that up immediately with the right investment in pricing to make sure we're competitively priced every day in those key categories. So we've got more work to do. We're certainly not satisfied with where we are, but we have been making some progress. And there are some bright spots, Mark that I think you can talk to.
Mark Tritton:
Yes. Just looking at the format, fresh produce is a really good example where we've changed our supply chain or assortment and have focused on quality and value. So investing there has really made a difference for the guest, they've really perceived and responded, too, with great growth in key categories. So here, we've invested in fresh. And we've gone from an organization that used to deliver multi times a week to every single day, increasing that freshness and quality, and guests are responding. Some of the tests that Brian talked about in L.A. and Dallas have really paid dividends for us. And one great example of that is our adult beverage business, where we've seen great growth in 2016. And we're going to amplify that growth and accelerate in '17. This is a business that for us, was our #1 growth category throughout all Target. And we see an upside of $1 billion business here that we're fast-tracking on in 2017.
Joseph Feldman:
Joe Feldman, Telsey Advisory Group. Way in the back, sorry. Wanted to follow up on that. Can you talk a little bit on the merchandising side, areas of the store that may be expanding or contracting? And then a little bit more specifically about those dozen brands that you're going to be adding in, what categories would those be in? What are the -- any preview you can give us? And how to think about that?
Brian Cornell:
Mark?
Mark Tritton:
Yes. So the key focus of the brand growth is really in what we talked about with John, and our key strength areas of apparel, accessories, footwear and home. So these are high-margin and high-strength areas for us. And we believe that Target has the right DNA on exclusivity and differentiation. Our guests love our brands and have loved them. But we've been a little slow here in terms of the changing face of the guest. And our Guest Insight show that we could sharpen that and bring new ideas. Great proof of concept in 2016 with the launch of Who What Wear, Pillowfort and, of course, Cat & Jack that showed us, where we replaced our strengths with a new focus, we could create double-digit comps and guests' love and trips for our store. So we've taken key areas across men's, women's, home and kids and are going to amplify our offers there and redefine. In terms of overall space, we're just utilizing our existing space and really refreshing that. So one of the things we're excited about in '17 is this combination of new brands, capital investment in the space for those brands but also the addition of extra resources like visual merchandising. They're really going to create a new experience for the guest at store and create real excitement.
Mark Miller:
Mark Miller with Crystal Rock Capital. You talked earlier about making price investments across essentials. I wanted to ask, what do you think is the risk that you've taken too much margin on exclusive items? UPT has come down, but average ticket has gone up with price per item. So I thought also it might be helpful if you could share market research on the customers' perception of value on exclusives now versus several years ago?
Brian Cornell:
Yes, why don't I start? And I think the proof is in the results we've delivered. Outstanding results, as we've talked about, with the launch of Pillowfort. The same thing's been very true with Cat & Jack. So I think this is an example where we've gotten the value equation right. Great quality, on-trend, at a great value, and the guest response has been terrific. So that's the same approach Mark's going to take with each one of those new brands, making sure we combine great quality, items that are on-trend for the consumer with the right value that drives trips but also make sure the guest recognizes they're getting great value from Target. So coming back to our brand promise
Kate McShane:
Kate McShane from Citi Investment Research. I have 2 unrelated questions today, one, a short-term question; one, a longer-term question. With regards to your guidance for the year, I'm wondering how much in terms of your competitor door closure are in your assumptions for guidance. And second, on the longer-term question for supply chain, just curious, it was a year ago that you walked us through some of the changes in your supply chain. I'm just wondering how much the game has changed since the last time we have heard about that strategy and how you're approaching the last mile.
Brian Cornell:
John, do you want to start with supply chain, and we'll finish up with guidance?
John Mulligan:
Sure. I think the past year, we spent doing really 2 things in supply chain. One was just optimizing what we do today to improve out-of-stocks in-store, which have been a chronic problem for us. They have improved dramatically. They're not where they need to be, but they have improved. The second thing we focused on is right to the heart of your question, which is how do we optimize the entirety of our supply chain, go back and relook at everything to
Brian Cornell:
Cathy, why don't I start by talking about the competitive landscape and let Cathy talk about guidance. But to your point, we certainly see, over the next few years, significant market share opportunities as we see the contraction in our competitive store base. And that's going to be particularly true in the Apparel and Home spaces, where we're strongest. But we also recognize, as you do, as many retailers are closing stores if not exiting the business, the short-term implication is massive promotional discounts, which takes consumers out of the marketplace for a period of time. So over the long haul, this is a growth story we're putting together. We think we're going to see significant market share opportunities across a number of categories. To capture that, we need to make sure we've got the right in-store experience and a very strong and easy digital experience for that guest. But in the near term, you're going to some deep discounting. You're going to see liquidation sales, which takes prices down and take consumer trips out of the marketplace. But over time, we see significant market share opportunities.
Catherine Smith:
Yes. The only thing I'll add on to that because it's where I was going to is, we are absolutely investing to be able to play offense. We see this is as a huge opportunity for Target when you think about the playing field that's going to be available. And so we are investing to play offense. But I don't anticipate and we don't anticipate that to be demonstrably changing this year. This year is an investment year for us, as we set ourselves up for that great success to take that share over the next multiple years, there's going ton of disruption in this space.
Daniel Binder:
Dan Binder with Jefferies. Had a few questions. First, there's been a few questions on Food today. I'm curious, as you think about the role of food at your competitors, it's been using as a traffic driver, today, we're not really hearing that from you. We're hearing more about remodels and brands outside of Food. Can you just talk a little bit about why you think Food shouldn't be the traffic driver for you? Why you shouldn't be reallocating space away from dying categories to expand the Food assortment? And my second question is, can you make money online longer term? And why doesn't the marketplace make sense for you as -- particularly as a source of fee income to offset maybe some of the pressure in your own business?
Brian Cornell:
So why don't I start about talking by Food, let Mark add some additional color, and then give Mike a chance to talk about our digital approach going forward. And one of the things that we've talked about over the last year as it pertains to Target's Food and beverage offering is the recognition that we don't have a full-service grocery experience. We don't have meat and seafood counters. We don't have deli counters. We don't provide a full assortment of experiences and services that many of our full-line competitors do. But we can offer a great self-service, convenient experience. And that starts with the right quality, the right assortment, the right in-store experience, great value. We've got to make sure we're supplying those products to our guests every single day to make sure the freshness is there. So we're embracing who we are. And we want to make sure that the guest knows, while they're shopping at Target, there's no compromise. We've got to build trust. We've got to make sure that while they're there shopping for their baby, picking up a toy for a Saturday night birthday party, picking up something new to wear for dinner that night, they have confidence in the selection and breadth of food products we offer. So we're being true to who we are and we're not a full-service grocer, we don't have rotisserie ovens in our stores, but we do have the right allocation of space and selection to compete and be that convenient alternative in Food. And we're going to build on that going forward. We're very pleased with the response we've seen in Los Angeles, in Dallas, where we enhance that experience, where we improve the assortment. The reaction, as Mark talked about, to categories like craft beer and wine that fit in very well with the Target guest. So we've got to strengthen that offering, make sure we've got great quality, the right assortment, that we've got the right experience in-store and that we provide the right value the guest is looking for. So we'll continue to build off of that going forward and make sure that while our guest are shopping Target, they're also shopping our food and beverage offering.
Mark Tritton:
Yes, I think our space is set. We're not talking about flipping or divesting or investing in more spice. It's how we utilize the space more definitively. And I think that what we've learned in these test markets is the role of fresh and convenience in creating trips and create guest loyalty has been very powerful. So reformatting the space and really curating the assortment is more of what we're focused on rather than wholesale changes to macro space.
Brian Cornell:
Mike, why don't you talk where we are with digital? We spent very little time talking about our performance in 2016. We felt great about how we exited the year. Comp's up 34%, making really good progress. Mike, we've doubled the business in the last couple of years. So why don't you talk about where we are and where we're going?
Michael McNamara:
Well look, I think, particularly in the last year, the focus has been on guest experience and making a flawless and great guest experience. And while some of those investments may not be obvious, they have paid dividends. We grew the business at almost twice the rate of the market last year. John talked about -- earlier how we expanded our ship-from-store capability, which has been really, really important to us. We shipped about 1 million parcels to our guests in the 2 days following Cyber Monday. And that's really important because that is our cheapest route to the guest at home, is shipping from our stores and as we can expand that model, we can be closer to our guests physically and in time. And we have the lead time during the holiday period to guests as well. And so all of those investments have improved the guest experience. We've almost doubled our guest satisfaction rating over the course of the year whilst we grew the business at twice the rate of the market. And we see that again going into this year. So there will be a relentless focus on the guest experience going forward. All of the work that John and his team are doing to reconfigure our supply chain will give us a lead time advantage and a cost advantage as we deliver more and more parcels to our guest store -- to our guests' doors. The work that Mark is doing on assortment and creating exclusive product, exclusive brand for Target that isn't available anywhere else will be vital to our online merchandising going forward. We will always look at other ways, maybe of how we would expand our assortment online, but right now, we've got our sights fairly firmly focused on how we can get to guests quicker, how we can execute flawlessly and how we can bring exclusive branded product to our guest.
Unknown Analyst:
This is Brian Cameron [ph] Daughtry and Cox [ph]. With all the seismic shifts that are going on in retail, as you outlined, I'm guessing you considered other strategic alternatives to the one you outlined this morning. What were some of those alternatives? And why is the one you outlined, you think, the best for the company going forward?
Brian Cornell:
Brian, we spent a lot of time as the leadership team looking at different alternatives. There was only one path forward, and that's the path we've chosen. We've got to invest to grow. We've got to reimagine our stores. We've got to enter new neighborhoods as we're doing with these small formats. We've got to transform our supply chain. We have to build out the digital capabilities required in this environment. We have to continue to elevate our proprietary brands. And I think most importantly, we just have to embrace the realities of this new era of retailing and make sure that we also embrace the way consumers are shopping today. So we certainly debated where there other options. Every time we came to the table, there was only one conclusion, and it's the path we've chosen to follow. We think this is the right path for our company, the right path for our shareholders, and ultimately, it's a path back to growth and an expansion of market share. So we've done our homework. We've looked at this from every different angle. This was the past we kept coming back to. It's the right path for the company today. It'll be the right path for the company 10 years from now.
Gregory Melich:
It's Greg Melich with Evercore ISI. I had 3 questions. I'll make them quick, into one. Cathy, does the guidance for this year assume that comps turn positive by the fourth quarter? Second is on CapEx. When we look at that $7 billion budget over the next 3 years, if you could break that down into existing stores, new stores, supply chain and give us some sense of where the money is actually going. And then lastly, and maybe I don't know who this is for, but for everyone. I guess, Brian, what will you be watching to know that this is working? So that basically, we want to double down or not or go the other way towards the end of the year? And specifically, there was an interesting comment, can't remember who made it, that our cheapest way to fulfill is through the store. I'd love to just hear -- that sort of shocks me, given what we're seeing Amazon do, and others. So just why is that true for Target and maybe not true for some of the others?
Brian Cornell:
Yes. Greg, why don't I start with the metrics, the things that we're going to be watching closest? And it's going to come back to we're going to watch the guest. How does the guest respond when we reimagine a store? How do they respond when we move into new neighborhoods? How do they respond to our new digital offerings? How do they respond as we roll out new brands? So ultimately, that guest satisfaction and that guest vote is the most important one. And when they're in our stores more frequently and visiting our site more frequently and shopping with Target versus other retailers, we know we're winning. But we're going to clearly monitor the guest reaction as we remodel these next 100 stores in 2017 and we continue to accelerate with another 30 small formats. And as Mark introduces new brands throughout 2017 and Mike enhances our digital offering, it's going to come back to the guest reaction. And we're fighting for footsteps, we're fighting for clicks online and we're fighting for a share of mind. So for this to be a growth story, it is all about gaining market share, and that starts with building greater trust, greater loyalty with our guest. So we'll be watching that each and every day across these initiatives we've played out today.
Catherine Smith:
Yes. So Brian, maybe I can address the other 2 questions, Greg. This is a multi-phase, multiyear journey. And so -- and we try to make sure we set that expectation. We are recognizing that the environment's going to be disruptive and we've got a ton of work still to do, although we're not starting from scratch. We're going to accelerate that pace and that investment. And so we're not, and we guided that in our guidance, planning for anything but low single-digit negative declines this year. For the -- and as we said, it's an investment year as we move into transition and then we'll get into stability, where we can sustainably, consistently drive profitable growth and market share gains. And so I want to make sure we do set that expectation appropriately. On your question with regards to how the capital allocation is being spent, over the $7 billion investment over the next 3 years, it's really in the 3 areas that Brian just talked about, the 3 big areas. The biggest ones being, obviously, as we reimagine our stores because they will still be central to our story. Their roles will evolve, but there'll be significant investments there as well as the new stores. Supply chain and digital, and that's exactly where you'd expect us to be spending that money.
Brian Cornell:
Mike, why don't come back to the shipping question?
Michael McNamara:
Yes. I mean, the reality is that in a digital business, one of your biggest costs, biggest marginal cost, is transportation. And it is cheaper for us to drive or to deliver from our stores, which are, as we said, about 10 miles from 75% of the population. So that last leg, being very shorter, makes it our cheapest option. The marginal cost of us getting product to the stores on the back of our existing network that already -- to the distribution centers already out there is very, very low for us, indeed. So the additional cost on that last mile is very low. We also have, of course, order pickup, which is probably our most economic fulfillment channel.
Brian Cornell:
Why don't we come up from -- Oliver, you've been very patient waving your arm. Why don't we see if we can get him a microphone.
Oliver Chen:
Oliver Chen, Cowen and Company. Had a question related to that topic of fill-in versus stock-up tactically in terms of what you're thinking about the future of fill-in and the opportunity there? And longer term, as you do your consumer insights on millennials and Generation Z, what do you think the 5-year story is for reimagining the store as you think about what the newest customers really want to see with disruption and transformation? And finally, on the topic of big data and data sciences, how does that interplay with how we should think about the model over the longer term? And what does that mean for what consumers want versus where you can deliver data science, whether it be supply chain, omni-channel or predictive analytics giving people something they don't even know they want?
Brian Cornell:
So Oliver, let's try to unpack those questions. Let me start with the last one as we think about the role of data science and analytics. And I made the comment that 3 years ago, this was nascent capability for us. It's now quickly become one of the strengths of the company. And we're applying that across all of our various functions. it's helping Mark and his merchant team make better choices. It's certainly enabling some of the work that John's leading from a supply chain standpoint. It's influencing how we lead and manage our stores. And Mike can talk about the important role it plays as we think about digital and the personalization of our communication. So data science is going to play an important role across all of our functions going forward to make the company focused on the right decisions, smarter decisions, more personalized decisions. And Mike, why don't you talk about the role that it's played just recently as we think about digital and how we're interfacing with the guest?
Michael McNamara:
Yes. Well I think, as Brian says, it's an important -- it's a very important growing area for us. And out in our data sciences team out in Sunnyvale, we have over 40 Ph.D.s who are nothing but thinking up of clever ways to how we tune our supply chain and how we personalize the offer to our guest, particularly online. One recent improvement they have made is on some of the bottom recommendations that we give on our home page. And we've seen and eightfold improvement on conversion rate on that. So we do know that as you make that experience more relevant to the guest, that we will improve our sales online, will make it -- will improve our conversion rates. And that's just one example. And I've seen a lot of examples in John's area around how we are improving sales forecasting and our ordering algorithms, which has helped the flow of stock all the way through our supply chain.
Brian Cornell:
Let me try to come back to your question around the consumer trends, the role of millennial, how that takes shape over the next 3 to 5 years. And I think as we look at it today, I'll start with the investment we're making in our stores. And as we've looked at the outlook, as you've done the Math, while we expect this continued accelerated shift to digital, stores are still going to be very important. And pick the number 3 years from now, the stores represent 85% or 80% or 75% of the business, I don't know. But even if they're 75% of the business 3 to 5 years from now, they're still the dominant portion. And what we know every time we talk to the consumer, every time we talk to the guest, they create experience. If they're going to shop at a physical store, they want it to be a great experience. So we've seen the reaction to the changes we've made with visual merchandising. Some of the things that Mark and his team are bringing to life every day in our stores, in our Apparel and Home categories, we've got to make sure it's a great experience. If they're using our stores as a smart pickup point, we need to make sure when they come to our stores, they're greeted by phenomenal team members who can quickly find their order and invite them to shop more often. So we've got to make sure that experience is critically important in our stores. We know going forward, that millennial consumer that we serve, they're going to be digitally connected and their shopping experience is likely always going to start with that digital device. Then they'll choose whether they want it delivered to their front door, they want to pick it up or they just want to make sure they know where the products are placed inside of that Target store in their neighborhood. So we've got to embrace the way consumers are shopping, but we recognize when they come to a physical store, they expect a great experience. When they shop online, they want it to be really easy. When they come to pick up a product at 1 of our 1,800 stores, they're got to make sure the product is there, we've got the right items and we invite them to enjoy the convenience that we did the shopping for them, and now they can take the next 20 minutes and explore the store and discover and enjoy the merchandise that we have to offer. So physical stores will continue to be important, but we've got to reimagine that store experience. Today's millennial shopper doesn't enjoy shopping one of our tired stores that hasn't been touched in 10 years. But they love the reimagined stores, and they give us that feedback. As we remodeled stores in Los Angeles and we've reimagined stores in Dallas or as we open up new flex formats, the feedback we're seeing is sensational. And they use those flex formats, those smaller stores as places to fill in. But they're filling in 2, 3 times a week. So we're looking at it very carefully, but we know stores will be very important, but it's going to be part of our smart network, where we combine the digital experience, the store experience as one and make it really easy for the guest to connect with the Target any time they want, any way they want in their local neighborhoods and towns.
Brandon Fletcher:
Brandon Fletcher with Bernstein. we see your competitive advantage as assortment and service. So when we talk about new brands, we love it. When you talk about service online and integrated ordering, matching online, awesome. Doing the picking from DCs for eaches [ph] is genius. And I think only you and the Home Depot are close there. The only place we get nervous is when you say things about price and convenience. I've sat across -- away from many CEOs who were desperately trying to drive traffic with price investments when they were not the low-cost operator, and it just doesn't usually work. And if you're seeing death in department stores and retailers and subscale grocers, where you guys are already way better on price, are you really sure you need to invest that heavily? And then secondly is, with the rollouts to new project touches in stores, will folks with disconfirming evidence have as much access to leadership as those with confirming evidence? As you guys have been extremely disciplined in the way you did LA25. But it's hard to get right. So those are 2 questions.
Brian Cornell:
So let's go back to pricing, and let me make sure that we're really clear about what we're doing and why. And we spent a lot of time looking at the changes that we had made following the breach. And we were very promotional, and that promotional intensity has actually continued. As we go into 2017, you're going to see us get back to our roots, get back to establishing everyday low pricing in those essential categories. There'll be a transition period, but it's really going back to what's always worked for us in the past and moving away from that promotional intensity, the reliance on big promotions, to making sure we give our guests the confidence and trust that every day they shop in our stores for those core essential items, they're getting a great value. So it's a transition, there's an investment involved in that, but it's really getting back to what's made us great going -- in the past and really making sure that's part of what we bring going forward. So we'll continue to be very disciplined. As we talked about the question about capital allocation, we're still going to be a company that will continue to innovate. Innovation is very important, and innovation is alive and well at Target. But we're going to make sure we test, we learn, we validate. And the innovation has to benefit our core enterprise. It has to translate to driving more traffic to our stores, more trips to our site, greater guest loyalty and engagement. So innovation will be an important part of our future. We'll do it, as we've done in the past, in a very disciplined way. When things don't work, we'll shut them down. When we need to iterate, we'll continue to iterate and learn. And when we've validated the model, we'll step on the accelerator, as we are right now, and we'll move forward quickly. I guess we've got time for one, only, last question. Why don't we go over here? Scott?
Scott Mushkin:
Scott Mushkin from Wolfe Research. So I just wanted to ask a couple of questions. One is just a clarification. The cost of the remodels I don't think we actually got that number. And I was wondering if we could get it. I was hoping for an update on store execution, specifically in-stock. I know that was a big focus. And then the final question would be around price investments. You have 2 large competitors driving down price, most notably Walmart, but also Amazon is doing a lot of work with their Subscribe & Save, and those prices are very low. So what gives you the confidence that it's won and done here, as one of your largest competitor's on a multiyear price-lowering campaign?
Brian Cornell:
John, do you want to start with stores? Then I'll come back and talk about pricing.
John Mulligan:
Yes. Just to check off really quick. Cost of a remodel for a prototype, what we call a P-Store. $5 million, $5.5 million. A little less for lower-volume stores, a little more for higher-volume stores. SuperTarget, what do you think, Cathy? About double?
Catherine Smith:
Yes -- no. A little less than double. Yes.
John Mulligan:
A little less than double. Store execution, I'd say 2 things about, one, on out-of-stocks, made a lot of progress. When we talked about it last year, they had improved by about 40%. Last year, almost another 15% improvement. We've seen significant improvement in doing what we do today. The next leap in improvements in out-of-stocks in our stores will come from fundamentally changing the supply chain, which is what we talked about today. And so that's on course. We'll keep working on it, and we'll update you as we go forward, I guess.
Brian Cornell:
And Scott, I'll finish my talking less about price and a lot more about value. We know we have to be competitively priced every day on those core essentials, but we win when we deliver compelling value, which means a great in-store experience; which means new, exciting brands; which means surrounding the guest with great team members; which means a great online experience that's easy and friction-free. So it can't be just about price, it has to be about value. And value is the combination of all the things we do and historically have done so well. So we've got to make sure we surround the guest with a great in-store experience. The reaction we've seen as we brought visual merchandising to life in our stores has been fantastic. We've got to continue to build compelling brands that deliver great value for the guest. We've got to surround them with a great experience, whether they're picking up an item or checking out our stores. And that's got to translate to how we interface with the guest online. So value is critically important. And we think we're positioned in way that's unique in the industry with our assortment, our in-store experience, our multi-category portfolio, the capabilities we've now built on line and the changes we're making in-store, that's what gives us so much confidence that we're on the path back to growth, that it will take time, but there's going to be significant market share opportunities in front of us. And 3 years from now, when we've reimagined stores and we're in new neighborhoods and we've rolled out new brands and we got a great new supply chain capability to complement what we've done from a digital standpoint, we'll be sitting here talking about the new Target, a growth company that's captured market share in this new era of retailing.
So I appreciate your time and your patience today. Thanks for joining us, and we look forward to look talking to you in the future. So thank you.
Operator:
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 16, 2016.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our third quarter 2016 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; Mark Tritton, Chief Merchandising Officer; John Mulligan, Chief Operating Officer; and Cathy Smith, Chief Financial Officer.
This morning, Brian will recap our third quarter performance and progress in pursuit of our strategic objectives. Mark will provide detail on recent category performance, along with our fourth quarter merchandising and marketing plans. John will provide an update on our efforts to improve operations and modernize our supply chain. And finally, Cathy will offer more detail on our third quarter financial performance and our outlook for the fourth quarter and full year. Following their remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer your follow-up questions. As a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure; and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalized operating leases. Reconciliations to our GAAP EPS from continuing operations and to our GAAP total rent expense are included in this morning's press release, which is posted on our Investor Relations website. With that, I'll turn it over to Brian for his comments on the third quarter and our expectations going forward. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. We are very pleased with the financial results we announced earlier this morning. While we have much more work to do, this quarter, we saw meaningful progress in our efforts to improve our traffic and sales as both metrics improved by about a percentage point compared with the second quarter.
In addition, we generated much stronger-than-expected EPS performance, driven by strong signature category growth, favorable results in Back-to-School and Back-to-College season and the continued benefit of our cost-savings efforts. Our third quarter adjusted EPS of $1.04 was 22.1% higher than last year and well beyond the high end of the guidance range of $0.75 to $0.95. With this outstanding third quarter performance, Target's adjusted EPS has grown more than 10% through the first 3 quarters of the year. This is particularly strong performance given that we've experienced flat comparable sales growth during this period. In addition, our business continues to generate very strong after-tax returns on invested capital. For the 12 months through the end of the third quarter, we reported a very healthy after-tax ROIC of 14.3%, excluding the onetime benefit of the gain on the sale of our pharmacy business. This performance represents an increase of approximately 130 basis points from a year ago. Of course, strong cash generation by our business allows us to continue to fund a healthy level of investment in our stores, supply chain and technology while funding robust cash returns to our investors. In the third quarter, we returned about $1.2 billion to our shareholders on the form of dividends and share repurchases. Year-to-date, we've already returned over $4 billion to our shareholders. I'd like to pause and thank our team for their boundless energy and passion to serve our guests by offering them unique merchandise, outstanding service and a best-in-class experience. They deserve all the credit for our outstanding financial results this quarter. As I look ahead, I'm really excited about our holiday merchandising and marketing plans, and I'm confident that our outstanding team will bring those plans to life for our guests in our stores and digital channels throughout the holiday season. Our third quarter results demonstrate continued progress on many of our strategic priorities. Reflecting our work on category roles, sales in signature categories accelerated in the third quarter, out-comping the company average by more than 3 percentage points. Signature growth was the key driver behind healthy comp increases in both Home and Apparel, and we continue to see market share gains in these important categories. Consistent with our recent strength around events and holidays, third quarter sales in the Back-to-School, Back-to-College season were very strong, resulting in favorable gross margin mix in our sales. In addition, our gross margin rate continues to reflect the cost of goods benefit of our ongoing cost-control initiatives.
Within our signature category results, we're seeing exceptional growth in our 2 new brands we launched earlier this year:
Pillowfort in Kids Home and Cat & Jack in Kids Apparel. We developed these new brands in collaboration with both kids and their parents, and our guests continue to respond to the unique combination of style, quality and value these new brands deliver.
We also continue to see robust growth in our digital sales. Digital sales grew more than 26% in the third quarter, and they've grown more than 20% year-to-date. This year, we have devoted both capital and expense to improve the digital experience, increase reliability and create additional capacity, and we're seeing really encouraging results. This quarter, we ran a promotion that, among other things, allowed us to stress test our systems in advance of the fourth quarter. This promotion was an unprecedented and compelling offer for our guests, 10% off our entire assortment in both stores and digital channel. As you'd expect, the offer drove strong traffic and sales in all channels, but our digital comp on that day was particularly high. In the face of very strong surge in traffic, I'm happy to report that our system performed very well, providing us valuable insight as we prepare for even bigger days this holiday season.
Last year, to support our strategic investments in Target's digital capabilities, supply chain and store experience, we launched a comprehensive cost-savings effort to free up resources and create capacity, and our team has really delivered. We had an ambitious goal:
to take a total of $2 billion out of Target's expenses and cost of goods over a 2-year period. Yet, as we approach the end of that 2-year period, I'm pleased that our team has actually exceeded our $2 billion goal, and importantly, the team has identified additional opportunities we'll pursue in future years. The ability to create additional capacity is critical given the sizable investments we'll continue to make as we position our business for long-term growth.
Finally, we are really excited about the continued strong performance of our new flexible-format stores. These new locations allow us to reach new neighborhoods in dense urban and suburban markets. We opened another 5 of these stores across the country in the third quarter, including our fantastic new store in the TriBeCa neighborhood of New York City. When we open and operate these stores, we go beyond legacy systems and processes, customizing the assortment and operations that fit the characteristics of the individual neighborhoods in which we operate, and we continue to see phenomenal responses from our guests. Including this quarter's opening, we are now operating nearly 30 of these new-format stores. Based on their performance, we are increasingly confident in the opportunity for Target to profitably operate hundreds of urban flex-format stores over time, reaching new neighborhoods where consumers have a strong affinity for our brand. As we look ahead to the fourth quarter and beyond, we are continuing to address the challenges I described on our last conference call. First and foremost is traffic. And while we saw considerable improvement this quarter, we are committed to growing our comp traffic and sales over time. A key factor is our ability to deliver on both sides of our Expect More. Pay Less. brand promise, and our signature category performance demonstrates that we continue to deliver on the Expect More side. However, earlier this year, we began to fall short in communicating value to support the Pay Less side both in our stores and in our marketing. In the third quarter, we began to address that imbalance by communicating our commitment to value more clearly. We believe those changes were instrumental in driving improved traffic and comp sales in the third quarter. Going forward, we are committed to striking the appropriate balance in all of our marketing communications. We also continue our work to improve the performance of our assortment of convenient, self-service Food in our stores. We saw another small decline in Food comp sales in the third quarter, reflecting near-term challenges presented by deflation and an intensely competitive environment. Despite these near-term challenges, we are focused on delivering stronger growth over time, and Mark will outline his team's plans in a few minutes. In addition, comp sales in our Electronics and Entertainment categories continue to underperform the company average. However, in the third quarter, we were encouraged to see a meaningful improvement in sales of Apple products, driven by their introduction of several new product innovations. As you know, Electronics, Entertainment and Toys are key gifting categories in the fourth quarter, and the team is excited about their plans to compete and win at this critical time. Finally, we continue to work with CVS to drive script count growth in the pharmacies in our stores. As a result of our coordinated marketing efforts, which included our stores, our weekly ads and CVS direct communication to their PBM members, we measured an increase in consumer awareness of the transition of our stores' pharmacies to CVS, and we've seen a corresponding improvement in the script trend in these pharmacies. We continue to believe our CVS partnership will be an important traffic driver over time, and we expect to see significant improvement in 2017. Before I turn the call over to Mark, I want to pause and reflect on the progress and the business results through the first 3 quarters of the year. When you focus on the top line, you'll see that we've generated essentially flat comps through the first 9 months of the year. This is well below the expectation we had at the beginning of the year, and our first and highest priority is to restore growth to the traffic and sales trend. However, when you move to the bottom line, you'll see that we've grown adjusted earnings per share more than 10% in the first 9 months of the year. This is outstanding performance, but it's particularly noteworthy in light of the sales challenges we've been facing. The performance is a testament to the resilience of our underlying business, our strategy and, of course, our team, the best team in retail. Now I'd like to welcome Mark Tritton onto the call. Mark comes to us with an impressive history in retail merchandising with experience at Nike, Timberland and, most recently, Nordstrom. Mark is a merchant's merchant and a strong leader. Since he arrived at Target, I've been impressed with how quickly he's become immersed in our business and integrated into our team. We're excited to have Mark leading merchandising, and I know he's excited about our plans for the fourth quarter and beyond. So with that, I'll turn it over to Mark so he can provide more details on the category performance in the third quarter and our plans to win during the holiday season and beyond. Mark?
Mark Tritton:
Thanks, Brian, and hello, everyone. I'm so happy to be joining all of you on the call today. I look forward to meeting with you in New York this spring.
As Brian mentioned, I spent the last several months digging into our business, understanding Target's strengths and exploring where we have the biggest opportunities to grow. And what I found is we have a strong business as it stands today, a powerful Target brand, an impressive own brand portfolio, great-looking stores, a friendly and engaged team and a huge base of passionate guests. With these strengths, we also have an amazing opportunity in front of us. It's been energizing to dig in with the team to develop merchandising's plan to drive Target's future growth. I look forward to sharing our vision in detail with you at our Financial Community Meeting. For today, I'm going to focus on our recent performance and our plans for this quarter and the holiday season. In the third quarter, sales performance improved across nearly every part of our business. Comp sales in Apparel and Home accelerated the most, providing a positive mix benefit on the gross margin line. Strong execution and markdown management compounded that benefit, leading to much stronger-than-expected gross margin in the quarter. As Brian mentioned, we saw very strong trends in Back-to-School and Back-to-College, reflecting our focus on key growth categories and the benefit of improvements we made to our promotional cadence. Digital growth played a big role in the season, particularly in Home, which is already one of our biggest and most profitable categories online. We've continued to see the fastest growth in signature categories sales. A few of the highlights from the third quarter include Kids, where we've seen an outstanding performance in Cat & Jack and Pillowfort. We've also continued to generate strong comps in women's ready-to-wear on top of outstanding growth in 2015, and within Home, our results were strongest in the decor and Seasonal categories. Given this strong growth in signature, both Home and Apparel saw low single-digit growth in comp sales this quarter, extending our record of market share gains in these strategically important categories. As Brian mentioned, in Electronics, recent product launches helped improved trends in Apple this quarter. However, we continue to see soft trends in mobile phones overall, which is what we've seen in the industry as upgrade cycles are lengthening. In Food and beverage, we saw another small comp sales decline this quarter. As we mentioned in the last earnings call, we have an opportunity to more clearly convey and resonate value for our guests in this important category. This is being done through our end-cap presentations, enhancing our use of local pricing and making changes to our promotional cadence, and we expect to see the full benefit from these changes in the fourth quarter. In essentials, where we identified a similar opportunity, we've seen faster progress. As a result, comp sales grew in essentials in the third quarter, and we expect to see continued progress this quarter. Also, as Brian mentioned before, we've seen a meaningful improvement in script counts in the CVS pharmacies in our stores. We're also seeing higher guest services scores compared with the period prior to and particularly during the conversion of our pharmacies. These improvements show that our guests are moving beyond the temporary disruption caused by those conversions, and with the disruption behind them, they're responding to the services and capabilities that CVS can provide. As we look ahead to the fourth quarter, we expect to build on our momentum from the third quarter.
Target is a destination for season, and no season is more important than the holiday. In Home, we're looking to build on last year's success, when we saw the biggest comp growth in more than a decade. Our holiday décor assortment will feature products based on 3 key Seasonal trends:
traditional, Nordic and modern.
New this year, we've created Wondershop, a destination in our stores and on target.com that will grab guests' attention and put them in the mood to shop for the season. Wondershop features thousands of new holiday interim items. In fact, about 70% of the assortment is new this year. We're also bringing back to the holidays our collaboration with stationery designer Sugar Paper, which was a big hit last year. This features a limited edition collection ranging from $1.50 to up to $15. Holiday is an important Apparel season for families, and we're well positioned to deliver for our guests with our new Cat & Jack collection. This new brand has hit a sweet spot with millennial parents in particular, and we have high expectations for what it can deliver during the holiday season. Between October and December, we are introducing more than 1,000 new pieces to our Cat & Jack assortment. Each piece is under $30, which is unbeatable value when you consider the design and quality. As Brian also shared, Toys play a key role in the fourth quarter. In fact, we do about 50% of our annual toy sales during this time frame, and this year, we're building on 10 consecutive quarters of growth in Toys, reflecting our investments in newness, differentiation and collectability. This holiday season, we've added nearly 1,800 new and exclusive toys, up more than 15% from last year. As you recall, Target had the #1 market share in Star Wars last year. This fall, we once again led the market with launch of our Rogue One assortment, and for holiday, we're featuring more than 100 new products. Beyond Star Wars, Disney princesses continue to do very well. Elsa from Frozen remains our top seller, selling more than the other 11 princesses combined. An emerging trend in board games has been a bright spot for us this year as families are looking for activities that bring them together. We've seen double-digit growth in board games so far this year, and we've got 50 Target-exclusive games this season for you. In Electronics this quarter, we are planning for strong demand for Apple new products given that preorder volume was 3x higher than last year. We're also expecting a lot of guest interest in virtual reality, along with connected home devices like Google Home. Elevated service in our Electronics department is also important to help make shopping in this area a more enjoyable experience for our guests and drive incremental sales in our stores. So more than 1,500 stores we're transitioning from Target Mobile reps who are focused only on mobile to Target tech whose scope will include all of Electronics. Last year, our exclusive CD from Adele was a massive hit for the holiday season. This year, we've got a collaboration with Garth Brooks, and we expect it to be huge. Target's 10-disc box set includes Garth's new album with 2 exclusive tracks, including the much hyped 25th anniversary edition of Friends in Low Places. By the way, Target is the only place you'll ever be able to find that track. The set went on sale for $29.99 on November 11, 2 weeks before Garth's new album will be available at other retailers. This year in Food and beverage, about 20% of our national brand holiday assortment is exclusive to Target, and we've more than doubled our assortment of craft beers from last year, growing from about 700 to nearly 1,500 options across the country. In our marketing and promotion, we're coordinating everything for our guests, inspiring them with providing ease and convenience during a stressful time of the year. From the Wondershop to the Wonderlist gift guide and the kid's Wish List app, we're making it easy and fun for guests to find the right gift for everyone on their list. Guests loved our 10 Days of Deals last year, so we're bringing back these popular promotions on the days leading up to and following Black Friday. Based on guest insight, we've optimized this year's cadence of deals and simplified offers to make them easy to understand. In addition, we've worked with our stores to streamline guest communication, freeing up store teams to serve our guests during the busiest time of the year. And finally, throughout the season, our broadcast ads will build excitement for the release of The Toycracker, our take on the classic story of The Nutcracker. We'll release this new holiday story in 2 4-minute segments during the world broadcast premiere of Frozen on December 11. Kids of all ages will not want to miss it. With all this amazing content, I hope you can see why we are so excited about our merchandise, promotion and marketing plans for the holiday season. However, as we all know, these plans will only come to life through the work of our operations team. So now I'm going to turn the call over to John, who will outline how his team is prepared to deliver on those plans and provide outstanding service to our guests throughout the holiday season. John?
John Mulligan:
Thanks, Mark, and good morning, everyone. Across every aspect of our operations, we are excited and prepared for the peak holiday season. And as a result of this year's efforts to increase the speed, accuracy and reliability of our network, we're well positioned to deliver great guest service and a better experience in every channel.
In our stores, we've hired and trained tens of thousands of seasonal team members who are already serving our guests. Notably, despite the tightest labor market conditions we've seen in some time, our hiring and training process went smoothly. In fact, we met our key hiring and training milestones earlier than a year ago. When guests shop our stores this holiday season, in addition to great products, displays and services, they'll find our in-stock position is better than we've ever measured, reflecting improvement across every category we sell. And importantly, we're attaining those in-stock levels with lower inventory than a year ago. Over the last 18 months, we've deliberately invested in our inventory position in key commodity categories to ensure we remain in-stock in categories where reliability is most important to our guests. However, now that we've annualized these investments and we're beginning to see the benefit of our work to make our supply chain faster and more reliable, we'll be able to deliver outstanding in-stocks on a smaller base of inventory over time. The accuracy of our inventory data is key to our speed and reliability, and we've been investing in our systems and processes to achieve greater accuracy. One example is our implementation of RFID technology in a portion of our Apparel assortment, which is currently in more than 1,600 of our stores. In affected categories, overall inventory accuracy has increased dramatically, meaningfully reducing the number of occasions in which we can't physically locate an item. In addition, we've made system changes to optimize replenishment of products that our guests purchase in multiples and make changes to minimum on-hand standards in higher-volume locations, both of which have dramatically reduced out-of-stocks on affected items. We will continue to test and rollout these enhancements throughout next year. Because of our efforts to eliminate nonguest-facing work in our stores, the team is delivering outstanding service to our guests while delivering efficiency in support of our cost-control efforts. Through the redesign of our in-store replenishment processes and algorithms, we've reduced store backroom trips dramatically this year, delivering tens of millions of dollars of payroll savings that we've reinvested in service. Two areas in which we've invested store labor are the Store Pickup process and our ship-from-store capability. Guests love the flexibility of these capabilities all year but especially during the holiday season. In fact, during the peak period from Thanksgiving through Cyber Monday, we expect our stores to fulfill more than half of our digital demand. While this is the third holiday season in which we've offered order pickup in all of our stores, we're planning for volume to grow another 50% from a year ago. Since last year, we've added additional holding capacity to more than 80 of our highest-volume pickup locations, and we've invested in scheduling tools and additional digital devices to enable high-volume locations to deliver fast service even in peak times. And this year, in more than 300 of our highest-volume pickup locations, our stores teams will wear unique shirts and deliver separately branded reusable bags to underscore our commitment to the pickup experience. By last year's holiday season, about 460 of our stores were shipping directly to our guests, up more than threefold from about 140 stores in 2014. This year, we've extended this capability to another 600 stores, meaning that well over 1,000 of our stores are shipping directly to our guests this season. In total, these stores are expected to ship more than 3x as many units as last year, accounting for about 1/3 of our digital volume during the peak period from Thanksgiving through Cyber Monday. Shipping from stores delivers a number of benefits to our guests and to our business. Most importantly, this capability reduces shipping times, given the proximity of these stores to the vast majority of the U.S. population. With that proximity of guests, we also save on shipping, helping to relieve the pressure from shipping growth in our P&L. It also allows us to balance our inventory across our store network, maintaining in-stocks while reducing markdowns in store locations with heavy inventory. And finally, store shipping release pressure on our fulfillment centers, especially during peak season, allowing the entire network to function more effectively. Our 3 delayed allocation centers, which have all come online this year, are another way we upgraded capacity. These facilities allow us to aggregate inventory in slower-moving but harder-to-forecast categories, allowing us to improve our store allocation without hurting lead times. During peak season, we will be fully utilizing these facilities to free up space in our regional DCs to enhance the overall speed and reliability across our distribution network. Finally, as a result of our efforts to optimize inbound processes, we expect to double the percentage of our holiday receipts that are processed within 24 hours of arrival. This will enhance our store in-stocks while freeing up meaningful space in our regional DCs, further enhancing speed and efficiency. While we're just getting started, our team is really excited about our progress in modernizing Target's operations, and we're pleased to hear from many of you that you're beginning to notice the difference when you shop with us. While that's great to hear, I want to emphasize that we are not slowing down. Our team is energized and focused on our plans for the next year and beyond, and I look forward to sharing those plans with you in February. With that, I'll turn it over to Cathy, who will share her perspective on our third quarter financial performance and our outlook for the fourth quarter and full year. Cathy?
Catherine Smith:
Thanks, John, and hello, everyone. Our third quarter financial performance was much stronger than expected, driven by strong execution across the board. Adjusted earnings per share of $1.04 was 22% higher than last year and well above the top end of our guidance range. This performance would be noteworthy in any environment but it's especially impressive given our challenging sales trends.
Comparable sales declined 0.2% in the third quarter. This was a full percentage point better than our second quarter performance and near the high end of our guidance range. However, it's well below the growth we expect to generate over time. With the removal of our pharmacy and clinic sales from this year's results, total sales were down nearly 7% in the quarter. Digital sales increased more than 26%, contributing about 70 basis points to our comparable sales. Digital growth was fastest in our signature categories and was particularly strong in Kids, driven by the strength of our Back-to-School offering and the launch of Cat & Jack. This is particularly exciting because signature categories are items and brands uniquely Target. Among the components of our comp sales, transactions were down 1.2% in the third quarter and 1 percentage point improvement from the second quarter. Average ticket increased 1%, in line with our performance so far this year. I want to pause here and make it clear that while we have made significant progress, we are not satisfied with our third quarter traffic and sales performance. First and foremost, we are focused on restoring growth to both of these metrics over time. Our REDcard program is our most powerful loyalty vehicle, and it's continuing to grow. Sales penetration on our REDcard was 24.3% in the third quarter, in line with our expectations and 2 percentage points ahead of last year. Excluding the benefit from the pharmacy transaction, penetration was up about 80 basis points in the quarter, which is consistent with our year-to-date performance. Moving down the P&L. Our third quarter segment EBITDA margin rate was 9.9%, up from 8.6% last year. About 2/3 of this improvement was driven by an increase in our gross margin rate combined with the benefit of a lower SG&A expense rate. Specifically, our gross margin rate improved about 80 basis points compared to last year, which was much stronger than expected. This improvement was entirely driven by merchandise mix resulting from both the pharmacy transaction and strong performance in our signature categories. On the SG&A line, we saw about 40 basis points of improvement from a year ago, which reflects the benefit of our ongoing cost-control efforts. As John mentioned, we continue to find ways to eliminate nonguest-facing labor in our stores. This creates capacity that allows our team to focus on guest service while maintaining outstanding efficiencies to support our financial performance. For the first time this year, our quarter-end inventory was lower than a year ago. The team has done a fantastic job responding to the recent slowdown in our sales by effectively managing inventory and receipt. With this strong execution, we've seen outstanding gross margin performance so far this year. And as we enter the peak of the holiday season, we feel very good about the level and the composition of our inventory. Let's turn now to capital deployment. We paid $345 million in dividends during the third quarter and returned another $878 million through share repurchase. A portion of our third quarter repurchase activity was accomplished through an accelerated share repurchase agreement. A portion of this ASR was settled after the end of the quarter. Through the first 3 quarters of 2016, we have repurchased more than $3 billion of our shares, which keeps us on track to invest $3.5 billion or more in share repurchase this year. One thing to note is that during the third quarter, our Board of Directors approved a new $5 billion share repurchase authorization. We'll begin repurchasing shares under this new program when we complete the current $10 billion program. As of the end of the third quarter, we had approximately $300 million of remaining capacity on the current $10 billion program. And one other item to note. During the third quarter, we obtained a new $2.5 billion credit facility that expires in October of 2021. This new facility replaces a $2.25 billion facility that was scheduled to expire in 2018. We have never borrowed under any of our prior credit facilities, and we would not expect to borrow under the new one either. However, it provides an important source of backup liquidity, and it serves as a backstop to our commercial paper program, which we use to fund our seasonal borrowing needs. Reflecting our focus on disciplined capital deployment, one of our goals is to grow our after-tax return on invested capital into the mid-teens over time. I'm pleased to share that we are making significant progress toward this goal. For the 12 months through the end of the third quarter, our business generated an after-tax ROIC of 16.3%. However, that calculation includes the onetime gain from the pharmacy sale, which we recognized in the fourth quarter of last year. Excluding that gain, our third quarter after-tax ROIC was 14.3%, up about 130 basis points from a year ago. Now let's turn to our outlook for the fourth quarter and full year. Consistent with last quarter, we are maintaining a cautious outlook, given the current environment and the prospect of a very competitive holiday season. With that in mind, we are planning our fourth quarter comparable sales to be roughly consistent with our third quarter performance in a range of around flat, plus or minus 1%. Total sales are expected to decline about 3% in the fourth quarter, reflecting the removal of pharmacy and clinic sales from this year's results. This will be the last quarter in which we will be comping over pharmacy and clinic sales from the prior year. In terms of operating margin, we're expecting our fourth quarter segment EBIT margin rate will be up slightly, about 10 basis points higher than last year. This outlook is based on an expected 40 basis point improvement in our EBITDA margin rate, driven entirely by a lower SG&A expense rate. Offsetting this improvement, we expect to see an increase of about 30 basis points in our depreciation and amortization expense rate. This will be driven by approximately $15 million of accelerated depreciation related to our 2017 store remodel program, along with the deleveraging effects of the total sales decline resulting from the pharmacy transaction. Altogether, in the fourth quarter, we expect to generate both GAAP EPS from continuing operations and adjusted EPS in the range of $1.55 to $1.75. When we combine these fourth quarter expectations with our year-to-date performance, we're expecting to generate approximately flat comparable sales for the full year and full year adjusted EPS in the range of $5.10 to $5.30. Notably, the top half of this updated EPS range is within the range we laid out at the beginning of the year. This demonstrates how effectively our team has performed in the face of unexpected sales challenges. Looking into next year, our first focus is to restore growth in our traffic and comparable sales. With sales growth, a strong gross margin mix and continued cost discipline, we believe we can sustainably grow both the top line and the bottom line over time. I look forward to discussing our longer-term aspirations and our outlook for 2017 performance at our meeting with you in February. Now I'll turn the call back over to Brian, who has a few closing remarks. Brian?
Brian Cornell:
Thanks, Cathy. Before we open up for questions, I want to pause and recap our position as we enter the final quarter of the year. Year-to-date, comp sales have been about flat, and we believe it's prudent to plan for a similar trend in the fourth quarter. That said, we're very excited about our plans for the holiday season, and our team is focused on outperforming our plans, gaining market share and delivering positive comp sales across our businesses, not just in signature categories.
On the adjusted EPS line, we have grown more than 10% so far this year. And based on our fourth quarter expectations, our updated range for full year adjusted EPS overlaps with the original guidance range we provided last March, reflecting the team's strong execution in the face of challenging sales trends. Signature categories sales continue to far outpace the company average, and we continue to gain market share in these categories. And because our digital growth continues to outpace the industry average, we continue to gain share in the digital channel as well. So while we continue to adjust our near-term tactics to better maintain the balance on both sides of our Expect More. Pay Less. brand promise, we believe we have the right long-term strategic plan to sustain Target's performance over time. I look forward to covering both our fourth quarter results and our longer-term strategic and financial plans at our Financial Community Meeting, which we'll be hosting in New York on February 28. We'll be providing more details on timing and location soon. But in the meantime, please mark your calendars for that date. With that, we'll conclude today's prepared remarks. Now Cathy, Mark, John and I will be happy to respond to your questions.
Operator:
[Operator Instructions] Our first question comes from the line of Bob Drbul with Guggenheim.
Robert Drbul:
I just had a couple of questions for you. On pricing, throughout the quarter and, I guess, into the holiday season, what are you seeing and what are you expecting in competition? And you talked a little bit about your ongoing strength in Toys. Can you just talk about the drivers of Toys in the fourth quarter and how you expect that to perform as a category?
Brian Cornell:
Bob, as we think about the holiday season, we expect it to be a very competitive, promotional environment, like we've seen over the last couple of years. So we've -- I think we've got great plans in place. We're very excited about the merchandising, the marketing and promotional plans, and we think we're going to be very competitive throughout the season. As it pertains to Toys, again, we've had a multiyear positive run in that category, and one of the things that's really been important for us is working with key partners like Disney, Mattel, Hasbro to make sure we bring new exclusive items to our assortment. As we go into the holiday season, we're excited to have 1,800 exclusive items in that category, and we think these are going to be very important to our guests throughout the holiday season.
Robert Drbul:
Great. Brian, can I just ask one more follow-up? So when you look at the business over a longer period of time, this has historically been a relatively steady business. I was just wondering, when you look at the volatility between what you saw last quarter and your results and sort of your forecast for the fourth quarter, within 3 months, that's a dramatic change in the outlook. Can you just talk a little bit about exactly what is factored -- what factors are driving this?
Brian Cornell:
Yes. Bob, as we think about our strategy and our approach, while we're certainly very pleased with the progress we saw in the third quarter, it's a result of being very focused on the strategy we've had in place for almost 2.5 years now. And our results and the improvement we saw in the third quarter is really driven by, one, our focus on those signature categories, our commitment to Apparel and Home, baby and Kids, where we continue to see very strong growth and market share improvement. We've been very committed to improving our digital engagement, and year-to-date, we're up over 20%. We saw a 26% growth in the third quarter. And the investments we've been making to improve functionality and ease online is certainly connecting with our guests. We've been very focused, as we've talked about, in expanding our format into new urban neighborhoods. And every time we open up a new store, whether it's in New York, TriBeCa or Philadelphia, we're seeing a great response from our guests. And we've been on a journey, over the last couple of years, to drive greater efficiency throughout our organization. And with John's leadership, we continue to see very strong improvement in operational efficiencies and costs that we're returning to the bottom line. So our focus over the third quarter is very similar to the journey we've been on for the last couple of years, and we've just intensified our focus on executing against our key strategic plan -- planks.
Operator:
Your next question comes from the line of Scott Mushkin with Wolfe Research.
Scott Mushkin:
So just kind of wanted to step back. And we've got traffic that's negative. And trying to understand, as we get out to like next year and the year beyond, where -- obviously, you guys are doing a great job controlling SG&A costs, but it's very hard for a retailer like Target to run this balance with traffic down and sales kind of flat, especially with wage costs rising rapidly. So Brian, if you could take us out and kind of talk about the strategy to drive traffic, get the sales up. I think you threw the number out there, 3% comp growth '17 and beyond. Just how do we get there?
Brian Cornell:
Scott, as we think about the next several years, you're going to continue to see us make significant investments in our assets, improve the in-store experience. We're already seeing the benefits of the investments we've made in Apparel and Home. We're very pleased with some of the learnings from LA25 that we'll be transitioning into our new remodels as we go forward. So we think the importance of the in-store experience, great customer service, continuing to bring newness to our assortment, elevating and developing our own brands -- I think one of the big highlights for Target in 2016 is the way our guest has reacted to 2 great new brands. Both Pillowfort and Cat & Jack have been incredibly well received. The style, the quality, the value we're delivering is connecting with our guest. So the combination of great in-store experience, making sure we surround our guest with great customer service, whether they're shopping in our store or they've ordered online and they're coming in to pick up that order, and then delivering great Target brands at a value. So we think that combination is the strategy that drives traffic into our stores, cars into our parking lot and even more engagement online.
Scott Mushkin:
All right. Perfect. And just as a follow-up to kind of thinking about the '17 and beyond, I know CVS was out, I guess, it was last week, they're losing a lot of scripts because of dynamics that are going on there. Now clearly, you don't -- scripts don't matter anymore to you guys, but how about traffic impact on Target as we get into '17 and beyond? Have you guys thought about that and what that can mean?
Brian Cornell:
Well, Scott, I will start with scripts matter a lot to us, and key to the partnership with CVS is making sure we're working together to drive scripts. Because back to the importance of traffic, scripts will be an important part of driving traffic to our stores, and we were very pleased in the third quarter with the progress we're seeing. We're seeing much greater awareness now that we've completed the new branding. The combination of our in-store marketing and CVS marketing and their PBM is driving increased traffic to the pharmacies. So that is a very important lever going forward, and we're very confident in our partnership. John Mulligan works very closely with the CVS team. We've got great plans in place for the fourth quarter and even stronger plans as we go into 2017. So that is a very, very important part of the traffic equation, and we think, over time, that's going to be a key driver of traffic into our stores.
Operator:
And your next question comes from the line of Greg Melich with Evercore ISI.
Gregory Melich:
I really wanted to follow up on Grocery and Food and the strategy there and how we're going to use that to drive traffic; and also on traffic, an update on your digital initiatives. I know you were doing some tests of combining Cartwheel with REDcard. Just love to hear how those are going and how you think those could help drive traffic into next year.
Brian Cornell:
Yes. Greg, let me start on the Grocery side. And clearly, we have more work to do there, but we feel like we're making very good progress, changes we've made to assortments, improvements we've made to the quality of our produce items. And we're certainly pleased with the reaction we're seeing as we enhance the experience in our LA25 stores. That being the case, we've got to continue to make sure we build a greater connection with our guest as it pertains to the convenient food offering we provide. And Mark and I are working closely on the next phase of our Grocery evolution to make sure that we continue to provide the right assortment, the right value, the right quality our guest expects from Target while they're shopping our stores. So you'll see a lot more of that when we get together in February, but we recognize that's an area that we've got to continue to drive progress in. From a loyalty standpoint, we are working very closely with the marketing team to ensure that when we get together with you in February, we'll be able to talk about the next iteration of our personalization and loyalty programs. Key to that, Greg, is bringing together some of the great assets we already have in place, leveraging our REDcard, leveraging Cartwheel, which continues to see great response from the guest, and making it easy for the guest to leverage the existing loyalty assets we have in place. So we think that's a key unlock as we go into 2017 and beyond, and that'll be a key topic of the conversation when we see you in February.
Operator:
Your next question comes from the line of Brandon Fletcher with Bernstein.
Brandon Fletcher:
First-time caller, long-time listener. My -- our core question is, who else can win in urban environments? I know you only have a few dots with the flexible formats, but we think you guys are pretty far ahead in terms of knowledge, how to run mass merchants in urban stores. And mostly, your competitors are pharmacy stores who are good competitors, but boy, they need a whole lot of price to make it work. Do you see somebody else who's dangerous around the corner for taking a spot in cities, obviously besides Amazon going ever more urban?
Brian Cornell:
Yes. Brandon, we're very focused on our own opportunity. Again, we're in 30 locations today. We think we have the opportunity to enter many, many new neighborhoods, and we're really focused on making sure we build the back-end capabilities in supply chain, in assortment management, the in-store operating capabilities that it takes to run these smaller stores. But we think the unique opportunity we have is bringing the best of Target to these individual neighborhoods, making sure that we custom tailor assortment, we bring the right assortment of Apparel and Home, baby and Kids that's right for that neighborhood, complement it with convenient foods and household essentials that really make that local Target run impactful for the guests. So we're still learning. We're very pleased with the feedback, but as we enter very competitive markets like New York, we're going to learn a lot from TriBeCa. We'll take that to other locations. As we do more and more business adjacent to college campuses, we'll understand more and more about the needs of the college student, but we really think, right now, we've got a unique opportunity to leverage this new footprint as a future growth element in our strategy, and the guest continues to say thank you every time we enter a new neighborhood.
Operator:
Your next question comes from the line of Matt Fassler with Goldman Sachs.
Matthew Fassler:
My question is focused on gross margin, where you really turned the corner year-on-year when you back out the pharmacy business. You all spoke to the impact of mix, but can you talk about the impact that you're seeing from cost cuts at the point of purchase for you and how deeply you are into that effort, whether you expect that to be sustained going forward?
Brian Cornell:
Matt, I'd start with we feel really good about the way Mark and his team have managed gross margin throughout the quarter, but it's really a byproduct of the strength we continue to see in those important signature categories. And both in-store but, importantly, online, our growth has been led by Apparel and Home, great strength in baby and Kids, those important high-margin categories that drive differentiation for our brand. So the benefits that we're seeing in gross margin are a byproduct of the strategy we've had in place and really making sure that we're building market share, we're bringing great style and design and newness to those signature categories, and the payback has been margin expansion while we continue to invest in value and getting back to rebalancing our brand promise. We're bringing tremendous product to the Expect More side. And now we've rebalanced our value message on the Pay Less side. So we were able to invest in value throughout the third quarter and still see gross margin range expansion. So we feel really good about the balance we're bringing there and think that can be sustained over time.
Operator:
Your next question comes from the line of John Zolidis with Buckingham Research.
John Zolidis:
Great to see the sequential improvement in trends.
Brian Cornell:
Thanks, John.
John Zolidis:
Question about some of the metrics within the comp. Looking at the average unit retail up 3.5% and units per transactions, down, I noticed that, that has been the case for about 10 consecutive quarters now. So just curious if you could talk about what's driving the average unit retail up and units per transaction down.
Brian Cornell:
Yes. Again, John, it comes back to the mix of our business and the strength we're seeing, particularly in categories like Home, the strength we're seeing in Apparel and accessories, some of the strength we're seeing in baby and Kids. So those are important categories, obviously, in many cases, higher ticket -- still a great value for our guest but higher ticket. And obviously, offset by some weakness we've seen in the Grocery category. So the mix is clearly impacting those metrics you're seeing, and we feel very good about the way the guest has reacted to the quality, the style and the value we're offering in those signature categories.
John Zolidis:
Is e-commerce growth also a factor then? I would imagine that's more focused into the higher purchase items [ph].
Brian Cornell:
Absolutely. And again, as we noted in our earlier comments, while, overall, we saw our digital business grow by 26%, the bulk of that business, the high-growth areas were in Apparel and Home, so again, higher-ticket items. We feel really good about the progress we're making from a digital mix standpoint, and that's also coming through in the metrics you're seeing.
Operator:
Your next question comes from the line of Chris Horvers with JPMorgan.
Christopher Horvers:
I wanted to think about the shift of the digital promotion in the second to the third quarter. How large of a contributor was that to your delta in comp performance in the third quarter versus second quarter? I ask this because if we look at these 2 quarters together, that's the low end of your 4Q guide. And so as we look ahead, what are the, I guess, big efforts or big drivers that you think drive the business to potentially the higher end of that range? Is it the focus on -- your customers tend to shop more around events? Is it the merchandising side? What drives the higher end of the comp outlook for 4Q?
Brian Cornell:
Yes. Chris, backing up, and I know there are a number of embedded questions there. One, there was some shift because of the promotion between Q2 and Q3. I'd really focus on the year-to-date number. Year-to-date, from a digital standpoint, we've been growing at 20%. As we talked about earlier in the call, we're very pleased with the reaction we're seeing during key event periods, Back-to-College, Back-to-School, a very important period for us both in-store and online. And we think the combination of the investments we've made to improve ease, functionality of our digital engagement and the fact that we're certainly showing the ability to win during key holiday and thematic periods, that's the right balance for us going forward. So we think digital is going to be an important part of our growth strategy going forward. We think digital is certainly the way our guest interfaces with the brand, whether they're in store or online. And we're very pleased with the progress we're making, and our overall growth rate is approximately 2x the digital industry. So we're building market share. We're winning during key seasons, and we certainly expect that to be a key driver to our fourth quarter success.
Christopher Horvers:
And then just one quick follow-up question. Can you talk about how much -- I think CVS was 60 or 70 basis points to the gross margin in the third quarter. You're going to start to lap that in the fourth quarter. It sounds like you're guiding to flat. So just help us understand how that sort of progresses out into the fourth quarter.
Catherine Smith:
Yes. So Chris, this is Cathy. As we said, we're guiding for EBIT margin to be up about 10 basis points. We do -- CVS was -- we closed it, remember, about halfway through the fourth quarter last year, so we'll get a little bit of that impact still. The biggest driver in the fourth quarter, as we said, was the -- is SG&A. So we'll continue to see some improvement there, and that's going to get us that 10 basis points of EBITDA margin.
Operator:
Your next question comes from the line of Robert Ohmes with Bank of America.
Robert Ohmes:
The question I had was just -- was actually -- this might be more of a John Mulligan question. I was hoping, John, you could maybe give a little more detail on what the opportunities are from here in terms of in-stocks, RFID, the stuff you're working on and sort of how that could support store comps as you -- in the fourth quarter and as you head into next year.
John Mulligan:
Great question, Robbie. I think the team has made a lot of progress. And as we said, at least the way we measure it today, our in-stocks -- out-of-stocks is actually the number we've been focused more on, is at our historically low number. So we feel great about that. Having said that, we think there continues to be significant opportunity for us. And I think we see opportunity, first, at a store level, ensuring we always have what the guest wants when they walk in. Because even though we've improved meaningfully, there's still a lot of distance there to go. And then, more important than that, digitally, ensuring we have the right unit at the right place for the guest, whether they want to come in store and pick it up, whether we're going to ship that from a store or ship that from a fulfillment center. And today, we're not completely optimized there either. And so while we've seen great progress and we -- there's absolutely benefit to the guest and their trust with us when they come into the store over time, we still think there's a lot of runway there for us to improve. And you'll continue to see us focus on reliability and speed in our supply chain, and those are the 2 things that we will continue to drive against over not only next year but the next several years.
Operator:
Our next question comes from the line of Dan Binder with Jefferies.
Daniel Binder:
It's Dan Binder. You highlighted that Back-to-School was strong for you, and it seems that the consumers are shopping Target when there is an event, which could be good for holiday. But I'm curious what you saw in the post Back-to-School period and just generally, when you look back over the last year or so, in between big events, whether it's a Memorial Day event or a Father's Day event or such, what you're seeing in those traffic trends between the big events.
Brian Cornell:
Dan, it's a great question. And obviously, we feel really good about the support we received during Back-to-College and Back-to-School. In those off-holiday periods, we've got to make sure we've got the right balance between newness and those important style categories and great value in our household essentials and Food. And Mark and his team have spent a tremendous amount of time reshaping our promotional strategies, making sure that, both in our circular but also in-store, it's really clear to our guests that we've got this great combination of newness and style and the value our guest deserves and is looking for in those key household essential areas. So we've done a lot of work in-store. I think with Mark's leadership, we're clarifying value on our end caps, clear assortment that connects with the guest in those off-holiday periods. So I feel really good about the progress. You'll see more of that as we go into the fourth quarter. But why don't I let Mark talk about some of the work that he's been leading as we think about really ensuring that value message is very clear to our guests when they're walking our stores each week.
Mark Tritton:
Yes. Thanks, Dan. What we've seen is like a really hypercompetitive market in the first half of the year that really made us take stock to look at how do we represent and resonate value to our guests more readily. So what you're seeing emerging in third quarter and more in the fourth quarter and beyond is a representation not just of price and value in our circulars, as Brian talked about, but in-store, ensuring the guest clearly sees that value up front and center, so representation on our end caps, increasing single price point end caps to really generate a buzz about our value and really delivering on Expect More. Pay Less. So this is a continuing trend. And then the spaces between the key seasonal events that you raised, as Brian said, we're hyper-focused on that. We've seen some strength in some of our options that we put in place and really looking forward to our plans about how do we continue guest traffic and love post major events where we do win.
Daniel Binder:
And then, if I could, just another question. In the last quarter or 2, you've highlighted that the Electronics business was, I think, about a 70 basis point hit to the comps. I was just curious if you could help us understand what that looked like in Q3. And then on the scripts that you mentioned were getting better, trend wise, it sounds positive. But I was curious, if you look at the script trends relative to what you were doing when you owned the pharmacy business, if there's some sort of relative measure you can give us there, that would be helpful.
Brian Cornell:
Yes. So let me start with E&E. And as I've mentioned in my earlier comments, we feel really good about our plans for the fourth quarter. And obviously, Entertainment, Electronics and Toys are critically important gifting items for the fourth quarter. So again, I think the work that Mark and his team have done to make sure, working with our vendor partners, we have a combination of new items, exclusive items, items that are on trend. We've seen a great reaction to our toy and gifting catalog, and we think like that we're very well positioned for the fourth quarter. Those categories did trend downward in Q3. But the important part of the year is in front of us, and I think we're very well positioned. And from a script standpoint, we are still rebuilding some momentum in that space. But sequentially, we've seen improvement from Q1 to Q2 and Q3, and we recognize that with time, as the branding's in place, as our in-store marketing and the CVS marketing take shape, we're going to be rebuilding and growing scripts in that very important part of our store.
Operator:
Our final question comes from the line of Oliver Chen with Cowen and Company.
Oliver Chen:
Solid margin and inventory control. Just wanted to ask you about fill-in versus stock-up. It's likely related to your -- the progress you've made towards the value messaging. So just curious about how you're feeling about that dynamic. And then I wanted you to try to brief us on the reality versus Amazon, the near-term strategies in terms of how you'll be competitively positioned versus Amazon in the holiday season period. And then as you look to bricks and clicks and the seamless experience over the longer term, for long-term investors, what should the key factors be as we engage in that share opportunity versus Amazon?
Brian Cornell:
Oliver, a great way to wrap up the call. From a fill-in and stock-up standpoint, again, the work that Mark just talked about on the value side is clearly addressing the fill-in guest, and I feel very good about the progress we've made and will continue to make in that space. I think to the broader question, it's a terrific way for us to wrap up before we all get together in New York City. We continue to feel very good about the strategy we have in place and how that will allow us to be very competitive and continue to win in the current retail environment. We think the investments we're making in our stores are critically important, and that store experience that we continue to elevate is a very important measure for our guests. We've learned, as I hope you have, guests still like physical stores, and year-to-date, still almost 90% of all retail shopping is taking place in a physical store. So we've got to make sure we've got a great experience, we've got great service, we continue to elevate that experience and service and combine it with outstanding merchandise and value every time our guests shop. We think our strategy of moving into new neighborhoods, whether it's these densely populated urban centers or on college campuses, is a critical growth vehicle. And again, the reaction we've seen every time we open up a store in Boston, Philadelphia, Chicago and certainly in New York tells us our guests love the convenience of having Target right there in their neighborhood. But we're also continuing to make investments online, and we want to make sure we continue to give our guests the choice of shopping any way they want, the ease of shopping online and picking up in our store, which we think is going to be a very important factor during the fourth quarter, but building out those capabilities, leveraging our stores as flexible fulfillment centers. As we go into this holiday season, well over 1,000 locations will be locations that not only you can shop in and pick up, but we're using to deliver the last mile. We think that's a huge competitive advantage. So we feel very good about the strategy we have in place. We think it's a strategy that will win not only in the short term but over the long term, and we look forward to seeing all of you in New York in February.
So with that, operator, we're going to wrap up our third quarter call. I appreciate everyone participating, and we look forward to seeing you in New York in February.
Operator:
Thank you for your participation. This does conclude today's conference call, and you may now disconnect.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation's Second Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, August 17, 2016.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our second quarter 2016 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; and Cathy Smith, Chief Financial Officer.
This morning, Brian will recap our second quarter performance, including results across our merchandise category. Then John will provide an update on our efforts to improve in-stocks and modernize our supply chain. And finally, Cathy will offer more detail on our second quarter financial performance and our outlook for the third quarter and full year. Following their remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer your follow-up questions. Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure; and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalized operating leases. Reconciliation to our GAAP EPS from continuing operations and to our GAAP total rent expense are included in this morning's press release, which is posted on our Investor Relations website. With that, I'll turn it over to Brian for his comments on the second quarter and our priorities going forward. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. Our second quarter comparable sales decline of 1.1% was near the middle of our guidance range for the quarter but well below the results we expect to deliver over time. Against that backdrop, we reported much stronger-than-expected profitability. This outperformance was driven by our ongoing cost-saving efforts, which benefited both our gross margin and expense rates in the second quarter. These benefits helped to offset pressure from the current promotional environment, declining comp sales and the investments we're making in our team. I want to pause and thank our team for delivering this outstanding financial performance.
At the same time, I want to emphasize that we are committed, first and foremost, to restoring positive comp sales growth in the quarters and years ahead. Based on the conversations with many of you, we know there's a great deal of focus on the broad macro challenges facing retailers, including a consumer focused on experiences, the impact of price deflation and a channel shift into digital. These are real challenges, but they are not new to our business. With the right strategy and strong execution, we've demonstrated our ability to perform in the face of those challenges, and our expectation is that we will continue to be a top retail performer over time. In the second quarter, our #1 challenge was traffic, which affected sales in all of our merchandise categories, and consistent with the first quarter, we saw higher-than-normal variability in sales patterns. Despite these challenges, we're encouraged that we saw the strongest sales performance around key second quarter events, including Memorial Day, the Fourth of July and the beginning of the Back-to-School season. As we analyze the drivers of our second quarter performance, we've identified some company-specific challenges we are actively addressing. This includes meaningful pressure in Electronics, where we saw a double-digit decline in comp sales this quarter, accounting for approximately 70 basis points of overall comp decline. Notably, about 1/3 of this pressure was driven by Apple products, which were down more than 20% in the quarter. We're focused on reversing these trends, and we're collaborating with Apple and other vendor partners to evolve our assortment and accelerate innovation to deliver stronger sales. In Grocery, despite improvements in assortments, quality, freshness, presentation and in-stock, we were disappointed with our sales performance as we saw a small comp sales decline in the second quarter. While our Grocery business was negatively impacted by Food deflation, which accounted for about 20 basis points of pressure, we clearly have more work to do to unlock the growth potential in this important category. Given our recent performance and the increasingly competitive Food environment, we're revisiting our second half Grocery efforts, from presentation to assortment to promotion, to improve our competitive position. And as I will discuss in a few minutes, we'll be leveraging the learning from our LA25 remodels to help guide our plans going forward. Beyond Food, we are rebalancing our messaging and promotions to ensure we continue to drive strong performance in Style categories and reach consumers who are intently focused on value in this environment. Finally, we experienced soft second quarter traffic trends in the pharmacies in our stores as we completed the rebranding transition from Target to CVS across the country. The execution of the transition went very smoothly, and we've been very pleased with the level of collaboration between our teams and our partners at CVS. While it's not surprising that the rebranding activity has resulted in some near-term disruption, we're focused on restoring growth in this traffic-driving area in our stores. As a result, we're working closely with our partners at CVS as they launch media, marketing and member engagement campaigns to increase awareness and utilization of CVS pharmacies in our stores. In addition, CVS is executing an in-store engagement campaign and plans to offer special flu shot incentives at the pharmacies in our stores. As we take steps to increase awareness of the CVS-Target partnership, both among our guests and members of the CVS PBM business, we expect to reaccelerate pharmacy traffic in our stores over time. Despite this quarter's challenges, we're pleased that the fundamental elements of our strategy are continuing to shape our results. Comparable sales in signature categories continue to lead the company, reflecting investments we've made in quality, presentation and marketing. In the second quarter, comp sales growth in these categories outpaced the company by approximately 3 percentage points. Within signature, we saw particular strength in both Kids and Style. Results in Kids reflected the launch of Cat & Jack, which is now positioned to become our biggest own brand. After the July rollout of this brand, we saw double-digit growth in Cat & Jack sales when measured against comparable sales of Circo and Cherokee last year. Within Style, we continue to benefit from strength in women's Apparel. We saw a mid-single-digit comp increase in the quarter. This performance was dribbled -- driven by double-digit growth in our Xhilaration brand, which is focused on a younger style-savvy guest. In addition, we're really pleased with the performance of Who What Wear, which is one of the most productive brands on our women's floor pad. As a result, we're expanding the range of this assortment for the fall, inviting more of our guests to enjoy the items from this fashion-forward collaboration. Digital sales grew more than 16% in the second quarter on top of 30% growth last year. We continue to invest in Target's digital assets to enhance the guest experience and drive sales in all channels, and our results demonstrate the impact of the investments we've made over time. For example, several years ago, we told you we had an opportunity to improve our digital conversion. Since then, we've invested to improve our conversion performance by streamlining online checkout, making the site more appealing and easy to use, enhancing our personalization capabilities and improving search. As a result, for several years in a row, we've seen meaningful improvement in our digital conversion across all platforms, particularly in mobile. In the second quarter, we launched a brand-new fully adaptive site, which means we now provide a seamless experience across all platforms, from desktop to tablets to smartphones. This is increasingly important because, for many guests, a single purchase journey crosses over 2 or more of these digital devices. We're really pleased with the results in our new flexible-format stores, which are designed for very dense urban and suburban neighborhoods. These stores allow us to operate in areas we've never been able to serve with our largest-format stores, allowing us to extend our reach to consumers with high affinity for our brand. In July, we opened up new flex-format stores in Washington Square in Philadelphia, Lincoln Park in Chicago, Commonwealth in Boston and Forest Hills in Queens. We're excited to be serving guests in these iconic neighborhoods, and the guest response to these new locations has been fantastic. Financially, flexible formats are very successful. The sales productivity is much higher than our company average, and they've been meeting or exceeding our profit targets. In total this year, we're planning to open 14 flex-format stores, including a multilevel location in TriBeCa this October. Based on our experience to date and our investments in capabilities, we're increasingly confident in our ability to successfully open and operate stores in a variety of neighborhood settings across the country. As a result, we're accelerating our pipeline of locations we can open in future years, and we expect flex-format stores to be a key driver of future growth. In our existing stores, we continue to invest in presentation and experience, particularly in signature categories. We completed the remodeling of our LA25 test stores in the second quarter, and we're in the early stages of a robust learning plan to measure guest reaction to the changes we've made. Overall, we're encouraged by initial results in these stores, and we're already rolling out some of the innovation from these stores more broadly. Namely, we're pleased with the presentation innovation in Home and Apparel and results from our work to elevate the order pickup experience. So we're already extending these innovations beyond the LA market. In addition, the changes we've made to the Food area in the LA25 test stores has really resonated with guests. Grocery sales in these stores are trending 2 to 3 percentage points higher than the comparison stores. Relative performance in produce is even stronger, driving perishable comps that are more than 5 percentage points higher than the comparison stores. Guests have told us the new Food area now feels more intimate and separate from the rest of the store, providing a distinct Grocery shopping experience they prefer. We're very encouraged with these initial observations, and we'll continue to leverage learning from these stores as we work to improve Grocery performance across the chain. We are fortunate to have a strong balance sheet and a business that generates a lot of cash even in challenging times. This cash allows us to make long-term investments in our business while returning cash to our shareholders at the same time. In June, we announced that our board had approved a 7.1% increase in our quarterly dividend, supporting our 45-year record of annual dividend increases. In addition, our cash position allowed us to return well over $1 billion through share repurchase in the second quarter in support of our goal to return $3.5 billion or more this year.
Looking ahead, we're very excited about the Back-to-School and Back-to-College season, which is second only to the fourth quarter holiday season in terms of importance. In Back-to-School, we continue to work with kids and parents to inform our product design and development process. So it's only natural that this year, we engaged with kids to design and execute our Back-to-School marketing campaign. Kids led all aspects of this campaign:
drafting storyboards, illustrating creative content, directing the spots and performing the music.
To make shopping fast and convenient for busy families, this year, we partnered with teacherlists.com to make nearly 1 million school supply lists available with our School List Assist tool on target.com. This tool allows parents to quickly and seamlessly purchase supplies off their kids' class lists, arrange for Store Pickup or have the items delivered directly to their home. In Back-to-College, our marketing campaign is designed around today's students which are digital natives. In this campaign, we're partnering with 3 recent graduates to create inspiring, do-it-yourself videos to help college students make their new dorm room or apartment feel like home. In addition, we provided tools to make college shopping convenient and fun, including college registry, order pickup, subscriptions and special offers on Cartwheel. As we've done for more than 15 years, we're hosting Back-to-College after-hour shopping events, which will take place at 85 colleges and universities in the next couple of months. In these events, we provide free bus transportation from campus and provide students the opportunity to stock up and save on everything they'll need for school. I want to pause here and mention how happy we are to have Mark Tritton on the Target team. Mark took on the role of Chief Merchandising Officer in the second quarter, and he's spent the last couple of months getting to know his team and becoming immersed in our business. Mark is creative and passionate about retail. He's had an amazing career building iconic brands, and I'm confident he'll be able to grow both our own brands and our Target brand. Mark is planning to speak on this conference call next quarter, when he'll outline our merchandising and marketing plans for the holiday season. We continue to believe we're focused on the right strategic priorities, and we're confident in our ability to grow profitably over time. We believe it's appropriate to update our sales and EPS outlook for the remainder of the year. Our decision is informed by the retail sales environment and the variability we continue to see in our weekly and regional results. While we are laser-focused on accelerating traffic and sales, it's prudent to build near-term business and inventory plans that are consistent with recent trends. As always, we'll be prepared to flex those plans upward if results begin to recover in the second half of the year. Before I turn the call over to John, I want to spend a second with a special thank you to our team and our stores. I visit our stores around the country nearly every week, and I'm so grateful to have a group of such smart and friendly team members serving our guests. John's team at headquarters is focused on ways to simplify our processes, modernize our supply chain and help ensure our stores feature the right assortment of items that are in stock every day. When we back up an outstanding team with the right business fundamentals, we offer an unparalleled experience in retail. With that, I'll turn the call over to John, who'll provide more details on his team's efforts to modernize our supply chain and improve our operations. John?
John Mulligan:
Thanks, Brian. Good morning, everyone. As Brian just mentioned, our store teams do an outstanding job serving our guests every day. It's long been a key point of differentiation for our brand. What I didn't fully appreciate until I came into my new role as COO was the workload that our supply chain processes have been driving into our stores. Historically, when we design processes to improve upstream efficiencies in our supply chain, we often achieve those benefits by moving work and complexity into our stores.
One of the key priorities of my new team has been to look at the entire supply chain and find ways to optimize it end to end to deliver reliability for our guests while driving efficiency for the organization as a whole. A key measure of reliability is our ability to stay in stock, and I'm pleased that we continue to see improvement even as we begin to compare against improvements from a year ago. In stores, as we entered the Back-to-School and Back-to-College seasons, Target's overall out-of-stock position was better than we have ever measured historically. In addition, out-of-stocks on frequency and commodity items, the items for which reliability is most important for our guests, are in an even stronger position. And in the digital channel, while we have much work yet to do, we have already reduced out-of-stocks by more than 50% in the last 6 months. Our work to reduce variability in our distribution centers has been one of the drivers of these improvements. In the past, an unacceptable number of vendor shipments were received by our DCs either too early or too late. This variability drove a lot of extra workload in the DCs while reducing our reliability downstream. As a result, this year, we have been collaborating with our vendors to increase the percent of shipments that arrive on the correct day, and we've already seen meaningful progress. The percent of shipments that arrive on time has more than doubled, and we expect to see additional improvement as we roll out new processes to additional vendors over time. As shipments arrive at our distribution centers, we've made changes to the prioritization of inbound processing, which have already cut the time to unload trailers by more than 50%, and we believe we can cut that time even further. In addition, we've improved process flow between our import warehouses and our regional DCs, reducing the average time it takes for an item in an import warehouse to reach the store shelves by more than half. We're also focused on our outbound processing, with a goal of enabling daily deliveries to every store throughout the week regardless of a store's sales volume. When implemented, this change will drive additional improvements to store in-stocks while reducing backroom inventory and store workload. I want to thank the entire team, from merchandise planning to our distribution centers, logistics teams and our stores, for these improvements. Without the engagement of the entire end-to-end supply chain, we couldn't have made such amazing progress. Before I move on to our work in the stores, I want to comment briefly on our overall inventory position. As we've mentioned over the last several quarters, a portion of our year-over-year inventory growth reflects intentional investments we're making in nonseasonal commodity categories to support in-stock improvement on items most important to our guests. In addition, our second quarter inventory reflected an investment to offer additional items in certain categories as we work with merchant teams to reliably offer appropriate assortment, both online and in our stores, to best serve our guests. Beyond our upstream supply chain work, our investment in self-checkout lanes is also reducing store workload, freeing up time for our store teams to focus on guest service while providing our guests a checkout option that many of them prefer. As of today, we have self-checkout in just over 1,000 of our stores. We're planning to add it to another 200 stores by the end of the year, and we will continue the rollout through 2017. In stores with self-checkout, nearly 1/3 of transactions go through these lanes, much higher than our initial projections. Our flexible fulfillment initiatives, including Store Pickup and ship-from-store, are one way we're reinvesting store labor savings to serve guests in new ways. At the end of 2015, more than 460 stores were shipping items directly to guest homes, and we're planning to double our capacity this year by expanding this capability to more than 500 additional stores. These additional locations will further improve our average ship time while providing deeper access to our store inventories, increasing the likelihood that we can ship a guest's entire order from a single nearby store location. And importantly, because we are now prepositioning high-velocity, web-only items in the back room of ship-from-store locations, we are able to reduce last mile and split shipment expenses dramatically. In-store pickup is an increasingly popular option for many of our guests. This year, we've seen 50% growth in pickup orders on top of 60% growth a year ago. Year-to-date, more than 90% of our pickup orders have been ready in 1 hour, and we've implemented process improvements to reduce wait times in stores. As a result, guest satisfaction with the pickup experience is up from a year ago, and a higher percent of guests are repeatedly using this service. To prepare for this holiday season's surge, we're investing to ensure our stores can continue to deliver a great pickup experience in the face of rapidly increasing demand. In 75 of our highest volume stores, we're increasing holding capacity to allow our team to retrieve items more quickly even during peak times. We're also investing in additional digital devices to support peak demand, and across all of our stores, we're rolling out new guidance on how our stores can optimize their storage space to enhance speed and efficiency. New this year, we've implemented systems and processes to allow stores to forecast and monitor pickup demand, ensuring we maintain proper staffing levels. In addition, during the holiday season, about 300 stores will be testing separate branded shirts for the team members in the pickup area and distinctive bags for pickup orders to underscore our commitment to this experience. Finally, as Brian mentioned, Back-to-School, Back-to-College season is our second most important sales driver of the year. As a result, we're planning to carefully measure our pickup reliability and speed during promotional peaks this quarter so we can apply those learnings in time for the holiday season when peak demand will be even higher. It was just a year ago that I began working with my new team, and I'm very proud of what we've accomplished since then. However, I'm also energized by the opportunities still ahead of us to further increase the speed, flexibility and reliability of our supply chain, to drive unnecessary workload out of our stores and to enable operational excellence across the organization. As we work to accomplish these goals, I'm fortunate to work with an experienced team, led by both internal talent and some amazing new hires, and I'm confident that with their leadership, we will continue to improve Target's operations on behalf of our guests. With that, I'll turn it over to Cathy, who will share her insights on our second quarter financial performance and our outlook going forward. Cathy?
Catherine Smith:
Thanks, John, and hello, everyone. Our second quarter adjusted earnings per share of $1.23 was better than the high end of our guidance and just better than last year. Second quarter GAAP EPS from continuing operations was $0.16 lower than adjusted EPS, driven by $0.17 of debt retirement costs due to settlement timing on a subset of our first quarter debt tender offers.
This quarter's profit performance was quite impressive in light of the challenging sales environment. Specifically, comparable sales declined 1.1% this quarter, in line with our guidance and well below our plan at the beginning of the year. As expected, the total sales in the second quarter were down more than 7% from last year, driven by the sale of our pharmacy and clinic businesses to CVS. Digital sales grew 16% in the second quarter, contributing 0.5 point of our comparable sales growth. Looking at the components of our comparable sales. Comp transactions declined 2.2%, partially offset by a 1.1% increase in average ticket. While ticket growth was broadly consistent with the last couple of years, traffic performance showed a meaningful change from prior trend. I want to pause and make it clear that we are not satisfied with our second quarter traffic and sales performance, and as Brian described earlier, we are taking steps to grow both our traffic and sales over time. REDcard penetration was 23.9% in the first quarter, up about 180 basis points from last year. However, given that last year's pharmacy sales had a much lower-than-average REDcard penetration, the removal of those sales from this year's results drove a portion of the penetration improvement. Excluding net benefit, REDcard penetration was up about 70 basis points from a year ago. Moving down the P&L. Our second quarter EBITDA margin rate was 11.2%, up about 30 basis points from 10.9% a year ago. This improvement was entirely driven by a year-over-year increase in our gross margin rate, partially offset by a modest increase in our SG&A expense rate. Among the drivers of our gross margin rate, the pharmacy sales drove about 70 basis points of improvement from last year. This improvement was offset by pressure from shipping expense resulting from online growth, along with the impact of second quarter promotional and clearance markdowns, partially offset by the benefit of our cost-control efforts. On the SG&A line, we saw pressure from investments in our team and in marketing, along with the deleveraging impact of the decline in sales. These pressures were offset by the rate impact of the pharmacy sale combined with the benefit of our cost-savings initiatives. Overall, we saw a year-over-year increase in our SG&A expense rate of about 20 basis points. Given the pressures we were facing, this is really impressive expense performance, and I want to thank the team for their tireless efforts to control costs. Quarter-end inventory was up a little more than 4%, consistent with last quarter. Given the investments we've made in essential categories and assortment enhancements as well as the impact of the sales slowdown that occurred in the second quarter, our quarter-end inventory position was relatively healthy. And of course, given our cost of sales outlook for the back half of the year, we will continue to monitor our receipts and inventory levels closely. Let's now turn to capital deployment. As we mentioned in our last conference call, this quarter, we deployed about $1 billion to settle a portion of our first quarter debt tenders -- tender offers, and we funded a $750 million debt maturity in July. In addition, during the quarter, we returned another $1.7 billion to our shareholders through dividends of $330 million and share repurchase of more than $1.3 billion. By the end of the second quarter, we had about $1.5 billion of cash and equivalents on our balance sheet, consistent with the guidance we provided in our first quarter conference call. One other note. Through the end of the second quarter, we had repurchased approximately $8.8 billion of shares under the current -- company's current $10 billion repurchase authorization. As a result, we plan to request additional repurchase capacity from our board in the next several months given that our outlook anticipates continued cash available for share repurchase going forward. I want to reiterate that our priorities for capital deployment have not changed. First, we fully invest in projects that meet our strategic and financial criteria. Second, we support the dividend and intend to build on our 45-year record of annual dividend increases. And finally, we return cash to -- by repurchasing shares when we have the capacity within the limits of our A credit -- long-term credit rating. Looking ahead, we will continue to govern the pace and magnitude of share repurchase in support of our goal to maintaining those credit ratings. Despite the challenging environment, our business continues to generate very strong returns. For the 12-month period through second quarter, we reported an after-tax return on invested capital of 15.8%, up from 13.3% a year ago. I'll quickly note, however, that this year's ROIC includes the onetime gain from the sale of our pharmacy business to CVS, which occurred last December. Without that onetime benefit, our second quarter after-tax ROIC was still a very healthy 13.7%, up about 40 basis points from last year. Before I turn to our outlook, I want to pause and discuss the factors that are shaping our expectations going forward. Obviously, one consideration is the sales and traffic environment we've faced over the last several months, in which overall trends have been challenging and weekly and regional patterns have been more variable than normal. The second consideration pertains to the relative benefit of planning our business conservatively. If actual sales turn out to be stronger than our expectations, our teams are prepared to chase inventory and ramp up hours in our stores and distribution centers. In those situations, we generally generate healthy profit rates on incremental sales. However, those same profit dynamics typically work in reverse when we miss our sales outlook given that it's more difficult to cancel orders and to pull back on labor hours. So despite the fact that we continue to believe in our long-term strategy and we're taking steps to address some of the company-specific challenges Brian addressed earlier, we believe it's appropriate to temper our near-term sales and EPS expectations. So let's turn first to our outlook for the third quarter, beginning with sales. This quarter, we are planning for a comparable sales range of a minus 2% to flat, consistent with our second quarter guidance. If our comp sales are near the midpoint of that range, we expect to generate gross margin and SG&A expense rates similar to last year's level. This expectation reflects the continued benefit from the removal of the pharmacy sales from this year's results, offset by a continuation of the headwinds we faced in the second quarter. One note. The pharmacy sales is expected to cause a delta of a little more than 6 percentage points between comp sales and total sales this quarter, similar to what we saw in the second quarter. As a result, we expect to deleverage depreciation and amortization line in the third quarter as the depreciation and amortization dollars are expected to be essentially flat to last year but spread over a smaller sales base. Altogether, in the third quarter, we expect to generate both GAAP EPS from continuing operations and adjusted EPS in the range of $0.75 to $0.95. As we look beyond the third quarter, we are planning fourth quarter comp sales in the same range as third quarter. And given our third and fourth quarter profit outlook, combined with our year-to-date performance through the second quarter, we're planning to generate full year adjusted EPS of $4.80 to $5.20. We expect full year GAAP EPS from continuing operations to be about $0.44 lower than adjusted EPS as a result of the debt retirement and pharmacy transaction costs, which we recorded in the first half of the year. While this outlook for full year EPS is somewhat lower than our expectation at the beginning of the year, it reflects healthy profit performance in the face of challenging sales, and consistent with our performance through the first half of the year, it reflects the benefit of our cost-savings initiatives and disciplined management by our team. Before I conclude my remarks, I want to thank the team for making cost control a long-term habit not a short-term focus. Last year, we announced a plan to save $2 billion over 2 years, and I'm pleased to say that we're not only running ahead of that goal, but the team continues to find new opportunities to eliminate unnecessary costs and activities. These savings allow us to reinvest resources in our enterprise priorities while still generating solid financial performance even in challenging times. With that, we'll conclude today's prepared remarks. Now Brian, John and I will be happy to respond to your questions.
Operator:
[Operator Instructions] Your first question comes from Matt Fassler with Goldman Sachs.
Matthew Fassler:
My first and primary question relates to the -- how much impact do you think the CVS pharmacy transition had on traffic? Did you see that dynamic deteriorate from the first quarter? And is there a way to quantify perhaps how much you feel like the spillover effect from that would have impacted the overall comp?
Brian Cornell:
Matt, as I discussed in my prepared comments, our traffic was impacted by a number of factors, including CVS. So we certainly saw a slowdown in our pharmacy operations. We're working closely with CVS to launch some new marketing campaigns to win back our Target guests and certainly to begin to unlock the potential of their PBM network. So that certainly played a role, but we also had other factors that we're focused on right now. We're not pleased with the performance we saw in Food despite making some really good progress in presentation, improving our assortment and, certainly, the freshness of our products. So our #1 focus as we sit here today is driving traffic back to our stores and accelerating visits to our site, and addressing the pharmacy impact is just one of the variables we're focused on today.
Matthew Fassler:
And by way of quick follow-up, a different topic. You touched on Apple products down over 20%. We're obviously in the middle of a bit of a pause between the iPhone releases, leading up to one most likely later this year. Is the Apple softness, at this point, really an iPhone story? Or is it a broader issue across the product suite?
Brian Cornell:
Matt, for us, it's a broader story across the product suite. And one of the first things we've had Mark Tritton do is actually spend time with our Apple partners, really making sure that we're putting the right plans together for the back half of the year, that we're ready to capitalize on their new innovation that they'll be bringing to market. But again, as we think about factors that we have to address to improve our traffic and overall sales performance for the back half of the year, we have to improve Electronics performance. It was a significant drag, 70 basis points on our overall comp decline in the quarter, and Apple played a significant role there. So we overindexed with Apple products. Our guests come to us looking for those products. They're looking for the newness and the innovation, and we're putting together plans with Apple and our merchandising teams to make sure we're ready to take advantage of that in the back half of the year.
Operator:
Your next question is from David Schick from Consumer Edge Research.
David Schick:
My question is on the competitive environment. You talked about all the different things you're working on with traffic. But is there anything out there that you're seeing in -- anything you could highlight sort of in the major categories that's going on in the marketplace that might be affecting your -- either your traffic or your customers' attention and how you're thinking about addressing that in the back half?
Brian Cornell:
Well, Matt (sic) [ David ], I think we've seen this environment persist now for well over a year. It's a very cautious consumer. If we look at the overall trends within retail, we've certainly seen, on a rolling 12-month basis, a slowdown in retail sales growth. But that's not an excuse for us. We're going to make sure we're leveraging our strategic levers. We continue to make sure we improve our in-store experience. As John talked about during the call, we've got to make sure that we offer a sensational in-store pickup experience and also make sure that our site is easier to work with and allows us to ship directly to home. So we're going to make sure we're leveraging the key components of our strategy. I feel really good about the progress we've made in store in preparation for Back-to-School, Back-to-College. I've been out into a number of markets. I don't think our stores have ever looked better. So it's a competitive environment. It's going to continue to be a competitive environment, and we'd better make sure that we leverage our strategy, make sure that we're bringing the best of our signature categories and bringing the value the guest is looking for in core household essentials to win trips and win back trips in the second half of the year. So it's competitive, but it's always competitive. And we've got to make sure that we're leveraging our assets and our strategy to continue to drive performance in the back half of the year.
David Schick:
I guess the follow-up to that would be, it's competitive, as you say. It continues to be competitive. Is there any change in the balance of whether it's new products and merchandising or pathways brought to market or pricing? Anything changing in the way the competitive environment looks to you, the makeup of it?
Brian Cornell:
David, you've used an important term that I've been using internally, and that is balance or rebalancing. And as I look at my experience now over the last couple of years at Target, we're best when we balance both ends of our brand positioning. We've got to deliver on the Expect More component, and I think we've done a sensational job there. Our progress in Apparel and Home has been really significant. And we've got to make sure we never lose track of the other side of our brand promise, and that's the Pay Less side, and that's all about those core household essentials that we have to make sure are presented effectively in store, in our circular, on our end caps to our guests each and every week. So as we think about the back half of the year and the keys to driving our business going forward, we've got have both of those levers in balance. We've got to continue to make sure our signature categories, and particularly those important Style categories, continue to connect with our guests, and we've got to deliver great value through household essentials, those everyday products that drive that Target run. So that balance or rebalance is critically important to the actions we're taking in the back half of the year.
Operator:
Your next question is from Oliver Chen with Cowen and Company.
Oliver Chen:
We had a question regarding the dynamics you're seeing between fill-in and stock-up trips. How are you feeling about that in your research? And also, as we look towards the back half and model our views on comp store sales, what would you prioritize as the biggest drivers to improve traffic in terms of the different initiatives that you're pursuing in light of what you're seeing? And just another question we had is why do you think this happened in pharmacy in terms of what was the consumer experiencing in your store that made the transition a little more disruptive than you would have wanted?
Brian Cornell:
Yes. Well, let me try to break apart those 3 questions and have Cathy and John jump in as appropriate. As we think about the rebalancing and the work that we're doing from a merchandising standpoint, an in-store presentation standpoint and also a weekly advertising standpoint, we recognize we have to continue to deliver the right presentation for that stock-up occasion and, particularly in the back half of the month, have the right assortment, the right presentation, the right availability of the items our guest is looking for in that fill-in occasion. So we're activating and ensuring we put those changes in place to find the balance as we speak today. So we're certainly very focused and aware of the fact that we have to win on both fronts. We've got to have the right assortment for that stock-up occasion, and we need to make sure we have the right pack-price architecture to meet the needs of the guest during that fill-in occasion. So we're very focused on that. From a CVS standpoint, I'll let John jump in here. It's not a surprise to us that there's been some disruption, and I think for all of us on the call, we know what it's like when we change a pharmacy prescription and move from one provider to another. And while they're staying in our location, they've got to sign up for some new programs. They're entering a new environment. There is some time that that's going to take, but we've been very pleased. John's been working with his CVS counterparts on the transition. We've had great collaboration and great partnership. We're starting to activate the marketing and the personalized messaging, and we expect, over time, we'll see that business accelerate. And we expect pharmacy and the partnership to be a future driver of traffic and growth. But, John, why don't you talk about some of the things we're doing at store level with CVS?
John Mulligan:
Yes. I think I'd start by first echoing what Brian said. We thought going into the deal we had a great partner. And certainly, what we have observed through the transition here, been a great partner to work with. Our teams have worked together very well to transition. We've done the best job we can in transitioning guests. But as Brian said, change is change, and sometimes you just need to work through that. From a go-forward perspective, we're working with CVS certainly on some of their capabilities that they'll bring to bear for Target and, as Brian said, unlock their PBM network into our stores. But more importantly, day to day in the stores, we see great guest service -- continue to see great guest service from our pharmacists, CVS would note that probably the best scores they've ever seen in a transition like this, and then starting to work with them to engage the pharmacy more back into the store through things like the opportunity here at Back-to-School, Back-to-College with flu shots and having the pharmacy play a more prominent role as we go forward. And so the teams continue to develop plans like that. They're very focused on it. We're focused on it, and we're very excited about the opportunity here as we continue to move forward.
Catherine Smith:
Oliver, this is Cathy. I'll add a little bit more, too, around priorities for driving traffic in the back half. And we're really excited because we go into this part of the year where we have a lot of the events, and that's where Target really has some great plans. We always have great plans. Back-to-School, Back-to-College, we're excited about. Obviously, the launch of Cat & Jack has started out very successfully with a lot of learnings that we took away from Pillowfort, both online and in stores, and then, obviously, we go into our prime time. And so standing tall on the events that we typically have always done, but we're really well positioned. And then it's the things that Brian and John have already mentioned, the rebalancing of our messaging. We are relooking at all of our Grocery efforts around presentation, assortment and promotion of the Electronics, the newness that Brian mentioned and then, obviously, the work that John just said around CVS.
Brian Cornell:
Yes. So Oliver, as we think about the second half, we've got to continue to build on the things that are working today. Even in a challenging second quarter, we grew market share in the important Apparel space. We saw very strong results in our home categories. We continue to be a destination for toys. So we've got to build on the things that are working and ensure that we're also winning trips for those core household essentials. So we'll be focusing on rebalancing, on leveraging the improvements we've made, both in store with our in-store pickup process and also online. And we're not altering our strategic focus. It's making sure we get our strategies in balance and we deliver against both signature categories and those important household essentials that drive traffic to our stores and put cars in the parking lot.
Operator:
Your next question is from Kate McShane with Citi.
Kate McShane:
I think when you gave guidance for Q2 originally, it was because of some of the higher inventories that you flagged at other channels, especially with regards to Apparel. So I was just wondering how much you think you're benefiting from some of the weakness that we have seen at the brick-and-mortar department stores, especially when considering your women's Apparel comp was up mid-single digits during the quarter.
Brian Cornell:
Well, we certainly think we are winning in the Apparel space, and I think a lot of that's really driven by the changes we've made, the improvement in our assortment, in quality and being more on trend with some of our fashion assortment. I talked about Xhilaration performing very well in the quarter. Who What Where continues to be a real winner for us in connecting well with our guests, and we've also matched that up with an improved in-store experience. We've been talking about mannequins for a while, but the role that our visual merchandisers are playing, the investment that John and I made last year to ensure we had not only mannequins and home vignettes but the talent in our stores to maintain that experience 52 weeks a year is certainly connecting with the guest. So we think we're benefiting by really executing against the strategy we've been talking about for several years, making sure we have the right quality, innovation, presentation in our stores and we surround our guests with great service. And that's paying off with market share gains in a challenging environment, where we continue to see improvement in our Apparel and home assortments.
Operator:
Your next question is from Greg Melich from Evercore ISI.
Gregory Melich:
I wanted to follow up a bit on traffic and then get into the guidance a bit. On traffic, if you think about it a different way, I think about a year ago, traffic had recovered nicely to, say, up 1%. And overall retail sales are growing roughly where they were, just looking at the government data, and now the traffic is obviously down a couple of percent. Is -- do you see any differences in terms of geographies or other things going on, income demographics around your stores, where that traffic trend is different just looking at the last 12 months?
Brian Cornell:
Yes. Greg, we certainly do, and Cathy and I talked about this at the end of the first quarter. We've seen quite a bit of variability on a day-to-day, week-to-week basis between different markets. We've seen particular strength in many of our West Coast markets, very strong performance in California, driven by a great performance in L.A. and San Francisco, but other parts of the West Coast. We've seen pockets of softness on the East Coast. And we've really tried to make sure, market by market, we're looking at those dynamics, looking at the competitive dynamics, understanding what we can leverage from the markets where we are seeing increases, like Los Angeles, and bring that into challenged markets. But we've seen, over the course of this year, in 2016, much more variability than I've seen in many, many years. So we're drilling down on that, and as we think about our plans for the second half of the year, we're building market-specific action plans to make sure we address the market-specific needs of our stores and our guests.
Gregory Melich:
That's helpful. And then, Cathy, I think on the margins, I just want to make sure I got the guidance right. If I take the midpoint, I get to the -- you mentioned the third quarter flat EBIT margins, although I imagine ex the CVS sale, they would be down like 30 bps. In the fourth quarter, I -- is that right?
Catherine Smith:
Yes. So it's slightly down EBIT margin. We said gross margin and SG&A, about where they were last year.
Gregory Melich:
Fourth quarter, is -- does the guidance imply that EBIT margins are going to be flat?
Catherine Smith:
It is slightly up, so -- yes. So slightly down, Q3; slightly up in Q4.
Gregory Melich:
Okay. I just want to make sure I got that right. And then, I guess, last on that, just to make sure. The inventory up 4%, do you guys think, I mean, that you're comfortable with that number, not like part of the third quarter is working that inventory down?
Brian Cornell:
Greg, we're very comfortable right now with our inventory position.
Operator:
Your next question is from Dan Binder from Jefferies.
Daniel Binder:
Dan Binder. I had a question on the consumer Electronics category. You talked a lot about that today, and I've noticed, in your stores recently, you've had some reset activity, particularly in TV as you offer more 4K. I am curious, as you work through these plans to improve that business, do you think that can be a category that returns to positive comps by holiday given all the changes you're making?
Brian Cornell:
Dan, I think it's going to be largely driven by the new innovation that we bring to the guest in the fourth quarter. So we've certainly seen pockets of strength. I mean there's certainly winners and losers within that space. We've seen continued performance with wearable technology, but it's not overcoming the softness we've seen in mobile, in tablets and in some of the core items. So I think the success of that category, as always, is going to be driven by new news and news that connects with the guest and drives traffic into those categories. So again, it's why Mark and his team are very focused right now in working with our Electronics vendors to make sure we have the right innovation, we're presenting it in a way that's impactful for the guests, and we have to see improvements in a category that's been a big drag on our comps over the last couple of quarters.
Daniel Binder:
And then a follow-up on the Food category. You mentioned you were reevaluating promotion in, I guess, Food and consumables. I'm just curious. It sounds like you'll increase it. So I'm just curious, are you seeing others out there being more aggressive in the category? Is that what you would attribute the softness to? And if that is the case, which channels are you seeing it in?
Brian Cornell:
Yes. Dan, I think there's been a lot written recently about the competitive nature of the Food channel. And for us, on one hand, we feel -- I feel really good about the progress we've made with assortment. If you walk our stores today versus even 6 months ago, aisle by aisle, you're seeing more organic, more natural, more gluten-free, more local items that are on trend. The freshness and the work that John and his team have done from a supply chain standpoint is clearly connecting with the product we're delivering to the guests, and we've seen an uptick in categories like produce because we're delivering better product. But at the same time, market by market, this is a very competitive space. There's clearly food deflation right now that we're facing, and it's a very competitive environment. And back to the earlier question about traffic and performance trends by market, we're looking very specifically at food by market across the country because we face a number of regional competitors, and we'd better make sure our presentation, our promotion, our approach enables us to compete market by market.
Daniel Binder:
Congratulations on the LA25. It sounds like you're getting good results out of that. I was just wondering if you could share with us the likelihood of being able to roll that out. Is it a cost-efficient format? Or are you primarily using it just for learnings?
Brian Cornell:
Well, Dan, we've certainly used it as a learning lab, but our intention is to lift the winners from LA25 and quickly bring them into other stores across the country. And while it's still very early, we have effectively 1 quarter learning under our belt, I'm very pleased with some of the results we're seeing in Apparel, in Home and certainly in Food, where, as I mentioned during my prepared comments, we're seeing performance in those 25 test stores that is clearly, clearly really encouraging from a Food standpoint, particularly in the perishables space. So we'll be looking to leverage that learning. That's part of our strategy that we've articulated for several quarters now, that we want to use L.A. as a test market to lift and shift the winning concepts into more stores across the country, and we'll continue to lift and leverage the learning from LA25 to improve the experience in the presentation of product throughout our Target stores.
Operator:
Your next question comes from Scott Mushkin from Wolfe Research.
Scott Mushkin:
Yes. I wanted to continue on the path where Dan was going. But before I get started, I have to say, on our store visits, you can definitely see the improving execution. So kudos to John on getting that done. But getting back to the Food discussion. Our research has shown some pretty aggressive moves, and I think Dan was getting at this. I mean, are you guys going to match what's going on in the market? And it looks like we're at the beginning end of a pretty aggressive price war. How do you see it? Where do we -- we're now seeing deflation reported by the government at 1.5%, 1.6%, and our pricing surveys are even greater than that. So where do you see this going? What do you guys plan to do to combat it tactically in the short term? And then I wanted to address the longer-term Food business after that.
Brian Cornell:
Yes. Well, Scott, I'll start with we're playing to win, and we've invested heavily in that very important category. We've had a long-term commitment to Food. We think it's very important for our guests. And over the last couple of years, while we've done it in a very disciplined fashion category by category, and I appreciate hearing you say that you've seen improvement in execution and, hopefully, in presentation, we've added thousands of new items, and we've worked with our vendor partners to make sure we're bringing the right innovation category by category. Our team is absolutely going literally item by item, commodity by commodity to look at how we source and how we flow product to improve freshness and the quality we present to our guest. So we've got to make sure we have the right assortment, the right presentation, the right quality. We have to have the right promotional strategy to compete, but we're playing to win both short and long term. We think it's very important that we continue to make progress in this space. We're going to make sure we do it in a very focused manner. We really like what we're seeing in LA25. We're not going to roll it out to 1,800 stores tomorrow. We're making sure that we can validate what's working and how can we drive profitable sales in that space, but we are playing to win in Food, and we're going to continue to roll up our sleeves and make sure that we're into the details, finding ways to unlock the growth potential in that critically important category.
Scott Mushkin:
So Brian, so to kind of dovetail more into the longer term. When you were at Safeway, you guys obviously did a lot of remodels that drove comp. LA25, it sounds like traffic's positive there. But in the article, I think it was in The Journal, they talked about the board is very reluctant to put more capital behind the Food effort. Talk us through this. I mean, you've got a traffic issue. Consumables mean traffic. But if you won't invest, it's hard to get the traffic, so you're almost kind of caught in a catch-22 here. And I just want to get your outlook or your thoughts on what I'm saying given the longer-term need for traffic and to drive traffic into the store to make earnings rise continuously as we look out in the out-years.
Brian Cornell:
Yes. And, Scott, in all due respect to The Journal, let me speak on behalf of our leadership team and the board. We have no hesitancy at all in investing capital in our business that drives growth and the right returns. And as Cathy has demonstrated throughout the last few calls, even in challenging times, we generate significant cash flows, and we want to make sure the first thing we do with that cash is invest back in our business. So it's why we're spending time looking at LA25. It's why we've been testing a number of different features throughout our stores from Apparel to Home to Food. It's why we're so excited about investing in flex-formats, where we see a very strong response from the guest. Those are delivering very strong returns, well ahead of our original plan, and Food plays an important part in those smaller flex-formats. So despite what you may be hearing, we have absolutely complete support from the board to make sure we're investing capital behind the initiatives that are going to drive future growth. So again, we're not playing for just the short term. We're playing for the long term. Those capital investments have to be done on behalf of the guest and our shareholders, but we're looking right now at a number of different opportunities to continue to invest to drive growth. So there's no hesitancy at all in making those investments. And as you just said, Food and perishable and consumable categories will play a very important role in driving traffic to our stores and in the future, we've got to continue to bundle that with the work John's doing to make sure -- and we're investing and improving our in-store pickup processes and experience. That's an investment we're making and an investment we're making for the holiday season. We're continuing to invest in our digital assets. So there's no hesitancy at all from this management team nor the board in making the right investments in our long-term success.
Operator:
Your last question comes from Joe Feldman from Telsey Advisory Group.
Joseph Feldman:
Brian, one of the questions I had was, you guys have made a lot of changes in the stores, and we clearly see them. And obviously, we talked all for the past hour about a lot of them. I'm curious about the marketing or communication of that, though, to just the consumer. I mean we see it because we're all following the company pretty aggressively and in the stores. But I wonder if there's more could be done on the advertising side to tell people that you've made so many changes in Grocery or that the home department looks better in a lot of stores. Or can you talk a little bit about that and where we're at in terms of when we'll see something like that communication-wise?
Brian Cornell:
Yes. Joe, it's a great question for us to end on, and I'll take personal responsibility for this. I talked earlier about the fact that we've got to be rebalancing our messaging, and we've done a really terrific job of elevating our messaging and communication around our signature and, particularly, our Style categories. As we go forward, I've used this term before, we've got to make sure we're rebalancing. And we've got to make sure we continue to elevate our messaging, our communication around Style and those core household essential categories, which include Food, that drive traffic to our store and are important to our guest. So making sure we go back to the brand promise. We've got to make sure those Expect More categories, like Style, we continue to elevate, and we've got to make sure we deliver the Pay Less component and ensure that we balance the work that we're doing from a Style standpoint with the progress we're making on those core household essentials, which include Food in that offering. So it's a really important question. It's certainly a big area of focus for us in the balance of the year and into 2017, and I think it's going to be part of the formula that drives traffic back to our stores and improves comp store growth over the balance of the year and into 2017.
So operator, with that, we're going to conclude our call. And I thank all of you for joining us for our second quarter earnings call today. Thanks for participating.
Operator:
Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. At this time, you may now disconnect.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation First Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, May 18, 2016. I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our first quarter 2016 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; and Cathy Smith, Chief Financial Officer.
This morning, Brian will discuss our first quarter performance, including results across our merchandise categories; then John will provide an update on our efforts to improve in-stocks and build our supply chain capabilities; and finally, Cathy will offer more detail on our first quarter financial performance and our outlook for the second quarter. Following their remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer any follow-up questions you may have. Also as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure; and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalized operating leases. Reconciliations to our GAAP EPS and to our GAAP total rent expense are included in this morning's press release, which is posted on our Investor Relations website. With that, I'll turn it over to Brian for his comments on the first quarter and our priorities going forward. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. Before I start with prepared remarks, let me set up the structure for our call this morning. We want to make sure we spend significant time talking about our first quarter results, and Cathy and John and I will cover both our first quarter performance, but also talk about the second quarter outlook. But we are going to make sure we leave significant time for Q&A. We want to make sure we have time today to address your questions, provide additional insights into our first quarter performance and the factors that are guiding our outlook for Q2.
Let me start with the first quarter. Our team delivered outstanding first quarter financial results in a very challenging consumer environment, which became softer and more volatile as the quarter progressed. Our first quarter adjusted EPS of $1.29 was well beyond the high end of the guidance for the quarter and more than 16% ahead of the $1.10 last year. These results demonstrate the value of our strategy in the face of more challenging consumer landscape. First quarter comparable sales growth was driven by an increase in both traffic and average ticket as traffic grew in both our stores and digital channels. Comparable digital sales grew 23% in the first quarter on top of 38% a year ago. We generated very healthy profit margins on our sales in the quarter as our team did a great job managing the business in the face of a number of headwinds, particularly following the Easter holiday. As planned, our first quarter gross margin rate reflected the benefits of the sale of our pharmacy business, favorable merchandising mix and our cost-savings initiatives. These benefits allowed us to offset markdown pressure in a very promotional environment. The team also delivered on the expense line, which benefited from the pharmacy sale and cost initiatives, offsetting pressure from investments we've made in our business, including our team. Cathy will provide more details in a few minutes. Sales in the quarter came in lighter than expected, and daily and regional shopping patterns were more volatile than in the prior periods. While guests generally maintained their pattern of larger pantry stocking visits, we saw a slowdown in growth of smaller convenience trips. Against that background, our results show that our strategy continues to resonate with our guests as comparable sales in our signature categories, Style, Baby, Kids and Wellness, grew more than 3x as fast as the company average. Given the concentration of signature categories in Home and Apparel, comparable sales in both categories outperformed the company, driving market share gains in both areas. Comps in Home grew nearly 4%, led by strength in domestics, decor and seasonal areas. Highlights included our Kids Home assortment, which saw comp sales in the mid-teens, driven by the successful launch of our new Pillowfort brand. We were also pleased with the results from our partnership with Marimekko, which attracted guests to explore our assortment in stores and digital, driving sales in both Home and Apparel. Overall comps in Apparel grew between 2% and 3%, led by sales in Baby, Kids and Women's ready-to-wear. Rapid growth in ready-to-wear is especially notable given the tough comparison from last year. Specifically, the 2-year stack of the first quarter comp sales in ready-to-wear is more than 16% higher than 2 years ago. First quarter comps in Food were down slightly as an increase in perishable was offset by a decline in center store grocery. While results were impacted by deflation in some categories, they also reflected a meaningful disruption from the reset of our center store grocery area, which was executed in stores across the country in April. Despite the disruption, this effort better positions us for success over the longer term as we've implemented changes to assortment, presentation and category adjacencies. Specifically, we've updated assortment and segmentation to align with local demographics and showcase wellness. And we integrated nutrition bars into the center store floor pad, creating an industry-leading destination for these items. In total, we added about 1,000 new items with this reset, including 55 new better-for-you brands across 25 categories. And we've incorporated our Simply Balanced brand into an additional 30 categories. This represents an important step in the reinvention of our Grocery business. Following the reset, we received very positive guest feedback. And the subsequent results have been better than expected. Within Hardlines, we saw a high single-digit increase in the first quarter of comparable sales in Toys even as we comped over high single-digit growth last year. Offsetting the growth in Toys, we saw declines in Electronics and Entertainment, reflecting the secular challenges these categories continue to face. These declines put about 70 basis points of pressure on our first quarter comparable sales growth. I want to pause and welcome Mark Tritton, who'll be joining our team as the EVP and Chief Merchandising Officer, overseeing our enterprise buying, sourcing, product design development and merchandising operations. We've conducted an exhaustive search for a new CMO, and I'm confident Mark is the right leader for our merchandising team. Mark comes to us with a wealth of retail and merchandising experience, including positions at Nike, Timberland and Nordstrom, where Mark doubled their private label business. Mark is a bold, decisive and visionary retail leader, and we're excited to have him on our Target team. Once again this quarter, we were able to return a compelling amount of cash to our shareholders through dividends and share repurchases. Altogether, we returned more than $1.2 billion to our shareholders in the first quarter, up from just under $900 million a year ago. In addition, given our strong financial position, this quarter, we were able to refinance some high-cost debt by issuing new debt at very attractive rates. Cathy will provide more detail in a few minutes. As we look ahead, we're approaching our business with appropriate caution as sales trends at Target and many of our key competitors weakened and became more volatile in the first quarter. In addition, many of our competitors are sitting on meaningful excess inventory, which we expect will extend a very intense promotional environment into the months ahead. Despite our near-term caution, we'll continue to execute the long-term strategy vision that we laid out 18 months ago, the vision which has been shaping our results ever since. We're very excited about the launch of our new Kids Apparel brand, Cat & Jack, which we'll roll out in the second quarter. And we'll continue to invest in quality through our owned and exclusive brand assortment with a particular emphasis on signature categories. We'll continue to work to enhance our Food offering to become more fresh and local with more natural and clean label offerings. And we'll continue to partner with our colleagues at CVS to complete the rebranding of our pharmacies within our stores. Following the rebranding effort, we'll collaborate with CVS on an awareness campaign to ensure that both our guests and members of their PBM businesses are aware of the change within our stores. As John will describe in a few minutes, we're also investing in store experience and flexible fulfillment capabilities, while modernizing our supply chain to become more agile in the way we serve our guests. We're very excited to be near completion of our LA25 remodels, which began more -- before the holiday season. And we're eager to gain guest feedback to determine which enhancements we'll roll out more broadly in the future. And finally, we're making investments in our team, adding specialized talent like new visual merchandising leaders, who are ensuring the store presentation in our Style categories highlight the investments we're making to enhance quality and innovation. Going forward, we'll continue to look for ways to simplify processes in our stores, bringing up time for our team to focus on serving our guests. Before I turn the call over to John, I want to thank the entire Target team for their tireless work on behalf of our business and our guests. As we've said many times, we have the best team in retail, both in our stores and our headquarters. And I'm continually inspired by their passion to drive Target's success by better serving our guests. With this outstanding team, a strong brand, great-looking stores, a resilient business model and a strong balance sheet, I'm confident we'll successfully navigate the near-term retail environment as we implement strategies that will drive Target's long-term success. With that, I'll turn the call over to John, who will discuss his team's efforts to modernize our supply chain and improve our operations. John?
John Mulligan:
Thanks, Brian, and good morning, everyone. Today, I'm going to provide an update on our efforts to reduce out of stocks and improve inventory flow throughout our supply chain. Then I'll cover our current work to enable our existing supply chain infrastructure to operate more flexibly in support of our strategy. And finally, I'll turn to our efforts to elevate the store experience on behalf of our guests, including enhancements to the order pickup process.
Many of you have told us that you noticed the improvement in our in-stock position in our stores, and our internal measures confirm what you have been seeing. Specifically, in the first quarter, we saw a 27% improvement in out-of-stock measures compared with the first quarter last year. This represents a sequential acceleration from our fourth quarter performance. And we are seeing improvements across all of our merchandise categories. Some of the in-stock improvement is being driven by additional inventory investments in its central categories, which drove a portion of our year-over-year increase in our inventory at the end of the quarter. However, we have opportunities to make other changes that will allow us to streamline our inventory position over time. Specifically, the team is taking a data-driven approach to reduce the number of SKUs in our assortment, making room for additional phasings of the best-selling, faster-turning items on our store shelves. In addition, the team is collaborating with vendors to reduce case pack sizes, which will reduce backroom inventory while increasing store labor efficiency by reducing the number of times an item is touched before it's displayed on shelves. Beyond these improvements, the out-of-stock team has successfully tested other enhancements that we'll roll out later this year. One test applied new replenishment algorithms for items with the regular demand patterns like Seasonal Sporting Goods. And the results of the test were dramatic as out of stocks improved by 50% on test items. Another test involves updates to our presentation standards for items that are typically purchased in multiples. This ensures that our minimum standards reflect the way guests are shopping today, allowing us to better optimize the trade-off between inventory investments and out of stocks. And with our vendor partners, the team has worked to meaningfully reduce shipping windows, which will enhance speed and reliability throughout the supply chain. We're very pleased with the collaboration we've seen from our vendors on this effort and improving ship from windows will be implemented across all merchandise categories by this fall. Beyond our work on in stocks, we're making changes in our distribution centers to modernize our capabilities. These changes will allow our existing infrastructure to operate more flexibly, simultaneously reducing shipping times while efficiently leveraging our entire network inventory on behalf of our guests. At our Financial Community Meeting in March, I outlined the conversion of 3 of our traditional regional distribution centers into delayed allocation centers, which can house slower-turning items with more variable demand, allowing the remaining DCs to process faster-turning SKUs more efficiently. In addition, these delayed allocation centers allow us to pulse the right amount of Seasonal inventory across the country throughout the season as demand patterns emerge, keeping us in stock longer in areas of unexpectedly high demand or reducing excess inventory in areas of unexpectedly low demand. We successfully completed the conversion of all 3 delayed allocation centers in the first quarter, and early results indicate that these additional nodes are improving product allocation compared with our past performance. Among our other regional DCs, this year as we're making changes to 3 facilities to enable them to ship directly to guests. This requires a meaningful transformation in the capabilities of these facilities as direct-to-guest shipments require the team to pick and pack individual items while shipments to stores require fast-moving shipments of case packs and pallets. Despite the challenge, we are excited about this work because like our ship-from-store capability, the ability to ship from our regional DCs directly to guests provides deeper access to network inventory, enhancing our digital in-stocks while allowing us to reach our guests more quickly while controlling costs. In addition, adding direct ship capability to one of our existing facilities requires 85% lower capital investment compared to the construction of a new dedicated web fulfillment center. As you know, a meaningful portion of our capital expenditures in recent years has been devoted to technology and supply chain. And we said that we expect these investments to continue in the future. At the same time, we know that investments in our store experience are more important than ever. And as a result, nearly $1 billion of our CapEx this year will be focused on the store experience. In addition to our store remodel program, which includes the LA25 stores Brian highlighted earlier, we continue to roll out new flexible format stores in dense urban and suburban areas. And we're really pleased with the performance of these new hyper localized stores so far. In addition, we continue to invest in presentation and experience across a broad set of our stores. This year, we're investing in self-checkout lanes, operational enhancements and merchandising innovations across a meaningful portion of the store base. A key area of focus in our stores is the elevation of our digital order pickup. And the team is taking steps to make the process more convenient and less transactional for our guests. Our goal in these efforts is to increase satisfaction with the order pickup experience, leading to more repeat usage of this capability by our guests. Speed is key, and our store teams continue to improve the speed with which they fulfill pick-up orders. In the first quarter, approximately 90% of orders were ready for pickup in less than an hour, up nearly 10 percentage points from last year. This is one reason that guest satisfaction regarding the pickup experience is up meaningfully from last year, and repeat usage is increasing as well. Despite this progress, we have more work to do. And we intend to continually improve our performance in response to guest feedback. To maintain our momentum, we rolled out streamlined order pickup communication to our guests this month. And in select stores, we are testing a separate pickup area with additional holding capacity, dedicated team members and enhanced merchandise presentation to encourage additional shopping on their store visit. While we are still early [ph] in our efforts, I am really pleased with the progress we've made in a short amount of time. By focusing on downstream outcomes and improving handoffs between every part of the supply chain from vendor to distribution center to our stores, we are making systematic, repeatable improvements which will sustain better operating metrics over time. Now I'll turn it over to Cathy, who will share her insights on our first quarter financial performance and our outlook going forward. Cathy?
Catherine Smith:
Thanks, John, and good morning, everyone. As Brian mentioned, we generated very strong financial results in the first quarter even in the face of an unexpectedly choppy and weak environment.
Our first quarter adjusted EPS of $1.29 was $0.19 higher than last year and $0.04 better than the high end of our guidance. First quarter GAAP EPS from continuing operations was $1.02, $0.27 lower than the adjusted EPS, reflecting $0.26 of losses related to our debt tender offer and $0.01 of expense related to the sale of our pharmacy business. Our first quarter comparable sales increase of 1.2% was driven by growth -- both growth in traffic and ticket, average ticket. As expected, total sales declined from last year, reflecting the sale of our pharmacy business to CVS. Within the quarter, we experienced solid results through the Easter holiday. Post-Easter, sales and traffic trends softened noticeably, consistent with what you've heard from many of our competitors. Also notable in the first quarter, we saw a meaningful increase in the volatility of our weekly sales performance compared with last year. Not surprisingly, weather patterns caused some of this volatility as we saw a meaningful correlation between sales and temperature trends in different regions of the country. We continue to invest in our digital and flexible fulfillment capabilities to drive sales in all channels, and we continue to see strong results. Comparable digital sales increased 23% in the first quarter, on top of the 38% increase a year ago. REDcard penetration was 23.4% in the first quarter, up nearly 200 basis points from last year. This represents the addition of nearly 700,000 new credit and debit accounts in the quarter combined with the impact of the sale of the pharmacy business. Excluding the impact of the pharmacy sales, penetration was up about 80 basis points from a year ago. Our team delivered a stronger-than-expected 11.5% EBITDA margin rate in the first quarter. On the gross margin line, we saw about 50 basis points of improvement from last year. This growth reflects the benefit of the sale of the pharmacy business and continued positive merchandise mix, driven by strength in signature categories. These benefits offset markdown pressure in an environment which continues to be very promotional. On the SG&A line, we saw the benefit of strong discipline across the organization along with the benefit from the sale of the pharmacy business. This allowed us to offset strategic investments we're making in our business, including our team. Altogether, first quarter SG&A expense was about 50 basis points better than last year. Quarter-end inventory was up a little bit more than 4%, rising faster than sales. As John mentioned, some of this growth reflected intentional inventory investments in -- to support in-stocks and essential categories. However, given the recent slowdown in our sales and our caution regarding the second quarter, we are planning to manage inventory carefully throughout this quarter and beyond. Turning to capital deployment. We returned $336 million to shareholders in the form of dividends this quarter and invested nearly $900 million in share repurchase. As Brian mentioned, we also took the opportunity to refinance some high-coupon debt during the quarter with the issuance of 10-year and 30-year bonds at very attractive rates. As a result, we recognized $261 million in debt retirement losses in first quarter GAAP EPS. And given that the settlement of -- on the last tranche of the debt tender occurred at the beginning of the second quarter, we expect to recognize another $161 million of debt retirement losses in second quarter GAAP EPS. Beyond these accounting losses, we expect this refinancing to reduce our ongoing interest expense by $5 million to $10 million per quarter. I want to pause here and discuss our quarter-end cash position. We ended the first quarter with about $4 billion of cash on our balance sheet, essentially the same as when we started the quarter. However, this was the result of timing. And we expect to reduce our cash position by more than 50% by the end of the second quarter. In fact, already this quarter, we've deployed nearly $1 billion to retire the final tranche of the debt tender. And we expect to apply another $750 million to fund a debt maturity in July. When you combine these uses with continued investments in the dividend and share repurchase, we expect to end the second quarter with a cash balance of between $1 billion and $2 billion. I want to emphasize that our capital deployment priorities remain the same. We invest first in our business to support projects that meet our strategic and financial criteria; second, we support the dividend and expect to maintain our record of consecutive annual dividend increases since 1971; and finally, we invest in share repurchase within the limits of our A long-term credit rating. One of our longer-term financial goals is to increase our after-tax return on invested capital, and we expect to reach the mid-teens or higher in the next 5 years. And I'm pleased that we are already making meaningful progress on this metric. For the 12-month period through the first quarter, we reported an after-tax return of 16%, including the gain on the pharmacy sale in the fourth quarter last year. Excluding that gain, our after-tax return on invested capital was a very strong 14% in the first quarter, up about 150 basis points from a year ago. On another note, our effective income tax rate from continuing operations was unusually low in the first quarter at 31.6%. This was the result of the adoption of a new accounting standard for employee share-based payments, which reduced our tax expense by $17 million combined with the impact of lower pretax earnings resulting from the loss on debt retirement. Now let's turn to our outlook for the second quarter and the implications for the full year. While we're coming off a quarter of outstanding financial performance, Brian mentioned earlier with elevated short-term volatility and softer sales trends since Easter, it's clear that consumers are behaving more cautiously. With that backdrop, we are planning for second quarter comparable sales of flat to down 2%. This would represent slower than second quarter performance than we were planning at the beginning of the year. But we believe this outlook is prudent given the trends we see as many others have been seeing. Given slower-than-expected sales, we are planning for a moderate year-over-year decline in our second quarter EBITDA margin rate in a range of 40 basis points at the midpoint of our comp guidance. Compared with our plan going into the year, our updated expectations reflect continued gross margin pressure from a very promotional environment combined with a deleveraging of SG&A expense on floor sales. Altogether, we expect to generate second quarter adjusted EPS in the range of $1 to $1.20. Given our performance over the last 1.5 years, we believe we're pursuing the right strategies, and our strategy is working. We have many levers we can deploy to drive our performance even if the environment remains challenging. As a result, even with a more tempered view of the second quarter, we are still focused on achieving full year adjusted EPS within the guidance range we provided at the beginning of the year. As we progress through the second quarter, all of us will gain more perspective, which will inform our outlook for the latter half of the year. As I mentioned at our Financial Community Meeting, one of my first priorities on joining this team last year was to dig in and understand in detail the factors that drive Target's financial performance. As a result of that view, I am confident in the resilience of our business model, which sustains our business through all consumer and retail environments. Importantly, our financial strength, combined with our business model, enable us to continue investing in our long-term priorities even when others are having to pull back. It's one of the many reasons I was so excited to join this team and this company last September. With that, we'll conclude today's prepared remarks. Now Brian, John and I are happy to take your questions.
Operator:
[Operator Instructions] Your first question is from Greg Melich from Evercore ISI.
Gregory Melich:
I have a few questions. Brian, I think, John and Cathy all gave a nice overview there when you described how the quarter progressed. Could you help us understand where April was? Was it actually negative? And also any geographic distinctions that you saw in the quarter? Then I had a follow-up on the margin.
Catherine Smith:
Greg, I'll start. We did see -- obviously, we had a very strong February and March and felt really great around our performance in Easter. We saw that we took share in Apparel in Easter, and so we're really good there but we did see a slowdown in April. A lot of it, though, is that ad shift that we were seeing. So that's part of what we're seeing with regards to April. But we did see slowdown throughout the course of April.
Brian Cornell:
And Greg, let me provide some color as far as the geographic volatility, and I'm going to be really transparent with some of the examples. And as we looked at business in April and again in the start of May, we've seen a significant performance difference between our West Coast markets, and particularly, our Northeast markets and significant variability where we've seen some very positive growth performance across our entire portfolio in Los Angeles, in San Francisco and many of our core West Coast markets, offset by significant slowness in the Northeast, in Boston, in New York, in Philadelphia, in D.C. In given categories, we've seen dramatic performance differences. In the ready-to-wear category, on the West Coast and in parts of the Midwest where we've seen an earlier spring, we're seeing double-digit growth in ready-to-wear, offset by fairly significant declines in the Northeast. We had a review with our team yesterday. We looked at categories like fans. We have markets that are up 20%, and markets that are down 90%. So we're seeing volatility driven by certainly climate, but I think a number of other factors that we're certainly analyzing. Cathy talked about an earlier Easter. We've certainly looked at weather patterns. We recognize that year-on-year, fuel prices have increased. And our guess is the consumer is spending more than they did a year ago at the pump. And we certainly recognize that within overall categories, today's consumer, our guest, is reinvesting in their homes. They're spending money on home improvement. We've seen that in our Home category, which was up 4% in the first quarter. So a lot of volatility, and it's both geographic and within category mixes.
Gregory Melich:
That's helpful. I guess that's also a transition into the margin. If I got your guidance right, the mid-point of it, I take the comp and to get to that EPS, I get EBIT margins down around [indiscernible] in the second quarter. One, is that right? And two, it sounds like the real reason for that might be a little bit of deleverage and then basically markdown risk on inventory given the rest of your comment. Is that fair?
Catherine Smith:
Greg, I'm really sorry, but you literally cut out right when you said what you were trying to ask about EBIT margins. So I'm sorry, can you please repeat?
Gregory Melich:
Yes, it looks to us from a guidance, EBIT margin is down 50 bps in the second quarter at the mid-point. I guess how much of that is just deleverage? And how much of that is markdown risk from the elevated inventories and categories?
Catherine Smith:
Yes, so we did talk about gross margin. We expect gross margin to be 40 basis points at the midpoint. And we still expect a promotional environment, and we're planning for that.
Brian Cornell:
Yes, and Greg, I think under the circumstances as we've looked at our competitors' reports, we recognize there's significant inventory in the marketplace. We expect the second quarter to continue to be very promotional. And that's factored into our guidance for the second quarter.
Operator:
Your next question is from Oliver Chen from Cowen and Company.
Oliver Chen:
We had a question regarding the smaller convenience trips slowdown. Could you just help us understand as you looked at the data, if there's patterns there that give you some insight into how that dynamic may be playing out? And what's the opportunity there? And secondly, on the promotional pressure that you're seeing, how -- what's the axis [ph] from which that may be happening in terms of a, categories; and b, Amazon versus bricks-and-mortar competition? Are there different aspects of competition that you're facing as you look to determine what's optimal from a executional and strategic point of view?
Brian Cornell:
Sure. Oliver, let me address the trips, and we talked about it in the prepared comments. We continue to see very strong performance in what we'll describe as that stock-up trip where, as a company, we performed very well throughout 2015 and again in the first quarter of '16. Where we have seen some trip erosion is with a guest who is coming in for that fill-in trip. So as we think about actions we're taking in our business right now, we want to continue to make sure we're serving the guest who's looking for that stock-up item, that stock-up trip. And we're going to be even more focused as we manage through the quarter and the balance of the year to make sure we're winning and driving more fill-in trips. So you'll see us enhance and change both our promotional calendar, our in-store presentation of more fill-in items to make sure that we're doing both, continuing to win with a guest who's shopping Target for that stock-up occasion, but also making sure we're capturing more of that fill-in trip throughout the quarter. So those are actions that we're taking right now. The team's working on making adjustments in our promotional cadence and presentation to make sure that we're doing both. We're continuing to win with the stock-up shopper, but we're also capturing more share of wallet with that fill-in guest. From a promotional standpoint, we would expect to see most of the intensity in the Apparel space, where we certainly recognize that many of our competitors are sitting on high levels of inventory. We've got to be prepared for continued promotional intensity in that space. And I think we're well positioned, as both Cathy and John have noted, to manage through that throughout the quarter.
Oliver Chen:
Okay. Just a quick follow-up. As you've been monitoring, and you've been really ahead of thinking in terms of the omni-channel experience. Brian, are there any little changes that you've been seeing in terms of how customers view convenience? Or what you're seeing now in terms of the online plus offline experience that are different in terms of like the trends you've been recognizing?
Brian Cornell:
Well, I think, Oliver, the one thing that we continue to see and we've embraced as an organization is whether our guest is shopping in store or online, it starts digitally. So we continue to make sure we're investing in our digital assets to make sure we're providing the ease and convenience for our guests whether they're in-store or shopping online. It's why we've made such a commitment, as John talked about, to enhancing our order online, pick up in store capabilities. It's why we've elevated our focus on making sure that we provide an easy shopping experience for our guests online. We continue to build out those capabilities. So we recognize that even as we look at the start of 2016, the majority of the retail business in the United States continues to be done in stores, but it starts online. So we've got to have great digital capabilities to make sure when our guest is shopping Target, no matter how they shop, we make it a convenient, easy experience, so that has not changed dramatically. And one of the numbers that we feel best about in the first quarter is the fact that on top of a very strong 38% growth in the first quarter of 2015, we grew our digital sales by 23%. So we're continuing to connect with that guest that wants to shop Target online, and we'll continue to invest and build our capabilities in that space.
Operator:
Your next question is from Joe Feldman from Telsey Advisory Group.
Joseph Feldman:
Yes. Wanted to ask, Brian, if you could talk a little about the infill trips again. Wanted to go back to Cartwheel. If I recall, I don't think you've even mentioned it on the call this time, and I'm just wondering if there's any changes going on there or what you're doing? Presumably, that would be a way to help stimulate the infill trips like localization, personalized marketing. I know you guys do a great job with that with your mobile effort. So just did something kind of fall apart on that front, or maybe some things weren't as effective? Could you talk about that a little?
Brian Cornell:
Well, Joe, in some ways, you're looking inside of our current playbook. And certainly, as we think about winning more trips with that fill-in guest, Cartwheel plays an incredibly important role. And we'll continue to make sure that we activate Cartwheel to drive those trips and meet that guest's need. One of the things that we're certainly recognizing as we look at 2016 shopping patterns is there is a consumer and a guest who continues to look for value. And that value's expressed in more fill-in trips, buying smaller packs, smaller baskets. So again, it's not a shift in our strategy, it's a recognition that we have to do both. We have to continue to delight the guests when they come to Target for that big stock-up occasion, and we have to have the right assortment, the right value, the right presentation for that guest who's coming to us for the fill-in trip. So Cartwheel plays a very important role in that. And as we think about adjustments and modifications we're making to our plans, Cartwheel plays a very important role in driving more trips back to our stores, and certainly meeting the needs of our guests who's coming to us for that fill-in occasion.
Joseph Feldman:
Got it. And then you guys mentioned that the center store disruption and all of the efforts you made -- that you are making to improve the healthy living in that category, I guess, were you able to quantify how much of an impact that had? Presumably, it was a decent disruption in April that could have had a bit of a drag.
Brian Cornell:
Joe, it was a significant disruption. You know our stores. You know the layout. And for all of our center store dry grocery items, we moved every one of those aisles in all of our stores. So significant disruption for the guest. Short term, it certainly has an impact on our performance in Grocery and Food. But as we've made the changes, the response we're seeing from the guests is very encouraging. They're recognizing the new assortment, the new brands, more local items, the fact that we have more organic and gluten-free items on our shelves. And in many of these categories like the significant change we made in bars, we're seeing very strong sales results coming out of the reset. So it was an investment we had to make in both labor and in disruption to make sure we continue to move forward in the reinvention of Food. So short term, it had a meaningful impact on our Food sales, but we certainly expect to see the recovery over the balance of this year as we provide a more relevant assortment to our Target Grocery shopper.
Operator:
Your next question is from Kate McShane from Citi Research.
Unknown Analyst:
This is Chris [ph] filling in for Kate. With the comp coming in below your expectations, is there a reason why you didn't choose to get more promotional this quarter? Could you walk us through how much of your gross margin was impacted by promotions? And was it more than last year?
Catherine Smith:
Yes, we were as promotional as necessary. We drove as we shared a 4% comp in our signature categories, which are the areas that tend to be more promotional. So we feel very good about our promotional cadence, continue to work on being more and more effective, but still have a long way to go there. So I wouldn't say that we saved any on promotions. In particular, we were as promotional as we thought was appropriate. And it showed up in our comp.
Brian Cornell:
And Chris, I'd only add that as we look at individual category performance, we felt like we were very competitive in categories like Apparel, where as we look at the NPD data, we look at the market share results, we were one of the big market share winners in the first quarter. And clearly in Apparel, we picked up market share the 2 weeks leading up to Easter, during the Easter week and the week following. So our assortment, our presentation, our promotions certainly connected with the guest. And in important signature categories, we continue to advance market share. But we feel particularly good in a tough apparel environment that we posted positive comps, we grew market share. And importantly, we grew market share before, during and after the important Easter holiday, which is a critically important holiday for the Apparel category.
Unknown Analyst:
And just looking ahead, you mentioned, I guess, Apparel's going to be very competitive. Are there any other categories you see that will also face pricing competition? And also just really quickly for your in-stock initiatives, how much did the improvement in those initiatives contribute to the comp in Q1?
John Mulligan:
Well, on the in-stock question, I think it's hard to parse that out, a very difficult question to answer. Certainly, we have some estimates internally, but it gets into trading behavior as you know and how guests will trade out. But overall, I think the in-stocks definitely having it there when the guest wants it, but more important than that is ensuring that they trust us that no matter when they come in the store, we'll have what they want. And that's about building trust for the brand over the long term. And so there is an immediate impact, but this is much more about being sure we're reliable all the time for the guests.
Operator:
Your next question is from Peter Benedict from Robert Baird.
Peter Benedict:
Just a clarification just on the second quarter gross margin outlook. I think you said down 40 basis points. I assume that's on a reported basis, right? So excluding the pharmacy impact, it would be down maybe closer to 100. Am I right on that?
Catherine Smith:
I thought I had said gross margin. We really -- I meant 40 basis points on EBITDA. So we should see actually a slight uptick in gross margin, a slight -- a downtick in SG&A and then EBITDA was the 40 basis points. So thanks for asking that for clarification.
Peter Benedict:
That's helpful. And then on just on SG&A, is it -- I mean it's fair to say that the SG&A dollars, if you exclude the pharmacy comparisons, were down slightly year-over-year in the first quarter? And I'm just curious if that's a trend that you think could persist over the balance of the year given the tougher sales environment?
Catherine Smith:
Yes. The team did a great job of managing expenses in the first quarter, and we'll continue to do that. And yes, it was down year-over-year. We'll continue to manage our expenses.
Peter Benedict:
Okay, last question. I apologize if I missed this, any change to the CapEx plan for the year, which I think was around $1 billion?
Brian Cornell:
No change in plan...
Peter Benedict:
$1.8 billion, sorry.
Catherine Smith:
The $1.8 billion, no change at all.
Operator:
Your next question is from Bob Drbul from Nomura.
Robert Drbul:
I guess I just follow on Peter's last question. But when you look at the sales results that you had the last few weeks and especially April, does that make you rethink your longer-term sales views that you laid out back in March?
Brian Cornell:
Bob, it does, and obviously, it's been a question that we've asked ourselves. And as Cathy and John have both mentioned, we feel very good about the progress we're making from a strategic standpoint. We talked multiple times now. Certainly, we talked to most of you on the call during our March Investor Day, our continued focus on building out our digital capabilities. We're making very good progress there. We think those are going to be essential to our future. We feel very good about the progress we're making on signature categories, where we continue to build market share and drive differentiation. We're very excited about the early results of Pillowfort and feel as if when we launch our new Cat & Jack brand for Kids, that is going to be another potential $1 billion brand in our portfolio. So great progress from a category role and signature category standpoint. As John mentioned during his remarks, our flex formats continue to be very well received as we move into new urban markets. We're excited about our TriBeCa store that we'll open up in October. But we've been excited about every one of these new flex formats, and they've been well received in both urban and college markets. We continue to think we've got significant opportunities in localization and the work we've done in Chicago. And now, Los Angeles just continues to confirm that. So our strategy continues to perform well. John and the team continue to enhance our store and supply chain capabilities to continue to meet the needs of our guests. So as we sit here today, there's no significant change in our strategy. But tactically, we recognize the consumer environment is tougher. We've got to make sure we're delivering the right value, we're winning with both the stock-up and the fill-in trip. We're making sure that we have the right experience for our guests, whether shopping in-store and online. And we don't see any structural change in the consumer environment. We think this is a short-term bump in the road, but we think we're well positioned. And everything we see from a GDP and consumer confidence standpoint gives us the confidence that this is going to be a short-term impact. And we're going to see very solid results in both the third and fourth quarter and keep us on our long-term guidance track.
Operator:
Your next question is from Scott Mushkin from Wolfe Research.
Scott Mushkin:
So I just wanted to clarify the resets in the dry grocery, when did that take place? Was that in -- during the quarter, or was that after the quarter closed? And if it was during April, what was the drag? Do you guys know?
Brian Cornell:
Yes, Scott, it took place right after Easter during the month of April. So a major effort inside of our stores. We touched, as I mentioned earlier, all of those center store grocery aisles. We added a number of new items over 1,000. We brought new brands into those categories, and we had expanded our Simply Balanced line. So all that took place, and it was very disruptive, and we planned for it in April. We now have the work behind us, and I'm very excited about the feedback we're receiving and the responses we're seeing in many of these categories, and certainly expect that we'll see those businesses accelerate now that we have more relevant assortment. And we've significantly increased the representation of organic and natural and gluten-free and local items in those aisles.
Scott Mushkin:
So Brian, the weakness you continue to see into May is, because I think you say, that reset went really well. And that's a chunk of sales. So the weakness you see continuing into May would be nonconsumable areas that are just, as you say, the heavy inventory in some of these signature categories. Is that a good way to frame it?
Brian Cornell:
Yes, I think that's largely the case, Scott. Again as I said earlier -- and I want to make sure we're really transparent about this with examples. We've seen very slow sales performance in the Northeast, and we had the same presentation. We had the same ads. We had the same value. We had the same great in-store experience. But on a day-in, day-out basis, we're getting very different outcomes. So on one hand, it gives me confidence to say what we're doing is working because it's working in many parts of the country. But we have isolated geographies, where whether it's late spring, whether it's a change in short-term consumer behavior, we're not seeing the same results, but we're delivering the same great content. So I expect the Northeast to recover. I think spring will arrive there, and I think when the guest is out shopping, they'll continue to choose Target. And we'll continue to provide them a great in-store and online experience, but we are seeing very significant geographic volatility unlike anything I've seen in many, many years.
Scott Mushkin:
Interesting. And so then I just wanted to touch on the fill-in trip situation. And I think you talked, talked about promoting a little bit more to try to get those trips. Is that promotion different? Is that promotion more in the consumable side of things as you look at it? It seemed intuitively that would be, but I just wanted to kind of get your thoughts.
Brian Cornell:
Scott, you're spot on. It's much more about consumables, household essentials. And to be very clear, it's probably less about promotional intensity, but ensuring that we are promoting and presenting the right items, particularly at the back end of the month when the consumer and our guest is more likely to look for single unit items, more items that have value. So we're going to make sure we're making the tactical adjustments to what we advertise, what we present in-store and making sure that we're winning both with the stock-up guests, but also with the guests who's looking for value and looking for smaller, single-unit packs at the right value.
Scott Mushkin:
Then I had just one last one I want to sneak in because I was in your store in Long Beach, which I thought was wonderful, that small Target.
Brian Cornell:
It's a fabulous store.
Scott Mushkin:
How close are you from test to actually maybe rolling out more of those? And then I'll yield.
Brian Cornell:
Yes. So I'm smiling, and I may turn this over to John, but we've all actually visited our Bixby store in Long Beach over the last few weeks. The store really captures the best of Target in a smaller, 30,000 square foot environment and very positive reaction from the guests. So as we think about future flex formats, that is a model that we're excited about, a model that certainly seems to be connecting with the guests. And you should expect to see more of those as we go forward. But let me hand it over to John, who's been intimately involved in the rollout of flex formats, and specifically, the work we're doing in Long Beach.
John Mulligan:
Yes, well I would just add, obviously, we're very excited about the performance of the stores. I think the financial performance certainly, but I think like Brian mentioned, really it's the guests' reception of those stores. And while they are very conveniently placed like the Bixby store, they're not convenient stores. The intent is to lead forward with what Target does well. Home, Apparel are signature categories, and that's what you're really seeing at Bixby store. So we will continue to increase the number we're doing as we go forward, but continue to test geographies and sizes of stores and how those 2 work together. Obviously, the Bixby store is quite large, and that's a little bit different neighborhood than we've done in the past. And so the TriBeCa store that Brian referenced, again very different, very dense, urban store, 2-level store. So we continue to test kind of configuration and neighborhood, but feel very, very good about what we found so far. And you'll see us continue to grow those number of stores that we open over the next several years.
Brian Cornell:
Just to finish up on that, Scott, I think the Long Beach store that you visited is a great example that really shows how we're approaching each of these initiatives. We are testing, we're learning. We're refining. The team's getting better and better at layout and assortment. And you've seen that when you walk the Long Beach location. And the feedback that we've received from the guest is even in a smaller box, it feels like Target. And it feels like the best of Target. The work that the team's done in the center of that store to merchandise our soft lines is really outstanding. We're getting great feedback around our Food presentation in that store. We've got the right Home assortment. So we're tailoring that for the local market, but it's example of the fact that we've been disciplined. We're not sprinting. We're making sure that we're really thoughtful. We're learning, we're adjusting. And you're seeing each of the new flex formats get better and better in layout, assortment and tailoring to meet the local market. So we are very excited about it, and we'll continue to take that learning and build it in the new flex formats that we'll be opening up over the balance of this year and into next year.
Operator:
Your next question is from John Zolidis from Buckingham Research.
John Zolidis:
Wanted to ask about the second half of the year. You've already addressed this a little bit. And you've provided us a lot of evidence, I think, that points towards weather as a significant culprit in the volatility in the sales at the end of the first quarter and the start of the second quarter. But you also alluded at some points that maybe there was something else going on with the consumer. So I was wondering if you could just talk about what else might be negatively impacting the consumer or your consumer that you're aware of? And do you have any data, for example, if you look by segment of consumer, income levels or REDcard usage that would help you understand the trends to a greater extent?
Brian Cornell:
Well, John, as you might imagine, we're spending a lot of time and have spent a lot of time as a team looking at performance from a number of different vantage points, both internally, but also certainly incorporating external data. So certainly, it was a earlier Easter. We recognize the impact of that. Certainly, weather in many major markets has been a factor. It's not an excuse. We've got to figure out how we perform under any circumstances. We know as the guests and our consumer has moved through the course of 2016, prices at the pump, fuel prices have risen, and that's certainly an impact. And then when we look at a macro basis on overall spending, we certainly recognize that consumers are spending more on travel, on leisure activities. They've been investing in their homes, as I mentioned before. But there's no structural change that gives us pause and has us changing our strategy, altering our outlook for the full year. We think we're continuing to improve our digital capabilities. I think our store experience is improving each and every week. The response we're getting from the guest based on changes we've made in Apparel and Home and recently in Food are very encouraging. As John mentioned, our flex format's performing quite well. So we feel confident that the content we have in place, the plans we have for the second half of the year, some of the enhancements we've made from a branding and in-store and online standpoint are going to continue to deliver solid results. So we see this as a momentary speed bump, but we see no reason to alter our strategy. These are tactical adjustments we have to make. And market by market, we've got to make sure we're well positioned to compete going forward.
Operator:
Your last question comes from Chris Horvers from JPMorgan.
Christopher Horvers:
So following-up on that question and just that thread of questions. So outside of the Northeast in California, has it been more consistent? And then related to that, as you think about the second quarter guidance, are you basically extrapolating current trends, which have been weather impacted? Or are you taking a directional view, either more conservatively expecting to pick up as the quarter progresses or in either direction?
Catherine Smith:
Yes. So we obviously have insight into where May is at today. And then we've got Memorial Day coming. We've got great plans around -- leading into Memorial Day and have every confidence we're going to -- that we're going to have guests come to Target whether in our stores or online. And then we -- summer and warmer weather will come. And so we have an expectation that the trend we see today doesn't change overnight, but it does improve throughout the quarter because we've got some really great plans to deliver for our guests. And then also in the latter part of this quarter, we have Cat & Jack launching. And we're very excited about Cat & Jack launching before Back-to-School season. And we expect that to be a leading Target only brand that will be $1 billion brand in time.
Brian Cornell:
So Chris, thanks for your question. And I really appreciate everyone who called in today. We tried to make sure we allotted significant time for your questions. Hopefully we had a chance to answer your questions, address some of your concerns. So that will conclude our quarter. I appreciate your time today, and thank you for dialing in.
Operator:
This does conclude today's conference call. Thank you for participating. At this time, you may now disconnect.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation Fourth Quarter and Year-End Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, February 24, 2016. I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our fourth quarter 2015 earnings conference call. We apologize for the delay. We were informed that some people were having trouble accessing our webcast and we delayed in order to make sure that they could access this call along with everyone else.
On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; and Cathy Smith, Chief Financial Officer. This morning, Brian will discuss our fourth quarter performance, including results across our merchandise categories. Then John will provide an update on our efforts to improve in-stocks and build our supply chain capabilities. And finally, Cathy will offer more detail on our fourth quarter and full year financial performance. Following their remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer any follow-up questions you may have. Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure; and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalized operating leases. Reconciliations to our GAAP EPS and our GAAP total rent expense are included in this morning's press release, which is posted on our Investor Relations website. Finally, one note, given that we're hosting our financial community meeting next week, our remarks today will focus on Target's fourth quarter performance and our guidance for the first quarter and full year 2016. At next week's meeting, we will provide insights into our strategy and priorities and how they will drive our financial performance in 2016 and beyond. As a result, we are shortening today's call to 45 minutes, and we'll look forward to spending another couple hours with all of you, either online or in person, at next week's meeting in New York. With that, I'll turn it over to Brian for his comments on the fourth quarter and the holiday season. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. As we look back at both the fourth quarter and the year, we are very pleased with the progress we made throughout 2015.
Traffic increased in all 4 quarters, and the team delivered on our comparable sales and operating margin rate goals by driving rapid growth in our signature categories. And our full year adjusted earnings per share of $4.69 was above the top of the range we provided last March, keeping us on track to deliver our longer-term financial goals. In the fourth quarter, our business generated adjusted earnings per share of $1.52, up $0.03 from a very strong performance in the fourth quarter of 2014. Comp sales grew 1.9% in the fourth quarter, building on a 3.8% increase in last year's fourth quarter. Target's great store experience, unique items at an unbeatable value and broad, simple promotions resonated with our guests and drove this growth. Transactions, our measure of traffic, increased for the fifth quarter in a row, up 1.3% in the fourth quarter, reflecting growth in all of our selling channels. Digital sales increased an industry-leading 34% in the fourth quarter, on top of 36% growth in the fourth quarter of last year. Strong Black Friday and Cyber Monday weeks drove this increase. In fact, after setting a new digital daily sales record in the week of Black Friday, we shattered all previous records on Cyber Monday. Our offer was broad and simple, 15% off everything on our site, and the guest response was exceptionally strong.
Our holiday season merchandising and marketing plans were focused on delivering broad, simple and compelling offers, like our 10 Days of Deals, Black Friday doorbusters and the site-wide offer on Cyber Monday and the bounce-back coupon we offered to guests in our stores on Black Friday, all supported by cohesive marketing plans featuring outstanding creative work. This plan delivered record sales over the November and December period, driven by comp sales in our signature categories:
Style, Baby, Kids and Wellness, which grew nearly 7% over that 2-month period. Sales in Kids were particularly strong, with the fastest growth in Toys and Kids Home products. In Style, we saw the fastest growth in women's apparel, led by double-digit increases in ready-to-wear. And in Wellness, wearable electronics and Food led the way.
Across our traditional category destinations, Apparel grew in the low single-digit range. In Hardlines, Toys grew comp sales more than 10% in the quarter, marking the third quarter of double-digit comp growth in Toys. This strength helped offset a sales decline in Electronics, where sales benefited from robust growth in wearables but also reflected the impact of industry-wide softness in tablets. Consistent with the third quarter, fourth quarter comp sales in Food grew faster than our overall sales, outpacing trends in the first half of the year, validating the changes we're making to the assortment, presentation and freshness. And finally, Home grew about 4% in the fourth quarter. With this performance, Home delivered a 4% comp sales increase for the full year, the strongest annual performance in this category in more than 10 years. Finally, prior to the holiday season, we reimagined the See. Spot. Save. area in the front of our stores, which is large and a very profitable business, and transformed it into Bullseye's Playground. We modernized the environment, making it easier to navigate, more appealing and fun, incorporating our much-loved mascot into store displays. While we love the new look, our guest reaction is what really matters, and the fourth quarter results showed they loved it too as comp sales in Bullseye's Playground grew more than 25% compared to See. Spot. Save. in the fourth quarter of last year. December marked an important milestone for the company as we closed on the sale of our pharmacy business to CVS Health. Our team has been working closely with our colleagues at CVS, both before and after the sale, to ensure this transition is seamless for our team members and our guests. And while the transition is not yet complete, we're very pleased with the progress we've made so far. A small number of our store pharmacies have already been rebranded as CVS locations, and over the next 6 months, we'll complete the rebranding of all our pharmacies and clinics in stores across the country. We believe this transaction will create value for our guests, providing them access to the capabilities of a best-in-class health care provider while they're shopping our stores. And we expect both Target and CVS to benefit from this transaction, allowing both companies to leverage their respective strengths. Importantly, we believe CVS will be able to grow traffic in our store pharmacies faster than we would have been able to do on our own, given our lack of scale when we ran this business. In addition to the ongoing value we'd expect to realize from this arrangement, the sale has already provided more than $1 billion of net cash that we'll use in support of our capital deployment priorities. Turning to capital deployment. We generated very strong cash flow in 2015, which we deployed for the benefit of our shareholders. Beyond funding capital investments in support of our strategic and financial goals, in 2015, we returned nearly $5 billion through dividends and share repurchase, well ahead of the goal we set at the beginning of the year. Even with this robust return of cash, we ended this year with a very healthy cash balance, positioning Target for another strong year in 2016. Now before I turn the call over to John, I want to pause and thank the entire Target team for what they accomplished in 2015. As I look back to a year ago, I believe we're operating on a much stronger foundation today. And while we've got much more to accomplish on this journey, the team today is agile and aligned around a small set of key enterprise priorities, allowing us to move much more quickly. Today, the team is taking an outside-in approach to our work, understanding how Target fits into the consumer and retail environment as we work to grow the company on behalf of our guests. When Cathy began working with us last year, her first observation was how talented this team is and how passionate they are about both Target and our guests. Not surprisingly, that was my first observation when I arrived at Target in 2014 and something I know John has experienced throughout his career with this great company. With that, I'll turn the call over to John, who will discuss his team's progress in efforts to improve our operations. John?
John Mulligan:
Thanks, Brian, and good morning, everyone. Today, I'm going to provide you with a brief update on our work to improve operations, and I'll provide more detail about our strategy and future plans at the meeting next week.
Our work to reduce out-of-stocks is continuing to pay off as metrics improved sequentially from the third quarter and even more dramatically when compared with the fourth quarter a year ago. Specifically, for the fourth quarter in total, out-of-stock metrics were 20% better than last year. And notably, by the end of the quarter, Target's out-of-stock metrics were 40% better than a year ago as the improvements we've implemented allowed for a faster post-holiday recovery this year. We saw out-of-stock improvements across every category in the fourth quarter. As I mentioned in the last conference call, our work has been focused primarily on essential items for which reliability is particularly important for our guests, and I'm really happy with our progress. For the set of focused items we've designated in essentials, our out-of-stock metrics are better than we have ever measured. While this progress is exciting, I'm even more pleased with -- that this improvement has been accomplished through systematic and therefore sustainable changes. In other words, this isn't an example of temporarily adding resources to work around systems and processes. Rather, this is a case of making improvements to those systems and processes to support a sustainable improvement in performance. Because upstream variability in the supply chain hampers our ability to keep our stores in stock and provide tight shipping windows to our guests, a key pillar of the team's work is focused on improving freight flow through the supply chain. As part of this effort, the team has created smart, systematic rules governing safety stock in distribution centers and they have optimized pick frequencies on priority items. In the fourth quarter, the team began an array of tests to reduce variability of inbound shipments at our DCs, with a goal of reducing inbound variability by 50%. Similarly, the team plans to engage in tests to optimize outbound volatility, which will further improve overall freight flow. While we are still early in this journey, the team's work on flow was a key reason we saw a much faster recovery this holiday season and why we entered 2016 with a much better in-stock position than a year ago. Beyond in-stocks, we are entering 2016 with very little clearance inventory even compared to a strong position a year ago. As you'll recall, last year's fourth quarter sales were much stronger than expected as we planned for a 2% comp and ended up with growth nearly twice as high. With last year's unexpectedly strong sales, we saw very high sell-through percentages on Seasonal merchandise. However, as a result of great product and of the changes we've implemented this year, quarter end sell-throughs on Seasonal merchandise were slightly better than last year, putting us in a very clean inventory position at the beginning of the year. These are just a few examples of the team's work to implement quick solutions that are already having a tangible impact on our results. At the same time, we are working to build capabilities that will support our future growth. I'll provide a lot more detail on these future focus efforts in my remarks at next week's meeting. As you know, we have been building our flexible fulfillment capabilities for several years, and this holiday season highlighted the power of these capabilities to serve our guests and drive business performance. And while we've added capacity across our entire direct-to-guest network, our fourth quarter experience demonstrated the power of relying on our stores to fill digital demand. This holiday season, our stores fulfilled 30% of our digital orders through the combination of order pickup and direct-to-guest shipments. On Black Friday weekend alone, our stores fulfilled more than 1 million digital orders. And even though the traditional view of Cyber Monday doesn't even include brick-and-mortar, Target stores set an all-time record for order pickup on that day, with more than 4x the volume compared with last year. And like last year, order pickup became even more important in the days leading up to Christmas, growing to half our digital volume. While our stores help us save meaningfully on shipping costs and allow us to fulfill guest demand faster, they also help us capture more sales. Because we now have a single view of inventory encompassing all of our distribution center and store locations, we can rely on our entire network when fulfilling digital orders, keeping us in stock on a greater percentage of digital orders. Specifically, during the holiday season, about 40% of our order pickup and store-shipped volume consisted of items that were out of stock in our web fulfillment centers. This preserved sales on orders we would have otherwise missed had we only accessed inventory in our web fulfillment centers. Before I turn the call over to Cathy, I also want to provide an update on our decision to bring visual merchandising talent into our stores. Last fall, we announced we were filling more than 1,400 new visual merchant positions in our store organization. In scoping responsibilities for these roles, we benchmarked industry leaders to define the necessary capabilities and enhanced our interview process to better assess for these skills when interviewing potential candidates. The majority of these positions have been filled by external candidates with experience at other retailers, but we have also tapped in the talent that we identified within the organization. Our visual merchants are focused on Style categories in our Home, Apparel and Seasonal areas, and they are trained to rely on sales and inventory data while developing compelling visual presentations in our stores. As a result, their job requires that they balance art with science and productivity with creativity. And because of their unique qualifications, this team is responsible for training their store team colleagues to understand the latest product trends so the entire store team can better assist our guests as they shop our stores. While the visual merchandising team is just ramping up its processes and tools, we can already see the early impact of their effort in our store displays, and we are very excited about the potential of this effort to elevate both signature categories and our store experience. Thinking back to the year just ended, it's amazing for me to realize that we only formed our new operations team about 6 months ago. In that time, we have already seen meaningful improvement in our operations and we're entering the year with a much stronger in-stock position than a year ago. As we look ahead, we see multiple opportunities to improve end-to-end processes and build the foundation for our future growth while improving the shopping experience for our guests and enhancing our business results. I look forward to discussing these opportunities with you in New York next week. With that, I'll turn it over to Cathy, who will share her insights on our fourth quarter financial performance. Cathy?
Catherine Smith:
Thanks, John, and hello, everyone. As Brian mentioned earlier, we are really pleased that our team delivered strong traffic and sales growth in the fourth quarter. Our financial results continue to validate the strategic changes we've made, confirming that we are focused on what's most important to our guests.
Our fourth quarter adjusted earnings per share of $1.52 was well within our guidance range and up $0.03 from last year's very strong performance. Fourth quarter GAAP EPS from continuing operations of $2.31 was $0.79 above adjusted EPS, reflecting the $620 million pretax gain on the sale of our pharmacy business to CVS Health. Comparable sales grew 1.9% in the fourth quarter on top of a 3.8% increase in 2014. Traffic was the primary driver of our comp growth, up 1.3%, building on a really strong 3.2% increase last year. This quarter marked our fifth straight quarter of traffic growth, and we are committed to driving continued traffic growth in 2016 and beyond. As I mentioned last quarter, results in our fourth quarter 2014 reflected a bounce-back from the impact of the breach in the fourth quarter of 2013. However, even on a 3-year stacked basis, our traffic was stronger in this year's fourth quarter than earlier in the year, demonstrating continued momentum from the strategic changes we've implemented. One note. Fourth quarter reported sales were down a little less than 1% from last year, reflecting our comp sales increase, offset by the impact of the sale of the pharmacy business, which closed in mid-December. Digital sales grew 34% in the fourth quarter, and we saw the most dramatic increases in the Black Friday and Cyber Monday weeks. These increases were driven by our simple, broad and compelling offers, and as John mentioned, our flexible fulfillment capabilities played a key role in driving our fourth quarter digital sales growth. REDcard penetration was 23% in the fourth quarter, up about 190 basis points from 21.1% last year. This increase represents a moderate acceleration from the trends we were seeing earlier in the year, combined with the impact of the removal of our pharmacy sales. Because a meaningful portion of our pharmacy sales consisted of reimbursements from third parties, REDcard penetration on our total pharmacy sales was very low. As a result, the pharmacy sale will increase REDcard penetration throughout 2016, and to add clarity, we've provided an apples-to-apples comparison in our press release schedules. For the fourth quarter, REDcard penetration would have been up about 160 basis points from last year had pharmacy sales been removed from both years. Our fourth quarter segment EBITDA margin rate of 9.8% was flat to last year's strong performance. Among the drivers, fourth quarter gross margin rate was down about 50 basis points from last year, reflecting a small benefit from sales mix, including the removal of pharmacy sales, offset by investments in promotions. As John mentioned earlier, last year's stronger-than-expected comparable sales growth drove very strong gross margin rate performance in fourth quarter 2014 as regular priced selling on Seasonal items was unusually high. This year, with sales in line with our expectations, our gross margin rate reverted to a more normal level, given the competitive dynamics we faced in the fourth quarter. Every holiday season, we gain insights into the evolution of our guests' shopping behavior, and this year's results showed us that clear, compelling, broad-based offers are appealing to our guests. This insight will inform our strategy as we work to further refine our promotional effectiveness in 2016. Favorability in our selling, general and administrative expense rate offset the fourth quarter gross margin rate decline. This performance reflected an increase in our store Apparel expense rate, driven by investments in our store team, including the visual merchants John mentioned earlier, partially offset by underlying improvement in unit productivity. However, the pressure from store labor expense was offset by favorability in our marketing and bonus expense rates and disciplined spending across the organization. At the end of the year, our merchandise inventory was up about 4% from a year ago, a bit more than our current sales trends. As John mentioned, we ended the year with a very clean inventory position, and the year-over-year increase reflects intentional inventory investments, which are supporting record in-stock levels in our focus categories. Turning now to capital deployment. We paid dividends of $345 million in the fourth quarter, up 4.4% from a year ago. Our business results and cash position also enabled $1.3 billion in share repurchases in the fourth quarter, meaning we returned more than 110% of our net income through dividends and share repurchases. And even though we returned about $4.8 billion to our shareholders in 2015, we ended the year with a healthy cash position, including cash from the CVS transaction, which closed late in the year. Before I turn to our guidance for the first quarter and provide some insights of our financial plan for the year, I want to review last year's performance against the guidance we provided a year ago. Let's start with sales. A year ago, we laid out a plan to grow total sales 2% to 3% on comp sales growth of 1.5% to 2.5%, led by growth in our signature categories. We achieved our comp sales goal by generating very solid growth of 2.1%, and comp growth in signature categories was more than 2.5x as high as our comparable sales growth overall. Total sales grew slower than comps this year due to the removal of the pharmacy sales beginning in December. Of course, the sale of the pharmacy business was not reflected in our guidance a year ago as we didn't enter into the deal until June. However, while the sale of the pharmacy business will continue to affect our total sales this year, we first articulated the expected benefits of the deal in June, which includes faster traffic growth, higher profit dollars and rates and higher ROIC from the upfront capital we received from CVS. Now let's turn to digital. A year ago, we laid out a goal to grow Target's digital sales an industry-leading 40%. And while we didn't quite make this ambitious goal, we did lead the industry with 31% digital sales growth in 2015. With this growth, we delivered our financial goals and we gained deeper insights into how our guests want to interact with Target. Moving down the P&L. A year ago, we said we expected to grow our segment EBITDA rate 20 to 30 basis points in 2015, given -- driven by modest improvements in both our gross margin and our SG&A expense rate. We ended the year ahead of that goal, up about 50 basis points, reflecting favorability on both the gross margin and the SG&A expense lines. Turning to capital deployment. A year ago, we were expecting 2015 capital expenditures of $2.1 billion, planning for a 5% to 10% increase in the quarterly dividend in the middle of the year, and we expected $2 billion or more in share repurchases for the full year. How did the year turn out? We spent about $1.4 billion on capital expenditures in 2015. We hit the middle of our guidance with a board-approved 7.7% dividend increase in June. And we exceeded our share repurchase guidance with about $3.4 billion in shares retired this year. Our 2015 share repurchase capacity reflected robust cash generation by our business and, of course, additional capacity from the closing of the sale of our pharmacy business in December. Regarding capital expenditures, our 2015 spending reflected the retiming of certain projects resulting from prioritization efforts initiated by our new Chief Information Officer, Mike McNamara, and his team. Following his arrival in the middle of the year, Mike dramatically reduced the number of non-infrastructure technology projects in order to refocus resources on the highest-priority initiatives and make faster progress. In addition, Mike's team began hiring hundreds of additional engineers in order to reduce our reliance on contractors and vendors. These changes reflect our commitment to prioritize spending on both capital and expense to best support our enterprise priorities. And in the current environment, our spending priorities are currently tilting towards expense, including investments in technology engineers; in our store team, including the hiring of visual merchants; and in our headquarters teams, in the areas of data science and operational excellence. So how did the elements of our 2015 P&L translate into adjusted EPS? By achieving our comp sales goal, while exceeding our guidance for profit margin and share repurchase, we delivered $4.69 of adjusted EPS this year, above our guidance range of $4.45 to $4.65 and more than 11% higher than 2014. And while we didn't provide specific guidance for return on invested capital in 2015, we reported after-tax ROIC of 16% this year. I'll quickly note, because the ROIC calculation doesn't adjust for nonrecurring items, this year's performance included the gain on the sale of the pharmacy business. Excluding this gain, our business generated a very healthy after-tax ROIC of 13.9% for the year, up well over a percentage point from 2014. So with full year 2015 performance as context, let's turn to our detailed guidance for first quarter. I will also provide some high-level details of our plan for the year and discuss those plans in more detail at our meeting next week. I'll start with our view of comparable sales for the full year. We are planning for comp growth in the 1.5% to 2.5% range in 2016, consistent with our performance throughout last year. Given that we're 1 year into a multiyear journey, at next week's meeting, I'll discuss why we believe we have the capacity to grow comps a bit faster than this range over time. However, in the current environment, we believe this is a prudent range to plan for this next year. With that context on full year sales, I'll turn to the first quarter. As we plan our first quarter comp in light of competitor inventory positions, we're anticipating growth in the lower end of the 1.5% to 2.5% range we're planning for the full year. First quarter reported total sales are expected to decline 4.5% to 5%, reflecting the removal of pharmacy sales from this year's results. One note on our sales guidance. We haven't specified a goal for digital sales growth. I'll discuss our reasoning for this change in more detail next week, but for now, I'll simply stress that our commitment to digital is as strong as ever. And while we will continue to include digital metrics in our financial reporting this year, we are going to gauge our success based on Target's overall traffic and sales growth without making an arbitrary distinction between channels. This change is consistent with how our guests think about shopping as we've confirmed with our guest research. Moving on to the first quarter P&L. On the EBITDA margin rate, we are expecting an improvement of 60 to 70 basis points in the first quarter, driven by an increase in our gross margin rate, partially offset by a moderate increase in SG&A expense rate. The expected gross margin rate improvement primarily reflects the benefit of the removal of low-margin pharmacy sales from the mix, combined with a moderate improvement in the underlying business. On the SG&A line, our forecast anticipates some pressure from the investments we're making in our store themes, along with incremental expense from the reissuance of REDcard debit and credit cards as we move guests to much more secure chip-and-PIN technology. On the depreciation and amortization expense line, we are expecting 20 to 30 basis points of pressure in the first quarter, reflecting the removal of pharmacy sales and a slight increase in D&A dollars over last year. We expect first quarter interest expense dollars to be flat to last year's. We're planning for a first quarter effective income tax rate of 35% to 36%, and we expect to continue to engage in meaningful share repurchase given our cash position. Altogether, these expectations position us to deliver first quarter adjusted EPS of $1.15 to $1.25 compared with $1.10 a year ago. Turning back to full year. We expect to deliver full year 2016 adjusted EPS of $5.20 to $5.40, and I'll provide more detail on the individual P&L items next week. For now, I would note that this performance would exceed our longer-term financial algorithm to generate annual adjusted EPS growth of about 10% as it reflects the expected share repurchase benefit of the incremental cash we deploy -- will deploy from the sale of our pharmacy business. Now I'll turn the call back over to Brian, who is going to provide a quick preview of next week's financial community meeting. Brian?
Brian Cornell:
Thanks, Cathy. Before we take your questions, I thought it would be helpful to cover our agenda for next week. In New York next Wednesday, I'll open the meeting with an update on our strategic priorities and the initiatives for 2016. Then John will provide deeper insights into the work his team's doing to transform supply chain and their efforts to drive operational excellence across the enterprise. And finally, Cathy will provide insights into how we expect to continue to deliver on the long-term financial algorithm we laid out last year.
Following the presentations, we'll have a Q&A session with all 3 speakers, along with several other members of our leadership team who will be attending this meeting. At last year's meeting, I outlined our enterprise priorities and told you that I hoped it would remain consistent for years. So here's the spoiler alert. Our priorities today remain consistent with a year ago. We made progress, but we have a lot more to do. And our tactics will always be evolving, but this year's results demonstrate we're focused on the right work. At this year's meeting, we plan to show you how we're getting even closer to our guests, gaining a deeper understanding of their wants and needs and how Target fits into their daily lives. We also plan to show you why we're so excited about all the new products we've developed for this year. And for those of you who will be with us in New York, you'll see vignettes showcasing newly developed products across multiple categories, including our incredible new Kids brand, Pillowfort. So whether you plan to be with us in New York next week or listening to our webcast, we hope you'll join us to gain a deeper understanding of our strategic and financial plans going forward and why we're so excited about the prospects in 2016. With that, we'll conclude our prepared remarks, and now Cathy, John and I will be happy to respond to your questions.
Operator:
[Operator Instructions] Your first question comes from the line of Kate McShane with Citi.
Kate McShane:
Can you hear me?
Brian Cornell:
We can now.
Kate McShane:
Okay. Great. My first question is on CVS. You had mentioned in your prepared comments that you've already converted some of the pharmacies. And I know it's early days, but I wondered if you could provide any detail on if you've noticed any notable changes in traffic in those particular stores. And just how disruptive is the rebranding across the chain over the next 6 months?
Brian Cornell:
Yes. Well, it's still very early, and we'll be tracking this carefully over the next few months. John Mulligan was actually down in the Charlotte market just a few weeks ago where we've rebranded some of the very first CVS pharmacies inside of Target. So John, why don't I let you share some of your impressions?
John Mulligan:
Yes, I think, overall, I don't think the rebranding will be a significant disruption for the store or the technology changes that are going to go on. As we walked the store, it looked fantastic. The CVS brand looks great. I think they've done good job, great job between our team and theirs, tying it into the total Target store environment. When we did this, we spoke a lot about the tools that CVS would bring not only to our guests but to our teams. The teams were certainly excited about the tools that CVS is bringing to them to help them do their job, so that they can focus more fully on guest service, so we're very excited about that. And we're excited to see, like Brian said, as we go along later in the year, we'll see more marketing to talk about the relationship of the 2 companies and also see the reaction of our guests as those capabilities are made more front-and-center for them as well.
Brian Cornell:
Yes. I'd only add, we've been working for months and months now with our colleagues at CVS to make sure this is a very smooth transition, and the plans we have in place will minimize the impact on the guests. So we're very excited about what this brings to Target, what it brings to our guests and to our shareholders and expect it would be a very seamless transition over the next 6 months.
Operator:
Your next question comes from the line of Michael Lasser with UBS.
Michael Lasser:
A 2-parter. Number one is on the promotional activity. Can you give us a sense for how much you think that impacted the sales for the quarter, and how is that going to influence your promotional posture moving forward? And then the second part of my question is on some of the stats, very helpful stats that Mr. Mulligan provided on the in-stocks, how much do you think that the increase in in-stocks helped in the fourth quarter?
Brian Cornell:
Yes. Why don't I start by talking about the promotional environment? And we approach every year recognizing that the fourth quarter, this holiday season, is a very important time of the year for us and it's going to be a very promotional environment. And as we sit here today, we really believe our playbook that we rolled out during the holiday drove traffic to our stores, drove traffic to our site, allowed us to accelerate our comp performance. And remember, we were comping a very strong Q4 from 2014. So we felt very good about the effectiveness of our promotions. They were broad, they were very simple, and they worked both in-store and online. So we feel great about the performance during the holiday where our signature categories performed well. We've worked with Nielsen and NPD to look at market share performance and clearly recognize that we gained market share as a by-product of our playbook in the fourth quarter. So we feel very good about our approach. But to your question about the future, we're always setting back and analyzing promotional effectiveness, looking back at our playbook. And as we plan for next year, we'll continue to enhance and refine and make sure that we have very broad, very simple and very effective offers that continue to drive traffic and profitably grow our sales. John, you want to talk about the impact of in-stocks?
John Mulligan:
Yes, I think we certainly can analyze, triangulate around the sales impact of in-stocks, but that would be providing you very rough estimates. What I think is much more important, when you talk about essential categories, ultimately, this is about the guest trusting that you will have the merchandise they want when they come in our stores. If a new mom takes her baby out in 10-degree weather for diapers and formula, you better have diapers and formula in your store. And so really, it's about the trust that they have in the Target brand to always deliver wherever and whenever they want. And over time, there is no doubt in our minds that, that will drive sales growth for the long term.
Operator:
Your next question comes from the line of Matthew Fassler with Goldman Sachs.
Matthew Fassler:
I'd like to talk for a moment about the SG&A line and just to put in context the cost cuts that you announced at last year's meeting, I guess, about $1.5 billion annualized. Talk about where we are in recognizing those and just thinking about the expense performance that you had against that. And as part of that, if you could address whether there's any incipient wage pressure that you've noted in the market would be very helpful.
Catherine Smith:
Yes -- go ahead, John.
Brian Cornell:
Matt, I'll start out and I'll let Cathy and John also build on it. But as we talked about last year, we had a very clear multiyear plan. We targeted over $2 billion of savings. And in 2015, we've made very good progress against that plan. We're on or ahead of all of the key metrics that we're tracking, and we expect that to continue as we go forward. So John and Cathy are working across the organization to make sure that those initiatives stay in place. And as John continues to build his team and we bring people like Anu Gupta on board to focus on operational excellence, we expect to find even greater opportunities for further improvement. So I think we're well positioned today. I feel very good about the progress we've made to drive productivity across the organization, and you should expect that to continue in 2016 and beyond.
Catherine Smith:
Yes, I'll just add on a little bit. With regards to our performance with SG&A, the beauty of what we're seeing with the plan we laid out last year is we're delivering upon it, but we're also recognizing how we can reinvest back in the business on the priorities that matter to our guests. And so if you think about our investment in visual merchandise leaders, that's a great example. 1,400 stores now have someone who is an expert at helping to showcase the categories that matter most to our guests. And so we're seeing the ability as we save on one line, we can invest in other areas in our business. And you had asked about wage pressure. I'm going to just put a plug in. We believe in having the best team in retail, and that has always been a differentiator for Target and we believe more today than ever that, that is going to be a differentiator, is that it's our wonderful team member engagement with our guests every single day, any way they interact with them. So we're going to be competitive in wage. We always assess it market by market and because we believe in fielding that best team in retail.
Operator:
Your next question comes from line of Greg Melich with Evercore ISI.
Gregory Melich:
I just wanted to ask a little more detail on the guidance, Cathy, that you outlined. If you think about all of 2016, how much buyback is there or isn't there in that guidance? And also, how should we think about CVS impacting the guidance, however you want to frame it, in terms of you mentioned sales but also margin, like should we expect a certain margin benefit if it's 50 to 70 bps up in the first quarter? Is that a good run rate for the year? Or how should we think of it?
Catherine Smith:
Yes, so Greg, thank you. First off, I'm going to put a plug in to say that we look forward to seeing you next week because we'll obviously unpack a little bit more of it then. But with regards to the share repurchase comment, in our guidance, we did assume a consistent level of share repurchase like we've been talking. However, we're also sitting -- we're ending the year with a pretty heavy cash position because we closed the transaction late in December. And so you'll see us provide additional color into that, but we -- but suffice it to say, it'll be at the level of this year or higher and we've included that in our EPS guidance of $5.20 to $5.40.
Gregory Melich:
And on the margins for the year?
Catherine Smith:
Yes. So as we've said, it obviously was an impact on sales but very little on the aggregate EBITDA line, which is what we've said longer-term.
Gregory Melich:
So your full year guidance assumes some slight EBITDA margin increase it seems?
Catherine Smith:
Yes, yes.
Brian Cornell:
Right.
Operator:
Your next question comes from the line of Sean Naughton with Piper Jaffray.
Sean Naughton:
Just on Q4, the gross margin was just a little bit lighter than I think consensus when we modeled [ph] that. Like can you provide just a little more detail on the variances or puts and takes in gross margin versus the internal plan that you had? Or was that 50 basis point decline kind of in line with your expectations?
Brian Cornell:
Sean, as we think about our performance in the fourth quarter, it's played out pretty much as expected. And we know that fourth quarter's going to be very promotional, very competitive. We certainly saw the guest respond very positively to our offers, and that drove great traffic. It allowed us to build market share in our signature categories, and I think it positioned us well for 2016. So as we sit here, there's a lot of variables that go into building our plans for a quarter like the fourth quarter, but we're very pleased with the way our plans drove traffic to our stores, visits to our site, allowed us to accelerate comps on top of a very strong quarter last year, and we saw very broad increases across many of our signature categories as we reported. So I think our plans were in line with our expectation for the quarter.
Sean Naughton:
Okay, great. And then just real quick, a follow-up for just on how you're thinking about 2016. Just from getting a number of questions about how you feel about cost of goods sold. Where -- are you seeing any inflation or deflation potentially in some of those categories? And specifically in Food, how is that playing through on the P&L right now?
Brian Cornell:
Yes, Sean, again a number of puts and takes as we look at the impact of changes in currency and cost of goods. But it's all baked into our outlook for next year, and I think we approach 2016 with a lot of confidence that we've got great plans in place, terrific momentum. And as you'll see next week at the conference, the team's done a terrific job in building some exciting new brands that we'll showcase next week and we're already seeing some really positive responses from our guests to our new Kids line to look forward. So we're excited about 2016 and we look forward to seeing you next week.
Operator:
Your last question comes from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
A quick question. There was a, I guess, a follow-up on something, just the top line versus gross margin trade-off. First, I take it you're pleased with the outcome. I recognize it's very difficult to optimize. But can you tell us, maybe at least the growth you saw in digital, was that existing customers versus new? I'm trying to gauge the stickiness of some of the customers that came to you in the fourth quarter.
Brian Cornell:
Yes, we're going to spend a lot more time unpacking this next week, but we recognize that today, our Target guest interfaces with the brand in a number of different ways. Sometimes, they're in our stores. Sometimes, they're shopping online. We certainly heard many times, because of some of the proprietary items that we offer during the fourth quarter, they were shopping online, but as John referenced, quickly coming to our stores to pick up those items. So we felt really good about the way the guest responded to our offers during the fourth quarter. And a great combination of in-store traffic, more guests than ever before clicking and collecting items in our store and then the fact that we were able to leverage our stores, this year over 460, where we were shipping from stores to our guests' homes, that overall package came together really effectively throughout the holidays. So we feel as if we had a winning strategy in the holidays. It drove great comps on top of a very strong performance last year. And you and many of the others that are on the call have asked me repeatedly throughout 2015, would we be able to comp the 3.8% increase in 2014? Well, hopefully, we answered that question. We answered it with strong momentum, and we were able to see both strong performance in our stores and we delivered industry-leading performance online. So we feel really good about the way we're exiting Q4 and well positioned for 2016 and beyond. So we're looking forward to seeing all of you next week in New York, and thanks for your patience this morning. I know we started a few minutes late, but hopefully, it was worth your time, and we look forward to seeing you again next Wednesday. So thank you.
Operator:
This concludes today's conference call. You may now disconnect.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation Third Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, November 18, 2015.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our third quarter 2015 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; and Cathy Smith, Chief Financial Officer.
This morning, Brian will discuss our third quarter performance, including results across our merchandise categories and plans for the fourth quarter and remainder of the year. Then John will provide an update on our operations and priorities going forward. And finally, Cathy will offer more detail on our third quarter financial performance and discuss our outlook for the remainder of the year. Following their remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer any follow-up questions you may have. Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure, and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalized operating leases. Reconciliations to our GAAP EPS and to our GAAP total rent expense are included in this morning's press release, which is posted on our Investor Relations website. With that, I'll turn it over to Brian for his perspective on our third quarter performance. Brian?
Brian Cornell:
Thanks, John, and good morning, everyone. As we step back and look at our third quarter results and our year-to-date performance, it's clear that our strategy is working and we're delivering on the financial commitments we laid out last March.
Following an extended period of declines, traffic has turned positive over the last 4 quarters and has been accelerating on a 2-year basis. Sales in signature categories have been growing much faster than our overall sales, and they are clearly exceeding industry benchmarks. So while consumers continue to spend cautiously, we feel confident as we enter the holiday season, and we're focused on continuing to deliver on both our strategic priorities and our financial goals. As we mentioned in our last conference call, our third quarter plans were based on the knowledge that we were facing stronger prior-year comparisons than we had experienced earlier in the year. Now with the quarter behind us, I'm pleased to report that not only did we meet our forecast, we saw continued progress on our strategy. Specifically, 2-year growth trends in comp sales, traffic and signature category performances each accelerated in the third quarter, following strong performance in the second quarter. Our third quarter adjusted EPS of $0.86 was 8.6% higher than last year and above the midpoint of our guidance range we provided at the beginning of the quarter. Third quarter comparable sales were up 1.9%, also near the high end of our guidance and driven primarily by growth in traffic. We're really pleased that our guests are responding to the investments we're making in our assortment, presentation and shopping experience, and we're focused on building on this year's traffic increases in both stores and our digital platforms in the quarters and years ahead. Our third quarter gross margin rate was down slightly to last year, reflecting the benefits of a favorable merchandising mix and the comparison over last year's intense promotional markdowns. These benefits were offset by reimbursement pressure in pharmacy, combined with the impact of investments in quality and innovation on our owned and exclusive brands. Third quarter SG&A expenses were solid and in line with our expectation, as Cathy will cover in a few minutes. We reported a very healthy after-tax return on invested capital of 13% this quarter, nearly 2 percentage points higher than a year ago as progress on our strategic priorities has driven improved profitability on a relatively stable base of invested capital. Given this favorable performance, we continue to have capacity to invest in our business while returning a compelling amount of cash to our shareholders. This quarter, we will return well over $1 billion through a combination of dividends and share repurchases, bringing our total cash return to well over $3 billion so far this year. Consistent with our guidance, our third quarter comp sales increase was somewhat smaller than in the second quarter. From a category perspective, the entire change of pace in sales was attributable to Apparel and Electronics. In Apparel, third quarter comp sales grew just under 3% compared with nearly 5% in the second quarter. This slowdown was correlated with warm weather in September, followed by a reacceleration when somewhat cooler temperatures arrived in October. In the Electronics category, we saw a double-digit decline in the third quarter comp sales. This performance reflects the comparison over last year's most intense electronic promotions, which occurred in August, and the continued softness in tablets, consistent with industry trends. One standout in Electronics was wearable devices, part of the signature Wellness category, where we saw nearly 100% growth in comparable sales. Another standout was our Toy category, part of the signature kids business, which matched its second quarter growth with another 12% comp sales increase this quarter. Beyond strength in licensed products, growth in Toys was broad based across multiple subcategories, including small dolls, LEGO, action toys and board games. We were also pleased with third quarter results from Seasonal programs, beginning with solid performance in Back-to-School and Back-to-College, all the way through Halloween, when we saw very strong increases in costumes and decor and solid growth in Candy. And to show you why we're so excited about the upcoming Star Wars release, we had the #1 market share in Star Wars when we launched our assortment back in September. Looking through the lens of our category roles, third quarter comp sales growth was led by signature categories, which grew more than 2.5x as fast as our overall sales. And as I mentioned, given the tougher prior-year comparisons, our 2-year stack comps in signature categories were stronger in the third quarter than either of the first 2 quarters of this year. Beyond toys and wearable Electronics, our third quarter standouts within signature included Baby and Kids Apparel, women's ready-to-wear and Wellness items in Food. In Food overall, for the first time this year, third quarter comp sales growth outpaced comp sales overall as our work to reinvigorate this category is beginning to shape our performance. In key categories like yogurt, where we added premium and better-for-you brands, we saw a high single digit comp sales increase in the third quarter. We saw similar comp increases in craft beer and wine, reflecting our work to enhance the assortment and bring locally relevant brands to our guests. Looking forward, we'll continue to enhance our Food assortment with a focus on Wellness, local relevance and seasonally appropriate items. And following the holiday season, we'll begin testing changes to Food shopping environments in a set of 25 remodels scheduled for the L.A. market, along with a set of SuperTarget remodels scheduled for next year. Digital sales increased 20% in the third quarter, contributing about 40 basis points to our comp sales increase. While significantly outpacing the industry, this performance was well below our expectation of 30% growth when we -- which we outlined in the last call. As we look at the drivers of this performance, it's clear the third quarter softness in Electronics was particularly impactful online. And like our stores, digital sales growth in Apparel was slower during much of the quarter, correlating with the relatively warm weather across much of the country. We know that our digital investments drive engagement and sales in all of our channels, and we're pleased that our third quarter sales were at the high end of our expectation. However, we believe we have an opportunity to accelerate digital transactions by enhancing the experience on target.com. Beyond our efforts to streamline the guest experience on our site, our team is rolling out multiple initiatives that we expect to drive digital traffic and sales over time. And once again, this holiday season, we expect to be offering free shipping on all digital orders. We were very pleased with the guest response to this offer a year ago, and we expect it to be a key differentiator for Target again this holiday season. Regardless of where our guest demand is ultimately fulfilled, in a store or on a guest's front porch, we know the vast majority of our sales in all of our channels are digitally enabled. For example, our guests access our brands through a digital device both in advance of and during their trip to one of our stores. As a result, we don't think of digital as simply a selling channel, but a critical enabler for the shopping experience in all of our channels. This has significant strategic implications, both in terms of organizational structure and the way we reward our team. Since I arrived last year, we have been evolving our approach to focus first on our core guests and build a total Target assortment that best serves the needs and expectations of our guests. Only after we've determined the appropriate assortment do we plan on how to offer to each of our selling channels. Consider our efforts in signature categories. For more than a year now, we've been investing in these categories with the expectation that they will grow most rapidly, and we've seen this play out in all of our channels. In fact, even while our digital footprint remains relatively small, we're approaching $1 billion of annual sales in our Home category, making us one of the leading digital retailers in the space. As we look ahead to the holidays, we are excited about our merchandising and marketing plans, and we believe we'll further differentiate Target during a critical retail season. In Hardlines, toys has already turned in a terrific performance so far this year, and we expect this strength to continue throughout the fourth quarter when we typically generate half of our annual toy sales. This year, more than 15% of our toy assortment is exclusive to Target, including the exclusive BB-8 Droid from the upcoming Star Wars movie, which we expect to be a top seller. We're also bringing back our kid's Wish List app this year, with enhanced features to make it easy and fun for family and friends to shop for the perfect gift for every kid in their life. Our gift catalog featuring more than 700 items was distributed to 40 million guests this year through direct mail, newspaper and distribution in our stores. On Cartwheel, we are seeing great results from our daily toy deal, which is featuring a different toy at 50% off every day through December 24. And finally, we're bringing everything together on our kid's gifting hub on target.com, which is designed to make shopping easy for parents and gift givers while creating a destination that's fun and inspirational for kids. In Electronics, we're excited to be one of the few retailers offering the Apple Watch in stores this season, and we expect this item to be a top gift item in wearable categories. Also in wearables, we partnered with UNICEF to offer their Kid Power Band, which encourages kids to get more active and, based on the points they accumulate, improve the lives of kids around the world. We also expect Drone to be a big hit this season. So we're featuring nearly 20 in-store and about 4x as many online. We're planning for a big season in video games, a key gifting category where hardware prices continue to moderate and software libraries continue to grow. And in Entertainment, where we're very excited to be featuring a Target-exclusive version of Adele's new 25 release that features 3 bonus tracks available only at Target. As we enter the holiday season, about 1,400 of our stores are featuring mannequins in Apparel, which is about double the number we had a year ago. Also this year, we've enhanced the shopping experience by updating presentations in Home and Electronics in more than 200 additional stores for each group. So we feel great about the ability of our stores to showcase our assortment.
And this year, when our guests shop at Target for the holidays, they'll find an assortment focused on 3 key things:
entertaining, decorating and gifting. To support each of these themes, we've invested in quality and differentiation, featuring real marble, hand-carved wood, copper accents and genuine leather. In fact, more than 20% of our holiday gifting items are handcrafted this year.
In Food, we're highlighting exclusive brands and flavors, including Republic of Wine, our new exclusive brand, which features unique discoveries from around the world. We're rolling out classic holiday and harvest flavors in Archer Farms, and we're offering exclusive indulgent seasonal flavors from great national brand partners with M&M's, Hershey's, Dove and Ghirardelli. And finally, anticipation's building for Black Friday, which is just over a week away. Once again, this year, we're opening our stores at 6 p.m. on Thanksgiving, and our team is already preparing to deliver a combination of great deals and a shopping experience that makes Target different from everyone else. But we're committed to offering compelling savings value beyond the traditional Black Friday event. Beginning this Sunday, we'll launch 10 days of deals on Electronics, Kitchenware, Toys and more, which will run through Tuesday, December 1. This Sunday's weekly ad will also reveal special deals from our Black Friday presale, which takes place on Wednesday, November 25. For our guests who prefer to shop digitally, all of our Black Friday deals will be offered on target.com. And finally, guests who spend $70 -- $75 or more on Friday, November 27, will receive a voucher for 20% off on future purchases, redeemable from December 4 through the 13th. Last March, in our meeting with the financial community, we outlined our plan to grow profitably by focusing on a set of key enterprise priorities. And while we have much more work to do, we remain committed to that plan and are pleased with our progress so far. Through the first 3 quarters of 2015, we've successfully grown traffic, sales and profits a bit faster than we originally expected by focusing on our core guests and providing them with differentiated assortments and the experience they expect and deserve. But we're not slowing down because we see enormous opportunity still ahead of us. We're going to continue to focus on elevating the assortment, quality and the presentation in our signature categories. Across every category, we'll differentiate Target's assortment by providing exclusive items from both our national branded partners and one-of-a-kind items from our outstanding product design and development team. And while we're encouraged with the recent acceleration in Food sales, we are still in the very early stages of our work to provide a unique assortment of fresh, local and healthy items to our guests. And finally, while I'm pleased we've already made early progress in our efforts to improve our in-stock performance, I believe we've got a multiyear opportunity to improve our reliability, both in stores and in digital channels, by modernizing the way we work and refocusing on retail fundamentals. Now I'll turn the call over to John Mulligan, who will discuss his team's early efforts to improve operations as well as John's priorities going forward. John?
John Mulligan:
Thanks, Brian, and good morning, everyone. Today, I'm going to provide an update on our initial efforts to reinforce our retail fundamentals, particularly our in-stock position, and I'll cover our priorities and progress in our work to modernize the supply chain in support of our strategic initiatives.
The good news is that while we have lots of work still ahead of us, we have seen meaningful improvement in key in-stock measures based on changes we've made in the last few months. While we strive to be in stock on every item in every store throughout every day, we know that need-based commodity categories are the most critical. If our guests don't believe that they can rely on Target to have their shopping list items available every time they shop, they'll begin to skip some trips to Target even though they enjoy shopping our more discretionary categories. As a result, when in-stock metrics on our core commodity categories began deteriorating this year, we created an out-of-stock action team to conduct deep dives by category to identify both short-term and long-term solutions. When a team identifies solutions within a category, we can quickly test them to confirm they improve our performance and then determine if those solutions can be applied more broadly. This team focused first on our Household, Personal, Baby category and more recently, they've done work on our center store Grocery category. In a short amount of time, they have identified opportunities related to the way we generate vendor orders, optimize tradeoffs between order quantities and frequency and our reliance on system-generated solutions versus manual processes. In high-volume stores, the team has implemented adjustments to planograms to enhance holding capacity on fast-turning SKUs, reducing the need for frequent store replenishment. And in our distribution centers, the team has identified opportunities to reduce lead-time variability, tighten delivery windows and, in some cases, increase safety stock on key items. I should note that this increase in safety stock is one of the drivers of the 4% inventory growth we reported at the end of the quarter. In a very short time, the results of our efforts have been encouraging. In Household, Personal, Baby, we've been able to reduce overall out-of-stock measures by approximately 50% in about 8 weeks. In center store Grocery, in less than a month, the team was able to reduce out-of-stock measures by about 25% and importantly, we've been able to reduce out of stock even further on the items most important to our guests. Given these encouraging initial results, the team is moving quickly to scale these solutions to a broader set of categories throughout the store and conducting additional deep dives in categories like Health & Beauty. Looking ahead, the team has a number of key priorities, including work to optimize case packs, which will better accommodate variability in store sales volumes across our network. In addition, they are implementing technology and process improvement to improve count integrity throughout our stores and distribution network. Included in these efforts will be a test of RFID technology in a few of our Apparel categories to gauge the effectiveness of the technology relative to the cost of implementation. This work is being supported by the rollout of an agile technology development in partnership with Mike McNamara, our new Chief Information Officer, and our newly hired Senior Vice President of Operational Excellence, Anu Gupta. We are very excited to have Anu on the team. She has more than 20 years of relevant experience in driving operational excellence by leveraging best practices in a variety of operating models, including procurement and Lean Six Sigma process redesign across a range of industries, including retail. We're confident Anu will accelerate the efforts of the outstanding team we already have in place. Beyond our work to improve reliability, our store teams are working diligently to support Target's efforts to become more flexible in the way we fulfill guest demand. As a result of last year's rollout of ship-from-store capability, stores have already shipped more than 10 million items directly to guests so far this year, and the percent of digital orders delivered in a 3-day window has more than doubled compared with a year ago. To showcase this improvement in our capabilities, last quarter, we rolled out new functionality we call available to promise, which offers guests a more precise shipping window. With available to promise, we expect nearly 2/3 of our digital orders will offer a guest a delivery window of 3 business days or fewer compared with our typical window of 4 to 7 business days prior to the rollout. We recently expanded our ship-from-store capability to more than 300 additional stores, bringing the total to more than 1/4 of the chain. This will enable about 40% of digital transactions to be shipped from our stores in the fourth quarter. In addition, 2 new direct-to-guest fulfillment centers became operational in the third quarter, in advance of the holiday season. With the expanded capacity these changes provide, we expect to continue making progress on shipping speed next year. As Brian mentioned, most of our store sales are digitally enabled, so we continue to integrate digital experiences into the stores. Guests increasingly use Cartwheel, our digital savings app with more than 20 million authenticated users, to plan their store trips in advance and then use the app to search for additional deals while shopping in store. In addition, because 10% to 15% of our digital orders are picked up in stores, we are exploring ways to streamline the pickup process by expanding holding capacity at the service counter and implementing process improvements to reduce wait times. For next year's L.A. 25 remodels, we will feature all of our latest merchandising enhancements. We will test changes to the front end that will make pick -- make order pickup even more convenient, including dedicated ambassadors to help store guests better understand Target's digital capabilities. Before I turn the call over to Cathy, I want to thank our store and distribution center teams for their great performance so far this year and for their current efforts to ensure we provide an outstanding guest experience this holiday season. It's an enormous challenge for both our stores and distribution teams to accommodate the surge in volumes we see at Black Friday. But our store teams don't focus only on moving merchandise. They focus first on our guests and do an amazing amount of preparation to ensure guests have a pleasant and safe experience. It's one of the many things that makes Target unique and one of the reasons why guests love our stores and our brand. With that, I'll turn it over to Cathy, who will share her insights on our third quarter financial performance and our outlook for the fourth quarter and full year. Cathy?
Catherine Smith:
Thanks, John, and hello, everyone. As Brian mentioned earlier, we are pleased that this quarter's performance was near the high end of our guidance for both sales and adjusted EPS. As is often the case, when you get into the detailed P&L, there were some ins and outs within the quarter that generally offset each other, which I'll cover in a few minutes.
This quarter, adjusted EPS was $0.86, above the midpoint of our guidance range and 8.6% above last year. GAAP EPS from continuing operations was $0.76, $0.10 lower than adjusted EPS, driven by $0.05 of asset impairment, $0.03 of data breach expense and $0.02 related to the corporate restructuring we announced last spring. Third quarter GAAP EPS was $0.87 compared with the $0.55 a year ago, as this year we recognized $0.11 of tax benefit related to our investment losses in Canada, while last year we incurred $0.27 of after-tax losses related to Canadian operations. Let's turn to third quarter segment results. Among the drivers of our 1.9% comparable sales growth, we are pleased that traffic grew a very healthy 1.4% in the third quarter. This growth is even more encouraging when we look at performance on a 2-year basis, as we faced a tougher comparison in the third quarter than either of the first 2 quarters of the year. October marked our 12th straight month of traffic growth, and we are laser-focused on this metric as a key indicator of the health of our business over time. Breaking out our sales growth between stores and our digital platforms, the stores accounted for a little over 3/4 of our comparable sales growth, while digital contributed about 40 basis points to our third quarter comp. Consistent with results from earlier in the year, our digital growth continues to be driven by a meaningful improvement in conversion. And although we have seen an acceleration in the last 2 months, we haven't seen the growth in digital traffic we expected to see this year. We believe our biggest opportunity to drive traffic continues to be our work to streamline and enhance the digital experience. Third quarter REDcard penetration was 22.3%, up about 130 basis points from a year ago, and we remain on track to meet our guidance for an increase of 100 basis points or more for the full year. As you'll recall, we tested REDcard Rewards in the Kansas City market for a year before we launched the program nationwide. With the benefit of that head start, penetration in Kansas City continues to run well ahead of the rest of the country, giving us confidence that we have continued room to grow this rewards program in the years ahead. In addition, we are optimistic that the industry's move to EMV or chip-and-pin technology will help restore confidence in the U.S. payment system and increase the willingness of consumers to add new cards to their wallet. Regarding our move to EMV, we are pleased to be one of only a few large retailers in the United States that are accepting chip cards for both credit and debit transactions in advance of this holiday season. We've already reissued chip cards to about half of our Target-branded debit and credit card holders, and we expect to complete the rollout early next year, following a pause for the holiday season. Our third quarter segment EBITDA and EBIT margin rates were both about 20 basis points higher than last year, consistent with our guidance as strong SG&A performance offset the impact of a lower-than-expected gross margin rate. On the gross margin line, third quarter performance was about 10 basis points below last year, short of our expectations. While we continue to benefit from the comparison to last year's promotions, the benefit is waning as the intensity of those promotions began to taper in the third quarter of last year. In addition, consistent with results from earlier in the year, we're seeing continued margin pressure from quality investments in our owned and exclusive brands. Finally, this quarter, we saw reimbursement pressure in our pharmacy business, which we expect to continue until we complete the sale of this business to CVS. I want to pause for a moment and comment on the CVS transaction. We continue to work closely with the CVS team to obtain regulatory approval for the transaction. And while we don't have an update on the potential timing for the transaction to close, we are pleased with our progress to date. Turning back to the third quarter P&L. On the SG&A expense line, we saw unexpectedly strong performance in the third quarter, about 30 basis points lower than last year. As part of our efforts to control costs, this quarter's expense rate benefited from the discontinuation of an outdated little-used retiree medical plan, but we also saw discipline across the organization, which drove outstanding underlying performance. Even on the marketing line, where some expenses were retimed into the third quarter from the second quarter last year, we recognized savings in other programs that led to overall favorability compared with last year. As John mentioned and consistent with last quarter, our inventory position at the end of the third quarter was about 4% above last year. This reflects a significant improvement from the higher year-over-year increases we were seeing earlier this year. And while inventory growth is slightly higher than our pace of sales, it reflects changes in receipt timing compared with last year, combined with the intentional investments we're making in commodity categories to improve our in-stock position. As a result, we feel very good about our inventory position going into the holiday season in relation to both our sales plan and our work to improve in-stock reliability. Turning back to consolidated metrics. Third quarter interest expense was $151 million, $5 million higher than last year. Our third quarter effective tax rate on continuing operations was 34.3%, up from 30.6% last year, when we recognized a $30 million benefit from the resolution of tax matters. We paid third quarter dividends of $352 million, up about 7% from last year. And given our cash position and continued strong business results, we had the opportunity to invest another $942 million in share repurchase this quarter. Given our long-range plan to generate profitable growth, we believe the continued opportunity to retire shares will prove to be a productive use of cash. To illustrate that point, under our current $10 billion share repurchase program, we have retired more than 77 million shares, representing more than 12% of our current shares outstanding at an average price of less than $69. As Brian mentioned, our after-tax return on invested capital, or ROIC, was a very healthy 13% for the trailing 12 months through the third quarter. This is nearly 2 percentage points higher than last year, when our business results were under pressure following the data breach. Given our plan to generate profitable growth on a relatively stable base of invested capital, we expect to continue to grow this metric over time with a goal of -- to reach the mid-teens or higher in the next 5 years. Now let's turn to our guidance for the fourth quarter and what that guidance implies for our expected full year performance. As we look ahead to the holiday season, we're mindful that the consumer remains cautious and there are indications of heavy inventory levels at some competitors. However, we remain focused on the things we can control and what has been working all year. These include our ability to deliver on our "Expect More. Pay Less." brand promise by offering great products at a compelling value, iconic marketing that guests love and an outstanding store experience that differentiates Target from everyone else. With that context, we expect to deliver a fourth quarter comparable sales increase of 1% to 2%, consistent with our third quarter guidance. Underlying that guidance, we expect digital growth of about 20%, consistent with our third quarter performance. Before I move down -- further down the Q4 P&L, I want to pause and discuss a challenge we hear a lot, which is based on the acceleration in 2-year stacked performance we're planning for the fourth quarter. John answered this question last call, but I think it's worth addressing in more detail today. Last year, our fourth quarter comparable sales growth was 3.8%, but that was on top of a 2.5% sales decline in the fourth quarter 2013, when we announced the data breach on the weekend before Christmas. So while the analysis of multiyear sales performance isn't always useful, I think in this case, it's important to think about a 3-year stack of our comp sales. Specifically, if we hit the midpoint of our fourth quarter sales guidance, the simple 3-year stack would be a 2.8% comp, slightly less than the 3% 3-year stack we've delivered year-to-date. So while there are always risks to every sales forecast, we don't believe the 2-year stack provides useful insight in this case. Moving back to the P&L. We expect our fourth quarter EBITDA margin rate to be flat to down slightly from last year's 9.8% rate. Among the drivers of EBITDA margin, we expect a moderate gross margin rate decline to be offset by a similar improvement in our SG&A expense rate this quarter. We expect our fourth quarter interest expense to be consistent with our third quarter, and our tax rate is expectedly -- is expected to be approximately 34% as we annualized over last year's favorable resolution of tax matters. With our current cash position and expected business results, we plan to continue repurchasing our shares this quarter, and we will continue to manage the magnitude and pace of repurchase activity with the goal of maintaining our current investment-grade ratings. Altogether, this performance would lead to fourth quarter adjusted EPS of $1.48 to $1.58 compared with $1.49 in fourth quarter 2014. Let's look at what this guidance implies for our expectations for full year 2015 financial performance, which I'll compare to the guidance we provided at our financial community meeting last March. At that meeting, we laid out an expectation for 2015 comparable sales growth in the range of 1.5% to 2.5%. Given our year-to-date performance and fourth quarter expectations, we expect our full year comp to remain firmly in that range. I would note that the channel mix of our sales has been different than expectations. Specifically, with year-to-date digital sales growth of 29% and our expected 20% growth in the fourth quarter, it's clear that in 2015, we don't expect to attain the longer-term 40% goal we laid out in March. However, we've delivered on our overall comparable sales goal every quarter this year, and we still expect to deliver industry-leading digital sales growth, both important benchmarks for us. In March, we laid out an expectation to grow our segment EBITDA margin rate by 20 to 30 basis points for the year, and we are on track to outperform that expectation with growth closer to 40 to 50 basis points in 2015. Regarding capital deployment, we are on track to meet our guidance for 5% to 10% dividend growth this year, and we've already met our goal for $2 billion or more in share repurchases through the first 3 quarters of the year. And finally, we told you in March that we expected to generate $4.45 to $4.65 in adjusted EPS for the year. And despite a challenging backdrop, with our updated guidance today, we are positioned to deliver performance at the high end of or above that range for the year. Beyond my love for the brand, I was attracted to Target because of our singular focus on delighting our guests and our tremendous desire to win. It's evident across our stores, online team, distribution centers and headquarters. I recently visited one of our stores and had the opportunity to meet Bev, who has been with the company for an amazing 44 years. In her current role, Bev is involved in the ship-from-store process, and she says their whole team loves this new capability because it allows our stores to drive sales by serving guests in new ways. Now that I've been immersed in our business for the past 3 months, I'm mindful of the opportunity ahead of us and the work we still need to do to accomplish, but I'm encouraged by the progress we've seen already. Traffic has increased for the full year. Signature categories are leading our sales every quarter. And with a renewed focus on retail fundamentals and the dedication of team members like Bev, we are delivering on our vision to provide shopping on demand while maintaining our focus on everyday in-stock reliability across our store network. The ultimate measure of this year's accomplishments can be seen in our earnings. We've delivered a 16.9% increase in our adjusted earnings per share so far this year. And with our fourth quarter guidance, we're well positioned to deliver double-digit growth for the year. We're excited about this initial progress, and we remain laser-focused on building on this momentum over time. With that, we'll conclude today's prepared remarks. Now Brian, John and I will be happy to respond to your questions.
Operator:
[Operator Instructions] Your first question comes from Matt Nemer from Wells Fargo Securities.
Matt Nemer:
First, Brian, I'm hoping that we can get a little bit of the pulse of the consumer from you. Clearly, there's been some weather impact in September and October, but we're hearing negative comments about November from another -- a number of retailers. So it feels like there's something else happening either from a macro or maybe a competitive standpoint. I'd love to get your sense for what you're hearing from your customers, your guests.
Brian Cornell:
Well, Matt, I would tell you we're feeling really good about the trends we're seeing, the reaction we're getting from the guests. Certainly, the growth in traffic for us is really encouraging. So we're seeing more Target guests come back to our stores and visit our sites, and they're continuing to respond very positively to the work we've done in signature categories. So sitting here today, we're very confident about our position. We think we're connecting with the consumer and our guests, and I feel fantastic about the plans we have in place for the fourth quarter. So while obviously still cautious as we sit here early in November, we feel very good about the way the consumer and the guest is responding to our brand, and I feel as if we're really well positioned for the fourth quarter.
Matt Nemer:
That's great to hear. And then just shifting gears to gross margins, I'm wondering if you can call out the impact of the reimbursement pressure in health care and any sense for the total impact or run rate impact following the closure of your deal with CVS, how that could help you next year. And then secondly on gross margin, you did call out in the press release private brand investments, and I'm just wondering if you could dimensionalize the potential size of that over the next few years.
Brian Cornell:
Let me talk about the owned brand investments we're making, and then let Cathy talk through the Rx implications. But as we've consistently talked about throughout the last year and 1.5 years now, we think one of the things that differentiates Target is the value, the quality, the innovation we bring to our own brands. So we're clearly looking to make sure we bring more value to our own brands. I talked about the number of handcrafted items we're going to have for the fourth quarter. And we're being very surgical with those investments, but we're seeing a great reaction from the guest as we elevate the value we offer in our own brands. So we'll be very surgical, very selective, but we're certainly seeing a great return for the investments we're making.
Catherine Smith:
And, Matt, this is Cathy. On -- with regards to the pharmacy reimbursement pressure as we said when we announced the transaction with CVS, that we lack scale and we knew that we were going to continue to see pressure here over time. So what we're seeing in this quarter is in the range of 15 to 20 basis points of pressure in the quarter and -- which is why we're excited to be partnering with CVS because they'll be able to help with that scale.
Operator:
Your next question comes from David Schick from Stifel.
David Schick:
I wonder if you could give us any extra color update on the localization work in Chicago.
Brian Cornell:
Right now, we're still very focused on testing localization in Chicago. We're very pleased with the results, and certainly a lot of the localization's taking place in our Food and beverage offerings. We're seeing the guest respond to that, and we're going to take the learning from Chicago and apply it to the 25 stores we're remodeling in Los Angeles. So we'll continue to expand the learning, take it from Chicago to L.A., but I am very pleased with the progress we're making. And we're partnering with John and the store and supply chain teams to make sure, over time, we can scale the learning from Chicago and Los Angeles to multiple markets around the country.
David Schick:
So last time you had updated us, I think you said 100 to 200 basis point comp lift is very pleased, sort of mean it's -- we're continuing to see that.
Brian Cornell:
We are consistently seeing those kinds of returns.
David Schick:
Got it. And then on the -- quick on the dotcom side of the business, there was some deceleration, still good growth in that line. Can you talk about any other metrics that help us understand the shift? Is it spent -- time spent on the site, capabilities? What is driving the difference in the growth rate? And it sounds like a growth rate you're comfortable with for next quarter.
Brian Cornell:
Well, I think the most important measure to look at is what's happening with online growth overall. And just in the last 24 months -- or 24 hours, we saw the October e-commerce growth rates in the U.S., and it was up about 8.6%. The outlook that NRF has for e-commerce growth in the fourth quarter is somewhere between 6% and 8%. So while our 20% growth rate is not in line with our expectations, it's still dramatically outperforming the industry. And I think the most important measure we're looking at is the fact that over 80% of our guests start their shopping journey online, either at home on their desktop or with a mobile device, and that digitally influenced guest is coming into our stores more often. So as we've talked about our strategy, our strategy is to make sure we allow our guest to shop anywhere, anytime they want with Target. And what we're seeing right now is they're voting with their feet to spend more time in our stores. They're downloading our Cartwheel app, and 20 million downloads so far to date. So I think we're seeing an overall slowdown in digital growth across retail, and we're really pleased that we continue to outpace the industry -- dramatically outpace the industry, but our digital efforts are driving more traffic into our stores and helping us grow our overall comps. So while there's been a slowdown broadly across the sector, we continue to outpace the industry, and that's our fundamental goal.
Operator:
Your next question is from Kate McShane from Citi Research.
Kate McShane:
It's encouraging to hear that a lot of the investments, especially in the signature categories, are panning out well for you. In your merchandising strategy specifically, where do you think you still have the most work to do? And what can we expect year-over-year when we see those categories for holiday?
Brian Cornell:
I think we're making some very good strides, starting in Apparel. And while 3% in Q3 was slightly less than the growth rate we saw in the second quarter, compared to many of our peers, we recognize that we're continuing to build traffic and growth in an important Apparel category. So the work we've done with mannequins, with changing the in-store experience is clearly paying off. One of the changes that we have announced recently is the addition of 1,400 visual merchandisers to make sure we combine the change in the ranking with mannequins and fixtures and layouts with experts in store that can maintain that great in-store merchandising experience. So that's a new venture for us. We're standing it up for the holidays. We expect that they continue to strengthen the in-store experience. And we know with our signature categories, we're still at the very, very early stages of standing up our Wellness position. But we feel like we're in an excellent position with Baby and Kids. We feel very good about our performance in the third quarter with Kids Apparel. Certainly, Toys has been a highlight throughout the year, and we feel as if we're well positioned coming off of second and third quarter comps in Toys that were up 12%, the reaction we've seen from the guest to our store -- Star Wars assortment, where we captured an industry-leading position and expect to be a destination during the holidays. So while we still have much more work to do, we feel very good about the progress we're making in signature categories, and I think the addition of digital merchandisers in store will help us maintain our merchandising appeal throughout the holidays
Operator:
Your next question is from Scott Mushkin from Wolfe Research.
Scott Mushkin:
So I wanted to get back into the Food discussion, if we could. I mean, I think you're testing stuff in Chicago, you're going to roll that into L.A. Brian, maybe a lot of people don't know this, maybe they do, but you had a good experience back when you were at Safeway and then on to Sam's. I think you talked about 200 basis points you're initially seeing. But what can we expect out of the company? I think Safeway saw more than that as they kind of brought in some kind of refurbishments. And when can we expect to see more from Target as far as refreshing the decor and maybe doing a fuller rollout? And is 200 basis points a good expectation? It seems to me it could actually be higher than that as you refine your lift, but wanted to get some more details there.
Brian Cornell:
Well, Scott, I'm glad you asked the question. I do think one of our highlights in Q3 was the improved performance in Food. Now we've actually seen Food comp acceleration throughout the year. And while we haven't made major changes with fixtures and in-store decor, we've been very focused on assortment changes and bringing more natural, organic, local items into many of our categories, and we're seeing the guests react very favorably. So to me, it's getting the basics right. And before we start making fixture changes and decor changes, it has to start with the right assortment and making sure we have the items, the brands our guest is looking for when they shop food at Target. So the acceleration you're seeing right now is driven by, section by section, getting the assortment right, bringing more appealing items to our guests, adding more natural, organic, gluten-free items that are on trend to those categories. We made some significant changes in yogurt in the third quarter and saw very, very positive responses, high single-digit growth rates in those categories. So while we're not shouting about it, we're making steady progress in Food. We'll learn a lot more in 25 stores in Los Angeles, where you will see some changes in fixtures and decor. And as we learn, we'll continue to grow. So I think we do have significant upside, but Scott, this is about making sure we get it right, and we're going to take a slow, steady approach, solid, consistent results every quarter and continue to deliver what the guest is looking for from an assortment experience standpoint when they shop food at Target.
Scott Mushkin:
So I mean, obviously, key. I think Cathy said you're measuring -- one of the big things you look at is frequency and this is obviously a core to that. So we look forward to seeing more, but my follow-up question is on the investment side. We get it a lot whether it be e-commerce, whether it be in the Food, in the logistics. Can you kind of talk us through why there won't be a massive ramp up in investment as we go out the next couple of years, and that you have enough money in the CapEx and then kind of the SG&A to kind of handle what the company needs to do?
Brian Cornell:
Yes, Scott, we've looked at this very carefully, and I know we've talked about it a number of times. We feel very confident that the CapEx budgets we've had in place will be very adequate over time to make the changes we need to make from a technology standpoint, a supply chain standpoint, continue to refresh our stores and maintain our focus on maintenance investments. So sitting here, Cathy and I have spent a lot of time recently. Obviously, John's been a great steward of our CapEx spending, and we feel very comfortable that our current spending levels will allow us to modernize the organization, enhance technology and improve supply chain. And make sure, along the way, we're continuing to enhance the in-store experience and match that up with a great online experience for our guest.
Catherine Smith:
I would offer just real quickly to add to that, because we have kind of pressure tested this one ourselves a lot. We have not -- Target has not underinvested over the years, and I think that bodes well with the state of where you find our stores as well as our technology and supply chain investments we need. So I feel very good about where we are, and with that level of investment, we've been pretty consistent.
Operator:
Your next question is from Matthew Fassler from Goldman Sachs.
Matthew Fassler:
I'd like to ask a 2-part question. The first relates to the cost-cutting initiatives that you discussed at your Analyst Meeting earlier in the year. You spoke about $1.5 billion of SG&A and then $0.5 billion of cost of goods over 2 years. If you could talk about the run rate that you're at now against those goals, and I guess another twist on Scott's question, the degree to which you've had investments in sight that would offset some of those. I think that was also part of the plan that you set forth.
John Mulligan:
So I'll jump in and take that. I think from a tracking perspective, what we said, right at your point, $1.5 billion of SG&A, $0.5 billion of margin and we would deliver in 2015 about $0.5 billion of that. We're running a little bit ahead of that pace and both in the cost of goods and in the SG&A space, both are running perhaps a little bit ahead of what we envisioned going into the year. So we feel really good about that. I think stepping back and kind of tying this back to Scott's question, the other thing we said at the time was we're taking $2 billion out of the P&L, but we didn't expect EBITDA margin expansion. And our view was that we would need this to fuel the investments, exactly some of the expense investments that perhaps Scott was referring to, and this would provide the capacity to do that, and that is, in fact, what we've seen. We've seen great expense discipline across the corporation, but where we needed to invest, we have had the capacity to do that.
Matthew Fassler:
And if I could ask a quick follow-up. You talk about $0.5 billion this year. Is that delivered -- I know it's not being delivered to the bottom line because there are some offsets, but is that annualized run rate achieved? Or is that actual cost cuts that would have come out on a gross basis against your cost base, offset by some of the investments?
John Mulligan:
We will take out $600 million this year.
Catherine Smith:
Yes.
John Mulligan:
And then part of next year will be annualization of that and part of it will be incremental.
Matthew Fassler:
And then a very quick follow-up. On wages, obviously, Walmart made an incremental announcement since your last call. Any sense as to whether this issue is kind of burning up organically in the field as you think about hiring and you think about intrinsic wage pressure in the marketplace and how you're thinking about that relative to your plan?
Brian Cornell:
Yes. We don't see any material change in the marketplace. Again, we've talked a lot in the past about making sure we're investing to have the best retail team. And we look at this very surgically, year after year, market by market, and we think we're in a great position and we think we're hiring terrific talent, and we're excited that we've got a great team in place as we get ready for the holidays.
Operator:
Your next question is from Greg Melich from Evercore ISI.
Gregory Melich:
I guess, my 2 questions are a bit of a follow-up, one on the last one. If you look at the fourth quarter guidance, if I'm getting this right, SG&A dollars are kind of flattish. And is that basically that cost out with the reinvestment going in? And then the nature of that question is really -- I think, John, you mentioned 40% of digital you thought would be ship-from-store in the fourth quarter. What has it been running? And what does that do to the labor model?
Catherine Smith:
Yes. So Greg, this is Cathy. I'll take the first part of it. To answer your question, yes, we expect it to be essentially flat and it will be pretty much offset. We'll have pluses and minuses. So the savings we're getting we'll continue to reinvest, as we have planned. John will answer the 40% digital shipment.
John Mulligan:
Sure, Greg. 40% this quarter, and it'll peak a little bit higher than that actually, typically running more in the 20% to 25% range. But as we peak, this is a great way for us to utilize our store assets. The labor model, what happens here is actually it's quite efficient because we have dedicated teams in those stores to do the picking, do the packing and then we're just able to use -- utilize them more efficiently. And so while there is more store labor that we are using, the offset clearly comes in our shipping expense because we're much closer to the guest we are shipping to. And they aren't on the same P&L line, but it's an outstanding trade for us.
Brian Cornell:
Yes. Greg, I think it's important is you tie-out the math on the ship-from-store, last year at this time, we had just over -- about 120 stores where we were shipping from store. As we sit here today, we're up to 462. So we've expanded the base. We're going to leverage and sweat the assets, I think, much more effectively. But importantly, that enhanced base allows us to deliver to our guests in a much shorter time frame. So we would expect that to grow during the holidays. We've certainly ramped up for it, and we think that's going to provide a much better shopping experience and allow us to deliver product to our guests in a much shorter period of time.
Gregory Melich:
That's helpful. And if I could follow up, I think earlier, you talked about private-label penetration a little bit. Could you talk about how the stronger dollar or falling raw material costs or lower fuel cost could be impacting gross margin today, differently than you would have thought a few quarters ago?
Catherine Smith:
Yes, I'll answer it briefly and then anyone can chime in. We're really not seeing an impact on it in our product cost or in -- obviously, in our margins. So it's really been kind of a nonevent for us.
Brian Cornell:
And remember, Greg, with many of those items, those are long lead-time items. So -- and we'll certainly be watching that over time. But as we sit here today, many of those orders and POs were placed many, many months ago. So we'll continue to monitor that over time, but we certainly like our position with our owned brands as we enter the holidays, and that's an important way that we differentiate.
Operator:
Your final question comes from Bob Drbul from Nomura.
Robert Drbul:
Just 2 quick questions. The first one is on the Apparel performance, you talked a little bit about margin pressure, I think, in private label and exclusive. Was that new to the third quarter? And how do you see that playing out in the fourth quarter? And then the second question that I have is on the e-commerce business, just give us an update on like the subscription offerings and how that's going from a fulfillment perspective as well?
Brian Cornell:
Yes. Well, Bob, first on the A&A side, again, we think the guest is responding really well to some of the changes we've made with our own brand assortment. And the investments that we talked about today, we've been consistently talking about for over a year now, making sure that we're reinvesting in quality, in innovation, in style, making sure that we deliver that "Expect More. Pay Less." brand promise. So the guest is reacting really, really well to that, and we're going to continue to make sure that we deliver great value in our own brands. So it shouldn't be a new phenomenon. It's something that we've been very clear and transparent about, and we think it's paying off with increased traffic and growth in those core signature categories. So it looks like we've run out of time for today. I do appreciate everyone calling in, and that will conclude our third quarter earnings call. So thanks, everyone, for joining us.
Operator:
Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. At this time, you may now disconnect.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation Second Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, August 19, 2015. I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our Second Quarter 2015 Earnings Conference Call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, currently our Chief Financial Officer, who has been promoted to Chief Operating Officer effective September 1; and Cathy Smith, who has been named Chief Financial Officer effective September 1.
This morning, Brian will discuss our second quarter performance, including results across our merchandise categories, and plans for the third quarter and remainder of the year. Then Cathy will provide her perspective as she prepares to join the team as Chief Financial Officer next month. And finally, John will offer more detail on our second quarter financial performance and discuss our outlook for the third quarter and full year. Following their remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, John and I will be available throughout the day to answer any follow-up questions you may have. Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalized operating leases. Reconciliations to our GAAP EPS and to our GAAP total rent expense are included in this morning's press release, which is posted on our Investor Relations website. With that, I'll turn it over to Brian for his perspective on our second quarter performance. Brian?
Brian Cornell:
Thanks, John, and good morning to all of you. We are very pleased with our second quarter financial results, which we announced earlier this morning. Our second quarter adjusted EPS of $1.22 is 20.6% higher than last year and $0.08 above the high end of the guidance range we provided at the beginning of the quarter.
We are also pleased that once again this quarter, we were able to grow traffic and sales, both in stores and in digital channels, even as we were cycling over a very promotional second quarter from last year. Our second quarter comparable sales increase of 2.4% was just ahead of our first quarter performance and consistent with our expectations. Notably, about 2/3 of this comp increase was driven by growth in traffic combined with a smaller increase in average ticket. Second quarter digital sales grew 30% from a year ago, slightly below our expectations as we compared against very intense digital channel promotions last year. Digital growth contributed about 60 basis points to our comp sales growth this quarter. Our second quarter gross margin rate was 0.5% higher than last year as we continue to benefit from favorable merchandise mix and the comparison over last year's promotional markdowns. On the SG&A expense line, we had an unexpectedly strong quarter as we benefited from discipline throughout the organization, along with the impact of expense timing, as John will cover in a few minutes. With these results, we continue to benefit from very strong cash generation by our core business, which enabled us to return a combined $1 billion to our shareholders in the second quarter through dividends and share repurchase.
As we've outlined in the last several quarters, we're working to define clear roles for each of our merchandise categories and devoting resources to growing what we call our signature categories:
Style, which includes the majority of Apparel; Home and Beauty categories; along with Baby; Kids; and Wellness. While we're still in the early days of this work, we're already seeing a compelling benefit from our efforts. Specifically, comp sales in signature categories grew more than 7% in the second quarter, 3x our overall comp growth.
This performance represents an acceleration from the first quarter when comp growth in signature categories was about double Target's overall comp growth. With strong signature category performance, comps in both Home and Apparel were in the 4% to 5% range this quarter. In Apparel, results were strongest in Baby and Kids, along with Women's ready-to-wear. Within Home, results were strongest in the core and Seasonal, including Back-to-School. Other category highlights this quarter included Toys, part of our Kids focus in Hardlines, which saw more than a 12% increase in comp sales. This growth helped to offset comp declines in Electronics, which is a primary beneficiary of the second quarter promotions last year, and where we're also seeing soft sales in tablets. Outside our stores, our focus on Style was evident as more than 80% of our second quarter digital channel sales growth was driven by Home and Apparel. In Home, where digital penetration is much higher than average, digital channel growth drove half of our total comp this quarter. Looking ahead, we'll continue to work to advance the key strategic priorities we laid out last fall. First on our list is to become a leader in digital. This is critically important because guest research shows that digital relevance drives traffic and engagement across all selling channels. While we are pleased with the industry-leading growth we've seen so far this year, we have much more work to do, and a key asset we'll deploy is our stores. We're already shipping digital orders from approximately 140 stores, and by the end of this year, we'll be shipping from more than 450 locations. Ship-from-store capabilities allows us to balance inventory across the network, leverage the capital and labor already in our stores and reach guests more quickly. To highlight the benefits in improved shipping times this fall, we'll begin testing what we're calling "available to promise," in which we'll offer the guest a specific delivery commitment, typically 2 or 3 business days if the guest orders on a specific date. We believe this capability will drive further increases in digital conversion rates, which are already improving rapidly as guests respond to a faster and firmer delivery commitment. Second on the list of key priorities is working on category roles. Beyond our efforts to grow signature categories, we're also focused on testing and learning how we can reposition our food offering to better serve our guests. While this work won't be complete until next year, we are engaged in many small tests throughout the country to gain a deeper understanding of how guests will respond to potential changes in assortment and presentation. Through guest research, we already know we need to be more clearly highlighting Wellness in our food offering through both assortment and the information we provide. We're also focused on ways to elevate our food presentation and experience to fit the way the guests live and shop. We know we have an opportunity to provide fresh, healthy options and more relevant and localized assortment as our guests are responding to healthy choices we're offering today. Within Food, our market share in Wellness is already double our food share overall, and this quarter, we continue to see double-digit sales growth in these important categories. This clearly shows that our guests are already responding when we enhance our assortment of natural, organic and better-for-you items in our stores. As a result, in the third quarter, we'll continue to expand our Wellness assortment in Food with new food items in our Made to Matter collection and nearly 50 new items across 6 categories in our Simply Balanced brand. Our third priority is to develop capabilities to offer more localized experiences across our stores and a more personalized digital experience for our guests. While this work is ongoing, we're already seeing encouraging signs of the early progress on both fronts. To inform our localization efforts, we launched a small test in the Chicago market, where we're working with a set of stores to test changes to assortment, presentation and inventory commitments on certain items. In these stores, we're highlighting locally relevant items, updating category adjacencies and changing shelf facings to reflect the demographics around these individual stores. While this test is still early, we're encouraged with the guest response so far. Specifically, comp performance in this group of test stores has been 1 to 2 points higher than the rest of the Chicago market and a set of control stores. Items featured in the test are present in 5% to 10% of the guest baskets in these stores, and we have seen a meaningful improvement in our guest survey scores for a variety of products in these stores. Given these strong initial results, we're working to quickly build our capabilities and create an operating model that allow us to scale our efforts across a broader set of stores and demographic clusters. As part of our personalization efforts, last year, we replaced a third-party recommendation engine with an internally developed product which incorporates both in-store and online guest history. In 2015, we've expanded the use of this engine across our mobile offerings, e-mail, subscriptions and Cartwheel. This new engine is driving a meaningful increase in conversion compared with the results on the prior third-party product, generating incremental sales of $50 million to $100 million so far this year. We've rolled out personalization recommendations to Cartwheel only a few weeks ago, but early data indicates the change is driving more than a 10% increase in the number of offers downloaded per user, a critical measure of engagement with this app. Our fourth priority is to test and roll out new, more flexible formats to urban markets, where populations are increasing, guest affinity for Target is high and our store penetration is low. This quarter, we were very excited to open a new CityTarget store in Boston, literally next door to Fenway Park, and we're pleased with the look and feel of the store and the positive response we've seen from our neighbors. We began working to develop the store a decade ago, well before we had smaller formats, and for this project, we were able to open a full-size store in a dense urban area. However, this opening begs the question of the criteria we're using to designate stores as CityTargets, a TargetExpress or simply, Target. As a result, we announced last month that going forward, we will no longer use a CityTarget or TargetExpress names on any of these new stores. This announcement doesn't reflect the change in our desire to open stores in urban areas. It simply reflects our goal to become flexible in how we fit into every community, with an ability to open up a variety of stores, different sizes and layouts, offer a locally relevant assortment and provide guests with easy access to items from our entire digital assortment through in-store pickup. Our fifth and final priority is to advance our growth initiatives by changing the way we work and becoming a more effective and agile organization. This week, we announced several changes to our team, including John's promotion to the newly created Chief Operating Officer role and the hiring of Cathy Smith as our new Chief Financial Officer. I am very excited about these changes and confident that John and Cathy will play a critical role in Target's long-term success. In the past year, I've developed a deep appreciation of John's knowledge and insight, and I believe he is the right person to improve our operations. Retail is changing more rapidly today than any time in my career, and we need to ensure that core operations keep pace with the new ways we're serving the guest. Over time, Target has developed an incredibly complex supply chain, built to serve an outdated linear model, in which product flowed from vendors through distribution centers, to stores. To serve guests today, we're becoming much more flexible in the way we fulfill demand for products and services, and this is stretching our supply chain well beyond its core capabilities. And frankly, as a result, some retail fundamentals have started to suffer. Specifically, in-stocks in our stores have been unacceptable so far this year, and our guests deserve better. In this new role, I have asked John to focus, first and foremost, on improving the capabilities of our supply chain, working across organizational boundaries to understand and address root causes that are hampering day-to-day execution. Beyond these immediate needs, I've asked John to continually assess and evolve our capabilities to ensure our operations keep up with our strategy in a rapidly evolving retail landscape. As we plan to move John into this critical Chief Operating Officer role, it was really important to me that we hired a Chief Financial Officer who is a proven leader, someone capable of upholding Target's strong track record of disciplined financial management. So I'm very excited that we've convinced Cathy Smith to join our leadership team. She served as a CFO at other large organizations, including Walmart, where Cathy and I were colleagues. I have the utmost confidence in Cathy as a strong financial and business leader. She'll be an outstanding addition to our leadership team, and John and I look forward to supporting her transition into this role. One year ago, I was only a week into my new position when I spoke on this earnings call. As I look back in the last year, I am very pleased with our progress and confident we're focused on the right strategic priorities because our guests are responding. As we plan for this year, we face the daunting challenge of sustaining traffic and sales without repeating last year's promotional intensity. So far this year, traffic and sales are increasing, digital growth is far ahead of the industry and signature categories are leading the way. Yet, we will not slow down. We'll continue to invest in newness, innovation and presentation while we focus on maintaining strong execution. We're seeing encouraging results in Back-to-School and Back-to-College, and we'll work hard to maintain that momentum for the rest of the season. Also, this quarter, we're excited about our new plaid program, including more than 50 items from our latest design partner, Adam Lippes. Beyond Adam's design, our plaid takeover will feature hundreds of other products across a broad set of categories. Beyond Apparel, Accessories, Home and pets, you'll find plaid soda bottles, shampoo, bandages, paper towels and more. We're pleased with the early guest reaction and the media buzz and looking forward to rolling out these items throughout the quarter. Target is also featured prominently in the September issue of Vogue, which includes a 1 -- a 21-page insert where we've reimagined some of the most iconic covers by incorporating products we sell. This insert will be digitally shoppable so our guests can go behind the scenes to buy what they see and access additional content. And while they'll become even important in the fourth quarter, we're already ramping up our support this -- around this year's hot license products for Kids, both young and old, from Minions to Marvel, Avengers to Peanuts and of course, Star Wars. These licenses are prominent in our assortment of Back-to-School backpacks, and this fall, we'll feature them on Halloween costumes, decor, apparel, toys and much more. Before I end my remarks, I want to pause and thank the Target team, including the colleagues I met on my recent trip to India, who are doing amazing work in sourcing and technology to support our strategic growth priorities. For our team members around the world, this has already been a very eventful year as we made changes to our team and our structure to better support our guests. Throughout all these changes, the team has remained resilient and energetic, with a passion to serve our guests that's contagious. Every day I step back and marvel at the amazing things this team can deliver, iconic marketing, amazing products at an incredible price, fast and easy digital experiences and of course, a unique store experience that brings our Expect More. Pay Less promise to life every day. None of this would be possible without our great team, and the outstanding results we've seen so far this year are a testament to their efforts. Now I'd like to turn the call over to Cathy Smith. Cathy won't officially begin her role until September 1, but I'm pleased that she's here today to introduce herself and share a few thoughts about Target and her new role. Cathy?
Cathy Smith:
Thanks, Brian, and good morning, everyone. Like Brian, I have long admired Target as a retailer and an iconic brand and a great American company.
During my career, I've had the opportunity to view Target through the lens of a competitor and of course, a guest. And now I'm really excited and humbled to have the opportunity to join the team as we work to transform how we serve guests while preserving what consumers love about this brand. While I won't start working here until next month, I've really enjoyed getting to know the leadership team, and I've had the opportunity to meet with many of the members of the finance team this week. Target's success comes from many things. Beyond the iconic brand, the company has an impressive array of owned and exclusive brands. As a guest and someone who loves retail, I am constantly impressed by Target's ability to deliver new, trendy, high-quality items at amazingly low prices. And I just know there are incredible product design, develop and sourcing teams behind those items. In addition, I appreciate that Target has just at 1,800 well-maintained, great-looking stores in convenient locations, delivering a great shopping experience, and near and dear to every CFO's hearts, we have a healthy balance sheet, which, when combined with our strong cash flow generation, creates ample capacity to fund robust investment in growth and the return of billions of dollars to shareholders annually through dividends and share repurchases. And lastly, Target is full of passionate team members who work tirelessly to serve our guests every day and who are proud of their Target. Let me tell you a brief story. As I was exploring the possibility of joining this amazing company, I wanted to move beyond the familiar experience of shopping at my Target. So I dedicated a couple of weeks to visit more than 55 stores across 10 states, and I dragged my family along for most of the ride. I spoke to guests in every store I visited, and I can tell you that they are clearly demanding enthusiasts. They love Target, and they enjoyed sharing their personal stories about why they choose to shop with us. Before I close, I want to say that I'm looking forward to reconnecting with those of you I know and getting to know those of you I don't. I plan to spend my first few months with the team immersing myself in the business to ensure I have a detailed understanding of where we've been, where we are today and where we need to go in the future. With that foundation, I look forward to meeting you and hearing your perspective. Now I'll turn it over to John, who will share his insights on our second quarter financial performance and our outlook for the third quarter and beyond. John?
John Mulligan:
Thanks, Cathy, and hello, everyone. We are really pleased with our second quarter results as virtually every line on the P&L came in at/or better than our expectations. Compared with our guidance going into the quarter, overall comparable sales were in line with expectations, but the mix of store sales was a bit stronger than expected.
Second quarter gross margin performance also met our expectations, but SG&A expense performance was much better than planned, reflecting our continued efforts to control costs, along with the impact of a timing change in marketing expense. As a result, our second quarter adjusted EPS was $1.22, $0.08 above the high end of the guidance range provided at the beginning of the quarter. Second quarter EPS from continuing operations was $1.21, $0.01 lower than adjusted EPS as pretax restructuring costs and breach-related expenses, worth $0.01 each, were partially offset by a $0.01 benefit from the favorable resolution of income tax matters. Second quarter GAAP EPS of $1.18 reflects a $0.03 loss on discontinued Canadian operations compared with a $0.25 loss on Canadian operations last year. This year's Canada losses were consistent with our expectations as an increase in our pool for estimated probable losses, primarily guarantee of leases, was offset by an adjustment to the tax benefit from the company's investment loss in Canada. Our second quarter comparable sales increase of 2.4% was just ahead of our first quarter performance and consistent with our guidance at the beginning of the quarter. Within the quarter, comps were strongest in May and June. However, this year's monthly pattern was the mirror image of last year's second quarter when the comp growth was strongest in July, which featured the most intense promotions in the quarter. As a result, on a 2-year basis, monthly comp trends were very consistent throughout the quarter. Importantly, transactions were positive both in stores and online throughout the quarter, driving 2/3 of our comparable sales growth. Digital channel sales increased 30% in the second quarter, on top of more than 30% growth in the second quarter last year. As Brian mentioned, second quarter 2014 was intensely promotional, and those promotions were a key driver of digital channel sales last year. Looking ahead, we will continue to focus on achieving our digital channel sales goals through a combination of both traffic growth and conversion improvement. REDcard penetration was 22.1% in the second quarter, about 130 basis points ahead of last year. Portfolio delinquency and write-off metrics are at historically low levels, and we continue to see an increase in payment rates. This means the size of the portfolio continues to slowly decline, but better-than-expected risk metrics are offsetting this impact. As a result, profit sharing income on the portfolio was up this quarter compared to last year. One other note. This week, we began accepting EMV or chip-card transactions at all stores across the country. As a result, this quarter, we will initiate the process of replacing all of our REDcard products with chip-and-PIN cards, including our private label credit and debit products. While sales were in line with expectations, our second quarter segment EBITDA margin rate of 10.9% was much stronger than expected. Our second quarter gross margin rate of 30.9% was half a point higher than a year ago, right on our guidance. Consistent with the first quarter, this year's rate benefited from lower markdowns as we annualized last year's post-breach promotional activity, and we saw a very favorable mix of sales in our signature categories. I mentioned this last quarter, but I want to emphasize it once again. It is really important that we've been able to grow our traffic and sales even as we cycle over very intense promotions last year. Beyond the benefit of growing sales, there is a compelling gross margin benefit from growing our signature categories 3 times as fast as the company, which more than offsets the pressure on our cost of goods for investments in quality, innovation and presentation. On the SG&A expense line, we had a standout quarter, with rate improvement of about 60 basis points compared with last year. This performance was driven by outstanding discipline across the enterprise, combined with the benefit of our cost control initiatives. These benefits more than offset a 40 basis point headwind from incentive compensation, which was unusually low in the second quarter of 2014 in light of the financial performance we were experiencing at the time. As I noted earlier, marketing expense timing was a meaningful benefit this quarter as last year's second quarter spending was unusually high to support our promotions. And this year, we've retimed some spending into the third quarter in support of our Back-to-School licenses in TargetStyle. This timing shift benefited our second quarter SG&A rate by about 30 basis points or about half our overall rate favorability, and we expect this shift will reverse in the third quarter. Before I leave our segment discussion, I want to comment on our quarter-end inventory position, which was about 4% above last year. This reflects a meaningful improvement from the 9% year-over-year increase we reported at the end of first quarter, driven by issues at the West Coast ports. While we made a lot of progress in the second quarter, the year-over-year increases moderated even further so far in August as our quarter-end inventory supported Back-to-School sales that moved into early August as a result of retiming of some tax-free holidays. Bottom line, we feel very good about our overall inventory levels in relation to our sales plans. However, we have a big opportunity to improve in-stock levels, which I'll cover in a few minutes. One note. You'll see on the balance sheet that we've moved pharmacy inventory into the other current assets line in all periods, reflecting their current status as held-for-sale pending the close of our transaction with CVS. Moving to consolidated metrics. Second quarter interest expense was $148 million, flat to second quarter 2014, excluding last year's $285 million charge for early debt retirement. We paid second quarter dividends of $331 million, up 22% from last year, and we invested another $675 million to retire shares. That adds up to a total of $1 billion returned to our shareholders this quarter, representing more than 130% of net income. Looking ahead, with healthy business results and an ample cash position, we expect to have the capacity to continue to returning a meaningful amount of cash through both dividends and share repurchases within the limits of our current investment-grade credit ratings. As anticipated, given our continued desire to repurchase shares, in the second quarter, our Board of Directors approved a $5 billion increase in our share repurchase authorization. As of quarter end, under this program, we have retired more than 65 million shares at an average price of just over $67 a share for a total investment of about $4.4 billion. With the expansion of the program, we expect to have sufficient repurchase authority well into next year, including any potential repurchase resulting from the proceeds of the CVS transaction. Regarding that transaction, things are continuing as expected as we work with CVS and regulators to advance the process of getting approval for the sale. Given the uncertainty of potential timing for regulatory approval and the closing of the transaction, the guidance we provide today does not reflect any expected impacts of the transaction, which includes application of proceeds and removal of prescription sales, costs and assets from our financial statements. As I described last quarter, this year, we began reporting return on invested capital from continuing operations, or ROIC, because we believe it is an important metric in assessing the quality of our capital allocation decisions over time. And as we covered in the financial community meeting in March, our goal is to reach the mid-teens or higher on this metric over the next 5 years. Not surprisingly, given our strong operating results, we reported a meaningful improvement in trailing 12-month ROIC this quarter as we grew 2 full percentage points to 13.3% compared with 11.3% a year ago. Now let's move to our outlook for the third quarter and the remainder of the year. In the third quarter, we are cycling over stronger sales results from last year, both in stores and digital channels, and we expect the consumer and competitive environment to remain choppy. As a result, we are planning for a third quarter comparable sales increase of 1% to 2%, including expected digital channel sales growth of about 30%. We expect our third quarter gross margin rate to increase 20 to 30 basis points compared with last year, reflecting a continued mix from the signature category sales and the benefit from cycling last year's promotional activity, partially offset by investments in quality and price on our owned and exclusive brand products. On the SG&A expense line, we expect our third quarter rate will be about flat to last year as the benefit from cost control is expected to be offset by a 30 basis point headwind from the shift in marketing spend from Q2. Combining our gross margin and expense rate reductions, we're looking for improvement in our third quarter EBITDA and EBIT margin rates of 20 to 30 basis points compared with last year. Third quarter interest expense is expected to be approximately flat for last year, and tax expenses expect to increase by about $60 million, reflecting improved profitability and nonrecurring favorable tax items in third quarter last year. Altogether, these expectations would lead to third quarter adjusted EPS of $0.79 to $0.89 compared with $0.79 a year ago. Note that this includes the impact of the shift in marketing timing, which translates to a $0.05 per share headwind in the third quarter. As we look ahead to the full year, we are certainly pleased with our results so far, which had been notably stronger than expected, and we've been pleased with comp performance so far this month, including Back-to-School sales which reflected retiming of some tax-free holidays into early August. At the same time, we remain mindful of the intensely competitive nature of our holiday season and have noted the inventory levels we're seeing at some competitors. Taking both of those factors into account, we are updating our guidance for the full year adjusted EPS to $4.60 to $4.75, a $0.10 increase compared with the prior range. Before I conclude my remarks, I want to pause and comment on my priorities as I enter the new role as Chief Operations Officer next month. As Brian mentioned, the #1 priority for my new team is to improve the way our supply chain functions from end to end. Achieving this goal will lead to many benefits, perhaps the most visible of which is an improvement in our in-stocks. Given the breadth and complexity of our business, it will always be a challenge to be in stock on every item in every store, in every moment of every day. But our guest need us to be consistent in delivering everyday essentials and unfortunately, in the last couple of quarters, our in-stocks have been deteriorating. This challenge is understandable because we've been asking our supply chain to move well beyond its original design and become more flexible in the way we serve our guests. However, while we understand the reasons, the simple fact is that our current performance is unacceptable. So beginning this quarter, my team will be looking for both quick and more comprehensive solutions to make improvements in the supply chain, both this year and over time. And beyond this initial effort, we will work to ensure that our operations and strategy move in lockstep, enabling us to serve our guests in a rapidly evolving retail landscape. I look forward to updating you on our progress over the coming months and years. With that, we'll conclude today's prepared remarks. And now Brian, Cathy, and I will be happy to respond to your questions.
Operator:
[Operator Instructions] Your first question will come from the line of Oliver Chen with Cowen and Company.
Oliver Chen:
Brian, as you've been so successful in this journey as traffic's come back to the stores, just a bigger-picture question. How do you think your priorities have kind of dynamically changed throughout the year? And where would you say Target is in terms of customers coming back to the store versus increasing customer spend? And John, I just had a question related to the comp guidance as well.
Brian Cornell:
Oliver, overall, I think we're making really good progress against our key strategic initiatives that we've been talking about for a year now. The change we announced this week is to make sure that we elevate our focus on execution and really ensuring operational excellence throughout the organization. And so I am so excited about John stepping into this new role to make sure that we complement the focus we placed upon creating strategic clarity with a recommitment to operational execution. And I think the combination of those 2 elements is critical to continuing to drive traffic, make sure we delight the guest, see an improvement in our Net Promoter Scores and make sure that both in-store and online, we're continuing to see an acceleration in traffic and visits to our site. So I think we're making very good progress right now. I think that's showing up in the results we delivered this quarter. But we're not satisfied. And we know we've got more work to do to ensure that we do meet the needs of the guests every time they shop, and critically important in meeting those needs is to make sure that we provide a great in-store experience and dramatically improve our in-stock conditions, particularly around core essentials. So I think very good progress, I think this is an excellent quarter where the entire team performed well, but we know we've got more work to do and we want to make sure, both in-store and online, we deliver a consistently great experience for the guest.
Oliver Chen:
And on John, I just had a question. On the comp guidance, would you expect this to be pretty broken out between traffic or ticket? Or do you think it's going to be more traffic-led? And as you do embark on the opportunity in supply chain, what are you highlighting as the lower-hanging fruit in terms of timing? And I was just curious about the categories that you see the most opportunity for when you think about further advancing your supply chain.
John Mulligan:
So on the comp guidance, we don't break out traffic and ticket. But I would tell you, from a -- just a business perspective, we're very focused on driving traffic over time. Ultimately, we have to bring people in our stores, we need to bring people to the site, on to mobile devices. And so that's a key driver for us for our sales as we continue to move forward. Related to the supply chain, there is -- the team has done a great job responding to the needs of the organization over time to develop more flexible ways to meet the needs of our guests and really fulfill on-demand shopping. I think we're just at a point now where we need to step back and build broader capabilities across the entirety of the supply chain as we continue to expand the way we want to serve our guests. So there's not one particular area of the company or one particular part of the business that we're completely focused on. Absent, I would tell you, as I said, and you heard from Brian, in-stocks are a key priority, and then specifically, being sure day-to-day, in every store, we're in-stock on essentials. That's a key priority for our guests. We hear it from them. It's a key focus for the team. And we have teams working on improving those in-stocks across our essential categories today and that will be a focus as we go forward.
Brian Cornell:
Oliver, if I can build on that because as we talk about improving our focus on operational and executional initiatives, I go back to some conversations we've had in the past. I absolutely believe we have the best team in retail. Our store operations, Tina and her team do a sensational job. But one of the things that John will be focused on is ensuring we simplify the work and we make it much easier for them to execute each day and take care of the guest. So we want to complement a very strong store leadership team that does a sensational job each and every day, executing store-by-store, by simplifying some of the work, by making sure that we push work upstream and allow them to focus even more on the store experience and the service we provide our guest.
Operator:
Your next question will come from the line of Matt Nemer with Wells Fargo.
Matt Nemer:
John, congrats on your new role, and Cathy, it's nice to have you back in the retail sector. First, I was wondering to what extent you're using price to drive the 3x growth in signature categories. Can you comment on what the growth in gross profit dollars for those categories has been like?
Brian Cornell:
Yes, Matt, I would tell you that the improvements we're seeing is really driven by mix, and as we've talked about, we've invested heavily in ensuring we're on trend, we're bringing great quality to the guest, we're accentuating our position in key categories. We were really pleased during the quarter to see how well we connected with sub-cats like swim. We've seen really strong performance in ready-to-wear and most recently, a very positive response to the changes we've made in denim. So the improvements we're seeing in those categories are really driven by great quality, following the trend curves, bringing great style and fashion to our guest, and it has not been driven by a reliance on pricing.
Matt Nemer:
Okay. That's helpful. And then secondly, your comments regarding the supply chain being stretched, I realize that the analysis is just starting or in the early days. But do you believe that there's a significant reinvestment required in the supply chain in terms of either DCs or SCs or something else?
John Mulligan:
No. Matt, we're in a place where we have, we believe, just great, great assets across the supply chain, great distribution centers, great upstream distribution centers, food distribution centers, fulfillment centers and of course, the stores. I think we said over the past couple of years, our focus of our investment has been supply chain and technology in support of becoming an on-demand company. That will continue to be the case. We're going to continue to invest in technology and supply chain. But the physical assets side, we feel really, really good about.
Matt Nemer:
Okay. That's great news. And then if I could just sneak one more in. The early Back-to-School strength and the marketing shift, is that fully embedded into the Q3 comp guide?
Brian Cornell:
It is, and it would be. And we are seeing a very positive start to Back-to-School and Back-to-College.
Operator:
Your next question will come from the line of David Schick with Stifel.
David Schick:
Wondering if you could give us a few more examples, concrete examples of how you're driving that localization success in Chicago, categories or items, and separately, if you could talk a little bit about digital approach outside of your own platform. So we've seen it and we've heard from you what you're doing, and that's exciting and driving growth, but we've seen a little bit of your outreach to bloggers and how you're working with them. If you could talk about the full view of how you're thinking about digital outside of the Target headquarters, that would be helpful as well.
Brian Cornell:
Sure. David, let me start with localization. And as I've said during the last couple of calls, this is still a very nascent effort for us. We're in one market, a handful of stores in Chicago. But we've really been focusing on a handful of areas where we recognize we need to change our assortment, change our presentation, be more relevant and really recognize the needs and the demographics of these local markets. So there's a handful of categories I might lift up. One, craft beer, and really making sure that in a category like craft beer, we have locally relevant items and we recognize that even in a market like Chicago, those need to be tailored neighborhood-by-neighborhood. So we've looked at specialty foods, we've looked at categories like craft beer. We've looked at categories like patio and grills and recognizing that in the suburbs of Chicago, we can offer and should have in store large patio sets, 5-burner grills. But for our stores located in more of the urban neighborhoods of Chicago, we need bistro tables and we need 2-burner grills because those guests are living in condos and apartments, they've got small patios, and we need to make sure we tailor our assortment and our presentation to recognize their needs and to make sure we're more locally relevant. So we're certainly spending a lot of time looking at food, and as we think about the food reinvention, a lot of this is going to be driven by making sure we have locally relevant brands, those hometown favorites, and also in broader categories like patio and furniture, making sure that we're matching up our assortment in store with the needs of that local guest. So a lot of additional work for us to do, but we're really pleased with the progress. And I talked about a 1- to 2-point lift versus the test and control stores, that is a very important measure for us to continue to evaluate. And working with John and our merch team, we'll be looking to rapidly roll out the learning from Chicago into other relevant markets. From a digital standpoint, David, obviously, we continue to see really positive responses to some of our efforts like Cartwheel. And Cartwheel has now been downloaded over 18 million times. And every time I'm in stores, I run into guests that have their smartphone in their hand and they're looking for their offers from Cartwheel. But we also recognize that Target is a brand that's talked about in social media every day, thousands of times every day. So if you were to visit our headquarters here in Minneapolis, just down the hall from my office, we have what we call "guest central." It's our guest command center, where we're monitoring what people are talking about, what they're blogging about, how Target's being referenced in the news, and we're making sure we're very engaged with those bloggers and making sure that we're in the discussion. So it's a very important part of how we think about the brand and making sure that we incorporate social into our overall brand development initiatives.
Operator:
Your next question will come from the line of Scott Mushkin with Wolfe Research.
Scott Mushkin:
Welcome, Cathy, and congratulations, John. Looking forward to working with you guys in your new capacity as we move forward. The stock obviously was up a lot earlier today. So it's kind of rolled over. And I think it's the sales line that people may be a little concerned about, the 1% to 2% guidance for the third quarter. But I'd also really look out over time, SG&A saves obviously tapered down, and so as you look out to '16 and '17, getting the sales line moving is going to be more important here. I know, Brian, you pointed to some things like the signature categories, but I was wondering, what else gives you confidence? We actually have a lot of confidence because we are -- focus groups are saying to us that people are really responding to what you guys are doing. But in your words, what gives you the confidence we can see sales trend higher over time?
Brian Cornell:
Well, I think it starts, Scott, with the reaction we've seen from the guests to some of the changes we've made in signature categories. And when I think about in today's marketplace, Apparel growing at 4% or 5%, the changes we've seen and the reaction we've seen from the guests to our Home offering, the fact that within Kids, Toys growing this quarter at 12% and while again still in the early stages, the reaction to some of the changes we're making in our Food assortment, the reaction the guest is taking to Made to Matter or Wellness initiatives, gives me a tremendous amount of confidence that as we continue to bring great design, fashion, quality and excitement to our signature categories and combine that with the opportunity to reinvent food, to bring the right assortment that meets the needs of our guest, that to me is the magic to unlock sustainable sales growth at Target and make sure we're driving traffic to our stores, more visits to our site. And it gets back fundamentally, Scott, I believe, we win and we'll continue to grow by combining a great store experience, the convenience of allowing our guest to order online and pick up in our stores whenever they want and also being able to ship directly to their homes and using our stores as flexible fulfillment centers to make sure that response is a quick one. So I'm very optimistic about the future. I think you're starting to see that embedded in the results, and the results in signature categories is very encouraging for us. We're getting great feedback from the guest. As I think about the third quarter, we expect plaid to be a really exciting initiative and the buzz that we're seeing already is really positive. So we've got work to do on Food, but when we reinvent Food and get the assortment right there and improve the presentation, I think that gives us all great confidence that we're going to continue to drive traffic to our stores and that's going to convert to really solid and sustainable comps.
Scott Mushkin:
All right. That's perfect. And then maybe just -- I hate to be this short-term focused, but the question I get all the time as we look at the fourth quarter, we're going to be going over a pretty, pretty significant comp from last year. How should we think about that? I mean, a lot of people look at stacks. I mean, you guys look at stacks. Or how do you think you wish to start framing the fourth quarter and maybe your thought there?
John Mulligan:
I think we can all drive ourselves crazy doing 2-year, 3-year, 5-year stacks, whatever you want. But in this case, I do think the 2-year stack is important. We have continued to see our 2-year stacks improve. If you do last year's Q4 against the previous Q4, the average there is about -- or the number there is about a 1 3. So we expect to cycle past that this Q4. And we've seen putting our -- putting the implied guidance, you guys can do a rough number around that. Putting that against last year's comp will be an acceleration of our 2-year stack. And so we feel good about that, and I think to the points Brian just made, part of it is we need to continue to grow. We feel confident we're going to continue to grow and comp against whatever it is we delivered in the prior year, and we feel good about doing that. We feel great about our fourth quarter plans. We're cognizant that, that's an intensely competitive time of year. We'll be very promotional. We're not going to get beat on promotions, and we'll be in the game. And we feel really good about what we'll offer the guests in Q4.
Brian Cornell:
Yes, and Scott, obviously, we'll update our guidance for the fourth quarter at a later date. But trust me, we are spending a tremendous amount of time evaluating our plans week-by-week in the fourth quarter. I spent time just yesterday with our team going through our fourth quarter plans, our merchandising plans, our marketing plans, how we're going to approach the key holiday periods. And to me, it's all about making sure we've got the right content, we've got to have great product, we certainly know we need to make sure we're winning from a promotional standpoint. But then we've got to make sure we surround the guest with a great experience and really iconic marketing. And I think we're going to combine a great in-store with an online experience and be very competitive and well prepared for the fourth quarter.
Operator:
Your next question will come from the line of Matt McClintock with Barclays.
Matthew McClintock:
Congratulations, both John and Cathy, on the new roles. I was just wondering if we could focus just -- I know we focused -- we've talked a lot about the significant categories. You've talked a lot about supply chain. But can we focus on -- and you've also talked about Food. Can you focus a little bit on Electronics? Continued weakness there. Clearly, the industry itself is a little bit challenged. But a lot of consumer interest in new products in that category, especially as we go into the holiday season. This upcoming holiday season, you're talking about the fourth quarter. Maybe dive a little bit into what you're doing there and that specific category to maybe try to gain market share in what is a challenged category.
Brian Cornell:
Yes, so Matt, I'm not going to go through the details of our plans. We'll kind of maintain that powder for the fourth quarter, but we're certainly looking at newness in Electronics. We're looking at categories where we think we're uniquely positioned to win, so working very closely with our suppliers to ensure that we have the right newness, that we're ready with the right presentation. I think there's a lot of exciting things in the pipeline. We certainly think as we continue to focus on Wellness that wearable technology is a space where we can and will win. But we also recognize right now that many of those categories are waiting for new innovation, and we're working closely with our key suppliers to make sure that we're going to be bringing that innovation to the guests and featuring it throughout the fourth quarter.
Operator:
Your next question will come from the line of Peter Benedict with Robert Baird.
Peter Benedict:
Two quick ones. First, on the digital side, obviously, impressive growth, 30%. I think the longer-term plan is closer to 40%. So curious, 2 things. One, what kind of gets that channel growing faster in the next couple of years? And related to that, a number of large retailers out there are opening up dedicated e-commerce fulfillment centers. I don't believe you guys have those. Is that something that makes sense for Target as you think out over the next few years?
John Mulligan:
I'll take the first -- second one first and then let Brian comment on the growth. I think on our supply chain for the digital channel, we actually have 6 dedicated fulfillment centers, and we think the combination of fulfillment centers with our existing regional distribution centers and along with the stores gives us all the capability we need. And then you'll see us continuing to grow the store channel, our regional distribution channel, all 3 of those channels as ways to fulfill depending on the product and how quickly the guest wants it.
Brian Cornell:
Yes. And Peter, I'll step back and just talk about some of the fundamentals. We've got to continue to make sure we build awareness. We've got to make sure that as our guest engages with us digitally, we make it really easy, we make it easy to find product, an easy checkout experience. We believe that "available to promise," which we'll roll out this fall, will give our guest the confidence that they know where the product is and when it will arrive for them, either in a store for them to pick up or being available directly to their home. So we're focused on making sure that we provide not only a great in-store but a great digital experience, and we've got to make sure that we continue to make our site easy to work with, and more and more that's the mobile interchange that we've got to make sure is easy for our guest to find product and check out. We want to give them the confidence that when they order, they know it's "available to promise," and we're going to have it there for them when they need it. And to the point John made, we don't need to be building upstream DCs, we're going to continue to convert more of our stores and as we go into the fourth quarter, close to 450, that will act as flexible fulfillment centers to make sure that we can quickly and efficiently get product to the guest. So those fundamentals are critically important as we think about driving industry-leading growth.
Peter Benedict:
Okay. That's helpful. And sorry, am I bad on that DC question. And then quickly over to SG&A. I think you guys had outlined $1.5 billion over the next couple of years in savings, $500 million maybe coming this year. Where are you trending towards those savings? And how are those savings kind of corporate versus in-store? I'm just curious, kind of how like store-level payroll dollars compare today versus, let's say, a year ago.
John Mulligan:
Yes, so we're right on track with the savings. We've got programs identified to deliver the entirety of the $2 billion, the $1.5 billion in SG&A, plus the cost of goods savings. So we feel really good about that. We're on track for our commitment for this year as well. One of the things we talked about when we first announced this, and we've talked about it in a great detail in the company, is the stores are already productive. And if we're going to take hours out of the store, it will be because we eliminate work, or to the point Brian made earlier, move work upstream into the distribution centers. And so we're not focused on taking hours out of the store. We are focused on taking work out and we haven't -- we're in the process of working through that. That's a little bit longer lead process than some of the other things we've done. But we're very focused on essentially freeing up those hours in the store and then we'll decide do we need them for improved guest service or how we'll utilize them. But in fact, we've -- there's a couple of areas where we have invested hours back into the store as we put in the whole merchandising sets. And as we put in mannequins, we've realized the need for dedicated store team members who can merchandise those displays and make them look great all the time. So that's an area where we've invested back into the store.
Operator:
Your final question will come from the line of Greg Melich with Evercore ISI.
Gregory Melich:
So Cathy, welcome. John, I can't let you get promoted without hitting you with a finance question. So how much did credit help? You said credit, I think, was a benefit in the core of the profit share. How much did that help in the quarter? And linked to that, how should we think about SG&A dollar growth? I mean, it sounds like third quarter will be up 1 to 2 with the comp, but it was flat in the second quarter. What's the normal run rate there now?
John Mulligan:
Yes, good questions. On the credit side, the benefit, it was up, but not meaningful, and it was less than -- I'd say less than half a penny of improvement versus last year, so very, very small. We're pleased it was up given that, as we said, payment rates continue to go up. And so we're seeing the portfolio continue to shrink, so clearly, a portion of where the gas dollars are going, at least from our perspective. SG&A, through time, we'd expect to lever SG&A, go up over the long term here, go up modestly, slower than sales growth. I think we've said, we're going to take -- continue to take expense out, but we also said that the majority of that expense will likely get reinvested. So I wouldn't count on big, big, big reductions in our SG&A over time. There will places where we have to add back expense to meet the needs of our guests I just talked about in the new stores. So modestly slower than sales growth over the long term would be what I'd say.
Brian Cornell:
Well, great, thank you. And for all of you, that concludes our Second Quarter Earnings Conference Call, and I really appreciate you joining us today. So thank you.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation First Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, May 20, 2015. I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our First Quarter 2015 Earnings Conference Call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Financial Officer; and Kathee Tesija, Chief Merchandising and Supply Chain Officer.
This morning, Brian will discuss our first quarter performance and priorities going forward. Then Kathee will provide insights into our first quarter results across our merchandise category and plans for the second quarter and beyond. And finally, John will provide more detail on our first quarter financial performance and expectations for the second quarter and the remainder of the year. Following their remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following this conference call, John and I will be available throughout the day to answer any follow-up questions you may have. Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure, and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalized operating leases. Reconciliations to our GAAP EPS and to our GAAP total rent expense are included in this morning's press release posted on our Investor Relations website. With that, I'll turn it over to Brian for his perspective on our first quarter performance. Brian?
Brian Cornell:
Thanks, John, and good morning to all of you. We're very pleased with our first quarter financial results, which we announced earlier this morning.
Our first quarter adjusted EPS of $1.10 is 19.6% higher than last year and $0.05 better than the high end of the range we provided at the beginning of the quarter. Comp sales increased 2.3% in the quarter, a bit ahead of our expectations. This increase was driven by a healthy balance of growth in both traffic and average ticket. First quarter digital sales increased 38% over last year, driven by higher traffic and a substantial increase in conversions. Digital growth contributed 80 basis points to our comp sales increase in the first quarter. While we enjoyed a healthy pace of sales throughout the first quarter, we saw particularly strong results in March as weather warmed across many parts of the country and Easter timing moved Seasonal sales into the month. In April, we were thrilled with the overwhelming demand for items on our collaboration with Lilly Pulitzer, with most of the collection selling out in the first few days. We were disappointed, however, that our digital channels were not able to properly accommodate the surge in traffic at the time of the launch, and the team is working to address root causes and learn from the experience as we prepare for holiday season peak later this year. The first quarter saw a meaningful increase in our gross margin rate as we've cycled over a promotional first quarter 2014, and we benefited from very strong mix of sales in our signature categories this year, both in stores and online. First quarter comp sales in signature categories grew more than twice as fast as our comparable sales overall, and mix in our digital channels was even stronger. Specifically, about 2/3 of our first quarter digital sales increase was driven by growth in Home and Apparel. Kathee will provide more detail on category performance in a few minutes. Once again, our stores did a great job controlling costs this quarter, while outside of the stores, we continue to move to a leaner, more agile way of working. During the first quarter, we recorded restructuring charges related to headcount reductions at our headquarters. While these reductions were very difficult for all of us, I strongly believe they were a necessary step to remove roadblocks, which were preventing us from moving more quickly and responsively to the guest needs. I want to thank the team for their perseverance during this time of significant transition. I continue to admire the energy they bring to work every single day. As you know, we are committed to returning cash to our shareholders through both dividends and share repurchase over time, and I'm very pleased that this quarter, we began returning cash through share repurchase for the first time in nearly 2 years. This change reflects the improving health of our U.S. business, along with the cash flow benefit of our fourth quarter decision to discontinue operations in Canada.
For several quarters now, I've been talking about the 5 priorities we are focused on as a leadership team:
becoming a leader in delivering shopping on demand for our guests; establishing clear roles in our merchandising categories, with particular focus on growing our signature categories, Style, Baby, Kids and Wellness; developing capabilities to become more localized in our store experience and more personalized in our digital interaction with guests; continue to develop and test urban formats like CityTarget and TargetExpress; and finally, transforming the way we work to create capacity to invest appropriately in the growth initiatives I just described.
I strongly believe if we make progress on these 5 priorities over the next few years, Target will deliver outstanding financial results and become an even stronger retailer. While we're at the early stages, I'm encouraged with signs of progress on these efforts. Specifically, our strong mix of first quarter sales in signature categories demonstrates the value of the work to define category roles. We continue to roll out upgraded fixtures in Apparel, Beauty, Baby and Home while investing in Wellness with programs like "Made to Matter." Our buying teams are focused on delivering enhanced newness, quality and value to our guests, and we're communicating this renewed focus in both traditional and digital channels. Our digital sales growth of nearly 40%, on top of 30% growth a year ago, shows that we have a meaningful opportunity to generate comp sales growth through investments in digital channels. And following our March headcount reductions at headquarters, our teams are taking a fresh look at everything we do and taking steps to remove approval layers and increase the speed of decision-making. While there will certainly be a meaningful adjustment process, I believe we will emerge with an agile and engaged team that is equipped and empowered to act quickly on behalf of the guests. These signs of progress are meaningful to the team and they demonstrate the value of our efforts and validate our strategic priorities. Yet as we look ahead, we realize we're on a much longer journey and need to accomplish many more things. Specifically, we're in the very early stages of our work on localization and personalization. In the future, these efforts should benefit both sales and gross margin rate. And while we're still in the testing phase, we're very encouraged by the progress in evaluating and rolling out urban formats like CityTarget and TargetExpress. We opened 2 new Express locations in the San Francisco market this quarter, both of which are quite different from our first location in the Minneapolis market. We expect to open 6 more locations this year in a variety of markets and demographic areas to continue to learn how to operate this new format in a diverse array of sizes and settings. Finally, we are just beginning to reinvent our Food assortment and presentation. We have an opportunity to drive more traffic and sales in this critical area of the store by becoming more specialized in our assortment, more focused on healthy options in support of wellness. We're testing potential assortment and presentation options, and this year, we plan to study the guest response to potential changes before determining what we'll roll out more extensively next year. While this quarter's results are encouraging, we're focused on the work ahead of us as we transform ourselves to become a truly modern retailer and more relevant to our guests. We're taking the necessary steps, both on our investment decisions and the way we work, to position Target for continued profitable growth in the years ahead. The momentum we've seen so far makes us more confident than ever that we're moving in the right direction and encourages us to move even faster. Yet we know that long-term success depends on achieving the right balance between speed and the time it takes to confirm we're making the right changes that we can execute at scale. Once we have that confirmation, we're committed to moving forward, both quickly and confidently, in becoming the retailer our guests want Target to be. Now I'll turn it over to Kathee to recap our first quarter results and plans going forward.
Kathryn Tesija:
Thanks, Brian. In the first quarter, we saw encouraging trends across many dimensions of our business, including traffic, sales, merchandise mix, markdown rates, digital channel growth and overall profitability.
Within our sales, our results reflect our continued focus on growing signature categories. Beauty had another outstanding quarter and delivered more than a 5% comp, but Apparel and Home were right behind with a mid-4% comp. Given weather trends and Easter timing, Apparel comps peaked in March but were strong throughout the quarter. Among the drivers was swim, where we saw better-than-expected results across the board in women's, men's and kids. In ready-to-wear, we saw particular strength in Merona and our new plus-size brand, Ava & Viv. And while it's small relative to the quarter, the response to the Lilly Pulitzer partnership was the icing on the cake as more than 90% of the Apparel items sold out the first day. Across the rest of our assortment, Food comps were just below the company average, and Hardlines experienced a mid-single-digit comp decline, reflecting a very tough comparison to last year when we saw particularly strong sales from Disney's Frozen, and elevated promotions drove sales in Electronics. As Brian mentioned, first quarter comparable sales were driven by a healthy combination of growth in both traffic and average ticket. Within average ticket, an increase in average retail was partially offset by a decline in units per transaction. This decline in average units was driven by category mix, particularly Apparel, along with channel mix as digital transactions typically have fewer units at higher average retail. Besides channel mix, growth in average retail was driven by a lower level of promotional activity this year and a trend in which our guests are trading up to higher-quality and premium-branded items. We were really pleased with the pace of digital channel sales growth this quarter and even happier that it was driven by Home and Apparel. But our digital goals are ambitious and we have a lot more work to do, so we're continuing to invest in and roll out new initiatives to maintain our momentum. The February launch of a lower $25 free shipping threshold drove a meaningful increase in conversion this quarter, and guests continued to embrace Store Pickup, which was up more than 100% from a year ago. Subscriptions are also growing rapidly. Sales on subscription grew 32% between the fourth quarter and the first quarter, and the active subscriber base grew 20% within the first quarter. And we continue to see great results from our ship-from-store capability, which delivers shipping savings for us and reduced delivery times for our guests. And we expect to roll out this capability to more than 200 additional stores this fall. As I mentioned in the last call, we were very happy to see the West Coast port situation resolved, yet we knew it would take a few months for the shipping backlog to be completely relieved. As of today, I'm pleased to say that those delays are fully behind us. Consistent with our fourth quarter experience, the team did a great job in the first quarter working around port-related issues by preordering inventory and rerouting shipments. However, despite these efforts, some categories, including Shoes, saw spotty in-stocks in the quarter and saw sales accelerate as receipts began to flow and in-stocks recovered. As we look ahead, we are working to build on our current momentum in the second quarter and beyond. In Apparel, beyond swim, we've been seeing encouraging trends in shorts, dresses, tanks and sandals and expect these businesses to be a key driver of second quarter sales. In Jewelry and Accessories, this morning, we announced a new limited time partnership, Eddie Borgo for Target, which launches -- that launches July 12. Eddie has crafted a first-of-its-kind limited edition collection of customizable jewelry, accessories and wall art featuring the designer's signature aesthetic and on-trend colors and finishes. In Home, we're seeing great momentum in our tabletop business, and we'll expand the offering this quarter with a broader selection of both indoor and outdoor options for summer entertaining. We're also excited [Audio Gap] programs, which will launch in July, featuring more exclusive content from licensed and exclusive brands and do-it-yourself programs, which will allow students to decorate their own journals, notebooks and lockers. In Wellness, we continue to see amazing results from the "Made to Matter" collection. Since the announcement of this collection, featured brands are running up 25% to last year, and the collection is on track to record $1 billion in sales this year. And in Kids, we have a blockbuster set of licensed programs planned for the second quarter and beyond. In stores now, we're offering about 150 items from the new Avengers movie, including many that are exclusive to Target. To support the release, we've created an omnichannel marketing campaign that includes social media engagement and a uniquely creative stop-motion broadcast spot that brings the actual 12-inch action figures to life. Also, this summer looks for exclusive items across multiple categories in celebration of the June release of Jurassic World and the July release of Minions. On target.com, we've expanded our licensed offering by creating experiences for our top 29 licenses. Each of these experiences includes favorite items that we carry in both channels, plus expanded -- extended assortments that include collectibles, more apparel choices and hard-to-find toys. We will continue to roll out experiences to more of our favorite characters throughout the year. To celebrate the 65th anniversary of the iconic comic strip, Peanuts, we're rolling out a summer collection of more than 100 exclusive products. These items are the work of our own product design and development team who partnered with current Peanuts cartoonists and the Charles M. Schulz Museum to design fresh, fun items that are true to the comic strip's roots. We'll roll out more exclusive items across multiple categories throughout the year, leading up to the release of the new Peanuts feature film in November. And finally, like moviegoers, we're already excited about the December movie release from the most famous license of them all, Star Wars. Earlier this month, as part of the worldwide "May the 4th be with you" event, we allowed Darth Vader and Yoda to take over the target.com homepage, offering special online-only deals on Star Wars licensed product. We'll provide more details on our next earnings call, but for now, I can assure you that Star Wars fans will find plenty of reasons to visit our stores and target.com this year. As we've said many times, we're encouraged by our progress but recognize that we are only at the beginning of a multiyear journey to transform our business. We continue to roll out new store fixtures to enhance the shopping experience in Apparel, Baby, Electronics and Home, and we're working quickly to develop and test ideas to reinvent our Food area to become more specialized and more clearly embrace wellness with local products, naturals, organics and clean labels. And we continue to invest in our technology and supply chain capabilities to allow our guests to shop on demand and receive products where and when they want. The good news is that even though we have much more to do, the positive guest response to what we've already accomplished makes us confident we are moving in the right direction. Now I'll turn it over to John, who will share his insights on our first quarter financial performance and our outlook for the second quarter and beyond.
John Mulligan:
Thanks, Kathee. Our first quarter financial results were stronger than expected, driven by better-than-expected sales performance, particularly in our signature categories.
Adjusted EPS of $1.10 was $0.05 above the high end of the guidance range provided at the beginning of the quarter. First quarter diluted EPS from continuing operations of $1.01, about $0.09 lower than adjusted EPS, driven primarily by pretax restructuring cost of $103 million combined with small adjustments for breach-related expenses and a favorable resolution of income tax matters. First quarter GAAP EPS of $0.98 included a $0.03 loss on discontinued Canadian operations compared with a $0.24 loss on Canadian operations in the first quarter of 2014. Our first quarter comparable sales increase of 2.3% was just ahead of the guidance of 2% we provided at the beginning of the quarter. We are pleased with the sales results throughout the quarter, but they were particularly strong in March as weather warmed and Easter timing moved Seasonal sales into the month. Comparable sales growth for March and April combined, which eliminates the effect of the Easter timing, was stronger than we experienced in February. Digital channel sales increased 38% in the first quarter on top of more than 30% growth in the first quarter last year. Digital channels drove about 80 basis points of our first quarter comparable sales increase, in line with our fourth quarter experience. Comparable transactions were up, both in the store and digital channels, accounting for approximately 90 basis points of our comp increase. REDcard penetration of 21.5% was about 110 basis points ahead of last year, in line with our expectations. This growth is faster than our fourth quarter pace and consistent with new account growth in the latter half of 2014. Risk levels on the portfolio continue to run at historically low levels, and this quarter we saw an increase in payment rates. This increase is consistent with commentary from others and potentially explains what consumers are choosing to do with some of their savings from lower gas prices. One other note. We've now begun piloting acceptance of chip transactions at our stores as the entire U.S. payment industry prepares to move to chip technology later in the year. Our first quarter segment EBITDA margin rate of 10.5% was stronger than expected, driven by an unexpectedly strong gross margin rate. Specifically, our first quarter gross margin rate of 30.4% was nearly 1 percentage point higher than a year ago. This rate -- this year's rate benefited from lower markdowns as we analyzed -- annualized last year's promotional activity following the data breach, and we saw a very favorable mix of sales in our signature category. In fact, the last 2 quarters are the only 2 in recent history in which sales mix has been a positive contributor to our overall gross margin rate. This shows the value of our focus on driving growth in our signature category. This quarter, we grew sales and traffic while replacing promotionally driven sales on lower-margin items with higher-margin sales in signature categories, and the benefit to our P&L was compelling. On the SG&A expense line, this quarter, we benefited from productivity improvements in the stores and overall leverage of pay and benefits, partially offset by higher technology expense compared with a year ago. Altogether, our first quarter segment SG&A expense rate improved about 20 basis points compared with last year. Before I leave our segment discussion, I want to comment on our inventory position at the end of the quarter, which was about 9% higher than a year ago. This increase was intentional and reflects some decisions we've discussed in the past calls. First, beginning last summer, we increased our inventory commitment in commodity categories to support in-stocks in these frequency-driving businesses. And second, our receipts this quarter reflected some pre-buying of imported product that the team had undertaken to mitigate risk before the West Coast port slowdown had been resolved. Looking ahead, we continue to feel very good about our overall inventory level and we expect year-over-year growth to moderate in the second quarter and beyond. Moving to consolidated metrics. First quarter interest expense was essentially flat to last year, and we returned $333 million to shareholders in the form of dividends in the first quarter, an increase of 22% over last year. As we mentioned during the last call, the improvements in our business results and cash balance have positioned us to once again return cash through share repurchase within the limits of our capital structure goals. As a result, this quarter, we bought back shares for the first time since the second quarter of 2013, investing $297 million in open-market repurchases and another $265 million through an accelerated share repurchase agreement late in the quarter. This means that in the quarter, we returned over 140% of our net income through dividends and share repurchase. Given our current cash position and continued strong cash generation by our business, we expect to continue to repurchase shares in the second quarter and beyond and believe we will have the capacity to retire $2 billion or more of our shares in this fiscal year, within the limits of our current investment-grade credit ratings. One note. We ended the quarter with about $1.2 billion remaining on our current share repurchase authorization, meaning that if this activity continues as expected, we would exhaust the current authorization later this year. As a result, we will be reviewing with our board the need to increase our share repurchase authorization at an upcoming meeting. Before I turn to our outlook, I want to pause and discuss our decision to begin reporting after-tax return on invested capital from continuing operations, or ROIC, in this quarter's earnings press release. As you know from our previous discussions and the long-term performance incentives described in our proxy statement, we believe ROIC is an important metric to measure the quality of our capital allocation decisions over time. Also, as you know, we presented our long-term aspirations for this metric during our financial community meeting in March. Specifically, we intend to reach the mid-teens or higher on this metric over the next 5 years. Beginning this quarter, we will report how we have performed on this metric for the most recent trailing 12 months, providing clarity on how we are measuring our own performance while allowing everyone to track our progress. To provide additional context, we're posting the last 2 years of quarterly calculations of this metric on our Investor Relations website in the Summary Financials section. With that backdrop, this morning, we reported that for the trailing 12 months through first quarter 2015, our after-tax return on invested capital was 12.5%, up about 60 basis points from a year before, reflecting improved profitability on a relatively stable base of invested capital in our continuing operations. Now let's move to our outlook for the second quarter and the remainder of the year. In the second quarter, we expect our comparable sales to increase between 2% and 2.5%, reflecting expected growth in digital channel sales in the high 30% range. Both of these expectations are similar to our first quarter performance. And while it is still early, our results through the first few weeks of the second quarter are consistent with that forecast. We expect our second quarter gross margin rate to improve about 50 basis points from last year as we benefit from the comparison to last year's promotional activity while we continue to make price investments and add quality back into our owned and exclusive brand products. On the SG&A expense line, we expect our second quarter rate will be 20 to 30 basis points higher than a year ago as the rate benefit from productivity improvement is expected to be offset by a planned year-over-year increase in compensation expense. You'll recall that compensation expense was unusually low in the second quarter last year as we significantly reduced our accrual for full year incentive compensation in light of softening financial performance. Combining our gross margin and expense rate expectations, we're looking for improvement in our second quarter EBITDA and EBIT margin rates of 20 to 30 basis points compared with last year. Second quarter interest expense is expected to be about $150 million, well below last year, which is unusually -- which was unusually high due to the retirement of some high coupon debt. Our effective tax rate is expected to be just over 35%, higher than last year's 33.7% rate, driven by improved profitability. Altogether, these expectations would lead to second quarter adjusted EPS, representing results of continuing operations in our single segment business, of $1.04 to $1.14 compared with $1.01 a year ago. While we've seen a strong start to the year so far, it is early and we have a lot more to accomplish as the year progresses. However, our first quarter performance validates that we are focused on the right strategic priorities to propel our business forward. And it certainly adds to our confidence that we can deliver on our guidance for the year. As a result, we've taken the lower end of our prior full year guidance up by $0.05 and now expect full year adjusted EPS from continuing operations of $4.50 to $4.65. With that, we'll conclude today's prepared remarks. Now Brian, Kathee and I will be happy to respond to your questions.
Operator:
[Operator Instructions] Your first question will come from the line of Oliver Chen with Cowen and Company.
Oliver Chen:
Regarding the comp in the back half, should we think about traffic as the main opportunity? Or would you feel like ticket will also be an opportunity? And as we think about gross margin and your product assortment, how are you balancing the idea of investing in price versus the innovation that you're conducting in your signature categories?
Brian Cornell:
Oliver, good morning, and thanks for joining us today. As we think about the balance of the year, I would ask you to think about 3 important variables, and you saw those come to life in the first quarter. We're clearly focused on driving traffic to our stores and we expect that to be a very important driver of our growth over the balance of the year. But you're also seeing the benefit of our focus on signature categories and the higher ticket that, that generates. But importantly, the third element is the increasingly important contribution we're seeing from our digital and online businesses. So as we go forward, we're going to continue to make sure we're seeing growth in traffic, growth in our signature categories that leads to that gross margin rate improvement we saw in the first quarter and the higher ticket, but importantly, the ongoing contribution of our online channel.
Oliver Chen:
Brian, you've been very agile with strategic decisions around the online and digital business. As we look forward to back-to-school and holiday, are there any key pointers in terms of the strategies you're undertaking, particularly as mobile and shipping continue to be hot topics?
Brian Cornell:
Oliver, you've heard Kathee talk about some of the key initiatives that came to life in the first quarter, and you're going to continue to see us build off of that over the balance of the year. We've completely rebuilt our app. We're focused on improving our subscription and registry. We're leveraging our stores to ship to our guests. So we're going to continue to build on those initiatives as we go forward and continue to make sure that we're making the investments, both in technology, but importantly, in the supply chain that brings that online business to life for our guests.
Kathryn Tesija:
And Oliver, if we can go back for a minute to your question on thinking about price versus innovation and how do we balance those. I would just say that we start from the guests, looking at what it is that they expect from any given product category and then how do we build the very best product, which is, depending on what it is, could be a combination of both price and innovation or more heavily leaning on one or the other, depending on what we're talking about. But very much guest-focused to make sure that we're offering them the content that's going to inspire them and resonate. So there's not one-size-fits-all, it's really guest-focused, driven by each category.
Operator:
Your next question will come from the line of Matt Nemer with Wells Fargo Securities.
Matt Nemer:
My first question is on gross margin. Does the gross margin guidance assume a continued mix shift to the signature categories that you enjoyed this quarter? And is the formula for Q2, in terms of price and quality investments, kind of what we should be thinking going forward, i.e. you were down about 100 last year and you recapture about half according to your guidance. Does that seem like a reasonable formula for Q3 as well?
Brian Cornell:
Well, let me start with the gross margin and the focus for not only the quarter but for many years to come. And we've been very clear about the importance of focusing in on our signature categories. We believe that's our path to differentiating the brand. So you should continue to expect us to focus on building our Style categories. And Kathee and her team are making great progress in Apparel and Home and Beauty. And you saw the comps that those categories produced in the first quarter. We'll continue to focus on Baby and Kids and accelerate our focus on Wellness. So we believe those categories both in store but, importantly, as we demonstrated in Q1, online, where a significant portion of our growth in the digital channel was driven by Apparel and Home. So that is a very favorable impact to mix, both in store and, importantly, as we improve and accelerate our online performance.
John Mulligan:
Yes, the other thing I'd add, Matt, more tactically, between Q2 and Q3, that's really last year where you saw us transition from focusing on significant promotions that were primarily Hardlines, or some of our lower-margin categories focus to the business, back to back-to-school and then into the holiday season. So as we think about the way Q2 looks versus Q3, where that promotional impact was real in Q2, but it was also we had a significant mix impact because of where we focused those promotions, a little bit less of that as we go into Q3 and Q4, so the delta between last year's margin and this year's margin will change meaningfully. And as Kathee said, we'll continue to invest in price and quality across all of our brands.
Matt Nemer:
That's very helpful. If I could just ask one follow-up on the e-commerce business. I'd love to get your insights perhaps using REDcard data in terms of how much digital growth do you think at this point is incremental, i.e. are these new customers or infrequent customers?
John Mulligan:
I think, Matt, I would answer it broadly and say that what we see across all guests is when they become engaged in the digital channel, we see incremental growth in that channel and importantly, incremental growth in the stores. So their total engagement with us is very incremental. We pick up incremental sales and, importantly, incremental profitability in both channels.
Operator:
Your next question will come from the line of Scott Mushkin with Wolfe Research.
Scott Mushkin:
I just wanted to get into the topic of traffic. I mean, I think traffic was up, second quarter in a row that it's been up, but I was wondering if you could maybe deep -- dig a little deeper into that. Someone on the grocery space talks about loyal households, and it seems to me when you think about Target, you guys want to build frequency and you want to build these loyal households. How are you thinking about that? Do you measure that? Is that measure improving? Some of our research suggests some of the early things you guys are doing should be building this number, but I wanted to get your take on it.
Kathryn Tesija:
Yes, I would say that, Scott, it's pretty early in our transformation to say that we see momentum in that measure as it pertains to Food. I will tell you a lot of our growth in transactions is driven by new guests, and that's driven more in the signature categories that we have been talking about. Now we believe that we have an opportunity to drive traffic in Food, and that's why we're in the midst of putting a lot of tests out in front of our guests, both product and presentation, to get that business on track and to make sure that we've got a really compelling point of view for our guests. And then we will measure that over time to make sure that we're making progress. But today, I would say it's more driven by the signature categories that we've highlighted.
Scott Mushkin:
Yes, I mean, that was actually where I was going. Not just Food, just on the idea that I think your heavy users were up 25, 30 visits a year. Are you seeing increase in those types of loyal households? It seems to me that might be a key driver here as we go forward to get that frequency up.
Brian Cornell:
Scott, it's certainly something that we're going to continue to monitor and measure over time. It's still very early for us, but that is a measure that we're clearly looking at. We absolutely want to make sure we're building loyalty. We want to build engagement and traffic. We believe our focus on signature categories brings guests back to Target, looking for what's new, what's exciting. And we also want to make sure we complement that with an improved Food assortment because we know Food is critically important to building engagement and driving overall traffic.
Scott Mushkin:
Right. Perfect. And I had one other one. We obviously are in the stores quite a bit, and I wanted to get your take, I mean, some of the pushback that we hear from investors is on the store-level execution, staffing levels, in-stock position. I think people wish it'd maybe just be a little bit better. And I was wondering what you think of that. And are there initiatives to kind of improve some of those measures? And where do think you are? Kind of what inning do you think you are in on these areas?
Kathryn Tesija:
Yes, I think as we would measure that and as we look at the guest feedback that we get, Scott, I would say store execution is very high. Guests are very satisfied with the number of people that we have, their ability to help them. I would say that we have an opportunity on the in-stock side, and we've been working on that collectively, stores and merchandising, as we work through the port situation and getting those back in stock, but also just our everyday basics. And it's one of the reasons why our inventory is elevated, as we've talked about, is that we have been making investments, particularly in essentials category to make sure that we can raise our inventory levels appropriate to be in stock in those categories. So I think that's where we have the most opportunity right now.
Brian Cornell:
And Scott, that's reflected in the key initiatives we've been talking about. As we think about changes we're making in experience to elevate Apparel with mannequins, to restructure our Home layouts, to begin to make changes in Electronics, we want to make sure we provide the guest with a great in-store experience, particularly in those signature categories. But as Kathee just noted, we also need to make sure we're focused on the basics every day, and we need to make sure we've got very high in-stock conditions, particularly in those key consumable categories. So for us, execution at store level is critically important. We believe we have the best team in retail, and our focus now is on elevating the experience in those key signature areas of our store and ensuring that we're improving the in-stock conditions for basic essentials.
Operator:
Your next question will come from the line of Robby Ohmes with Bank of America Merrill Lynch.
Robert Ohmes:
I think maybe for Kathee, the comment you just made to Scott Mushkin about a lot of the growth in transactions being driven by new guests. Can you give us a little more insight to that? Is that a shift in traffic away from frequency and towards new guests? And how significant is that? And is there -- how are you doing it? Is it -- are there some new marketing approaches you're taking to get people into the stores to alert them about the signature categories, et cetera? Just some color on that would be great.
Kathryn Tesija:
Yes. So this is something that we aim to do all the time and of course, right now, we're comping against some pretty weak numbers post-breach last year, so certainly that's part of it. As we focus on signature categories, I do think that's getting more new guests back into the brands and in a variety of different areas because signature categories cover so much from Beauty to Home, et cetera, to the different Style categories. And I think the way that we're doing it is really what Brian was just talking about
Robert Ohmes:
And Kathee, can you just comment more on the sort of propensity to trade up for the guest? Is it -- is there something changing there? Or is that just easy comparisons?
Kathryn Tesija:
We've seen this coming for a little bit now. Third quarter was the start of it, continued into fourth quarter and now again in our first quarter. But I think as we're improving quality, as we're stepping up our assortments to be more aspirational, we're seeing the guest really resonate with that product and move. And that's broad across virtually all of our categories, so not just in one segment of our business but really all of them. So I think it's driven by the guest perhaps having a bit more money in their pocket. I think it's the quality that we've put in. They're recognizing those benefits, and they're wanting to be able to trade up.
Brian Cornell:
Robby, the one point I'd emphasize so that we're really clear
Operator:
Your next question will come from the line of Sean Naughton with Piper Jaffray.
Sean Naughton:
Just, I guess, a regional question. In terms of the comp on a regional basis in the first quarter, did you see any differences in your sales trends in states that are potentially a little more dependent on oil and gas? And then I guess the follow-up there is, can you also address any negative or potentially positive impact on the organization you see in areas that are increasing the minimum wage?
Brian Cornell:
Yes. Let me start with the regional performance trends, and we didn't see any correlation between what you just referred to
John Mulligan:
For the minimum wage question, no. We haven't seen those types of impacts either.
Sean Naughton:
Okay. And then just secondly, it looks like REDcard, a nice pick-up.
Brian Cornell:
Yes.
Sean Naughton:
Looks like on a sequential basis and year-over-year. Can you just talk about where management expectation is now on this particular product and where we think this could potentially go over the next 2 or 3 years here?
John Mulligan:
It's a great question, Robby, and I think we're sorting through that. We wanted to get through annualizing past all of last year with the breach and the impact there. We're really pleased that we saw 110 basis points of penetration growth. We're seeing new accounts grow again, roughly split equally between credit and debit. I think as we learn a little bit more here as we
[Audio Gap] through this year, we'll figure out where we want to go. We still are very energized by REDcard as a product offering. I think the opportunity for us is to tie that into a more holistic loyalty offering for our guests. We're testing some of that now out east. And you'll see us, as the year goes on, continue to test that; take those learnings and apply it more broadly to loyalty for our guests.
Operator:
Your next question will come from the line of Greg Melich with Evercore ISI.
Gregory Melich:
I have a couple of questions. I wanted to make sure I understood the SG&A progression a little bit better. I think, John, in the guidance you said we would delever 20 to 30 bps in the second quarter, which if I take your comp guide, suggests it will be up around 5% in dollar terms. Is that -- are we thinking about that right? And what's the real run rate once you get through some of these other timing issues and the breaches on SG&A dollars?
John Mulligan:
Yes, I think, yes, you're right, and all of that increase is really incentive expense offset by, again, some productivity improvements. I think as the year progresses, we'll continue to see improvements in SG&A. As we said throughout the year, as the year progresses, we'll continue to start to see the savings that we committed to the $2 billion
Gregory Melich:
Okay. Got that. And then, Brian, I think in your prepared discussion, you've mentioned some disappointment on digital execution, particularly around the Lilly launch. Could you give us a little more detail on what's being done to address those issues in terms of how the website actually works or supply chain? Will you ultimately invest more in fulfillment center capacity? Or just some actual actions to try and address that.
Brian Cornell:
Greg, in some ways, you've answered the question for me, and we've been very clear in the fact that we're going to make a $1 billion investment in technology and supply chain to enhance those capabilities, to improve our capabilities, to make sure we're partnering up technology with the ability to provide the product effectively through our supply chain. So the Lilly event, while a sensational event for the brand and we're really proud that we were able to create a Black Friday-type event in the month of April with hundreds and thousands of our guests lining up, waiting for that product. But online, we know we had some missteps. And we're doing a deep dive, we're looking at root causes, and it's going to provide important learning for us as we get ready for the traffic we expect to generate during the holiday season. But we are very committed to putting our capital behind improving technology capabilities and the supply chain requirements necessary to continue to grow that business at the accelerated rates we're delivering right now.
Gregory Melich:
When do you think you'll know the things you need to get done for holiday? Is that something you'll know now? Or is it something to learn in the fall?
Brian Cornell:
Well, this afternoon would be nice, but we are actively tearing apart the learning and, clearly, want to make sure that we have the diagnostics in place as soon as possible, and we're making the necessary adjustments and investments to enhance our overall digital experience. So this afternoon would not be soon enough, and the team has an incredible sense of urgency to ensure that we have the right capabilities so that we're constantly meeting the needs of the guests.
Kathryn Tesija:
And Greg, I would just add that we're never done with that. So certainly, we're learning from the Lilly event and we will put that into place as soon as possible. But as we're growing at the rate that we are and we're introducing new code all the time, we are never done. So this is an ongoing effort probably until the end of time.
Operator:
Your next question will come from the line of Peter Benedict with Robert W. Baird.
Peter Benedict:
A couple of questions. First, just on "Made to Matter." Just can you revisit how many brands have been designated with that, what categories you're seeing being most impactful so far, and what you're doing from a marketing standpoint to support them?
Kathryn Tesija:
Yes. So "Made to Matter" has been a fantastic program for us, Peter. As you know it, we went from about 15 vendors last year and we increased that to about 30, 31 vendors this year, and we're seeing about 25% lift in sales. So the guest is really loving the product that we're offering. It's in a variety of categories. There are certainly Food products, but there is Beauty products. There's OTC. There's Baby. All of them, though, are really driven by a simpler, better-for-you product, whether that's in Food with cleaner labels and organic, or whether that's in Baby, where it's cotton and more natural materials, but really great results. And we marketed it most recently in the past month in what we call the rear seasonal area of our store, where we brought all the products together for the first time and had really fantastic results. There was a marketing campaign that went along with that, that really resonated with the guest and then the in-store presence helped make it easy for them to find when they came to the stores.
Brian Cornell:
Peter, I think the great part of the program is it's just another point of validation that when we understand what the guest is looking for and we deliver the right curated assortment, they respond really well. You know that we have over 25 million guests visit our stores every week. We know that 98% of our guests purchase natural or organic products. Thus, we need to make sure we offer them the products and the selection they're looking for. It doesn't mean that conventional products don't play a very important role going forward, but our guest has voted. We understand the guest better than ever before, and Kathee and her team are just doing a sensational job of curating the right assortment and bringing the guests what they're looking for when they shop at Target.
Peter Benedict:
And that's helpful. Do you think -- is 30 to 31 a good number that you guys think you'll stick with? Do you think you'll add additional vendors to that program over the next 12 months or just maybe rotate out some and keep the number at 30, 31?
Kathryn Tesija:
I think that's a pretty good number. We're still evaluating the program. It's just -- we launched the new vendors this spring. So we're still analyzing those results. But to Brian's point, the guests will guide that work. The important part about "Made to Matter" is that while these brands might be carried elsewhere, we have exclusive products with meaningful innovation within the program within Target, and that's what's really resonating with the guests. They recognize those brands are at Target, and they love to buy them, but they come looking for those new exclusive, really innovative products. So I think keeping the number at a reasonable amount so that we're sure that we can drive that right innovation that's very much a partnership with us and these suppliers. So I think we're in the hunt with the right number.
Peter Benedict:
Okay. That's how we've definitely seen it in the stores as well. A quick one just on the Food repositioning. What should we -- in terms of the cadence this year, in terms of testing things, what should we be looking at? Is there going to be space allocation changes? Is it going to be just new brands? And once you do decide what you're going to do, is it going to be an early 2016 kind of rollout, something that could impact a lot of that year? Or is it something that would happen kind of later in '16?
Brian Cornell:
Peter, Kathee and I have been talking about this for several months now. We're using 2015 to test and learn. Kathee's talked about key categories within Food that we really think Target should stand for, and we're looking very closely at how we evolve assortment and how we merchandise those categories going forward. But this is not about how fast we make the changes. We want make sure we really have a chance to test, learn, get the feedback from the guest, iterate, so that as we move into 2016 and beyond, we move forward with confidence and with the confidence that the guest has guided us through the changes we're going to make. So we're clearly focused on it. The team is making very good progress, but we're in that test and learn and validate environment right now, and you should expect to see much more unfold as we get into 2016.
Kathryn Tesija:
The thing that I would add is as we're going through the testing, as Brian mentioned, we're testing many different things, whether that's assortment changes that we're making, presentation changes that we're making, supply chain changes, part of our testing is to try to isolate those tests so that we can get a good read. So there's not going to be one place that you can go and look at what does the new Food innovation look like. We've got it all over the place. And the other thing that I would add is you know that we've just hired Anne Dament to run the Senior Vice President of Grocery, and we're very excited about that. She's been on board now for about a month. Anne brings us 19 years of experience in grocery and CPG. So she's certainly learning and on-boarding into Target and bringing a wealth of knowledge from Grocery, which will also impact what we put forth in terms of tests for the rest of the year. But I think you can look to 2016, as we learn and prove out what's working with the guest, what's resonating. We will start rolling those in 2016, but don't expect a big bang on January 1. To Brian's point, this is really about getting it right and delighting the guests, not moving fast.
Operator:
Your next question will come from the line of Bob Drbul with Nomura.
Robert Drbul:
I just had a couple of questions. On the gross margin line, did shipping expense at all impact you with the move to $25? And how many REDcard holders are utilizing their cards for free shipping? And how do we think about that as e-commerce continues to grow?
John Mulligan:
So certainly, shipping expense went up when we moved to $25, but I would tell you not a material impact on the quarter. And net-net, as we've said, as that brings more guests online, they shop our store and so a net positive as far as we're concerned across the lifetime value of those guests. I don't have the actual number of REDcard holders that use free shipping on the site, but I can tell you the penetration of free shipping due to REDcard on the site is very, very high. We -- in general, we have a very high percentage of our shipping that goes out free from the site. We talked about this last year when we shipped to free -- switched to free shipping during the holiday season. And I think that is why, going back to what Brian said, the supply chain investments we make are incredibly important for our guests because they provide speed to market from their perspective, but they're incredibly important for us because they improve the economics of our online business meaningfully.
Robert Drbul:
Got it. And the second question I have is there's a lot of license initiatives that are coming over the next several quarters. When you think about the year-over-year impact on the business overall, are those gross margin-accretive in terms of what they're trying to do? Or will they be lower margin? And just how do we think about that as it relates to mix and the gross margin overall?
Kathryn Tesija:
Yes, a lot of that depends on the categories. I think the good part about licenses at Target is that our guests respond to them very broadly. So it isn't just a toy or a video game. For us, there's Apparel involved, there's back-to-school products like backpacks and notebooks. So it's a pretty -- they have a pretty healthy margin mix just given the breadth of category, and most of them fall into our signature categories. So we're very excited about the lineup of licenses and the fact that they start this summer and really go all fall.
Operator:
Your final question will come from the line of Christopher Horvers with JPMorgan.
Christopher Horvers:
So 2 quick ones. You usually guided the first quarter gross margin up 40 to 50, so I was curious what came in better versus your expectations? Was it mix? Or was it the level of promotions -- lapping the level of promotions year-over-year? And then I have a follow-up.
John Mulligan:
Yes, it was mix, is what came in better. I think we see that in 2 ways. First of all, there's just the mix of selling those products, and then when we see strength in Home and Apparel, of course, our sell-throughs go up and so we have less markdowns. And so the positive benefits of mix go on and on.
Brian Cornell:
Yes. I'd only add, Christopher, that again, we saw that mix benefit both in-store and online. So the combination of those 2 channels working together clearly impacts and improves gross margin rate.
Christopher Horvers:
Understood. And then so the outlook, I know you mentioned this going forward. So the outlook in the second quarter is predicated on recapturing both of those and then going on further in the year. It's really expectation that the signature categories out-comp more the essential side.
Brian Cornell:
That is certainly core to our strategy as we go forward. And I think what you saw, what we saw in Q1, very solid performance. Kathee and her team did a terrific job of curating the right products, particularly in those signature categories for our guests. Despite some of the port challenges, our supply chain teams did an outstanding job of making sure that we had inventory in place for the guests. I was very pleased with our marketing program. And if you haven't seen the Target Style campaign or some of the things we just did for Avengers, it's spectacular advertising and the guest is responding to it. And our store teams just did a phenomenal job throughout the quarter, despite port challenges and weather challenges, in providing the guest with a good experience, and it added up to really solid results in Q1. So we hope that continues. We're confident it's going to continue throughout the year. But -- and we feel good about the progress, we know we've got a lot of work in front of us, but that combination of strong in-store and online growth in the first quarter gives us a lot of confidence that we're heading in the right direction. So operator, that concludes our call today. I thank everybody for their participation, and we look forward to talking to you next quarter. Thanks.
Operator:
This does conclude today's conference call. You may now disconnect.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation Fourth Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, February 25, 2015.
I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.
John Hulbert:
Good morning, everyone. Thank you for joining us on our Fourth Quarter 2014 Earnings Conference Call. Sorry about the technical difficulties that delayed us a couple of minutes there.
On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Financial Officer; and Kathee Tesija, Chief Merchandising and Supply Chain Officer. This morning, Brian will discuss our fourth quarter performance and our priorities going forward and Kathee will provide insights into holiday and fourth quarter results across our merchandise categories. And finally, John will provide more detail on our fourth quarter and full year financial performance. Following their remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others, who are listening to our comments via webcast. Following this conference call, John and I will be available throughout the day to answer any follow-up questions you may have. Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP EPS is included in this morning's press release posted on our Investor Relations website. Finally, given that we're hosting our Financial Community Meeting in New York next week, our remarks today will focus on Target's fourth quarter performance and our guidance for the first quarter of 2015. At next week's meeting, we will describe in detail our longer-term expectations, including full year 2015 financial performance. As a result, we are shortening today's call to 45 minutes, and we look forward to spending another 2.5 hours with all of you next week. With that, I'll turn it over to Brian for his comments in the fourth quarter and holiday season. Brian?
Brian Cornell:
Thanks, John, and good morning to all of you. Appreciate your patience this morning.
We are very pleased with our fourth quarter financial results, which we announced earlier this morning. Our fourth quarter adjusted EPS of $1.50 was 14.9% higher than last year and above the high end of the updated range we provided in our January 15 press release. Our fourth quarter comparable sales increase of 3.8% was also stronger than the updated guidance we provided in January as we saw unexpected strength in our store channel sales in the last 2 weeks of the quarter. And of course, when we look back at our point of view going into the fourth quarter, comparable sales growth turned out to be nearly double our original expectations, as our combination of products, promotions, holiday marketing, fulfillment capability and in-store execution drove profitable growth in an intensely promotional environment. We are pleased that comps in all 3 months of the quarter were positive, and November's strength was particularly notable given that we were annualizing a strong increase in November 2013. We're also pleased that traffic was the primary driver of our fourth quarter growth as well as the fact that the digital channel growth contributed nearly a full percentage point to our fourth quarter comparable sales increase. Our fourth quarter gross margin performance was also very strong with a favorable mix reflecting strength in signature categories. Our merchant team did an outstanding job managing inventory flow, benefiting both in-stock and gross margin, which was particularly challenging this quarter in light of the slowdown in productivity at the West Coast ports. Once again, our store team did an outstanding job of managing core costs in the fourth quarter, delivering productivity improvements along with outstanding service to our guests. As I've mentioned to many of you, one of our priorities going forward is to harness best practices from our stores and apply them to the rest of the organization to modernize the way we work and drive productivity improvements while maintaining quality in everything we do. If we look back at the full year, it's clear that 2014 was a year of transition, in which we began to lay the foundation for the transformation we will accomplish in the next few years. A year ago, we were in the recovery mode, working to repair guest relationships following the data breach while we undertook an assessment of the long-term prospects for our Canadian business. Fast forward to today, and we've ended the year with the data breach fully behind us, and now that we've made the tough decision to exit the Canadian business, our team is focused and aligned on 5 priorities I outlined in our third quarter call. The first priority is to drive industry-leading digital sales growth as we build the capabilities to become a leading omnichannel retailer. Our digital growth led the industry in 2014, and we're working to build on that success in 2015 and beyond. Our second priority is to clearly define roles for each of our merchandise categories and build appropriate plans for each of them. While we're in the early stages of this journey, I am pleased with our efforts to invest in the growth of our signature categories like Style, Baby, Kids and Wellness. These are the categories we're most famous for, and our guests has asked us to lead with them in the years ahead. Beyond these signature categories, we're defining appropriate roles for each of our categories, and we'll invest in them appropriately to ensure we're providing our guests convenience through a differentiated, inspirational and one-stop shopping experience. Our third priority is to become much more localized in the assortment and experience we provide in our stores and more personalized in our digital interaction with our guests. We are in the very early stages of these efforts, and we see huge opportunity ahead of us. So we're investing in these capabilities; we'll need to make progress on this priority over the next few years. Our fourth priority is to develop and test new formats that will help us better serve our guests over time. We're seeing strong financial results from our 8 CityTarget stores, and we've seen very strong initial performance in the test of our first TargetExpress location, which opened here in the Twin Cities last August. In 2015, of the 50 new stores we're planning to open, more than half of these are new formats with 8 additional Express stores and a new CityTarget set to open in Boston next to Fenway Park. And finally, we're committed to reducing complexity and controlling costs in order to fuel our investments in the growth priorities I've just outlined. As mentioned earlier, our stores have been leading the way in these efforts. So in the next few years, we're looking for opportunities outside our stores to become more agile, move faster, gain scale efficiencies in the way we work. We believe meaningful opportunities exist, and the leadership team is committed to moving decisively to modernize the way we work and create the capacity we'll need to invest in the priorities that will drive growth and returns on invested capital. At our meeting with you next week, we're looking forward to providing you more specifics on how we're planning to advance these 5 priorities while providing insight in how our plans will translate into financial results, both this year and over the long term.
Our plan for the day is as follows:
I'll lead off the day by providing details on our strategic priorities, our approach to growth and the principles guiding our leadership team as we work to deliver on these priorities. Then John will provide more detail on our financial expectations for each line of the P&L going forward, and he will provide full year guidance for 2015 financial results from continuing operations, reflecting our plan to grow earnings per share this year. Casey Carl will follow with details on our digital progress and his plans to transform the organization by developing new capabilities that will support our growth, control costs and recapture the innovative spirit that's part of the company's DNA. Then Kathee Tesija will provide more insight into our core guests and our plan to develop products, experience and formats to serve those guests over time. And then Jeff Jones will provide insight into the guest relationship with the Target brand and his team's work to modernize our marketing and the way we interact with today's core guest. Finally, we'll end with a Q&A session.
We're looking forward to the opportunity to share these plans with you next week and we're confident that we can build on the early momentum we've seen over the last few quarters. We have a fantastic foundation to build on with a great brand, loyal guests and an outstanding key team, and we're committed to maintaining our focus on our key priorities and making the tough decision to position Target for long-term success. Now I'll turn the call over to Kathee to recap our fourth quarter and holiday season performance. Kathee?
Kathryn Tesija:
Thanks, Brian. Across the U.S. Retail landscape, this year's holiday shopping season began earlier and ended later than ever before. This lengthening of the season reinforced the pattern we've seen for well over a decade, where we saw the strongest sales in the early and late portions of the season and experienced a period of softness in the middle.
Specifically, throughout November, our comparable sales performance, including the Black Friday weekend, was very strong on both a 1-year and 2-year basis, driven by strong promotions throughout the month combined with in-store events and Cartwheel daily deals. In December, following the characteristic lull that we've seen for more than a decade, we saw a very strong surge in traffic and sales in the days leading up to and after Christmas. And in January, we continued to see unexpected strong results throughout the month. As Brian mentioned, we saw particularly strong trends in fourth quarter sales in our signature categories, specifically health care, Beauty, Apparel and Home all grew faster than our overall sales. Within Apparel, results were strongest in Baby and Kids, and Home comps were led by Domestics and Seasonal items. In Hardlines, our Toy category had a fantastic quarter, recording a double-digit increase in comparable sales driven by a strong lineup of Target exclusive items throughout the assortment. Average retails were up across all of our categories as guests were trading up within assortments, and we saw strong regular price sell-throughs in Seasonal and markdown-sensitive categories. Digital channel growth also contributed to the growth in the average retail, particularly in Home and Apparel, both of which saw digital channel penetration growth of more than a percentage point in the fourth quarter. Throughout the holiday season, we were very pleased with the performance of our fourth quarter limited-time partnerships with TOMS and Faribault Woolen Mill. Guests responded to the stories behind these brands, and we're delighted by the combination of quality and price we could deliver. I already mentioned the great quarter in Toys, which we supported this year with the launch of our Kids' Wish List app, a fun, interactive way for kids to let their families know which gifts were at the top of their list. We saw strong guest engagement with this new app, as nearly half the families who used it created a list for 2 or more kids. And by the end of the season, thousands of new target.com accounts had been created by Wish List users. Our intention going forward -- excuse me, our intention-getting offer to ship all digital orders for free during the holiday season provided compelling value and convenience to our guests. The offer created a surge in traffic and conversion on both our conventional sites and mobile, which, as expected, was partially offset by a moderate decline in average transaction size. Because our guests responded so well to this holiday promotion, we were excited earlier this week to announce that going forward, we are reducing the order threshold for free shipping from $50 to $25 with virtually no exclusion. This new minimum is among the most compelling offers in digital retailing, putting us ahead of many of our key competitors. In our digital channel for the fourth quarter overall, we saw a high single-digit increase in visits driven entirely by growth in mobile, which includes both tablets and smartphones. Orders were up well over 50% driven by very strong conversion increases on both the conventional site and mobile. Mobile is becoming increasingly important to all digital retailers, and given the profile of our guests, it's particularly important for Target as mobile accounted for more than 40% of our digital orders in the fourth quarter. And notably on Black Friday, 10% of our iPhone app revenue was from guests purchasing on their phone while they were simultaneously shopping one of our stores. Our flexible fulfillment efforts play a key role in supporting our digital growth, and we're pleased with the results of our Store Pickup program and our recent rollout of ship-from-store capability. This was the second holiday season in which we've offered Store Pickup. And since last year, we've added more dry grocery items, extended the pickup window from 2 to 4 days, and we've begun testing dedicated parking spots. This year, we had more than 400,000 Store Pickup orders on the Black Friday week alone, and they accounted for half of our digital traffic in the last 4 days leading up to Christmas. For the year in total, 84% of Store Pickup orders were picked on time, and 35% of the time, guests who picked up a digital order also shopped the store on the same visit. This was our first holiday season with ship-from-store capabilities, having rolled out to 139 stores at the end of the third quarter. This capability allows us to ship more than 60,000 items directly from stores to our guests' front doors, dramatically cutting shipping times while reducing our shipping costs. We were pleased with the ability of this initial group of stores to handle the shipments from their back rooms, which peaked in the last week of November. And importantly, this capability allowed us to continue to fulfill holiday orders late in the season for items which were already sold-through in our fulfillment centers, but still available in our stores, allowing us to capture incremental sales. Before I move to our plans going forward, I want to pause and discuss the situation at the West Coast port. As you know, the slowdown at these ports began several months ago, and our fourth quarter performance clearly demonstrates that our team was effective in handling the slowdown by rerouting, expediting and pre-ordering inventory to support in-stocks. We were very pleased with last weekend's news that a tentative agreement had been reached, but we know it will be some time before the backlog at these ports will be fully eliminated. In the meantime, we have contingency plans to continue to work around potential issues. But at times, we may encounter periods of light inventory in some assortments. Now I want to give you a few highlights of our plans going forward, and of course, we will have much more to cover with you next week. Last year, we began to test and roll out a variety of store presentation innovations to elevate the shopping experience and differentiate our brand. Based on the guest response to these changes, we are planning to accelerate our rollout in 2015. For example, following the addition of mannequins at the apparel floor pad in more than 600 stores last fall, we are planning to roll them out to another 400 stores this quarter. And based on the guests response to our enhanced Entertainment and Electronics experience, which is currently in 42 stores, we plan to roll this environment out to another 275 stores this year. In Home, we've begun testing highly inspirational vignettes to show products in lifestyle settings, which we're rolling out to another 15 stores this quarter. Farther back in the testing phase, we are looking at innovations to bring even more fun to our toy area with easier navigation, interactive experiences, larger-than-life displays and floor graphics. We are always looking for creative platforms to engage guests in new ways that are meaningful to them. Snapchat provides a fun channel for us to quickly share exclusive behind-the-scenes content with our guests that they can't get anywhere else. If you are one of the fans who witnessed Target's Snapchat debut, you caught a glimpse of the first story, which teased our history-making GRAMMY commercial with Imagine Dragons, to announce the Target-exclusive version of their new album containing 4 exclusive bonus tracks. Jeff will have more to say about this groundbreaking GRAMMY moment at our meeting next week. Guests are excited about the recent launch of our new plus-size brand, AVA & VIV, which we launched earlier this month. Designed by our own product design and development team, AVA & VIV features stylish basics along with trend-driven statement pieces. Similar to Target's other apparel line, AVA & VIV will be updated monthly with prices ranging from $10 to $80. And the anticipation is building for our upcoming partnership with Lilly Pulitzer. With a modern interpretation of the American resort wear brand's exuberant prints and patterns, the limited-edition Lilly Pulitzer for Target collection features 15 exclusive prints, which are original works of art created by Lilly Pulitzer artists specifically for this modern collaboration. Available exclusively at all Target stores in the U.S. and on target.com beginning April 19, the 250-piece collection includes apparel, accessories and shoes for women and girls as well as home accents, outdoor entertaining accessories, beach gear, travel essentials and more. And finally, as Brian mentioned, wellness is one of the signature categories in which we're reinventing -- or investing to differentiate our brand and our assortment from the competition. We have a huge opportunity in this space because our guests have told us it's particularly important to them. Specifically, nearly every household that shops at Target buys natural and organic products, and more than half of them indicate that they prefer to purchase natural and organic products when available. These guests insights are reinforced by their behavior in our stores. While overall sales in the natural and organic industry are growing rapidly, sales of these categories at Target are growing even faster, outpacing the industry by 50% in 2014. The "Made to Matter" collection remains one of the most prominent and active examples of Target's focus on wellness, offering guests a selection of natural, organic and sustainable products across multiple categories. In 2014, sales of the brands featured in our "Made to Matter" collection grew twice as fast at Target than they did elsewhere in the market. In 2015, we'll reinforce our commitment to newness and better-for-you choices with the refreshed "Made to Matter - Handpicked by Target" collection. This year's collection will double in size compared to last year, delivering more than 200 new and exclusive products from 31 leading and upcoming brands. As we look ahead to the new year, our priorities in merchandising are clear. We will build appropriate plans for each of our categories based on the role they play in supporting our brand and delivering superior shopping experience. In our signature categories, we will invest in product development, marketing, fixtures and store service to elevate and differentiate both the assortments and the shopping experience, fully delivering on our "Expect More. Pay Less." brand promise. Our fourth quarter results demonstrate that we are making some early progress in this work, and we are dedicated to moving much faster in this transformation in 2015. Now I'll turn it over to John, who will share his insights on our fourth quarter financial performance and our outlook for first quarter 2015. John?
John Mulligan:
Thanks, Kathee. Our first quarter financial results were stronger than expected driven by better-than-expected sales performance in the U.S. Our adjusted EPS of $1.50 is better than the high end of the guidance provided in our January 15 update and about $0.11 better than our expectations for U.S. performance at the beginning of the quarter.
Fourth quarter diluted EPS from continuing operations was $1.49, about $0.01 lower than adjusted EPS driven by a combined $0.02 of dilution from the reduction of the beneficial interest asset combined with net data breach expenses, partially offset by the benefit from the resolution of income tax matters. Fourth quarter GAAP EPS losses of $4.10 reflected $5.59 in losses from discontinued Canadian operations. Our fourth quarter comparable sales increase of 3.8% was above the guidance of around 3% that we provided in our January update and nearly double the 2% growth we expected at the beginning of the quarter. More than all of the sales outperformance in the last few weeks of the quarter was in our stores as digital channel sales came in a bit softer than expected in those last few weeks, reflecting a slowdown in demand sales growth as we annualized over promotions from a year ago combined with returns, which came in somewhat higher than expected. Even so, digital channel sales increased a robust 36% in the fourth quarter on top of a very strong increase in the fourth quarter of 2013. And as Brian mentioned, digital channel growth delivered about 90 basis points of our fourth quarter comparable sales increase, up from a 60-basis-point contribution in the third quarter. U.S. REDcard penetration of 21.1% was about 20 basis points ahead of last year and in line with our expectations. As I mentioned last quarter, based on trends in new accounts, we believe this quarter represented a trough in penetration growth. And we expect to see a moderate reacceleration in penetration growth in 2015. This growth should benefit later in the year from the introduction of chip-and-PIN technology for all of our REDcards and the changeover to MasterCard on our legacy co-branded credit card program. Our fourth quarter EBITDA margin rate of 9.9% was somewhat stronger than expected driven by very strong gross margin rate performance, partially offset by a small increase in our SG&A expense rate. Specifically, our fourth quarter gross margin rate of 28.5% was nearly a percentage point higher than a year ago and the strongest fourth quarter performance we've seen since 2010. This year's rate benefited from a favorable mix of sales growth in our signature categories combined with better markdown rates as we annualized last year's clearance and promotional activity following the announcement of the data breach. I want to pause here and comment on our inventory position at the end of the quarter, which was about 6% higher than last year. This increase was intentional and reflects 2 separate decisions. First, in the last 6 months, we've chosen to increase our inventory in commodity categories to enhance in-stocks in these frequency-driving businesses; and second, we ordered ahead in import categories in light of the slowdown of the West Coast ports. Bottom line, the inventory increase is the result of specific decisions we've made and we feel very good about our overall inventory level as we enter the new fiscal year. Getting back to the fourth quarter P&L. On the SG&A expense line, we benefited from productivity improvements in the stores and overall leverage on pay and benefits, offset by higher marketing, technology and extensive expense rates compared with last year. Altogether, our fourth quarter SG&A expense rate was about 20 basis points higher than last year. Moving to consolidated metrics. Fourth quarter interest expense was up about 6% from last year, and we paid $330 million in dividends in the quarter, an increase of 22% over last year. As expected, we didn't repurchase any shares in the fourth quarter. However, as we discussed in our January update, the exit from the Canadian market will meaningfully improve our credit metrics going forward. And provided the wind down of our Canadian operations continues to operate -- to proceed as planned, we will be in a position to revisit the possibility of share repurchase later in 2015. As always, I will reiterate that we will only resume repurchase activity if we believe it can be accomplished within the limits of our current investment-grade credit rating. As we look back at full year performance in the U.S., our 2014 adjusted EPS of $4.27 was down slightly from $4.38 in 2013 driven by earlier challenges as we recovered from the data breach. However, the healing of our business has been evident in the progression of our financial results throughout the year. Specifically, comparable sales, digital channel growth and year-over-year gross margin rate performance all improved as we move throughout 2014, and expenses remained well controlled throughout the year. Next week at our meeting with you in New York, we will outline in detail our plans to build on this early momentum over the next few years. Before I turn to the outlook for the first quarter of 2015, I want to cover a small change to our adjusted EPS reporting, which we present in order to reflect the results of operations from what is now a single-segment business. Given that we have now amortized $151 million or 2/3 of the original value of the beneficial interest asset related to the 2013 sale of our Credit Card receivables portfolio, beginning in 2015, we will no longer remove the amortization of the beneficial interest from our adjusted EPS calculation. This is because both the quarterly amortization amounts and the year-over-year changes in those amounts are expected to be immaterial going forward. And therefore, we believe our reporting will be streamlined if we make this change. In our reporting throughout 2015, prior year adjusted EPS results will also reflect this change to ensure consistency for comparison purposes. With that, let's move to our outlook for the first quarter. We expect our comparable sales to increase about 2% driven by an increase in digital channel sales of 30% or more combined with modest growth in store channel sales. While it's still early in the quarter, our results for the first few weeks of February are consistent with that forecast. On our first quarter sales, we expect our gross margin rate to improve 40 to 50 basis points from last year as we annualized last year's very intense promotions, which we used to recapture traffic coming out of the data breach. On the SG&A expense line, we expect our first quarter rate to be flat to down slightly from a year ago as we expect that benefit from store productivity improvements will be offset by higher marketing and technology expense rates compared with last year. We expect our G&A expense rate to be about 10 basis points higher than last year, reflecting the impact of continued investments in technology to support our digital, flexible fulfillment efforts. Altogether, we expect an improvement in our first quarter EBIT margin of 30 to 40 basis points above last year. First quarter interest expense should be approximately flat to last year, and tax expense is expected to be about $50 million higher than last year, reflecting improved profitability and a higher consolidated tax rate compared with a year ago. Altogether, these expectations would lead to first quarter adjusted EPS, representing results of continuing operations in our single-segment business of $0.95 to $1.05 compared with $0.92 a year ago. As John mentioned at the beginning of the call, we're going to wait until next week's Financial Community Meeting to provide specific guidance for full year 2015 earnings growth as well as our expected financial algorithm over the longer term. This will allow us to present our financial outlook in the full context of our specific business plans, which reflect necessary investments to accelerate growth and build capabilities along with the opportunity to reduce costs over time, providing fuel to fund those investments. With that, we'll conclude today's prepared remarks. Now Brian, Kathee and I will be happy to respond to your questions.
Operator:
[Operator Instructions] Your first question comes from Simon (sic) [Simeon] Gutman from Morgan Stanley.
Simeon Gutman:
It's Simeon Gutman. First question on gross margin for John or for Brian. It was quite solid in the fourth quarter. Last year, you had a little pressure but not nearly as much as, I guess, we all expected given some of the discounting. So can you talk about what drove the expansion year-over-year in this year's fourth quarter?
John Mulligan:
Sure. I'll start. I'm sure Kathee will jump in, but I think overall what you have heard is there's certainly some savings relative to last year with the clearance activity that went on, but I think much more important to that is you saw the acceleration of what we -- the signature categories, Home, Apparel, Style, Kids, many of those with margin rates well in excess of our average margin rate. And I think for the first time -- Kathee and I couldn't even remember the last time where both Home and Apparel out-comped the company. So we really saw a very strong mix in the quarter delivered by the product in the stores.
Kathryn Tesija:
Yes. So on top of the mix, I would also say that regular-priced sell-through was very high. So less on clearance or markdown and more at full retail, which also contributed.
Simeon Gutman:
Okay. And just one follow-up. I'm sure this will get addressed next week. But can you just tell us what the average wage for full-time associates and/or part-time associates are at Target?
John Mulligan:
We don't disclose the average wage for our team members. What I would tell you is the store's team has always been a point of differentiation for Target, and we've always prided ourselves and believe we have the best team in retail. And so very focused on ensuring we have competitive wages and that we're developing our team members. We're all the time assessing the marketplace to determine competitive wages and making adjustments, and we feel very confident that we'll be paying the teams appropriately. I think importantly, if you look at our team leaders, 60% of them came from team members. So development is a really big part of what we offer to our team as they progress. Overall, as we look at some of the announcements that's been made in the marketplace and the minimum wage legislations act really hasn't changed our view of the quarter or the year really at all and won't be material changes to us.
Brian Cornell:
To really build on that, I'm sure we're going to receive this question again next week. But to John's point, our goal is to make sure we have the very best team in retail. And we're going to continue to invest in their development and make sure that from a marketplace standpoint, we're very competitive with the wages we provide. So I've been very pleased to learn that over 60% of our team leaders actually started as part-time hourly employees. That development is critically important. It allows us to attract terrific team members. And as John stated, we do not expect to see any material change next year.
Operator:
Your next question is from Matt Nemer from Wells Fargo Securities.
Matt Nemer:
I want to follow up on that last comment around wages. Brian, can you just provide some context around how much opportunity you think there is to reduce complexity and improve efficiency in case you needed to respond to wages or you wanted to respond?
Brian Cornell:
Well, it's certainly going to be an area that we'll highlight next week, and I think you've captured it really, really well. Our focus right now throughout the organization is to reduce complexity, simplify the way we work, the way we operate each and every day, continue to empower our team members to make the right decisions that are going to impact the business. We want to create an organization that's much more agile, that moves with much -- increased pace as we go forward, and we deliver the right innovation and product that our guest is looking for. So it is a significant area of focus for us. We're going to talk about it in great detail, but we think it's going to be a very important part of our strategy going forward. It's going to fuel the key growth priorities that we've been talking about and we'll go through in great detail next week. But our goal is to make sure we eliminate complexity at Target, we simplify our operating model, we empower our team members and create an environment where we're agile, we're taking advantage of marketplace opportunities and we're bringing products and services to market that respond to the needs of our guests.
Matt Nemer:
And then just a quick follow-up on the higher online return rates. Do you think that's primarily a function of the free shipping offer? Is it more prevalent in certain categories? And is it related at all to error rates?
John Mulligan:
Actually, the return rates were higher than our expectation, but they were essentially right-on last year. We had seen some improvement throughout most of the year, and they basically just returned to last year. So not a material change, just a little bit different than our expectation for the last couple of weeks.
Operator:
Your next question is from Scott Mushkin from Wolfe Research.
Scott Mushkin:
The first thing I wanted to poke at was frequency. Brian, you mentioned that you were real pleased with the frequency going up in the quarter. Is that a focus for the company to drive frequency to the stores? And kind of maybe as a preview how -- what -- how do you get it done?
Brian Cornell:
Scott, while there's certainly a number of critically important metrics as we look at the business going forward, I can tell you that the entire leadership team has prioritized, one, increasing traffic to our stores; and two, visits to our sites. Those are critically important as we go forward. So we're going to do that by executing many of the priorities that we outlined today. We certainly want to make sure we're building the right digital and, importantly, mobile capabilities that drive greater visits to our site and build greater engagement with our guests, not only when they're shopping at home, but also when they're shopping inside of our stores. And Cartwheel is a great example of how we've used digital to drive greater engagement. I am really pleased, and Kathee highlighted the fact that our signature categories drove our growth in the fourth quarter. And it's critically important that while we're in the early stages, we're already seeing the guests react well to our focus on Style, on Baby and Kids and importantly, Wellness. And the fact that health care and Beauty and Home and Apparel outpaced our overall performance in the fourth quarter is a sign that we're connecting with the guest, and we're certainly driving more of the traffic because of these great new offerings in-store. So our focus on elevating signature categories, we think, brings our guests back to Target more often. They're going to be coming back in to see what's new. And Kathee and her team have a great lineup in 2015 of new, exciting products, coupled with an improvement in our in-store experience and merchandising. So those elements are critically important. We think localization allows us to build a more meaningful relationship with the guest, which will result in more traffic and more visits. And certainly, as we expand our smaller format, both CityTarget and TargetExpress, it's a way for us to engage the guest in these urban settings that are critically important. So all of those are focused on making sure we build greater engagement, but the metrics that are going to be important for us is to ensure it results in more traffic like it did in the fourth quarter and more visits to our site. So we're pleased with Q4. Lots of work in front of us, but I felt very good as did the entire leadership team that our comp increase of 3.8% in the fourth quarter was primarily driven by traffic. And our industry-leading growth in digital, it was certainly going to be fueled by more visits and better conversion from our site.
Scott Mushkin:
That's perfect. And I just have one quick follow-up. I have a ton of questions, but I'm just going to do one quick follow-up to what you said, Brian. You didn't mention, although Kathee did, she mentioned Food. How do you think of Food in context to traffic, and then I'll yield.
Brian Cornell:
Scott, I think you already know the answer to that. We're going to talk about this specifically next week. Food is very important to our guests, and they've confirmed that with us as we've gone back and researched the Food category through the eyes of the guest recently. We all know food trips drive traffic, and we want to make sure we complement our signature categories with guests that are coming to us for the great food products we can curate. We recognize we have a lot of work to do in Food. And Kathee and I were recently out in the market together. We spent several days visiting our stores, looking at competitive food retailers as we begin to build our reinvention plans for Food. But as Kathee will talk about next week, we recognize we need to make changes to our assortment. "Made to Matter" and some of the changes we're making right now in our assortment that deliver more organic, natural, gluten-free items, critically important to the guest and we also recognize we have to change the in-store experience and really make sure our Food and Grocery merchandising complements the great experience we create at Target. So a critically important area of opportunity. We won't get there overnight. It'll be a multiyear transition, but Food is going to play a very important role in complementing our other signature categories and making sure we drive traffic to our stores and to our site.
Operator:
Your next question is from Matthew Fassler from Goldman Sachs.
Matthew Fassler:
If you could frame some of the marketing and technology spending in the fourth quarter, just let us know what that was directed towards. And I know you're holding back to some degree on '15 guidance, but were some of those initiatives that you would expect to persist through the upcoming year?
Brian Cornell:
Matt, we'll certainly go through much more of this next week. I think if you were to look at the changes we made from a marketing standpoint in the fourth quarter, the big change would have been a significant increase in our digital support of our brand. So as we continue to make sure we're connecting with our guests, we're connecting with them the way they're looking to connect with the Target brand, digital is going to play an increasingly important role. And we were very pleased with our overall marketing in the fourth quarter. We had some outstanding creative on air. It received very positive response from the guests and we complemented that with a very strong digital campaign. So I felt, and the team felt, very good about the progress we made from a marketing standpoint in the fourth quarter. We had creative that broke through the clutter, connected with our guests, drove traffic to our stores. We complemented that with really impactful digital and online communication, and tied that back in with great in-store marketing. So you'll see more of that as we go forward into 2015, and we'll take you through a lot more of the investments and the plans we have when we see you next week.
Operator:
Your next question is from Sean Naughton from Piper Jaffray.
Sean Naughton:
I just wanted to follow up on the Food question, and then specifically inside of the fresh component of the business. This was supposed to be a big part of driving transaction to the store over the long term. Could you just maybe give us a little bit on where Target is with its fresh offering today? How is it evolving? And are you happy with the performance of the sales and margins on this segment of the business?
Kathryn Tesija:
Yes, Sean, we're going to talk about Food in much more depth next week, but fresh is a very important part of Food, not only traffic and number of trips for our guests but just in terms of what's important to them in terms of wellness. Fresh food plays a very important part. And as Brian said, we've got a lot of work to do here. So both in SuperTarget as well as in PFresh format, and it centers around our assortments, how fresh the product is and ways that we can improve upon that, the presentation, showing abundance in that great product. So we have a lot of work to do but critically important to us because our guests have said they want to be able to eat better, both natural and organic. We see it in our results today, and we know that there's much, much more opportunity.
Sean Naughton:
Okay. And then maybe as a follow-up here. Just on the inflation front, can you just give us an idea of how inflation trended maybe across the store in the quarter and your expectations kind of in the near and medium term?
John Mulligan:
Sure. Lots of variability across categories as is always the case. We saw some inflation in Food. We saw some -- a lot of deflation in Electronics like we always do, but if you look across the entirety of our business, essentially flat to last year. So no net impact to the business from inflation in aggregate. But as I said, lots of variability within that.
Operator:
Your next question is from Michael Lasser from UBS.
Michael Lasser:
As you look back at the fourth quarter, can you dimension what do you think the -- well, how the performance was driven by your own initiatives, the easy comparison versus last year and just an improving macro environment due in part to the lower fuel prices. If there's any way you could potentially quantify that, I think it would be really helpful.
Brian Cornell:
Michael, let me start. I'll let Kathee and John jump in. I think you've certainly identified some of the big levers. And I think as we sit here today, we recognize that the consumer confidence has certainly improved. Lower gas prices certainly helping the industry overall. We did have some favorable overlaps, certainly, as we overlapped the breach. But I also think we made significant strides from a merchandising standpoint, from a marketing standpoint and we continue to deliver great execution and service inside the stores. And when you look at the 2-year stack, we had a very challenging November, a very strong November from 2013 that we overlapped and saw growth. Now that, to me, was a sign that not only was the consumer healthier, but they were choosing to spend their dollars in Target stores. And they came back in December, as Kathee alluded to. We had a very strong close to the holiday season. But importantly, we felt really good about traffic and our performance in January, particularly in the last 2 weeks of the quarter. So a combination of we certainly did have some issues from last year that we were overlapping. The consumer, we do believe, is healthier, and we're pleased that they're spending in our stores, both in our stores and online, but I also think we made significant strides from a merchandising standpoint. We had terrific marketing and a great digital connection with our guests. We were able to leverage both an improved in-store experience, the convenience of shopping online and picking up in store, and we had industry-leading online sales. And we leveraged our stores to help make sure that we fulfilled the needs of our guest. So I think the combination of all those elements added up to a very solid quarter.
Kathryn Tesija:
The only thing that I would add to that is just that a lot of that focus came in our signature categories, which is why you saw our growth there in particular. So major investments in product, both quality as well as aesthetic and number of SKUs, newness that we brought to the market. The marketing reinforced that, and that was very well received by our guests and then coupled with presentation, both online with enhancements in our app, in our desktop site and the presentation in our store driven by focus on signature categories really helped drive our growth.
Michael Lasser:
That's helpful. The follow-up question I had is are there any particular call outs you can offer about the strength in the last 2 weeks of the quarter? It just strikes us as interesting, and we're curious about what drove that strength?
John Mulligan:
I think we continue to see gift card redemption. We intentionally -- we had a significant gift card promotion on Black Friday that was very successful. We saw all of those come back in January. I think that helped, and we saw continued strength in the product in Home and Apparel, very strong sales in Home and Apparel, and I think that was an element of it as well and I think it's a combination of both.
Kathryn Tesija:
And our wellness business is healthy. As we turned the corner into the new year, we saw that continue. So the trade-up that we have seen during Christmas, we saw continue into January, which is just guest choice for products in our discretionary category. So I think lots of things drove it.
Brian Cornell:
Yes, Michael, I think -- well summarized. I would put 4 elements on the list. John talked about gift cards. I think that was very important, and we certainly saw our guests come back to Target with gift cards after the holidays and through January. Our focus on wellness, certainly well received by the guests. We had great newness in our stores to start the new year and our store teams did a terrific job of recovering after the holidays and we offered our guests a very strong in-store shopping experience. So a lot of the basics, but our gift card plans were well executed. We saw the guests come back in January. Our focus on wellness, that important signature category, well received. We've brought newness into the stores to start the year, and our store teams did a terrific job of recovering after a very busy Christmas holiday season.
Operator:
Your next question is from Greg Melich from Evercore ISI.
Gregory Melich:
That's great. I had a couple of follow-ups. It'd be great to know, you said the signature categories did well. Do you have the actual numbers like which ones were better than that the -- by category for Food and wellness, et cetera?
Kathryn Tesija:
Well, Health & Beauty were both very strong. So in the health category, that's spread across many categories. I talked about "Made to Matter," I talked about better-for-you products in Food, but it was also in our health business. In our Style business, both Beauty was strong as well as in Apparel. It was driven really by Kids and by Baby. And in Home, it was Domestics and Seasonal products. And then in Kids, we had an incredible season in toys with a double-digit comp. We really were pleased with the overall holiday.
Brian Cornell:
Yes, I think as we mentioned earlier in the call, Wellness, Home, Apparel, all comped in excess of the 3.8% we reported for the quarter. So strength across all those categories. And to win in the fourth quarter, you have to win in Toys. Well, our team won in Toys. And showing a double-digit comp was critically important. So we felt very good about the early progress in those signature categories, and we'll build off of that momentum as we go into 2015.
Gregory Melich:
And maybe a follow-up on that momentum and seeing the traffic get back to -- up 3%. When you look out to your first quarter, that 2% expectation, do you expect traffic to be half of that comp or positive in the first quarter? Or what's built in your expectation?
John Mulligan:
Well, I think Brian hit on it earlier, right? We're continuing to drive for positive traffic. I think positive in the store and growing digital online. That's part of our guidance.
Gregory Melich:
Great. And then, John, maybe a quick follow-up on SG&A. It looked like, and I could be backing the math out wrong here, but SG&A dollars in the fourth quarter accelerated to maybe 4% or 5% growth. Was there anything that caused that in particular?
John Mulligan:
Yes, I think, like we said, it was a little bit of de-leveraging. There was some marketing expense we talked about in November moved from November into -- or from Q3 into Q4. As Brian said, we made some investments in marketing. The other elements were ongoing all year. We had some technology, and then the thing that really drove a lot of it relative to the other quarters was incentive expense. We clearly outdelivered our expectations, and that will be reflected in our incentive expense.
Brian Cornell:
Okay. Thanks for joining us today. That's going to conclude our Fourth Quarter 2014 Earnings Conference Call. We appreciate everyone's participation today, and we really look forward to seeing you next week in New York City. So thank you again.
Operator:
Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. At this time, you may now disconnect.
Operator:
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 19, 2014. I would now like to turn the conference over to Mr. John Hulbert, Senior Director, Investor Communications. Please go ahead, sir.
John Hulbert:
Good morning, everyone, and thank you for joining us on our third quarter 2014 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Financial Officer; and Kathee Tesija, Chief Merchandising and Supply Chain Officer.
This morning, Brian will discuss our third quarter performance and our priorities for the fourth quarter and beyond. Then Kathee will provide more detail on recent performance and outline our plans for the fourth quarter, including the holiday season. And finally, John will provide more detail on our financial performance and outlook for the rest of the year. Following their remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following this conference call, John and I will be available throughout the day to answer any follow-up questions you may have. Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Finally, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP EPS is included in this morning's press release posted on our Investor Relations website. With that, I'll turn it over to Brian for his comments on the third quarter and our priorities going forward. Brian?
Brian Cornell:
Thanks, John, and good morning to all of you. We're pleased with Target's third quarter financial performance, which we announced earlier this morning.
Our adjusted earnings per share of $0.54 was better than our guidance of $0.40 to $0.50, driven by U.S. Segment comp sales growth of 1.2%, which is also better than our expectations. Importantly, the U.S. Segment saw positive comps in all 3 months of the quarter, and we're encouraged that the pace of U.S. traffic continues to recover from a very challenging trend earlier in the year. While U.S. traffic still declined slightly in the third quarter, performance was more than a full percentage point stronger than traffic trends through the first half of the year. As we mentioned in our second quarter earning call, we saw a strong start to Back-to-School and to the Back-to-College season, and that strength continued in September. Like many others, our sales slowed as we entered October but recovered nicely towards the end of the month as we approached Halloween. While our Canadian Segment continues to see robust year-over-year growth, third quarter sales in Canada fell short of our expectations. As Kathee outlined in our last earnings call, the team in Canada has been working diligently to make improvements to operations, assortment and pricing in preparation for the fourth quarter. With these changes, we believe we're better positioned to serve our guests at a time of the year when traffic will naturally be higher. The guests' response to these changes, both in their shopping behavior and overall sentiment towards Target, will inform our perspective as we continue to assess our longer-term potential in Canada.
As I've visited stores across the U.S. and Canada and worked with the Target team, I've been continually impressed with the level of their talent and passion to perform. As the leadership team has begun our work to develop Target's longer-term goals, we've aligned around 5 key operating principles:
first, we will provide strategic clarity to the team; second, we'll articulate what Target stands for in today's retail marketplace; third, we will thoughtfully prioritize what we do, applying discipline to ensure we're focused on work that adds the most long-term value; fourth, we'll invest resources and build capabilities to support our priorities so the team is equipped to deliver on these goals; and finally, we will foster a culture of accountability at all levels of the organization.
While our work to define Target's longer-term vision is not yet complete, we've made significant progress in defining the short- and longer-term priorities for our business. First, omnichannel and flexible fulfillment capabilities are key to our long-term success. Target's digital sales are growing much faster than the industry, and they've been accelerating all year, and we're planning for even faster growth in the fourth quarter. But our omnichannel journey is just beginning.
As we plan for the future, we will take a channel-agnostic view of our growth, allowing our guests to interact with us where and when they want:
online, in stores and on their mobile device. And because an increasing number of Target business begins on a digital platform, we will continue to push ourselves to innovate and build capabilities and features into our digital experience that will inspire our guests while removing friction from their daily lives.
Second, we're defining how we'll strategically segment our categories and increase our focus on signature categories we can and should be known for, categories like Baby, Kids, Wellness and Style. Over time, we will work to grow these areas more quickly by investing a higher share of our resources, including capital, marketing and product development. Importantly, this view of segmentation doesn't mean we're abandoning our other categories. Let me restate this. It does not mean we're abandoning our other categories, but we'll have different expectations for those categories compared to the ones in which we're investing to outperform. For example, we believe we should continue to present a meaningful Food offering in our stores and online, but we need to ensure that our Food offering is uniquely Target and clearly differentiated from our competitors. Looking ahead, we know our identity in Food will continue to involve a combination of national brands and our own and exclusive brands, with an increased emphasis on natural and better-for-you products. Third, we know that localization and personalization will be a key focus going forward. 15 years ago, all Target stores were virtually identical and were focused on providing consistent assortment and experience across the country. In today's world, we need to continue to maintain our brand standards across every store, but our guests expect each of our stores to reflect the local communities in which they operate. In the past, we've taken some initial steps to localize our store environment and assortment, but we've only scratched the surface to this opportunity. Similarly, Target's digital experience will become increasingly personalized for every guest. This year, we've developed and rolled out a new personalization engine, which is currently generating product recommendations for guests on our digital platforms. Even though this new engine is still in the beta rollout stage, conversion rates from its recommendations are already exceeding what we were previously seeing with a third-party product. As we continue to make changes based on initial learning, we expect conversion rates will expand further over time. Looking ahead, we expect to leverage this engine's capability to provide customized experiences across our digital platforms. As we contemplate potential store growth, we believe that smaller formats present an exciting opportunity for Target because urban consumers have such a high affinity for our brand. If we can reach more of these guests with small flexible formats, like CityTarget and TargetExpress, we can offer urban consumers greater convenience, unique merchandise and an outstanding value, with extended assortment available at target.com. And finally, as we plan for the future, we must focus on ways to responsibly control cost to help fuel investments in our growth. The team has made solid progress in expense optimization efforts over the last few years, but we believe we must continue to find cost-saving opportunities in the years to come. In the coming months, the leadership team will continue our work to more fully map out longer-term aspirations for Target, and we will communicate those plans to you early next year. In the near term, we are focused on strong execution of our fourth quarter plans in both the U.S. and Canada. These plans are designed to embrace the core of our Expect More, Pay Less brand promise, inspiring our guests with unique products and experiences while providing unbeatable value through our low prices. Kathee will provide more detail in a few minutes. In Canada, we're expecting much better fourth quarter performance than we experienced last year, but we know that to succeed in Canada, we will need a major step-change in performance. The fact is given where we are performing today, we need to see improved financial performance from every Target store in Canada over time. The team has worked hard to prepare for the Canadian operations for the fourth quarter. And we'll be watching to see how those improvements connect with our guests during the holiday season. While there is much more work to be done, I'm very pleased with the momentum we're seeing in the U.S. business and the changes we've implemented to better position our Canadian Segment. My confidence in the potential of this company and this brand have only been reinforced in the last 3 months as I've gained deeper knowledge of Target through my work with the team. I'm committed to realizing the potential of this great American brand to the benefit of our guests, team, shareholders and communities. And I believe we're taking the right first steps in that journey. Now I'll turn the call over to Kathee for a recap of the third quarter performance and our plans for the holiday season. Kathee?
Kathryn Tesija:
Thanks, Brian. On our last conference call, we outlined that we'd already seen a strong start to the third quarter, driven by initial results in the Back-to-School and Back-to-College seasons. A key question at the time was whether this early strength would prove to be temporary, resulting in a pullback later in the quarter.
With the quarter now behind us, I'm happy to report that we continue to outperform our U.S. forecast throughout the quarter and saw positive U.S. comps all 3 months. As Brian mentioned earlier, third quarter U.S. traffic was down slightly from a year ago, but we're encouraged that our traffic trend has improved meaningfully every quarter this year. Consistent with year-to-date trends, average ticket increased 1.6% in the third quarter, driven by growth in average retail per item, particularly -- partially offset by a decline in items per basket. At a category level in the U.S., third quarter comparable sales performance was strongest in Health Care and Beauty, led by Beauty, which continues to benefit from this year's store fixture innovations and the introduction of new brands. Third quarter comps in Home were up in the low single digits, with particular strength in Seasonal categories benefiting from Back-to-School, Back-to-College sales early in the quarter and late-quarter strength in Halloween. Third quarter comp sales in Grocery were up in the low single digits, and Hardlines was up slightly, led by Toys, which saw a high single-digit increase on strength in licenses like Frozen and Teenage Mutant Ninja Turtles. Comp sales in Apparel were down slightly as strength in Baby and Kids was offset by softness in Jewelry, Accessories and Intimates. From a mix perspective, it's worth noting that our combined Home -- our combined comp in Home and Apparel was the strongest we've seen in 2 years. In October and early November, we completed the rollout of our new Apparel fixtures and layout to an additional 600 stores, bringing the total to about 650 locations featuring this enhanced presentation. Consistent with our expectations, the U.S. third quarter gross margin rate was about 50 basis points lower than last year, about half the decline we saw in the second quarter. This reflects continued moderation of our promotional intensity, which we intentionally moved higher in the wake of last December's data breach. Digital sales were up more than 30% in the third quarter and contributed about 60 basis points to our U.S. comparable sales growth. Consistent with the rest of the industry, all of our digital traffic growth is on our mobile platforms, where third quarter traffic grew more than 50%. Conversion this quarter was up strongly on both the conventional site and on mobile, compounding the benefit from the traffic growth. Following the success of our second quarter decision to offer free shipping on all target.com orders over $50, in October, we announced that we're offering our guests free shipping on all orders this holiday season. Since the announcement, our guests have responded enthusiastically. We've seen a meaningful increase in both orders and conversion compared with trends prior to the announcement. Of course, I'd be remiss if I didn't point out that REDcard holders continue to receive free shipping on all orders year-round. In Canada, third quarter sales were up 44% from a year ago, moderately below our expectations. Our third quarter gross margin rate of 19.5% was consistent with our expectations as we continued to clear excess inventory from earlier in the year. As Brian mentioned, the team in Canada has been working diligently to improve operations, assortment and pricing, and our internal measures show that we are making progress. However, we're also measuring the impact these changes are having on Canadian consumer sentiment, and that data is more mixed. We will continue to measure guest sentiment in the fourth quarter when all of our recent improvements will be fully in place and traffic will be naturally higher. As we look ahead to the fourth quarter and the holiday shopping season, we're excited about our plans to inspire our guests with unique products, outstanding deals and increased convenience provided by our flexible fulfillment efforts. On our digital platforms, we are coming into this holiday season with many more capabilities than we had a year ago. In fact, it was about a year ago that we rolled out in-store pickup across all of our U.S. stores. So far this year, Store Pickup orders have averaged about 15% of digital traffic, with more than 80% of orders ready within an hour. Based on last year's results, we expect in-store pickup orders will become a much higher share of digital traffic in the days leading up to Christmas as consumers increasingly value the certainty this service provides compared with the potential risk posed by weather-related shipping delays. And we continue to explore potential enhancements to flexible fulfillment like our curbside test -- pickup test in 10 San Francisco Bay Area stores and our same-day delivery test in Minneapolis, Boston and Miami. The Target app and Cartwheel are both top 10 retail apps, and we continue to innovate to maintain our leadership position in this space. In the third quarter, we relaunched our mobile and tablet apps, making it easier for guests to locate and purchase what they're looking for with interactive store maps and shopping lists, streamlined checkout and the addition of Apple Pay for the iPhone app. Our new list function automatically notifies guests when an item is on sale or eligible for an offer on Cartwheel, and our new interactive store maps show item locations throughout each store. For our in-store Black Friday guests this year, special interactive maps will show doorbuster locations throughout each store. We completed the successful nationwide rollout of ship-from-store capability in October. With this rollout, we are now shipping about 60,000 eligible products from 136 stores in 38 markets, covering more than 90% of the U.S. population. The ability to access stores' inventory to fulfill online orders improves our digital in-stocks and drives incremental sales in situations where we are out of stock in our fulfillment centers. And while shipping from stores significantly lowers shipping costs, most importantly, it allows us to get items into our guests' hands more quickly. This change is already being noticed. In the third quarter, Internet Retailer reported a survey showing that we were leading our competitors with the fastest delivery, having been near the back of the pack earlier in the year. We've recently rolled out an improved omnichannel experience for our registries, with new web-enabled smart scanners and a matching target.com user experience. The new smart scanners allow guests to add items more quickly to a registry, and new features like collections and checklists provide inspiration and help guests build registries more quickly. Guests can add online-only items, like specific colors or models, right from the device in the store without having to edit online at home later. And companion and related products are suggested immediately when a guest adds an item to their registries. And when gift-givers access a registry on our new in-store iPad kiosks, they can send gift lists to their smartphones via SMS with -- saving time, reducing costs and eliminating waste from paper printouts. As we enter the holiday shopping season, we are featuring a dazzling array of unique and exclusive products and of course, outstanding deals. In September, we announced that Target would be partnering with TOMS on a limited-edition holiday collection of Home goods, Apparel, Accessories and Shoes for women, men and children. Similar to TOMS' One-for-One giving model, for each item purchased, a donation will be made with the potential to provide more than 11 million meals, blankets and shoes to those in need. The collection rolled out at all Target stores in the U.S. and Canada and on target.com on November 16. We also recently announced our holiday collaboration with Faribault Woolen Mill. Founded in 1865 and located on the banks of the Cannon River in Faribault, Minnesota, this mill is part of American history, having provided woolen blankets for pioneers headed West and for American troops in 2 World Wars. On November 2, we rolled out a variety of American-made giftable items from this iconic company, featuring 100% wool scarves, throws, tote bags and tech accessories in 4 patterns, available exclusively on target.com. If there's one thing we've learned from our past 3 partnerships with Taylor Swift, it's that our guests can't get enough of Taylor and her music. Even though gifting season is yet to come, our Target-exclusive deluxe edition of Taylor's CD titled, 1989, featuring 3 exclusive songs and voice memos that give fans unique insight into her songwriting process, has already become our best-selling album of all time. Disney's Frozen has been huge for us all year, and it's positioned to be one of the most popular licensed brands at Target this holiday season, with 600 Frozen products, 60 exclusive to Target, across 20 categories. For the holidays, we're partnering with Renée Ehrlich Kalfus, costume designer, for the contemporized Annie film to offer guests a limited-edition collection of kids' apparel and accessories inspired by the film. Annie for Target will be available through December 26 or while supplies last at all U.S. Target stores and on target.com. The film debuts in theaters nationwide on December 19. In Beauty, we continue to experience strong growth in natural products, and we are constantly on the lookout for new lines that will appeal to our guests. We've already launched 7 premium skincare brands this year, and we're thrilled to announce that 2 more super lux lines are on the way. Available now on target.com and in select stores in March 2015, Target is adding S.W. Basics of Brooklyn and Nuxe to its lineup of premium skincare products. Also new in Beauty, Skinfix, the experts in steroid-free skin-healing solutions for the whole family, debuted its incredibly effective product exclusively at all U.S. Target stores and online at target.com. Skinfix products are based on an original formula created over 150 years ago by pharmacist Thomas Dixon in Yorkshire, England. And in Hair Care, we're seeing continued momentum in naturals with our "Made to Matter" products, and we're excited about recently added salon products like Proganics from Vogue and exclusives like Procter & Gamble's Hair Food and L'Oréal's DESSANGE. In Health Care, we announced earlier this week that Target and Kaiser Permanente are teaming up to launch 4 Target clinics in Southern California. For the first time at Target, guests will have access to expanded services not typically available in retail clinics, including pediatric and adolescent care, well-woman care, family planning and management of chronic conditions like diabetes and high blood pressure. And coming in 2015, our new pharmacy app, Target Healthful, will allow guests to organize and transfer prescriptions, check a prescription status and order refills. And finally, of course, we're designing our marketing plans to bring the entire holiday season together, from amazing products to outstanding deals. Our holiday marketing campaign is designed to encourage people of all ages to let loose, get into the spirit and feel the unmistakable joy of the holiday season. The advertising will boldly embrace the iconic elements that make Target, Target, lots of red, white and our lovable mascot, Bullseye. The campaign will include broadcast, radio, out-of-home and catalogs, and we're increasing digital media support by 50% over last year. Target stores will be transformed with fun and whimsical in-store decor created in partnership with David Stark, one of the top event planners. This year, we're partnering with innovative New York retailer, STORY, which brings an editorial lens to Retail and reinvents itself every 4 to 8 weeks, from merchandise and store design, to floor plans and fixtures, bringing to life a new theme or trend. From Target's design partnerships to its everyday collections, STORY has curated its favorite holiday treasures from Target alongside its other must-have items for the season. We just launched our kids' Wish List app on October 31, a modern and digital take on the classic tradition of creating holiday wish lists for parents and kids. Kids can add must-have items to their lists, while parents can share the list with friends and family. Plus, guests can save 10% on their Wish List on 1 day of their choosing before November 26. Through the holiday shopping season, Cartwheel, Target's industry-leading savings app, will offer daily deals for its more than 11 million users. And from November 2 to December 24, it will feature 50% off a different toy every day. The app will have new features for the holidays, including special deals for top users, personalized recommendations and a select number of popular offers that don't expire. As always, REDcard holders get 5% off nearly all purchases, free shipping at target.com and an extra 30 days for returns. Since 5% REDcard rewards rolled out in 2010, Target has saved guests more than $2 billion, and we will thank guests for their loyalty with perks throughout the holiday season. We know our guests are pulled in a million different directions as the holidays get under way. So we're helping them save time and money by offering more access to Black Friday deals. Whether shopping online, on their phone or in our stores, Target guests will find Black Friday deals on top gifts throughout November. We already offered early access to Black Friday deals for 1 day only on November 10. We've announced a presale on Wednesday, November 26. And Cartwheel will feature access to additional Black Friday deals between November 23 and November 29. On Thanksgiving Day, Black Friday deals will be available first in the morning on target.com. Then at 6 p.m., Target stores will open for Black Friday shoppers, and the first several hundred guests will receive a Christmas cracker, a gift synonymous with the holidays in many parts of the world, which will include a Target gift card or a coupon. On Black Friday, from 6 a.m. to noon, guests can purchase up to $300 in Target gift cards at a 10% off at Target stores and target.com, the first time Target has ever offered a discount on Target gift card purchases. The following day, additional Saturday-only deals will be available in Target stores and at target.com. And finally, beginning Monday, December 1, guests will find new deals every day at target.com as part of Target's largest-ever cyber week sale, with more than 100,000 items on sale throughout the week. The offers will include category-wide sales in key gifting areas and steep discounts on Apparel, Toys and Housewares. More information and deals will be available at the end of November. As we look back at an eventful year, we're pleased with the steps we've taken to improve our performance in both the U.S. and Canada, and our financial results show that we're making meaningful progress. While there is much more work to be done, we are confident in our plans for the upcoming holiday shopping season and pleased with our progress in charting a longer-term course for the Target of the future. Now I'll turn it over to John, who will share his insights on our third quarter financial performance and our fourth quarter outlook. John?
John Mulligan:
Thanks, Kathee. Our third quarter financial performance was better than expected, driven by stronger-than-expected sales and operating margin performance in our U.S. Segment.
Adjusted EPS of $0.54 was $0.02, or 2.9%, below last year, reflecting a decline in U.S. Segment profit, partially offset by the benefit of reduced losses in our Canadian Segment. GAAP EPS of $0.55 was $0.01, or 2.7%, higher than last year, benefiting from the resolution of tax matters in the quarter. Our third quarter U.S. comparable sales increase of 1.2% matches our best performance in the last 2 years. Digital sales in the U.S., including flexible fulfillment, grew more than 30%, contributing about 60 basis points to our U.S. comparable sales. With ship-from-store capabilities now fully in place, we expect digital sales growth to accelerate to nearly 40% in the fourth quarter. Our third quarter U.S. Segment EBITDA margin rate of 8.5% was ahead of our expectations, driven by a better-than-expected SG&A expense rate of 21%, which is about 20 basis points lower than last year. This performance was the result of our expense optimization efforts, better leverage on stronger-than-expected sales and retiming of some expenses into the fourth quarter. U.S. REDcard penetration was 21% in the third quarter, up about 110 basis points from last year, driven by growth in both credit and debit penetration. As we described last quarter, applications for new REDcard debit cards are running below last year, causing penetration growth to decelerate from last year's pace. We believe this trend will continue in the fourth quarter, when we expect U.S. REDcard penetration will be flat or up slightly compared with last year. With the success of recent initiatives designed to increase REDcard applications, we expect the fourth quarter will mark the low point in year-over-year penetration growth, after which, we should see a reacceleration in 2015. In our Canadian Segment, third quarter sales were below our expectations, growing 44% above last year, reflecting sales from new stores and a comparable sales increase of 1.6%. As I mentioned last quarter, the comparable sales metric in Canada will be noisy until we fully annualize the rapid pace of last year's store rollout given the sustained grand opening surges we experienced in those stores and the densification around early cycle stores that occurred later in 2013. REDcard penetration continues to grow in the Canadian Segment, reaching 4.2% in the third quarter compared with 2.9% last year. As expected, third quarter Canadian Segment EBITDA and EBIT margin rates improved somewhat from last year, and EBIT dollar losses were about 18% lower than a year ago. While this improvement is encouraging, financial results in this segment remain unacceptable. And as Brian mentioned earlier, we need to see a significant step-change in Canadian Segment financial performance. Outside of operating results in the U.S. and Canada, our third quarter GAAP EPS of $0.55 reflects a few items not included in adjusted EPS, specifically, $0.05 of accretion related to the resolution of income tax matters and $0.04 of offsetting dilution from data breach-related costs, reduction in beneficial interest assets and impairment losses. Moving to the consolidated metrics. Third quarter interest expense was flat to last year, and we paid $330 million in dividends in the quarter, an increase of 21% over last year. As expected, we didn't repurchase any shares in the third quarter. And given current performance and our goal to maintain our Single A debt ratings, we don't anticipate any share repurchase in the fourth quarter as well. Of course, the timing and magnitude of any future share repurchase activity will depend on the pace of improved financial performance in both the U.S. and Canada. Before I move to our outlook, I want to first address our inventory, which at quarter end, was about 7% above last year. This increase was entirely driven by our U.S. Segment and was the result of 2 factors. About 1/3 of this increase relates to our recent efforts to reduce out-of-stocks on commodity products, while the remainder reflects receipt timing, including the impact of our efforts to manage around the slowdown at West Coast ports. Bottom line, we feel very good about our current U.S. inventory levels. Now let's move to our outlook for the fourth quarter. As we consider the broader environment, we see some encouraging signs, including lower gas prices than we've seen in some time. However, consumer spending patterns remain quite volatile, and we expect the competitive environment will remain highly promotional this holiday season. Based on this backdrop and the Q3 to Q4 expense retiming I covered earlier, we're continuing to plan cautiously and maintaining our prior full year guidance despite stronger-than-expected third quarter performance. In the U.S., we're expecting a fourth quarter comparable sales increase of about 2%. So far in November, we're running ahead of our forecast, but I'll quickly remind everyone that the bulk of the season remains ahead of us. We expect our fourth quarter U.S. gross margin rate will improve somewhat from a year ago. Last year in the U.S., we faced unexpected gross margin headwinds because of the data breach, including the pre-Christmas weekend in which we gave our guests 10% off every transaction, along with incremental clearance markdowns resulting from softer sales. So while we expect the typical year-over-year gross margin pressure from an intensely promotional and highly competitive fourth quarter, we believe that pressure will be more than offset by the benefit from annualizing last year's breach-related markdowns. We expect our U.S. Segment SG&A expense rate to be flat to down slightly from last year as the benefit from expense optimization and better leverage on a 2% comp is expected to be offset by the timing of expenses which moved from the third to the fourth quarter. Altogether, our outlook is for the U.S. Segment EBITDA margin rate to improve 50 to 60 basis points compared with last year. In Canada, we expect a high-single-digit increase in total sales, driven by a mid- to high-single-digit increase in comparable sales. We expect a gross margin rate of around 20%, much better than last year's 4% rate, which resulted from extreme clearance activity and reserves taken on excess inventory. With an expected SG&A expense rate of between 35% and 40%, we anticipate fourth quarter Canadian Segment EBITDA losses of about $100 million, an improvement of about $160 million compared with last year. Turning to consolidated metrics. We expect a small increase in fourth quarter interest expense compared with last year. And for the first time this year, we expect our tax expense to be higher than last year in light of the expected improvement in profitability. Altogether, these expectations will lead to fourth quarter adjusted EPS of $1.13 to $1.23, well above the $0.90 we earned last year. Fourth quarter GAAP EPS is expected to include $0.02 of dilution from the reduction in the beneficial interest asset and any future data breach expenses, which are not expected to be material. For the full year, the center of our adjusted EPS expectation remains at $3.20. GAAP EPS is expected to be $0.45 lower than adjusted EPS, reflecting a variety of adjustments, including debt retirement and breach-related expenses. The fourth quarter will mark a notable inflection point as we annualize the data breach and expect to see the first year-over-year increase in operating profit this year. This will provide clear financial evidence of the healing process we've been engaged in throughout the year, and we look forward to entering next year with an energized team and positive momentum in our financial results. With that, we'll conclude today's prepared remarks. Now Brian, Kathee and I will be happy to respond to your questions.
Operator:
[Operator Instructions] Your first question comes from Sean Naughton from Piper Jaffray.
Sean Naughton:
So, John, you mentioned this. There has been a lot of talk about gas prices and the potential positive benefit on the consumer. But just curious if you could speak to the potential benefits you may receive on the P&L from a distribution standpoint. And if those are savings that are there, how would you guys look to use those additional distribution savings between flowing through the earnings and potentially reinvesting to drive traffic?
John Mulligan:
Yes, I think a couple of things. Certainly, there would likely be some benefits if we continue to see fuel prices come down, but we haven't reached the threshold where fuel surcharges begin to come out of our contracts. And I think importantly, given the great work the team has done to manage the -- some of the port issues out West, we're working around that and moving some freight further, expediting some freight, flying some freight. And I think net-net, that will probably be more of a drag than any fuel savings we will see.
Sean Naughton:
Okay. So -- and then I guess just a second question on the overall basket. The UPT continues to be -- to decline and actually looks like it decelerated a little bit on a 2-year basis. Just wondering if you could give us a little bit more color around that particular dynamic, either at the store level perspective -- given the higher Food concentration, I would be expecting that to improve, but maybe this is being offset by online. And I guess the follow-up would be is how do you improve that dynamic moving forward?
Kathryn Tesija:
Sean, this is Kathee. You know that it's predominantly a mix story for us. So we have higher-ticket items like all the Apple products, including the launch of the iPhone 6 in the quarter. We've got video game consoles that are higher. We have a lot of trade-up strategies, both in essentials like you talked about like in Grocery with organics, but also in areas like skincare, which I described a little bit earlier. So this is really a mix story.
Sean Naughton:
Okay. So it's less about the shift between online and store.
Kathryn Tesija:
Correct. Correct, yes.
Operator:
Your next question comes from Matt Nemer from Wells Fargo.
Matt Nemer:
My first question is on expenses in the U.S. They basically have been running flat on a dollar basis this year, down a little bit per foot. I'm wondering if you can get into a little more detail on what's driving the cost savings. And then in terms of the outlook, is this a line that you think you can run flat to up in dollars, up slightly in dollars over the next year or so? Or should we expect it to grow a little faster than that?
John Mulligan:
Matt, yes, I think the expense savings, I would tell you, we've talked about the expense optimization efforts all year, been very focused on that and has been across the entire enterprise. And we've seen good news in SG&A and also in the cost of goods. The couple of areas I would point out
Brian Cornell:
Matt, it's Brian. And to build on John's point, and as I discussed in my prepared comments, as we move forward, we recognize that we're going to continue the need to focus on expense management to fuel the investments we're going to make to drive continued growth across our store base and our digital platform. So as we come back to you in the spring and we talk more specifically about our strategies, you should expect us to continue to talk about cost-optimization efforts and how we'll use those efforts to reinvest in the fuel that's going to drive our growth.
Matt Nemer:
Okay. That's great. And then secondly, on target.com, I wanted to ask a question about the free shipping program. Does the incremental volume offset the incremental shipping expense? Is it profit-accretive? And do you think that the customers that are utilizing this offer are high-lifetime-value customers?
Kathryn Tesija:
Yes, it's not accretive. I will tell you, we do ship -- even prior to the holiday free shipping, we do free ship a lot more than perhaps you would think and certainly more than some of our competitors, given REDcard and the fact that, that ships free all year round. So we have seen -- we know it's the #1 frustration with our guests and the #1 reason for abandoned carts. And so it was important for us this holiday season to be able to take that friction away, and we have seen a meaningful move in orders and conversion because of it. So we are very pleased with the results so far.
John Mulligan:
Yes, Matt. The only thing I'd add, while not accretive, the other thing I would add is it's not material either to our results in the fourth quarter.
Operator:
Your next question comes from Oliver Chen from Cowen and Company.
Oliver Chen:
Regarding the great idea regarding signature categories and where you're focusing there, how would you help us just prioritize which categories have the most opportunities in terms of lead time and revenue mix and timing of impact? And is the extrapolation there that traffic will be the biggest kind of comp upside driver as you do focus on these categories?
Brian Cornell:
Yes, Oliver. I think as we go forward and as Kathee and the team really elevate our focus around those signature categories, categories like Baby and Kids, Wellness and Style, you should expect to see additional focus in-store. You should see additional innovation partnerships, but really ensuring that we're leading with trend. We're anticipating what our guest is looking for in those categories, and those are categories that Target becomes famous for. And we're certainly going to double-down our efforts in those categories because our guest has asked us to. They are categories that are very important to our guests. They're synonymous with the Target experience the guest is expecting, and you'll see signs of that as we move into 2015 and beyond. Certainly, some of the work that Kathee and her team have done in preparation for the fourth quarter are already bringing our efforts to life in Apparel, some of the things that we've done in Home, the partnerships that Kathee talked about in her prepared comments, our continued focus on Baby and Kids. And we know how important Toys are during the holiday season. So we're already making progress in those spaces, but I also want to make sure it's really clear
Kathryn Tesija:
So a couple of things that I would add to that, that you will already see in stores right now. Brian talked about those 4 areas
Brian Cornell:
Oliver, the final point I'd add as we think about Style, certainly Apparel and Home are critically important in that space, but so is Beauty. And as John and Kathee have referenced, Beauty was one of our standout categories in the third quarter, and we expect continued strong performance as we exit the year.
Oliver Chen:
And just as a follow-up and it's related. There seems to be a lot energized agility, Brian, regarding thinking about what Target stands for from a bigger-picture perspective. What are some of the initial thoughts on where you see that opportunity as you work to further differentiate and innovate yourself?
Brian Cornell:
Oliver, I think we're making progress across a number of different areas. Certainly, we talked about omni-channel and really making sure that we are a significant player in this space, and we're seeing very strong performance, up over 30% in the third quarter. John talked about the fact we expect that performance to accelerate in Q4. We clearly took away the pain point of shipping by announcing free ship in the fourth quarter, and we think that's another way for us to declare we are significantly committed to this space. We're seeing a great response to Cartwheel, 11 million users today, and we're going to use that to make sure that we use digital as the front door to connect to the Target brand going forward. We've talked about some of the progress that's being made in merchandising, and we've added 35,000 new items in stores for the holiday. And we're going to continue to test and partner as we continue to make sure we're bringing the right solutions to our guests. If you haven't seen some of the holiday creative, I think it's some of the best Target's delivered in years. And I'm getting e-mails and comments from guests and friends and people I know every day talking about their reaction to the holiday creative and how the creative campaign is uniquely Target. And we're certainly upping our game both in-store but we're also going to spend significantly more in digital this year to touch our guests no matter how they're connecting with the brand. In-store, we've made significant progress in a very short period of time, going from testing ship-from-store, to now we're in 38 markets, 136 stores, where our stores are acting like flexible fulfillment centers. You can shop there. You can pick up there, but they're also shipping to -- directly to our guests and allows us to cover 90% of our marketplace in a very short period of time. It takes the pain away from that last mile. So I think you're going to continue to see us make these points. And that's a sneak peek of Target in the future, and I think that is creating positive energy in the organization. Kathee and I are hearing really positive things from our vendors. Our organization knows we've got to be more -- we've got to show more agility. We've got to be responsive. We've got to make sure we're externally focused and following the guests. But I think you're seeing some of those things take shape today.
Operator:
Your next question comes from Wayne Hood from BMO Capital.
Wayne Hood:
Yes, Kathee, I had a question, and this maybe is a little bit longer-term and it places the context of how you evolve the company, and that is related to where you see AUR turning because you're talking about more emphasis in Kids and Baby, which typically is lower ticket, and maybe pulling back on promotions in Electronics because that's not core. And I'm just wondering where you think your AUR might land over the next few years in light of kind of the 2% to 3% growth you've been experiencing under the existing strategy. And then if you could talk about -- John, if you could talk about the growth in inventory next year and its impact on working capital as you think about being better in stock on the ad merchandise and the like.
Kathryn Tesija:
Wayne, we haven't modeled exactly what that will be yet, but I would tell you I think that it will be moving up for a couple of reasons. So you heard Brian talk about those areas that we're going to focus on and really being famous for them and delighting our guests. And when we are at our best, we offer both Expect More, Pay Less together in all of these categories, and that means a really thoughtful balance of good, better, best; having clear features and benefits as we move up that ladder; allowing guests to be able to buy whatever's important to them, but importantly, offering really good trade-up opportunities. So you're seeing some of that right now in some categories, but I think as we move forward and we become famous again for some of these categories, there will be a lot of trade-up opportunities. So I would say, overall, seeing it moving up.
John Mulligan:
And then, Wayne, your second question, inventory. I think the one thing I'd say, if you look at our number this quarter, 6% to 7% all of the U.S., really only about 1/3 of that do we view as temporary. The vast majority of that was receipt timing. But that 1/3 we expect to stay around. We started that in second quarter this year. We'll cycle it again next year in second quarter, somewhere around a 2% to 3% increase for the first half of next year. But offsetting it ultimately, as we start to get back to positive comp sales, we should see a faster turn that should ultimately lead to better payables leverage. So not a meaningful impact overall once we get past fourth quarter here on our working capital.
Operator:
Your next question is from Greg Melich from Evercore ISI.
Gregory Melich:
I have 2 questions that are maybe a little bit linked. John, if we start on dot-com, which if my algebra's right, is around 2.5% of sales in the quarter, what does that do to the margin going forward? I know you mentioned it's sort of immaterial for the fourth quarter, but could you tell us what it did in the third quarter and how we should think about it? I mean, it's probably dilutive of some effect and whether it's more in gross margin or SG&A, and then I had a follow-up.
John Mulligan:
On margin, it's definitely dilutive, Greg, if for no other reason than the shipping expense. And I think as it continues to grow, that will put margin pressure on the P&L. And we've talked a little bit about this. There are lots of puts and takes in gross margin as we think about it going forward that we're working through today. As that business grows, it will be margin-dilutive. But as we increase penetration of ship-from-store and Pickup in Store, that significantly not only improves our guest experience, but significantly improves the P&L. We're also balancing how we look at pricing right now and balancing inventories across the network as we ship-from-store. So some of those are up. Some of those are down. And we're working through right now where ultimately gross margin will land.
Gregory Melich:
And then the follow-up and maybe, Brian, you -- in your comments, you talked about making sure in the -- those were 5 key operating principles, the invest-to-build capabilities. I love your perspective on this year CapEx is down a lot, and we're running, I guess a little over $2 billion as the run rate. What do you think does the CapEx need sort of going forward to invest in what Target really needs to do to be the best it can be?
Brian Cornell:
Greg, we're assessing that right now as we think about 2015 and beyond? But you should expect us to be investing in the capabilities to continue to build out our digital experience, to continue to enhance our in-store experience, to make sure we have the analytical tools to properly manage expenses in margin even more surgically going forward. And I talked about, while certainly in the early stages, we're going to continue to look at smaller formats and how we use smaller formats to penetrate urban markets, allow our guest the chance to interact with the Target brand both in-store, but also continue to build out the opportunity for them to purchase online. So we're in the early stages of assessing our long-term capital needs, but you should expect us to be investing in the right capabilities and tools to provide long-term shareholder value and allow us to continue to fuel our growth and enhance both margins and continue to manage operating expenses effectively.
Gregory Melich:
Would that mean CapEx would be above D&A at some point in the future? Or do you think you can stay below that?
John Mulligan:
Greg, we think -- at least Brian said, I think, with the caveat that we're working through this right now, we think we're probably in about the right range right now. The spend may move around a little bit. I think the one wildcard is the point Brian made about small formats. But I would note that, obviously, the investment there is significantly below what a prototypical Target would look like. So it would take a lot of those to meaningfully move our CapEx number. So like we've talked about, something in -- for the U.S. in that $2 billion, $2.5 billion range still makes sense, but we're doing the work right now.
Operator:
Your next question comes from Matthew Fassler from Goldman Sachs.
Matthew Fassler:
I know there's a lot of big-picture questions to discuss, but actually, I have 2 quantitative ones related to the quarter. First of all, John, can you talk about the expense -- the magnitude of the expense dollars that shifted from the third quarter to the fourth, and talk about perhaps, functionally speaking, what they're related to?
John Mulligan:
Yes. Most of it is marketing moved around. And the magnitude, if you think about us beating by somewhere in the neighborhood of $0.09, it is a little bit less than half the beat. So somewhere in that $30 million to $40 million move between the quarters.
Matthew Fassler:
Got it. And then secondly, you talked about running ahead of the fourth quarter plan. Just as we think about the cadence of that plan, obviously you had a tough January, as did many retailers, particularly given the breach. So when you say running ahead, is that running ahead of the 2% number as we speak? Or running ahead of a plan that's maybe a bit more nuanced than that as we think about where we are in the progression of the quarter and your comparison a year ago?
John Mulligan:
Well, I wouldn't want to get into that level of detail. Clearly, last year, pre-breach was stronger than post-breach, and we took that into account as we thought about the calendarization of the plan. And right now, we're running ahead of that and we feel good about where we're at, not only relative to the plan but on an absolute basis is what I'd say. But there is a lot of business left to be done before we get to the end of January.
Operator:
Your final question comes from Michael Lasser from UBS.
Michael Lasser:
It's on the Food category and recognizing that you're not going to de-emphasize it, you're just going to streamline it, how are you thinking about the return profile of that base within the store? And then could there be any differences in -- amongst how space is allocated? Could that area get less over time?
Brian Cornell:
Yes, let's drop back and we make sure we clarify our point on the Food category. We have no intentions today to streamline those categories, but Kathee and the team are certainly stepping back, listening to the guest, really understanding what the Target guest is looking for in Food, from an assortment standpoint, from a newness standpoint. We talked about the fact that as we go forward, you should expect to see more natural and organic offerings. We've seen a terrific response from the guest to something that we call "Made to Matter," a collection of items that are on trend for our Target guests, feature a number of exclusive items to Target from manufacturers that are in the organic and natural space, that can bring great innovation, gluten-free, on-trend products to our guests. And we certainly recognize that we have an opportunity to connect with the guest in a different way when it comes to Food. But you shouldn't expect us to de-emphasize those categories. That's not the point. We're not streamlining our Food offering, but we are stepping back and really listening to the guest, making sure we curate on their behalf the right items that are uniquely Target, that meet the needs of our guests in the Food categories. So a lot more to come as we talk about this in the first quarter. But to make sure we're really clear, we're not streamlining Food. We're not de-emphasizing Food. We're not walking away from Food, but we certainly want to make sure we put our mark on the Food category with items that are uniquely Target, that are right for our guests, that are on trend, and you should certainly expect to see more natural, organic offerings in that space, because the Target guest has asked for them.
Michael Lasser:
Okay. That's very helpful, and do you think you can manage the return profile on that space to generally meet the hurdle rates that you expect from it?
Brian Cornell:
We would certainly expect to see that. And Kathee talked about some of the changes we're seeing in mix. And certainly when we talk about natural organic, when we talk about some of these unique items, they tend to have a higher average unit rank. So you should expect to see some mix changes, but importantly, Food is an important part of our future. We're not going to de-emphasize the category. We're not looking to take away space. We want it to be more impactful, more on trend, and we want to fill it with items that the Target guest is looking for.
John Hulbert:
That concludes Target's third quarter 2014 earnings conference call. Thank you, all, for your participation.
Operator:
This concludes today's conference call. Thank you for participating. At this time, you may now disconnect.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation Second Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, August 20, 2014.
I would now like to turn the conference over to Mr. John Hulbert, Senior Director, Investor Communications. Please go ahead, sir.
John Hulbert:
Good morning, and thank you for joining us on our 2014 second quarter earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Financial Officer; and Kathee Tesija, Chief Merchandising and Supply Chain Officer.
This morning, Brian will provide his initial impressions on joining Target and his priorities going forward. Then Kathee will discuss results in the U.S. and Canada and plans for the third quarter and beyond. And finally, John will provide more detail on our financial performance, along with our financial outlook for the third quarter and the full year. Following their remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others, who are listening to our comments via webcast. Following this conference call, John and I will be available throughout the day to answer any follow-up questions you may have. Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Finally, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP EPS is included in this morning's press release posted on our Investor Relations website. With that, I'll turn it over to Brian for his initial impressions of Target and his priorities going forward. Brian?
Brian Cornell:
Thank you, John. Before Kathee and John provide their perspective on Target's second quarter performance, I want to take a few minutes and discuss why I made the decision to come to Target and outline my priorities over the next few months.
Even before I accepted the offer to lead this company, I have known and admired Target from multiple perspectives throughout my career. As a vendor partner, I've known Target as a smart, savvy, innovative, ethical and guest-focused merchandiser. As a competitor, I've known Target as a disciplined, tough, focused retailer, a company that redefined the discount space by delivering outstanding design, world-class fashion, innovative products at amazing prices. As a guest, my family and I have known Target as a unique place that makes shopping fun, saves us time and offers a differentiated experience based on newness and discovery. And finally, as a member of the community, I've known and admired Target for its commitment to making the places where we live and work better, both through its corporate giving programs and the commitment to volunteerism from our team members. With my appointment as Chairman and CEO, I now have the opportunity to learn about Target from the inside, and I could not be more thrilled to have the opportunity to lead this great company. In the weeks and months ahead, I'm planning to spend a great deal of my time listening to the team here in the U.S. and Canada in both our stores and headquarter locations, hearing directly from them about what's working and importantly, what we need to change. In fact, I just got back from a visit to Canada, where I spent time with the team to get a firsthand update on their review of strategy and operations. While that review is not yet complete, based on what they've learned already, the Canadian team is making broad changes as they focus on improving performance in time for the key holiday season. In the U.S., I've been spending time with John, Kathee and others in the leadership team to understand in detail our plans for the remainder of the year. In those discussions, I'm ensuring that the team is focused on execution across every aspect of our business, particularly in the holiday season. In addition, I'm deepening my understanding of Target's pipeline of omni-channel innovation, and I'm focused on our opportunities going forward. While I'm very impressed with the progress the team has made recently, including innovations on our mobile platform, subscription service, Cartwheel and flexible fulfillment, we need to continue to move faster and grow faster than the marketplace. We need to build capabilities focused on satisfying the wants and the needs of our guests and ensuring that our digital and store operations operate seamlessly to provide a single superior experience. Finally, I am working with the leadership team to begin detailed planning of next year's strategy and financial results. I'm impressed with the progress that John and the team made in the last 3 months, including a strategy review that is the most comprehensive effort I've seen in my career. Their foundational work is providing me with a fresh, fact-based perspective on Target's strengths and opportunities, serving as the foundation for next year's plan and beyond. Now before I turn the call over to Kathee, I want to thank Roxanne Austin and John for their commitment to Target and to the team, which they've demonstrated through their willingness to serve as interim Chair and CEO over the last 3 months. In addition to the critical strategy work they initiated, Roxanne, John and the leadership team moved forward confidently to make important changes to internal processes, removing roadblocks, empowering teams and accelerating the pace of decision-making. While there's a lot of work ahead, I've been blown away by the passion and commitment displayed by team members across the country. This team is focused on winning in the marketplace by better serving our guests in both stores and digital channels. I look forward to working with this team to harness their passion and develop the appropriate strategies to position Target for success both today and over time. Now I'll turn the call over to Kathee and John for a review of the quarter and our outlook for the rest of the year, starting with Kathee, who will provide detailed plans on our category performance, merchandising plans for the third quarter and beyond. Kathee?
Kathryn Tesija:
Thanks, Brian. The second quarter marks a period of transition in both of our segments as the U.S. traffic trend improved over recent quarters and our monthly U.S. comps increased throughout the quarter. In Canada, Mark Schindele and the leadership team have been engaged in a comprehensive review of strategy and operations and are beginning to make changes to address their initial findings.
In our U.S. business, second quarter comparable sales were strongest in Hardlines, driven by both Toys and Electronics. Comparable sales were also positive in our less discretionary Food, Health & Beauty categories, while they were down slightly in Apparel and down low-single digit in Home. In our digital channel, second quarter sales, including flexible fulfillment, grew most quickly in Health & Beauty, Hardlines and Home. U.S. Segment comparable transactions were down 1.3%, completely offset by an increase in the average basket. While we aren't satisfied with the traffic decline, we are pleased that the U.S. traffic trend improved a full percentage point compared with the first quarter. Our U.S. Segment first (sic) [second] quarter gross margin rate was down a full percentage point from last year, driven by higher promotional intensity compared with a year ago. While the impact of promotions was a bit less than we experienced in the first quarter, it was more than we expected at the beginning of the quarter, reflecting a retail environment in which a broad set of competitors are leaning heavily on promotions and a consumer environment in which shoppers are still cautious and focused on deals. However, while it's still early, we've been pleased with the results so far in the Back-to-School and Back-to-College season, in which we've seen improved sales trends from guests focused on the occasion rather than promotions. Second quarter digital sales, including flexible fulfillment, increased more than 30% over last year. This increase reflects a nearly 50% increase in visits to our mobile website, including iOS and Android apps, which more than offset a decline in visits to our conventional sites. Importantly, conversion continues to improve rapidly on both our conventional site and mobile platforms, driving a meaningful improvement in overall conversion despite the unfavorable mix shift between the migration to mobile.
To build on our momentum in digital, we recently launched a new ad campaign focused on millennials that aims to expand the brand perception of Target from a brick-and-mortar destination to a total retail experience. The campaign features 3 of our most prominent omni-channel initiatives:
subscriptions, store pickup and Cartwheel. Market research indicates that these 3 solutions are among the most important to guests because they help them save time, save money and stay organized.
This year's Back-to-College assortment includes a set of unique own brand items that our own product design and development team developed in partnership with college students based on the challenges they face when living with roommates in very small spaces. And since we're already planning for Back-to-College 2015, we recently partnered with Betterific, an open crowd-sourcing community focused on innovation, to help us think of other innovative products that could make life in a first apartment or dorm room even better. The community proposed hundreds of ideas. Then together, Target and the community built on each other's ideas and voted on the best ones. Now our team is using the ideas to identify unmet guest needs, determine if there are products that we can bring to market for Back-to-College next year and uncover completely new, industry-first products. Betterific is part of Target's larger guest-to-guest initiative that is working to connect guests to each other and to Target in meaningful ways. Our first TargetExpress store opened in late July here in the Twin Cities, right next to the University of Minnesota campus. The store looks great, and we're excited about the insights we'll gain from operating this new format over time. At approximately 20,000 square feet, 15% of a typical general merchandise store, TargetExpress is designed so guests can get what they need and get out quickly. So far, sales at the store have come in as expected, and not surprisingly, we are seeing much more traffic and a much smaller basket than our chain-wide average. Also as expected, sales have been heavy in Food and essentials, with the mix of own brand sales in those categories far outpacing the chain average. We're also seeing strong sales in mobile Electronics, including Accessories and in our fan central area, where we feature University of Minnesota clothing. We plan to expand our test of this new format to several additional locations outside the Twin Cities next year. Cartwheel just celebrated its first birthday, and we celebrated with the crowd-sourced Cartwheel offer, a first for Target, for a special limited-time discount. The winning offer generated a high level of engagement during the promotion period, more than doubling the typical rate of new users and activations. Also in July, we launched a proof of concept to integrate target.com into Cartwheel with the goal of making it simple for guests to shop with Cartwheel across channels. In this test, guests can see online eligible offers in their Cartwheel app and are directed to the target.com mobile website to add them to their target.com cart. After testing these initial deals, we will expand the number of offers, and we'll begin promoting the functionality when the testing period is complete. In June, we meaningfully simplified the target.com shopping experience by rolling out free shipping on all orders over $50. We made this change because research shows that the #1 cause of abandoned carts is a surprise at checkout, including uncertain shipping charges. Since we made this change, we have already seen measurable improvements in digital conversion rates and sales. Of course, I should mention that Target card guests continue to receive free shipping on every order every day. In late July, for the first time, we ran a promotion on our store pickup program with the goal of raising awareness of the service while testing systems and processes before the fourth quarter peak. The guest response to the offer was far ahead of our expectations at 5x the volume of a regular week, with a particularly strong response in mobile. The offer attracted many guests to use store pickup for the first time, and some were even new to target.com. Importantly, about 1/5 of those guests engaged in additional shopping in store when they picked up their online purchases. We're pleased with continued strong growth in the number of guests signing up for Target subscriptions. Among the nearly 4,000 eligible items, subscription orders account for more than 15% of digital sales. In the back half of 2014, we're focused on enhancing the guest experience, including continued assortment expansion, consolidating shipments, simplifying communication and rightsizing packaging. We're also developing an optimized mobile experience and moving to test in-store acquisition via mobile devices, and we're exploring gifting subscriptions, which would allow guests to register for subscriptions that are easy for gift givers to fulfill. We're pleased with results from our second quarter test of ship-from-store capability in the Boston, Miami and Minneapolis markets. As part of the test, some guests were offered the option of a $10 service to get same-day delivery on target.com orders placed before 1:30 p.m. In the 3 test markets, the ability to leverage our store's crossover inventory has allowed us to capture more sales by meaningfully improving digital in-stocks. In addition, shipping from a store dramatically reduces shipping times without the need to rely on airfreight. This fall, when we roll out standard ship-from-store capabilities to 35 additional markets, we will be within 1- to 2-day ground transit of 91% of the U.S. population. In Canada, second quarter sales accelerated meaningfully from the first quarter but fell somewhat short of our expectations. Gross margin was also lower than expected, driven by elevated markdowns resulting from continued operational issues. As I mentioned earlier, the Target Canada team is engaged in a comprehensive review of strategy and operations, which incorporates feedback from guests, teams and business partners, and the team is taking decisive steps to address our guest concerns head on, including changes to address in-stocks, pricing and assortment.
To address in-stocks, the team is taking action on 4 dimensions:
better reporting to identify in-stock issues sooner, retraining our teams on best methods, developing new best methods tailored to Canadian Segment systems and reconfiguring systems to work more effectively over the long run. On pricing, while both our own studies and external surveys show that we're already priced very competitively, the team has made decisive changes to ensure we respond even more quickly to pricing dynamics in the Canadian marketplace, including comparison shopping our prices versus competitors on more items more frequently; implementing enhanced tracking of competitor promotions to ensure we react quickly; and implementing a price-match policy, which includes online and local competition with a more flexible process for guests.
Regarding the Canadian assortment, we're adding product lines that our guests told us were missing from our everyday lineup. We're adding more newness to our stores, and we're adding more exclusive items and designer partnerships, what we're known for in both the U.S. and Canada. Putting all these changes together means that of the 70,000 items in a typical Canadian Target store, about 30,000 items will be new between now and the holiday season. We believe these changes will position the Canadian Segment for improved performance in time for this holiday season, and the Canada leadership team will look for additional opportunities as they continue their review. As we look ahead to the third quarter and beyond, we are excited about our plans to introduce new products, partnerships and capabilities in our stores and digital channels. We've been very pleased with early results from the Back-to-School season, including the [indiscernible] give one offers on our own Up & Up supplies, along with our exclusive line of colorful notebooks, pens and rulers from Yoobi. Like our Back-to-College assortment, many Up & Up Back-to-College products were developed by our own design team in partnership with students and teachers who tested them and gave us report cards on how they could be improved. The guest response to the Up & Up school assortment has been phenomenal. Last year, comp sales in Up & Up school supplies were up more than 25% during the back-to-school season, and we're planning another healthy increase this year. Our Back-to-College assortment highlights mix-and-match options for guys and gals to outfit their entire dorm in a stylish and affordable way. Some of our guest favorites are space-saving, multiuse items like a storage mirror, a task lamp with iPhone and iPad storage, multifunctional and collapsible tables and desks and innovative storage solutions designed to go over the bed or chair to hold laptops and mobile phones. This year's edition of registry capability for college students has been outpacing expectations. On average, a student registers for 30 items totaling more than $1,000. We're excited about our upcoming designer partnership, Altuzarra for Target, which will arrive on September 14. Designer and Creative Director, Joseph Altuzarra created a limited-edition fall collection of women's ready-to-wear lingerie, accessories and shoes, which will be available at most Target stores in the U.S. and Canada, as well as target.com. In addition, an edited assortment of the collection will be available globally at net-a-porter.com. In May 2013, Target entered into a partnership with Sam & Libby, and it's been a huge hit with our guests who love classic styles, like the original leather bow ballet at an unexpected value of $30. In September, we'll be extending our Sam & Libby assortment with the launch of the exclusive Sam & Libby handbag line in over 1,000 stores throughout the U.S. with 2 fall collections featuring 20 styles in stores and an extended assortment on target.com. In women's Apparel, the fall assortment will reflect the #1 current trend we call neo-traditional, with feminine menswear-inspired looks in plaids and florals. This look will be most visible in Merona, with hints in our acceleration in Mossimo Supply Co. lines. After rapid growth in 2013, we're expecting another big increase this fall in women's boots, including riding boots from Merona and lace-up ankle boots from Mossimo Supply Co. Another hot trend is sports, and this fall, we'll be riding the leisure trend in our juniors assortment with leggings, sweatshirts, yoga pants, joggers and fashion athletic shoes. In denim, a huge category for Back-to-College, we just launched a new improved shopping experience for our guests with improved navigation, new fits, a broader range of sizes, more stretch and the most relevant washes and styling, all highlighted through compelling promotions. In Threshold, the fall season is all about natural materials, beautiful textures and warm metallics with key solutions in entertaining like our warm metallic bar cart, accessories, glassware and flatware and decorative items like lanterns, throws, toss pillows and perfect accent tables. In July, Target launched S Sport, designed by Sketchers, partnering with one of the hottest footwear brands in the industry today. The S Sport label is a lifestyle brand targeted to appeal to the entire family with offerings in kids, men's and women's. The initial response has been overwhelming, and we have seen styles performing at 4x to 8x the average of our shoe category. S Sport Shoes for men, women and children are available at all U.S. and Canadian stores and at target.com, ranging in price from $25 to $40. In Housewares, in September, we'll be featuring new products from some of the hottest national brands in small appliances with the introduction of the VertuoLine from Nespresso, single-serve blenders from Vita Mix and the new Keurig 2.0 line. In June, Target teamed up with The Honest Company to offer guests nontoxic, ecofriendly products by co-designers Jessica Alba and Christopher Gavigan, featuring diapers, biodegradable wipes, organic bath and skincare and an expanded assortment on target.com. Based on the success of the collaboration, we recently expanded our Honest Company assortments to include a line of all-natural cleaning supplies. Like Honest Company, our Made to Matter collection was inspired by our guests' desire for better-for-you natural and organic products. This unique collection differentiates Target in the marketplace and provides vendor partners a stage to innovate in support of their leadership positions in respective categories. The collection launched in April with an initial set of items, and the guest response has been outstanding. So we are excited about the upcoming launch in September of an expanded assortment of more than 100 Made to Matter products, including exclusive new-to-market items from Method, Seventh Generation and many others. At CHEFS Catalog, which just celebrated its 35th anniversary, we're excited about our upcoming October collaboration with chef and longtime host of Bizarre Foods, Andrew Zimmern. The partnership includes several products which meld the design elements of Japanese, Chinese and French cutlery into items Andrew describes as one-knife-fits-all pieces of kitchen magic. The collaboration also features spice blends with names like Flex Your Mex, Winner Winner Chicken Dinner or Grill Buddy. For Halloween, we're excited to be partnering once again with designer Chris March to offer a whimsical wig and accessory collection. This unique assortment reinforces both sides of our Expect More. Pay Less. brand promise with wigs that look like curlers or lobsters and decor items from candy bowls to hand towels all priced at $20 or less. The collection, available exclusively at Target stores in the U.S. and Canada and at target.com, will launch mid-September online and later that month in our stores. In Canada, we just announced that we've extended our very successful Beaver Canoe collaboration with an expansion of home decor items, along with men's and women's sleepwear and slippers. Also in Canada, on September 7, we'll be launching 2 new lines of cleaning product, Better Life, an all-natural line of cleaning products designed by 2 fathers with charismatic packaging designed to speak to younger generations; and Ecover, a European brand recently merged with Method, which we'll relaunch with better formulations and modernized packaging. Increasingly, consumers expect everything they do to be personalized, and this is particularly true of millennials, Target's fastest-growing guest segment. For the last 6 months, target.com has been building an engine that will enable personalization across all of Target's selling channels. Personalized product recommendations, the first iteration of this work, will launch this fall at target.com. When a guest shops our site, we will suggest products based on their store and digital purchase and browse history. This presents a significant opportunity to ensure guests see the products and offers most relevant to them both in-store and online and in turn, generate additional sales. We'll continue improving the guest experience, and we're working to extend personalization to more guest experiences, including product content and offers in the future. We also continue to add mobile enhancements to drive additional traffic and conversion. Just today, we launched a new header to enhance navigation in the mobile landing page, and we're streamlining mobile checkouts to 2 clicks. Also this year, we're overhauling our registry service with a new best-in-class experience that combines the power of online and mobile shopping together with in-store tools like new web-enabled smart scanners and iPad kiosks. Registry is already important for Target, and the new experience puts us at the forefront of the industry by making the entire process easier, smarter and faster. Improvements include faster scanning and adding of products, easy addition of companion products, full product information, access to reviews and inspiration through collections and lists. And in our stores, we're pleased with results from our efforts to refresh the shopping experience in key categories, including baby, Apparel and Beauty. In July, we added another 167 stores with the enhanced baby layout, bringing the total number to more than 200. In Apparel, we have about 50 stores today with an enhanced presentation, including mannequins, and we're planning to expand this layout to another 600 stores by October. And in Beauty, we continue to see strong results from this year's refresh of displays throughout the U.S. while featuring Beauty Concierge service in more than 400 stores. We're excited with our plans for the fall and believe we're taking the right steps to improve results in both the U.S. and Canada, and we're encouraged that, based on the changes we are making, we've seen positive comps over the last 6 weeks in the U.S. We are working hard to ensure that teams in both countries are focused on execution during the upcoming holiday season, and we look forward to working with Brian to map our vision for Target's future. Now I'll turn it over to John, who will share his insights on the second quarter financial performance and our third quarter and full year outlook. John?
John Mulligan:
Thanks, Kathee. As I mentioned in today's press release, we're not satisfied with our second quarter results, but we are seeing early signs of progress. In the U.S., our second quarter traffic was notably better than the first quarter pace, enough to improve the traffic trends on a 2-year basis. However, the level of second quarter promotions in the U.S. remained elevated. And looking ahead, we are working to moderate our promotional intensity to a level we believe is more appropriate in the long run. We are encouraged with the recently improved U.S. comparable sales trend, in particular because our promotional intensity over this period was not as elevated as earlier in the year.
In Canada, the team has been working hard to assess root causes for underperformance and implement changes to improve operations and the product assortment, with a focus on improving results in time for the holiday season. However, I want to be clear that current financial performance in Canada remains unacceptable. Our second quarter comp in the U.S. Segment was flat, largely in line with our guidance. As Kathee mentioned, digital sales, including flexible fulfillment, grew more than 30% compared with last year, contributing about 60 basis points to comparable sales. While this demonstrates meaningful progress on our omni-channel journey, we will continue to invest in digital capabilities as the importance of this channel continues to grow. Our second quarter U.S. Segment EBITDA margin was lower than expected, about 80 basis points below last year, driven by a lower-than-expected gross margin rate, partially offset by better-than-expected SG&A expenses. Specifically, the U.S. Segment gross margin rate was down about 100 basis points from last year, somewhat better than our first quarter experience but not where we expect to perform over the longer term. The U.S. Segment second quarter SG&A rate improved about 20 basis points versus last year, reflecting impressive discipline across the organization, combined with the benefit of our expense optimization efforts. In the U.S., second quarter sales penetration on REDcards was 28.8%, up more than 2 percentage points over last year. As I mentioned on the last call, we have seen a slower trend in debit card applications since the data breach, which is leading to slower growth in sales penetration. We've taken steps to reaccelerate growth in REDcard applications, including increased activity in our stores, and we've begun to see improvement in REDcard issuance as a result, particularly in the last few weeks. However, given there is lag impact of applications on penetration, we expect penetration growth will continue to moderate in the third and fourth quarter, reflecting the slowdown in new REDcard accounts we've seen so far this year. Specifically, our current expectation is that U.S. REDcard penetration growth will be in a range of flat to up 1% in the third quarter and will reach a trough at around flat in the fourth quarter before reaccelerating in the next year. In the Canadian Segment, second quarter sales were 63% higher than last year and about 14% above the first quarter. For the first time, we began reporting comparable sales in Canada this quarter as 48 states -- stores became mature at various points within the quarter. However, this metric is expected to be very noisy initially due to the strong and longer-than-normal grand opening sale surges we saw last year and the fact that we densified around these initial openers later in 2013. As a result, this quarter, the Canadian comp was down more than 11%, reflecting these impacts and less-than-adequate progress in our efforts to grow sales in these stores. On our Canadian sales, we earned a gross margin rate of just over 18% in the second quarter, well below where we should operate in the long run. Both sales and gross margin rate continue to reflect operations that are not working optimally, resulting in lumpy inventory. We continue to see inconsistent in-stock levels by item and location, and we have excess inventory overall, leading to elevated levels of clearance markdowns. This is why the Canadian leadership team has put its highest priority on implementing system and process changes designed to improve operations with the goal of improving performance in time for the holiday season. And as Kathee outlined, the team is already making a host of changes based on findings from our operational review. Second quarter Canadian Segment expense rates were better than last year, reflecting the startup nature of results a year ago. However, these rates will remain elevated until we gain more scale in this segment. REDcard penetration in Canada was 4.8% in the second quarter, more than double last year's 2.3% as Canadian guests continue to respond to the value these cards provide. We expect to continue to see robust growth and penetration for quite some time. Beyond operating results in the U.S. and Canada, our second quarter GAAP EPS reflected the impact of several items not included in adjusted EPS. The largest adjustment was a $0.27 per share charge for the accounting loss associated with our second quarter early debt retirement. We funded this retirement, along with a $1 billion maturity, with the issuance of $2 billion of debt at very favorable rates in the quarter. Not reflected in this accounting loss is the fact that the early debt retirement has a positive net present value. Also in the quarter, we recognized data breach expenses of $148 million, partially offset by the recognition of a $38 million insurance receivable. In addition to legal, consulting and administrative fees, second quarter breach expenses included an additional accrual for estimated probable losses for what we believe to be the vast majority of actual and potential breach-related claims, including claims by payment card networks for fraud and administrative costs. This means that, in total, over the last 3 quarters, we have recognized and accumulated $236 million of gross expenses related to the breach, offset by a $90 million insurance receivable, for a net of $146 million. This number is dramatically lower than many external estimates at the time of the breach, and it reflects the benefits of our efforts to rapidly notify both card networks and our guests when we learned of the breach, enhancing the effectiveness of fraud prevention and detection. Looking ahead, we will continue to incur legal, consulting and administrative costs related to the breach, but we don't expect those costs to be material in any period. And of course, it will take more time to resolve all breach-related claims, and while we don't believe it is probable, it is possible that we could incur material losses beyond the amounts we've already approved. Beyond these 2 larger adjustments, in the second quarter, we also recognized $0.01 each related to the impairment of some undeveloped land and a continued reduction in the beneficial interest asset associated with last year's Credit Card portfolio sale. Turning to the consolidated metrics. Second quarter interest expense was $282 million higher than last year due entirely to the loss on early debt retirement I covered earlier. We also paid $272 million in dividends this quarter, up 18% from $231 million last year. As expected, the board approved a quarterly dividend increase during the quarter, raising it 21% from $0.43 to $0.52. This increase builds on our company's track record of annual dividend increases, which have occurred every year since 1971.
Beyond the noncash share settlement of forward contracts related to our deferred compensation plans, we did not engage in any share repurchase in the second quarter, and we don't expect to do so in the third quarter as well. While we continue to expect to return robust amounts of cash through share repurchase over time, our business performance is not where it needs to be to sustain our middle A credit ratings. As I've said previously, to resume share repurchase, 2 things need to happen:
first, we need to have sufficient visibility into our potential liability for claims related to the data breach; and second, we need to see sufficient improvement in our U.S. and Canadian operations to create a clear path for our credit metrics to return to acceptable levels, in support of our A rating. While this quarter's recognition of an additional breach-related accrual reflects progress on the first condition, our current and expected operating performance does not meet the second. As a result, we expect to continue to spend -- suspend cash investments in share repurchase until operating performance improves.
Now let's turn to our outlook for the third quarter and full year. As I mentioned last quarter, in light of the environment and our performance so far this year, we will continue to maintain a cautious outlook for sales in both segments, allowing us to plan inventory and expenses flexibly while maintaining contingency plans to flex higher when sales grow faster than expected. One note:
Consistent with guidance last quarter, our outlook does not include potential additional costs related to the data breach beyond what we have already recognized as they are not estimable.
With that, let's turn to our third quarter expectations. We're currently forecasting U.S. comparable sales will be flat to up 1% this quarter. And as Kathee mentioned, we're encouraged by the positive comps we've seen so far in August. On our sales, we expect to see an EBITDA margin rate of 8% or a bit better. This rate reflects continued expected pressure on the gross margin line, but we expect about half the pressure we experienced in the second quarter. Consistent with earlier in the year, our third quarter EBITDA performance will benefit from our ongoing expense optimization efforts. In Canada, we expect sales growth of more than 50% above last year and more than 10% from the second quarter. This growth would lead to an expected positive single-digit comparable sales growth rate. EBITDA and EBIT margin rates are expected to improve compared with last year and be in line with or slightly better than the rates we saw in the second quarter. Altogether, these expectations would improve third quarter Canadian Segment EBITDA by approximately $25 million compared with last year. We expect third quarter consolidated interest expense to be approximately flat to last year and tax expense to be somewhat lower. Altogether, these expectations would generate adjusted EPS, reflecting results from both our U.S. and Canadian operations, of $0.40 to $0.50, excluding $0.02 related to the reduction of the beneficial interest assets and any potential costs related to the data breach, which are not expected to be material. For the full year, we now expect U.S. comparable sales in the range of flat to up 1%. In the U.S., we continue to expect an SG&A expense rate of about 20% for the full year and a gross margin rate between 29% and 30%. These expectations reflect the year-to-date results, along with anticipated year-over-year favorability in fourth quarter gross margin and SG&A expense rates, as we annualize the impacts of the data breach in fourth quarter 2013. In our Canadian segment, we continue to expect full year sales of about USD 2 billion. However, given our recent experience and moderated expectations for gross margin in the near term, we now expect an EBITDA margin rate near minus 25% for the full year. Altogether, these updated expectations would put our full year adjusted EPS in the range of $3.10 to $3.30, below the range we provided a quarter ago. These expected results are clearly not where we expect to perform over time. Over the last 90 days, Kathee and I have worked with the leadership team to take visible steps to continue healing our U.S. business by removing unnecessary bureaucracy to speed up decision-making, devoting resources to drive increased newness and innovation in our merchandise assortments and store presentation and investing in our digital transformation. While there is a lot more work to do, I'm encouraged with our quarter-over-quarter improvement in U.S. traffic and our sales experience so far in July and August, particularly because this improvement has not been driven by intense promotions. In Canada, Mark and the team are making meaningful changes to operations, pricing and assortment as they focus on improving performance in the upcoming holiday season. Finally, as Brian mentioned earlier, over the last 3 months, in partnership with interim Chair, Roxanne Austin, the leadership team has conducted an in-depth review of our strategy, our brand, our guest and our capabilities in both the U.S. and Canada. Since Brian arrived, we have spent a great deal of time with him sharing insights from this review, and we believe this work will provide the foundation from which we can build a longer-term vision for our strategy and financial model. We are so excited to welcome Brian to the team and committed to working with him to move this company forward. And like Brian, we believe the best days for Target lie ahead. With that, we'll conclude today's prepared remarks. Now Brian, Kathee and I will be happy to respond to your questions.
Operator:
[Operator Instructions] Our first question will come from the line of Wayne Hood with BMO Capital.
Wayne Hood:
Brian, I had a question for you and then 1 for Kathee. When you arrived, the role of president was left open. And I was curious whether or not you anticipate filling that role and any organizational structures that you might contemplate to speed the company to getting to market? And then, Kathee, if you could just peel back the onion around why the UPT was down 1.7%. You made good progress in transaction, but you took a step back in UPT. And I'm just wondering why and what you expect for those metrics into the third and fourth quarter.
Brian Cornell:
Wayne, let me start by answering your first question. My focus right now is to really understand the business in both the U.S. and Canada, and I'm spending a lot of time with John and Kathee and the team to understand the guest perspective on Target, how we improve our traffic, how we enhance our performance in Canada and how we continue to build out and rapidly build out our omni-channel capabilities. So I'm very focused on making sure that we're going to make progress against those key 3 initiatives as I continue to look at the broader and longer-term strategic options. So my focus is really understanding the business today and strategy before we have any discussions around organization modifications going forward.
Kathryn Tesija:
And then, Wayne, in terms of the unit per transaction, most of that was driven by higher-dollar items that we were selling, things in Electronics and Entertainment. So you see the healthy selling prices you mentioned but fewer units. The other portion of that, that I would say is that we are seeing really good momentum in our trade-up strategies. So we are selling, in some cases, fewer units, but higher price points in other categories across the company, but it's predominantly Electronics and Entertainment.
Operator:
Your next question will come from the line of David Strasser with Janney.
David Strasser:
I just wanted to step back a little bit. And look, you talked about even gross margins for this year at a 29% to 30% range. It's a pretty wide range. And as you think about a world -- an e-commerce world and how things are changing fairly rapidly out there, I'm just trying to get a sense if you think, over time, that the gross margins are within that range, the lower end of that range and sort of how you're thinking about that competitive landscape. I mean, you talked a lot about a lot of new merchandising initiatives and stuff, which can help offset some of that, but at the same time, as every company that we've seen kind of get more focused and driven around e-commerce seems to see their gross margins lower by the nature of what that business is. So I'd love to hear a little bit about your thought process there.
Kathryn Tesija:
Yes. David, there's no doubt, with e-commerce being as immature as it is, there is some pressure on gross margin. We are committed to going where our guests go. And they want to be able to shop online, and we are going to make sure that we've got all the right products for them both online and in our stores. So that does give us a little headwind on the gross margin. But as you pointed out, all of the newness that we're bringing in, the things that our guests love most about Target, that helps to offset it. So we don't have a number to share with you today, but we are very focused on driving sales, going where the guest is and offering them those products that delight them.
David Strasser:
So I mean, I guess, just as a follow-up to that, I mean, are -- if the guest does go more rapidly towards dot-com, are you willing to accept lower gross margins to do that? And then just, I guess, sort of a related question to that, too, is you talked about opening stores for greater hours. Is there an SG&A investment as well that would be related to e-commerce, aside from just the build-out of e-commerce, that you think that you need to add to the stores, once again, as this world is shifting?
John Mulligan:
On the gross margin rate, I think Kathee said it really well, we're going to go where the guest is and meet them, provide the product they want, where they want it, when they want it, how they want it. But there's a lot of tools in our toolkit to manage gross margin rate. There's certainly the product that Kathee talked about, emphasizing the style categories with newness and differentiation. Beyond that, there's the flexible fulfillment options, where we lower shipping expense by moving the product closer to our guests and also, ultimately, balancing inventories better across the entire network and reducing markdowns that we incur today. So there are lots of puts and takes. And like Kathee said, we don't have it all sorted out today. We'll provide more information as we do, but I think there are a lot of puts and takes as we think about gross margin rate more broadly. On the store hourly payroll, first, on the extended hours, the investment there was immaterial to the quarter. Again, that was about half the stores adding 1 hour of operation, so not significant investment there. But with Tina Schiel, our Head of Stores, we continually talk about ensuring that we're striking the right balance between productivity in those stores, and we're having great guest service results. And what we see today, our guest surveys scores are as high as they've ever been, and the team continues to drive really strong expense controls. So we feel good about where we are today, but we constantly evaluate that.
Operator:
Your next question will come from the line of Matthew Fassler with Goldman Sachs.
Matthew Fassler:
Brian, I'd like to start out by asking you for your long-term perspective on thresholds for Canada as relates to time and financial performance. Obviously, that business today is performing at a materially lower level than what was originally conceived when it was opened and presumably, well below its cost of capital. What would you want to see over time to keep that business running? And what kind of time frame do you have in mind for, say, material improvement in that business?
Brian Cornell:
Yes. Well, Matthew, as I mentioned earlier, I spent time this last week with the Canadian team, and I'm certainly aware that the expansion has been challenging. And from a Target standpoint, we've disappointed many of our Canadian guests, and Kathee has already referenced the fact that we're conducting an in-depth evaluation of our Canadian business. That began several months ago, and we're certainly looking to make material improvements in that business. Right now, short term, the focus is on improving in-stock conditions, our pricing and assortment and really ensuring that we've got plans in place to improve our performance in the holiday upcoming. So you can expect me to be spending quite a bit of time with the Canadian team, along with Kathee, to make sure we understand the opportunities, we understand the challenges that we have to address. And we're focused on improving in-stocks, our value position and assortment as we go forward. So I'm going to spend, clearly, the balance of the year working very closely with that team to make sure we've got plans in place to improve performance as we go into the holiday season.
Matthew Fassler:
Just a quick follow-up on the U.S. business. In the markets where Buy Online, Pick Up in Store is more mature, how additive do you find that is, either online sales or to the business overall? I know that for some retailers it can be as much as 30% or 40% of the overall online sales number. So where have you seen -- where you have the most track record behind you, if you will, what's your sense of how additive that can be?
Kathryn Tesija:
Well, we did add it to the chain all at the same time, so we don't have any markets that are more mature. We did do a little testing with team members in Minneapolis before we rolled out, but basically, we rolled it all around November 1 of last year to all stores. And we have been very pleased with the results from Buy Online, Pick Up in Store. And about 14% of our digital sales today are being picked up in store. And then, when they go to the store to pick up those orders, we're seeing about 20% of those guests shop in the store to pick up additional items, and there's a very healthy basket with that as well. So still early but very, very promising. We think it saves guests time, it saves them money, and it allows them to consolidate their shopping.
Operator:
Your next question will come from the line of Greg Melich with ISI Group.
Gregory Melich:
John, I wanted to follow up a bit on the gross margin. It's down 100 bps in the quarter. If I remember correctly, you had a goal for $600 million of cost reductions this year, roughly 1/3 of it in cost of goods sold. Could you give us an update as to where we are on that and how much that may have helped the quarter in terms of U.S. margin?
John Mulligan:
Yes, sure. You're right, it was the goal for expense optimization, about $650 million incremental to last year, which gets us to $850 million total. Of the $650 million this year, just rough numbers, about $200 million of that was on the gross margin line coming out of cost of goods. More of that back weighted than front weighted. We're probably about a little bit more than 1/3 of the way through that, probably a little bit more than that, maybe half the way through that. So there was definitely some benefit in the quarter from expense optimization. That was also true in the first quarter. Both quarters have benefited, but later in the year, we'll see more benefit as we continue to grow those savings.
Gregory Melich:
And the same with the SG&A, out of that $650 million, it's more back end?
John Mulligan:
Yes, it builds as the year goes on. We're annualizing on the roughly $200 million we saved last year. That was primarily SG&A. So there's probably a little bit more good news in SG&A right now, but that will continue to build as well as we go throughout the year.
Gregory Melich:
Great. And if I could, Brian, welcome back to retail.
Brian Cornell:
Thank you. Good to be back, Greg.
Gregory Melich:
How long do you think it'll take for you to sort of get to understand the business and the customers and actually come up with a plan? Is this something we should expect by year-end or early next year? Can you give us any time horizon on that?
Brian Cornell:
Well, Greg, I'm going to quickly immerse myself in the details of the business, both here in the U.S. and Canada. And John and Kathee and the leadership team have already spent hours with me, walking through a lot of the strategic work that they've been doing over the last 90 days. As I said earlier, during my very first week, I visited the Canadian market to spend time with that team. And I want to be a good student of the business, but clearly, we have to have a sense of urgency here and a sense of pace. And while I want to study the business and certainly listen and learn from our team, no one is happy with our current performance. And our focus right now is to make sure we've got plans in place in the short term to improve traffic, we've got plans in place to improve our performance in Canada. And we've got to continue to move faster from a digital and mobile standpoint to meet the needs of our guests. So you can expect a clear sense of urgency, but I certainly want to make sure I give myself the time to listen, learn, understand the business both from our team's standpoint but also from the eyes of the Target guest. And you can expect me to dive in very quickly to understand the business, to look for the opportunities and to work with the leadership team to develop very focused priorities as we go forward into 2015 and beyond.
Operator:
Your next question will come from the line of Matt Nemer with Wells Fargo Securities.
Matt Nemer:
I was hoping to get some more detail on the improved performance in July and August. And I'm wondering if you have a sense, from your guest surveys, how much of that change is driven by price investments, efforts to improve the presentation or maybe a change in the broader environment.
Kathryn Tesija:
Yes, Matt, I think it's more about product and the newness that we have on the floor for Back-to-School, Back-to-College. We've seen both of those start off really strong. Even in their peak weeks, those stores are doing better the week after their peak. So we're seeing it stronger in the peak and then get even stronger after that. So I think it's really product related and newness. Certainly, we've had promotions. Most of them are devoted to those core categories like Apparel, some of the Back-to-College items. But the guest right now is more focused on the occasion than they are on the promotion. So that is very encouraging to us, and I think it's product driven.
Brian Cornell:
Matt, if I could, it's early days, but the current performance on Back-to-School and the way Kathee and the team have put Back-to-School together at Target has been very impressive to me. And I think it's a great example of getting the product right, the right balance of newness and innovation, great advertising communication that really captures the guest's attention and very strong in-store and online execution. So I think that's one of the great examples that we're going to continue to build from as we go forward. But I think Kathee and the entire team have brought Back-to-School to life, Back-to-College to life with the right products, the right newness and innovation, great advertising communication to support it and then very strong in-store and online execution.
Matt Nemer:
That's very helpful. And then 1 housekeeping follow-up, if I may. Your Canada comp transactions were only down about 2%, which, frankly, was a little bit surprising against the grand opening halo. I'm wondering why UPT was down so much. I think it was down over 8%.
John Mulligan:
UPT down 8% in Canada, Matt, I think a lot of that -- what I would tell you is a lot of noise going on in the Canada comp overall. So much of the surge last year, we saw very different types of transactions than we saw once we moved past that. As we opened stores, we saw that in each cycle, very different behavior for those, I don't know, 4 to 6 weeks when we had the surge period. And then, as the business settled down and got into a more normal state, we saw more routine transaction counts and baskets. What I would tell you is we're going to continue to see this. It's going to be noisy in Q3. And really, it won't be until we get to Q4 when we've cycled past all the opening cycles, all the densification, that we get a real read on what's going on, on a comparable basis from the business year-over-year.
Operator:
Your next question will come from the line of Matt McClintock with Barclays.
Matthew McClintock:
Welcome, Brian. Kathee, my question is actually for you. You talked a lot about product freshness and newness, and I was just wondering as you look to the fall merchandise plan, how far can you push freshness and newness into that plan. What inning would you say that represents overall relative to what you consider to be more optimal level? And when can we realistically expect you to reach that more optimal level?
Kathryn Tesija:
Well, hadn't thought about it in terms of innings, Matt, but I'll tell you we are excited about what we have coming for the fall season. I highlighted a lot of things that are coming in September and October. But then moving on to the fourth quarter, which we won't be specific about today, but we're excited about what that brings as well. We have about 85,000 items in our assortment, and we'll have 35,000 new items this fall season. So I do feel pretty optimistic about the content, the quality, the trend, the presentation. But clearly, in spring, I think you'll see that will be a full cycle out, and we'll have much more to come as we turn the corner into the spring season.
Operator:
Our final question will come from the line of Simeon Gutman with Morgan Stanley.
Simeon Gutman:
Welcome, Brian. A quick one for Kathee. We talked in New York, about a month ago, about traffic trips and that 9 out of 10 were still intact from the customer, but you lost 1 out of 10 and that maybe e-commerce was the angle of you to get that back. My question is how confident, and I don't know if you have any early indications from your own data, that when that customer does shop online with you that either they're not going to visit the store less or that they'll not maintain the same level of purchasing?
Kathryn Tesija:
Yes. The guest that shops Target online is absolutely our best guest. They shop both online and in stores. It's really all about what's convenient for them. And sometimes, it's just easier to knock an item off your list by buying it on your mobile device. Sometimes, you want to purchase it online but pick it up in-store to do the rest. But this is absolutely our best guest and one we will not cede. So we will go after being a seamless omni-channel retailer with confidence knowing that it's the best thing for our guest and best thing for our business. And I do think that, that -- when we think about the lapsed guests, they're basically back, and so traffic changes are more about consolidated trips and trips shifting online. So it's an important part for us to own, which is why you see all the efforts in our omni-channel capabilities and strategies with subscriptions and with personalization and with ship-from-store and Buy Online, Pick Up In Store. There's a lot of things that we're putting effort into that will help drive that momentum.
John Mulligan:
Right. Simeon, thank you for the question. And that concludes our Target Second Quarter 2014 Earnings Conference Call. And I thank all of you for your participation today.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation First Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, May 21, 2014.
I would now like to turn the conference over to Mr. John Hulbert, Senior Director, Investor Communications. Please go ahead, sir.
John Hulbert:
Good morning, and thank you for joining us on our 2014 first quarter earnings conference call. On the line with me today are
This morning, John will provide a high-level summary of our first quarter results and strategic priorities for the remainder of the year. Then Kathee will discuss results in the U.S. and Canada, guest insights and plans for the second quarter and beyond. And finally, John will provide more detail on our financial performance, along with our outlook for the second quarter and the full year. Following their remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following this conference call, John and I will be available throughout the day to answer any follow-up questions you may have. Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Finally, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP EPS is included in this morning's press release posted on our Investor Relations website. With that, I'll turn it over to John for a review of the quarter and our priorities going forward. John?
John Mulligan:
Thanks, John. First off, today, I want to thank the Target team for their energy and commitment. The first quarter was unusually challenging as we worked hard to help our guests recover from the data breach. Because of the team's efforts, traffic and sales trends have improved substantially, and we're in a much better position today than we were just 3 months ago.
Also, before I turn to the first quarter operating results, I want to briefly discuss the board's recent announcement of Gregg Steinhafel's departure and the initiation of a comprehensive internal and external search for a permanent replacement. I want to thank Gregg for all his contributions to Target over his 35-year career, and I'm humble to follow him into this role even on an interim basis. With the full support of the board, Kathee and I, along with the rest of the leadership team, have made it clear to the entire Target team that we are not going to wait for a permanent CEO to improve our operations and performance. We are already taking important steps, including management changes announced yesterday, to move the organization forward. This morning, we reported adjusted earnings per share of $0.70, above the midpoint of our guidance. This is the result of generally in line performance in both the U.S. and Canada, combined with a better-than-expected tax rate, driven by a variety of small matters none of which was individually significant. Our U.S. segment comparable sales decline of 0.3% was near the upper end of our guidance and reflects meaningful improvement from trends we are experiencing shortly after the breach. When we survey consumers, we increasingly hear that they have put the breach behind them and they're resuming their Target shopping habits. We're pleased with this progress and continuing to take steps that reinforce our commitment to earn back the trust of our guests. We recently announced that we've hired Bob DeRodes as our new Chief Information Officer, and I'm confident that Bob is the right person to lead our technology transformation and data security remediation efforts. That same day, we also announced the important decision to move all of our REDcards under MasterCard's industry-leading chip-and-PIN technology. This decision, along with our accelerated rollout of chip-enabled card readers to all of our stores by this September, are among many crucial steps we're taking to restore confidence among our guests that it's safe to shop at Target. First quarter Canadian segment results were also largely in line with our expectations. Sales were just below the expected range, driven by softness early in the quarter. While losses were meaningfully lower in the fourth quarter, we're still far from where we need to be. We continue to roll out enhanced tools and technology, we've increased the intensity of our value-messaging, and we've made several important changes to the Target Canada leadership team during the quarter. As a result, we're beginning to see improved guest satisfaction measures regarding in-stocks and price perception. While these early signs of progress indicate that we're moving in the right direction, we're committed to moving faster. As we look ahead to the second quarter and beyond, the board and our team are aligned on 3 priorities. The first is growing traffic and sales in our U.S. segment. While the environment is challenging, we can do better. We need to improve on something we've historically done well, delivering unique products and services at great prices. As a result, we are working quickly to drive more newness in our merchandising and presentation, helping to keep Target top of mind with guests by continually reminding them why they fell in love with Target in the first place. Second, we must improve our Canadian segment performance. Canada is a great market, and Target is a great retailer. But so far, we have not lived up to our potential or our expectations. Improving operations is key, but we need to think broadly about all aspects of our business and whether other changes are needed. We made changes to the Target Canada leadership team so they could take a hard look at our current performance and apply fresh thinking about how to improve. And finally, we need to accelerate our digital transformation and become a leading omnichannel retailer. To do this, we'll move more quickly to become more flexible in how we serve our guests, eliminating barriers that prevent them from shopping with us where and when they want. This includes delivering products and services more flexibly in our stores or anywhere else the guest wants to receive them. Our common theme across all of these priorities is a continued focus on our guests. Not just the ones we currently have, but the potential guests who aren't shopping with us today. We need to listen intently to all of them, how they're feeling, what they want and how well we're serving them. With that knowledge, we need to make decisions based on what will inspire them, deepening their love for Target by making their lives easier and apply all of our energy to make that happen. And finally, we know we can't accomplish any of this unless we unleashed the talents of our great team. So we are focused on prioritizing and aligning our efforts to provide greater clarity and removing roadblocks that have been slowing our team down. We will empower them to take smart risks and hold ourselves accountable for learning quickly from the results. We have been on this journey for some time but the board believes, and we agree, that we can accelerate our progress. Given recent announcements of leadership changes, many of you ask what is going to change? While that is certainly important. I want to make sure we discuss what is and is not going to change. What clearly will change includes our emphasis on speed throughout the organization, our commitment to more rapid improvement in Canada, our focus on digital and becoming a leading omnichannel retailer and a level of investment in newness and innovation in what we offer to our guests. While we work towards those goals, we'll continue to develop smaller, more flexible store formats to allow us to serve guests in markets that can't accommodate our larger store layouts. We'll continue our expense optimization efforts. Our goal is not to cut away the prosperity but to free up resources we can leverage in support of faster growth.
And finally, our point of view on capital deployment remains the same. This has always been a board level discussion and we continue to be aligned with them on the following priorities:
invest everything appropriate in our core business on projects that will support Target's growth and generate superior returns; support the dividend and build on our record of more than 40 years of annual dividend increases; and beyond those first 2 uses, return cash through share repurchase when we have room within our middle A credit ratings.
The board has made it clear that they agree with these priorities and that our leadership team has their full support. Our mission from the board is clear:
provide focus, remove roadblocks, and unleash the team to move faster.
As Jeff Jones, our Chief Marketing Officer, likes to say, "Interim will not mean idle." We are committed to making real changes now, accelerating our transformation during this transition period, while the board conducts its search for a permanent CEO. Now Kathee will provide more details on first quarter results, second quarter plans and key priorities for the remainder of the year. Kathee?
Kathryn Tesija:
Thanks, John. As John mentioned, we entered the first quarter during a tumultuous time for our U.S. business, as traffic and sales trends were still recovering from the meaningful declines we saw following the data breach.
Our plan was clear:
make Target irresistible to our guests with exciting content and compelling deals. Our efforts produced mixed results for the quarter, reflecting unfavorable weather in February, followed by the strongest results in March and weaker-than-expected Easter sales in April.
In total, first quarter performance was meaningfully better than the fourth quarter, as comparable sales improved by more than 2 percentage points and comparable transactions improved even more. In our U.S. business, first quarter comparable sales were strongest in Hardlines, driven by a mid-single digit increase in Electronics, which continues to benefit from strong trends in mobile. Comparable sales in our less discretionary Food, Health & Beauty categories were slightly positive, while Home and Apparel saw small comp declines. With our digital channels, first quarter sales were strongest in Health & Beauty and Home. U.S. segment comparable traffic was down a little more than 2%, which was nearly offset by a healthy 2.1% increase in basket size. Within the average basket, we saw an increase in both units and average retail, reflecting our continued success in attracting guests to add more items to their carts and trade up to higher price points. First quarter digital visits were up more than 20% from a year ago, which, according to comScore, was the fastest growth among a group consisting of Target and 7 of our largest online competitors. The share of digital visits from a mobile, phone or a tablet continues to grow, and in the first quarter, almost 2/3 of our digital traffic was on one of these devices. Conversion rates on both our conventional and mobile sites improved in the first quarter, driving an increase in overall conversion despite the mix headwind created by the shift into mobile. The combined benefit of traffic and conversion improvements drove first quarter digital channels sales up more than 30% from last year. Our U.S. segment first quarter gross margin rate was down more than a percentage point from last year, as our team focused on providing irresistible deals for our guests. Based on the success of fourth quarter promotions prior to the data breach, we had already planned for a steady drumbeat of compelling offers this spring. However, following the data breach, we decided to ramp up the intensity of these promotions even more to motivate guests to reestablish their shopping routine at Target. For example, in late February, we offered 5 12-packs of Coke product for $10, our lowest price in more than a decade. In early March, we featured a spring cleaning incentive, offering $20 in savings when guests spent $50 on cleaning products. Also in March, our shoe sale featured a buy-one, get-one half-off promotion, and in April, we ran a Cartwheel offer to save an extra 10% on 42 of our biggest deals from the front and back cover of our weekly ad. In the U.S., to help reinforce Target as the destination to shop for anything, anytime, anywhere, we have launched a year-long Target-run marketing campaign, featuring national and owned brand items across categories like Food, personal care, Baby, paper and pets. This fun campaign will change with seasons and other timely events and is intended to make Target our guest destination for those fill-in trips they might consider making at a drug or grocery store. While there is certainly more work to do, we are pleased that so many of our guests have responded to our promotions and moved beyond the data breach to resume their Target shopping habits. In fact, recent survey research show that the vast majority of our lapsed guests, those who had changed their shopping habits had not visited -- and not visited Target since the data breach had come back for at least 1 visit by the end of the first quarter. And while irresistible first quarter promotions were key to reinforcing the Pay Less side of our brand promise, we were equally focused on initiatives that offer newness and deliver on the Expect More side of that promise. We led off the quarter with the February launch of PETER PILOTTO for Target. Guests in the U.S. and Canada and worldwide, through our collaboration with Net-A-Porter, responded enthusiastically to Target's exclusive collection of women's apparel, accessories and swimwear. Home is already one of our fastest-growing online categories, and while we feel good about our opening price point offerings, we believe we can more fully serve guests at higher price points. To begin addressing this opportunity, in March, Target.com launched over 2,000 new furniture items from Safavieh, a brand that online guests recognize for having great style at an accessible price. Target's assortment features stylish items in furniture, rugs, lighting and soft home, including many Target exclusives. Safavieh anchored the Spring Home Sale during April week 3 and was showcased in the target.com homepage, and we're happy with early sales results. Guests are increasingly looking for natural, organic and sustainable products that are better for them and their families. So in March, we launched “Made to Matter – Handpicked by Target," a first of its kind collection that brings together 16 leading natural, organic and sustainable brands to showcase new products and make them more accessible for our guests. The Made to Matter products span 6 categories, featured both in our regular locations and in specialized displays, while select products are available at target.com and our mobile app. We'll be adding new items to this collection throughout the year and enticing guests to try these products with offers on Cartwheel. Also in the first quarter, we were blown away by the response to the release of Disney's Frozen on DVD and Blu-ray, as we saw amazing results across Music, Movies & Books. In fact, when Frozen was released on DVD and Blu-ray in March, it became the most successful first-day release for any movie in Target history. And in the short time since, the movie has become Target's biggest movie ever. In the first month alone, we sold more units than we sold in the first year of Finding Nemo, which previously held the record for our biggest release. In children's books, Frozen continues to be the #1 license in the first quarter, and we sold hundreds of thousands of units since its set last September. And finally, in Music, the Frozen soundtrack also held the #1 spot throughout the first quarter, selling more units in April than all of our other releases combined. Cartwheel just celebrated its 1-year anniversary, having far outpaced our expectations. Cartwheel has attracted more than 7 million users in that time, most of whom continue to use Cartwheel after their first redemption. Cumulative Cartwheel savings have grown past $70 million, and our active Cartwheel users have, on average, increased their trips and spend at Target by nearly 30%, driving hundreds of millions of incremental sales from these households. And in the first quarter, we saw a 33% increase in new Cartwheel users when we integrated the app into our weekly ad for the first time. We continue to see encouraging results from our recent rollout of in-store pickup of digital orders. These orders make up about 10% of our digital transactions, and when guests pick up their items, more than 20% of the time, they take the opportunity to shop at the store and spend much more than our average basket. In the first quarter, we expanded the number of SKUs eligible for in-store pickup to more than 60,000, including some shelf-stable grocery items. Following a successful ship-from-store test with Minneapolis team members, we are planning to launch a guest-facing $10 rush delivery pilot in June in the Minneapolis, Boston and Miami markets, offering guests the ability to order as late as 1:30 p.m. in the afternoon and receive a delivery of qualifying items between 6:00 and 9:00 p.m. the same day. Later in the year, we plan to roll out standard shipping from 136 stores in 38 markets across the country. By leveraging the store network as fulfillment centers, we can offer faster standard shipping, typically, 1 to 2 days and provide access to store-only items not previously available from target.com. We will continue to monitor results to determine further rollout plans. As John mentioned, in Canada, we continue to enhance our operations in the first quarter, and our in-stocks have started to show meaningful improvement. At the same time, we ramped up our promotional intensity to show our guests the depth, breadth and pricing of our assortment in frequency categories, and our guests have taken notice. In a recent survey of Canadian guests, we saw double-digit improvements and favorable responses to questions regarding our in-stocks, whether we provide a good value, our everyday pricing and the quality of our deals. First quarter Canadian segment sales were slightly below plan, driven by softness in February and March and stronger performance in April. Our gross margin rate of 18.7% improved dramatically from the fourth quarter, but it remains far below where it needs to be as we continue to clear excess inventory on long lead receipts. While our progress in Canada is encouraging, we have an opportunity to move much faster. Yesterday, we announced that Mark Schindele has assumed the role of President, Target Canada, reporting to me. Mark is a strong leader who has spent the last 15 years at Target. He has broad experience in merchandising and operations and he will bring a fresh perspective to the Target Canada team. Mark will join Janna Adair Potts, who recently took on responsibility for our Canadian stores and distribution; John Butcher, our new leader of merchandising in Canada; Livia Zufferli, who leads Target Canada marketing; Tiffany Monroe, who leads Target Canada human resources; and Mark Wong, Target Canada's general counsel, as they elevate all aspects of our Canadian business and implement changes to improve our performance. Yesterday, we also announced that Target will be naming a Nonexecutive Chair in Canada, someone with deep knowledge and expertise in the Canadian market, who will collaborate with the President of Target Canada to ensure our strategies and tactics align with the Canadian marketplace. Here in the U.S., as we survey our guests and monitor consumer sentiment, we continue to see what we have seen for some time, signs of optimism, combined with reasons for continued caution. On the positive side, recent stock market highs, slow but persistent job growth and rising home values are driving improved consumer sentiment metrics. However, lack of income growth among more moderate income families and persistent lack of household formation are hampering the pace of recovery. Given our exposure to lower- and middle-income households, the environment remains challenging overall, and we face the additional challenge of addressing the lingering effects of the data breach. Consumer survey data shows that we've made substantial progress on measures of Target's favorability and integrity in the U.S., and they are approaching levels we were seeing prior to the data breach. However, while trust measures have improved as well, we need to make more progress to restore them to pre-breach levels. That's why we're focused on delivering on our commitment to accelerate the rollout of chip-and-PIN on our cards and in our stores, along with many other visible steps we are taking to increase the security of the entire U.S. payment -- U.S. card payment system. As John mentioned, for the remainder of the year, we're working quickly to enhance the flow of newness and innovation in our products, presentation and promotions. For the second quarter, we have lined up compelling deals, services and products designed to accelerate trips to Target across all of our channels. We are further enhancing our mobile platform to improve the experience and drive continued increases in conversion. Advancements underway or planned for this year include more sorting options for guest shopping on a mobile device, a save-for-later option in the mobile basket, better visibility to our in-store pickup capabilities, streamlined mobile checkout and dynamic customized landing pages. We're also growing services like Target subscriptions that make life easier for our guests. With very little marketing, the pilot of our subscriptions program quickly grew to account for more than 15% of target.com sales on eligible items. As a result, we recently enhanced the program by expanding eligible items nearly tenfold and offering a 5% discount on all subscription orders, helping our guests save even more time and money. We're continuing to integrate last year's acquisitions into Target's digital and store experiences. At DermStore, we're testing integration into our weekly digital ad, and we'll begin selling DermStore gift cards in all stores in July. At CHEFS and Cooking.com, we're working to integrate their site content into our overall digital experience, continuing to expand the CHEFS' assortment on target.com and promoting both digital brands through inserts in millions of target.com orders for cooking and kitchen items. Beyond acquisitions, we are excited about our investment in startup company, Cosmic Cart, which offers a universal shopping cart for publishing websites and blogs. Their technology allows retailers to make sales directly from Cosmic Cart's affiliate sites and allow shoppers to easily buy items while browsing online content. Beyond our investment, Target incubated the Cosmic Cart team at our Minneapolis headquarters for 3 months. During that time, the team built a white label product for Target to use on our own online and social channels. This product allows shoppers to purchase a Target product they see on a specific channel, like the Instagram page of Target Style, without having to leave to checkout on target.com. We look forward to seeing how our guests respond to Cosmic Cart as we continue to test new ways to use their technology. Our wedding and baby registries have always been a smart way to shop for gifts, but in U.S. stores this summer, they'll get even smarter with new Web-enabled iPod-based scanners that give guests a much more user-friendly experience. In Apparel, earlier this month, we launched a new exclusive Mossimo Supply Co. apparel collection in partnership with San Francisco-based artist and avid surfer, Jeff Canham. This collection of classic surf-inspired apparel includes tees, tanks, board shorts, flip-flops and beach towels. Also this month, we launched a new Archer Farms mix & match meals program in all of our SuperTarget and PFresh locations, more than 1,500 stores in all. With this program, guests can create a custom-designed meal for their family of 4 that's ready in 10 to 15 minutes and costs less than $18. These meals are comprised of unique sauces, fresh-cut and prewashed vegetables, fully cooked pastas and starches and all-natural precooked meats. And of course, we're investing in service -- in store service and layout enhancements that will continue to differentiate the Target experience. In Baby, we've heard from guests that they love shopping our stores but want help in making the smartest choices. Our enhanced Baby experience provides just that, with dedicated service, enhanced technology, expert information from BabyCenter and an easier-to-shop layout that allows guests to try out items like strollers. We expanded the test of this layout to nearly 30 stores this spring, on our way to more than 200 locations this summer. Like Baby, the Beauty category can be overwhelming, and we want to inspire, educate and engage our guests. Our Beauty Concierge program, currently in more than 400 stores, offers guests the opportunity to interact with brand-agnostic, noncommissioned-based advisors who help them feel confident in their purchases, driving sales through increased trips and bigger baskets. This spring, we executed the largest physical update to the skincare and cosmetic aisle since 2001. The new environment includes brighter, more inviting LED lighting, large backlit signage, highlighting product attributes and ingredients to help inform decisions and shelving that allows for brand customization and cleaner presentations. In Entertainment and Electronics, we're testing a new layout that invites guests to discover products and make more informed purchase decisions. Examples include discovery tables to display featured items and allow guests to interact and play with products, as well as the integration of all children's books, movies and video game products in one convenient location. In addition to physical changes, this test incorporates enhanced team member training on product features and functionality. This redesigned experience is currently being tested in 17 stores and will determine future plans based on guest feedback. Based on our experience in Canada and our CityTarget stores, we are testing enhanced displays, including mannequins, which elevate the environment and help our guests save time by providing navigational cues throughout the area. Based on positive results from a limited test this spring, we plan to roll out enhanced apparel displays to 50 additional stores this summer and several hundred more stores this fall. And we're in early stages of a test of a new toy floor pen that offers more hands-on experiences, where families can explore and interact with products. The reinvention offers fun, interactive experiences, including larger-than-life toys, and features streamlined shelving to improve sightlines for the guest. Based on results of this small test, we expect to roll out this layout to a number of additional stores this fall. In Canada, we're introducing a new format for the flyer, their version of our weekly circular, with a radical new design based on feedback from our Canadian guests. The new format features a clean design, bolder price points and more products across all categories. We will use a consistent format each week that separates needs from wants, making it clear to our guest that we offer great deals on both. Specifically, we're adding an 8- to 12-page wrap filled with frequency items so that the actual flyer has more room for discretionary categories like Apparel & Accessories, kids, Seasonal and Home, the categories Canadian guests most associate with Target. And to further drive awareness and consideration of Target's frequency categories, Target Canada launched an integrated essentials marketing campaign highlighting products such as laundry detergent, diapers, grocery, multivitamins and more. The check-it-off-your-list-for-less campaign, which includes radio, TV, digital and the flyer, launched on March 14 and is planned to run for 18 weeks. While we've made considerable progress in the first quarter, the entire leadership team is working to achieve faster growth in the U.S., dramatically improve Canadian segment performance and accelerate Target's digital transformation. To accomplish this goal, we're going to leverage the fantastic assets we already have, a world-class brand, a strong network of newly built or remodeled stores across the U.S. and Canada, strong partnerships with leading national brands, combined with a set of powerful owned and exclusive brands, which benefit from our design and sourcing capabilities and, most importantly, a motivated and talented team that's eager to win in the marketplace. Beyond the changes to the Canada team, yesterday, we also announced changes to my team in the U.S., which will better leverage functional expertise to speed up innovation, drive newness and accelerate our digital transformation. With these changes, the team will be more agile, better positioned to deliver increased traffic and sales in the U.S., on our way to becoming a leading omnichannel retailer. These leadership changes are among several we've made to focus our priorities and remove roadblocks that might slow down our teams. With these changes in place, we believe we can move faster, and the team has enthusiastically embraced the challenge. Now I'll turn it back over to John who will share his insights on our first quarter financial performance and our second quarter and full year outlook. John?
John Mulligan:
Thanks, Kathee. As Kathee mentioned, our first quarter results were markedly better than our fourth quarter performance, specifically compared with the trends we were seeing late in the fourth quarter following the announcement of the data breach. In the U.S. segment, our comparable sales decline of 0.3% was near the high end of our guidance and flat to down 2%. Comparable traffic declined 2.3%, dramatically better than our late fourth quarter trends but well below where we should perform over time.
Consistent with broader trends in the U.S. market, traffic in our stores has been declining, while transactions in our digital channels have been growing rapidly, particularly in mobile.
However, given the relative size of these 2 channels of Target today, the mix effect of these opposing trends is driving a decline in overall transactions. The key to reversing this decline is clear:
accelerate our digital capabilities and leverage assets across both our physical and digital channels to lead guests to choose us more often than they are today.
The distinction between channels is increasingly unimportant because single transactions are already straddling both the physical and digital channels. Ultimately, we should be agnostic about which channels guests choose and enable them to interact with us where and when they want to, in our stores, digitally or preferably both. First quarter penetration in our REDcards was 20.4%, up 3.3 percentage points from last year. This is very healthy growth, but a couple of percentage points below rates we were seeing prior to the data breach. In the first quarter, as research showed that most consumers are putting the breach behind them, we ramped up REDcard offers to guests in our stores. And by the end of the quarter, we were making those offers with the same frequency as before the breach. When we make an offer, the application rate for our Credit Card has largely recovered to pre-breach levels, but the rate for the debit card is responding less quickly. As a result, we expect slower U.S. REDcard penetration growth in the second quarter, up between 200 and 300 basis points from last year. Looking ahead, as part of our broader effort to rebuild traffic and sales, we will work hard to reaccelerate REDcard growth, particularly the debit product, through our marketing and an enhanced focus on the role our store team members play in generating REDcard applications. Our first quarter U.S. segment EBITDA margin rate was 9.5%, down nearly a percentage point from last year, driven by a gross margin rate decline of more than a percentage point. As Kathee mentioned, we ramped up the intensity of our deals in the first quarter to get guests back into our stores. And this decision was reflected both in better sales and traffic and a lower gross margin rate. Our SG&A rate improved about 30 basis points from last year, reflecting outstanding discipline across the company, including the benefit of our expense optimization efforts, as well as the timing of some expenses compared to last year. In our Canadian segment, first quarter sales were below expectations in February and March, but were better-than-expected in April. Our first quarter gross margin rate was 18.7%, much better than the fourth quarter but still below our full year expectation as we work to clear excess inventory on long lead time receipts. Expense rates were much better than a year ago, reflecting scale benefits and a comparison to last year's preopening costs. First quarter REDcard penetration was 3.9%, was nearly double last year's rate, but still well below where we believe it will be over time. Consistent with last quarter, beyond operating results, our first quarter GAAP earnings reflected several items that reduced EPS by approximately $0.04. These items include the data breach-related costs, net of an insurance receivable, continued reduction in the beneficial interest asset and a charge related to our decision to move from Visa to MasterCard for our co-branded REDcard credit product. Turning to consolidated metrics. Our first quarter interest expense of $170 million was down more than $450 million from a year ago as we annualized the first quarter 2013 charge for the early retirement of high-coupon debt. We returned $272 million in dividends this quarter, up from $232 million last year as our $0.43 per share quarterly dividend was more than 19% higher than a year ago. We plan to recommend that our board authorize another similar increase this summer. We did not repurchase any shares in the first quarter. While we expect to generate cash well beyond our expected uses over the next several years, our current metrics are beyond the typical boundaries of our middle A credit rating. As a result, we do not expect to repurchase shares in the second quarter and may resume repurchases in the back half of the year at the earliest. To resume this activity, we need to see continued improvement in our U.S. and Canadian operations, moving our credit metrics back to acceptable levels relative to our single A rating. In addition, we believe it's prudent to hold off on any repurchases until we have more visibility into our potential liability for third-party card networks fraud and administrative costs related to the data breach. Based on what we know today, we do not expect to have visibility into those claims until the third quarter or later. I'll turn now to our outlook for both the second quarter and our updated expectations for the full year. Given our current trends and challenges in both the U.S. and Canada, we believe it's appropriate to maintain a cautious outlook for sales in both segments. This allows us to plan inventory and hours effectively, while building contingency plans to allow us to flex higher if sales grow more rapidly than expected. We've updated our full year expectations for profitability in both segments, taking a more cautious view in light of the environment and the additional steps we're taking to grow U.S. traffic and sales, accelerate improvement in our Canadian operations and step up the development of our digital capabilities. While we don't expect these additional efforts to change our 2014 capital expenditures in a meaningful way, we are planning for lower operating margins in both segments as we dedicate additional resources to make progress. Specifically, we expect to invest more in gross margin for newness, product innovation and promotions in both the U.S. and Canada to enhance our value proposition across both sides of the Expect More. Pay Less. brand promise and incur incremental expenses as we develop more resources to improve operations in Canada and speed up the development of digital and flexible fulfillment capabilities in the U.S. Longer-term, we believe these investments will be paid back in the form of faster, profitable growth and increasing market share in both segments. One note. Consistent with guidance last quarter, our outlook does not include potential additional costs related to the data breach beyond what we've already recognized as they are still not estimable. As I mentioned, we continue to believe we have the financial strength to move beyond these near-term impacts once they are known, even as we continue to invest to grow in both of our segments. So with that context, let's turn first to our expectations for the second quarter. In the U.S., we expect a slow improvement in sales trends, meaning second quarter comparable sales should be flat to slightly positive. We expect U.S. segment EBITDA margin rate will be below last year's 10.8% rate, but we expect a smaller year-over-year decline than we experienced in the first quarter. Both gross margin and SG&A expenses will be pressured by our efforts to grow traffic and expand our digital capabilities. But we also expect an offsetting benefit on both gross margin and SG&A expense lines from our expense optimization efforts. In Canada, we expect sales measured in U.S. dollars to be up about 75% from last year's second quarter, and about 25% higher than the first quarter. We will report Canadian segment comparable sales for the first time in the second quarter, but this measure will be highly volatile in the near-term as we'll be measuring it on a small set of stores. Specifically, we expect to report a single-digit decline in second quarter Canadian segment comparable sales as we'll be comparing against the very large grand opening surges we experienced a year ago, combined with the impact of our market densification later in 2013, which redistributed sales from our initial openers. We expect the Canadian segment gross margin rate will improve beyond 20% in the second quarter, but will continue to reflect pressures from promotions and efforts to eliminate excess inventory. Expense rates in this segment should show modest improvement from our first quarter rates, but will remain elevated far beyond what they will be in the long run. All together, second quarter Canadian segment EBITDA losses measured in U.S. dollars are expected to be approximately flat to last year. We expect second quarter consolidated interest expense to be approximately flat to last year and tax expenses to be somewhat lower. All together, our expectations would generate adjusted EPS, reflecting results from both our U.S. and Canadian operations, of $0.85 to $1, including -- excluding $0.02 related to the reduction in the beneficial interest asset and any potential costs related to the data breach. For the full year, we continue to expect U.S. comparable sales in a range of flat to up 2%, and we still expect an SG&A expense rate of about 20%. However, we've taken our gross margin rate expectation down below 30% to make room to invest more in products and promotions. In our Canadian segment, in light of recent trends, we've taken down our full year sales expectation to closer to USD 2 billion and, with that new view of sales, we expect lower gross margin rate and higher expense rates than before. Specifically, we now expect our full year Canadian segment EBITDA margin rate will be closer to minus 20% compared with our prior expectation closer to minus 10%. All together, these updated expectations would put our full year adjusted EPS in the range of $3.60 to $3.90, $0.25 lower than the range we have provided a quarter ago. While these are our current expectations based on where we are today, I don't want to create the impression that we're satisfied. Recent management changes, including yesterday's announcements, demonstrate that we believe meaningful change is needed to put us on a different long-run trajectory. In Canada, we need much more urgency to improve our operations, so our systems and supply chain can enable the rapid growth in sales we'll be driving to achieve scale. And in the U.S., even though we're seeing industry-leading growth in the digital channel, we need to grow even faster to catch up with others who have been on the journey for a much longer time. And we need to become much more willing to deliver more newness and differentiation to our guests. Given that we're already known for it, we need to continually raise the bar on what newness means, providing our guests with a sense of inspiration and discovery that makes them want to visit us more often in whatever channel they choose. With that, we'll conclude today's prepared remarks. Now Kathee and I will be happy to respond to your questions.
Operator:
[Operator Instructions] Your first question comes from the line of Matthew Fassler with Goldman Sachs.
Matthew Fassler:
Two questions. The first one, I want to ask, it's sort of a governance-related question. So answer it as you can. You talked about some of the company's initiatives and your key strategic direction in areas where you felt, perhaps, the company had fallen short. Were any of these areas themes where perhaps Gregg and the board or Gregg and the rest of the management team had a difference of opinion, such that your focus on them today would be different from what the firm's focused on them had been under his leadership?
John Mulligan:
Matt, all I can tell you is what we're focused on going forward, and we're focused -- Kathee and I and the whole leadership team have been talking to the team for the past couple of weeks about our focus is on driving the business forward, and we have 3 key objectives
Matthew Fassler:
That's very helpful. And then my second question, just a quick one, on Canada. If you could try to help us frame the magnitude of inventory sort of left in the pipeline that you need to clear, maybe how much of a factor that was in the grosses in Q1? And whether that's -- whether you're cleaned up at that -- at this stage?
John Mulligan:
Matt, as you know, when sales get out of -- when sales aren't on expectation and inventories get a little heavy, they get lumpy. And so there's areas where we're a little bit heavier than we'd like, there's areas where we're a little bit lighter than we'd like, and we're working to, I'd say, balance all of the inventories. And a lot of it, frankly, will be dependent on do we meet our sales objectives. In the first quarter, a little bit light but not materially so. And if we continue to hit to our sales objectives, I think we'll see our inventory smooth out over the course of the year and be in a manageable position for the remainder of the year. I don't know if there's anything to add, Kathee.
Kathryn Tesija:
Yes, the thing that I would add, Matt, is we're working on making sure that our forecasts are accurate, and then as we buy into them, that we've got chase and cancel plans built-in so that we're able to react in-season versus what we've done in this past year without any history and having to react at the end of the season to clear more. So we are still lumpy. We still have products to clear. But we're getting our arms around that forecast, and I think that will help us as we move through the year.
Operator:
Your next question comes from the line of Bob Drbul with Nomura.
Robert Drbul:
Just two questions. I guess, first, in terms of the search for a new CEO, is there like a reasonable timeframe that you think it can be resolved? And then the second question is on the share repurchase, you gave a lot of detail on it. Is it -- in terms of the second half confidence level, do you think that you will have better visibility? And what gives you that visibility around the cost of the breach in that third quarter? Just -- I'd like to better understand that situation.
John Mulligan:
Sure. On the first question on the CEO search, certainly, that's under the board's purview, and I would tell you, rather than focused on time, they're focused on getting the right individual to lead the company, as I said, to become an omnichannel retailer. So that's their focus, and the time will take as long as it's appropriate to get the right person. On the second one on share repurchase and specifically related to the potential breach liabilities, getting visibility to that in the second half of the year, there's a process that is agreed to within networks. They get some information from their forensics investigator and then they go through a process to evaluate incremental fraud where we may have potential liability. And then they come back to us after a period of time, and as we've looked at that historically, we've seen that that's taken several months and that's why we get to the third quarter. We don't have, frankly, Bob, a lot of visibility to that, but as I said, as we look at other incidents, that's what we've seen in the past for timing of when some of those potential liabilities may become more clear.
Operator:
Your next question comes from the line of Greg Melich with ISI Group.
Gregory Melich:
I had a couple of questions. John and Kathee, it sounds like growing that digital is a key focus right now and driving that faster. Could you help us understand where we start from, like what percentage of your sales or maybe some of the cross-shopping between REDcard members and how much they shop online, or maybe how those people season after they've had a REDcard a few years? And anything you have on that, I think, would be helpful.
John Mulligan:
Sure. I'll talk maybe a little bit about where we are today, and Kathee can talk about what we're doing to drive growth there. I mean, the sales in our business, somewhere between 2% and 3%, digital-channel originated, probably in the 2.5% range right now. REDcards, given the free shipping online, we have a lot of our REDcards guests shopping online, and I think we talked in the past, Greg, we have a very high penetration of online orders that we free-ship because of that REDcard. We think it's absolutely the right incentive or part of that loyalty package for REDcard, but it drives a very high penetration. And Kathee, you can talk about where we're going.
Kathryn Tesija:
Yes, in terms of growth, Greg, mobile is where we're really focused and about 2/3 of our traffic right now comes from mobile. So we're really pleased with the results that we've seen there, not only in traffic, but also conversion. And we did improve conversion both on the site and on mobile, and in total -- and you know that mobile conversion is lower than site conversion, so that headwind from the mix is there but we still improved overall conversions. So we're happy with that. There's also a lot of new things that we're doing. Certainly, there's product introductions. I talked about the furniture a few minutes ago. There's always new stuff that we're adding on the site. We're expanding. We've got all -- almost all-store products online, now setup online, lots to be sold online. But now we're adding out in other areas where we should have a much larger selection and we think online is a place to do that, things like Apparel, Home, Beauty. In addition to that, there's a lot of services that we are adding that are doing really well. We talked about Buy Online, Pick Up in Store subscriptions has been really successful for us. We started last fall with about 150 SKUs, and in those items, our online sales were about 15% in subscriptions. So with no marketing and just beta on the site. So we've now got about 1,500 items, and by June, we'll have 5,000 items that will be available for subscriptions. When guests purchase those items, they will be able to get a 5% discount for signing up for subscriptions. So a lot of product and a lot of services that go with that to drive our growth.
Gregory Melich:
That's great. And if I could follow up on the guidance. It sounds like it's really margin investment in Canada that has taken the guidance down, if I have summarized that right. You left the comp the same in the U.S. If we get back to that 0 to plus 2%, do you expect traffic to be positive at all as part of that guidance? Or do you think it could still be negative through the year?
John Mulligan:
Yes, I think if you mean for an annual number, getting to an annual positive traffic number, very difficult. We're working hard on increasing traffic for each of the quarters, and I think our benchmark is are we seeing continued improvement in traffic as we go sequentially? But for the full year, even if we just pick a number at random -- 1 comp, I don't think we'll see positive traffic for the year.
Operator:
Your next question comes from the line of Matthew Nemer with Wells Fargo.
Matt Nemer:
I'm just wondering on the digital transformation that you talked about, is there a target level of investment from both the P&L and a CapEx standpoint?
John Mulligan:
I don't think there's a target level of investment. I think, first, from a CapEx standpoint, our approach has been we're going to invest in all the investments the business needs to grow profitably and generate appropriate returns. The length of time over which those returns occur, we have a very long lead time as we think about capital investment. Stores have a very long return cycle. So we're used to making investments that pay back over a long period of time. From an expense standpoint, I think there, probably the biggest investment and where you'll see us accelerate is in speed and doing more testing and learning. And that's not just digital, but also in our store, just getting more activities out into the business that we're testing, we're modifying and adjusting and improving on. And if it doesn't work, pull it back and retreat from that and learn from the testing. I think the best example of that is Cartwheel. We put that out in beta. We knew there were things about the app that we didn't particularly like. Our guests let us know what they didn't like about the app. The team iterated and iterated. And 1 year later and, really, not with much marketing until more recently, we have 7 million users, and the app has evolved as our guests have provided us feedback. And as Kathee talked about, a lot of the merchandising initiatives in Baby and in Apparel and in Toys and in Electronics, that's the same approach we've taken, get it out in the stores, modify it, test it somewhere else, and modify it and then we'll move to scale. And so those are the investments we'll see in expense, and I don't think that it's limited by some false number of expense dollars we have to allocate toward it. It will be driven by the appropriateness of what we're testing.
Kathryn Tesija:
Yes, the thing that I would add to that, Matt, the reason for getting more out -- and historically, we've tended to work on our newness until we felt we got it to an almost complete level and then we would put into pilot. The point now and John's point about Cartwheel and some of the in-store things that we're doing, we want to get in front of our guests very quickly, get their reaction to it so that we're fine-tuning it much more quickly and then able to move out to roll out at a much faster pace, with the products and the service that we know our guests will love.
Matt Nemer:
Okay. Great. And then secondly, can you talk to the early-cycle stores versus the later-cycle stores in Canada? Anything you can share on the difference between the financial metrics in the various cohorts.
John Mulligan:
Yes, as we said, we continue to see improvement across the business into April as the guests data improved and our sales performance improved. And the early-cycle stores continue to be the best. And it's, again, almost in order down the sheet, cycle 1, cycle 2, cycle 3, cycle 4, cycle 5. So the earliest stores, the longer they've been open, they perform the better. But the good thing is all cycles on an upward path. We're not where we need to be and we're not where we need to be versus our expectations, but it's good to start to see some progress.
Kathryn Tesija:
And I think the key to each of those cycles and improving them is getting this history under our belt, and now, we can forecast more accurately as we move forward. And as John said, we're very committed to accelerating our performance in Canada, and we think that it will continue to go by cycle as it has this past year.
Operator:
Your next question comes from the line of Sean Naughton with Piper Jaffray.
Sean Naughton:
Two questions. First, on online, and I guess, specifically, Amazon, it seems to continue to infringe on Target's everyday business and, increasingly, the consumable category. So I guess, the question is twofold
John Mulligan:
I'll take the second one and then Kathee can answer the first. I think on sales tax, we definitely see an impact when Amazon collects sales tax and, in particular, in states that have much higher sales taxes to begin with, where essentially the price differential is much more meaningful. And so we've definitely seen that impact as we've watch them collect sales taxes across the country. And Kathee, you can talk about the rest.
Kathryn Tesija:
Yes, in terms of our online business, the part that I'm very encouraged about is that as comScore reports, when we look at traffic on our site versus the top 7 retailers, we led by far, and obviously, Amazon has a lot of traffic, but it was flat in the quarter and ours was up considerably. So I'm pleased with -- that the changes that we're making to this site, with the user experience and the added product that we're adding, is driving that guest behavior and that we're seeing the traffic. Clearly, Amazon is doing very well and they have in the consumables category a lot of business. We've been now ramping that up, starting with some more style-related consumable business. If you think Beauty, for example, you'll see us pushing forward there faster versus Grocery, which we're doing dry grocery now but we're not working on refrigerated and frozen at this point.
Sean Naughton:
Understood. That's helpful. And then I guess, the second question on the logistics side of the organization. It sounds like you're having good success with the ship-from-store test and then Buy Online and Pick Up in Store, at 10% of the sales seems to be going relatively well. Can you talk about any of the longer-term P&L benefits from these initiatives, both maybe from a top line and a margin perspective?
Kathryn Tesija:
At this point, I don't think we're ready to commit to what that will do from a financial perspective. Our main focus right now is what will most resonate with our guests, getting pilots out in beta so that we can learn and experience from them. Ultimately, we have to work to be profitable on all of those. But our main goal right now is sales-driven and understanding guest behavior so that we can then tailor the assortment to suit them and be profitable at it. I will tell you, I've been really pleased with some of these new initiatives and how rapidly our guest is responding to them. Store pickup is the biggest because it's now rolled out, but ship-from-store, which was really a Minneapolis team member test so far, we're going to be expanding that in June and make that guest-facing, having that $10 rush delivery in Boston, Minneapolis and Miami. And based on our team member response and the feedback that they gave us, I think that this will also resonate with our guests, so I'm really excited to see where that goes. And then later in the year, we're going to be adding standard shipping from 135 stores in about 38 markets, and that will allow faster delivery, not the express that I just talked about, but 1- to 2-day delivery and as well as provide access to the store assortment that you can't get right now on target.com. So lots of good things happening. Not yet ready to say what it means in terms of our sales or our profit.
John Mulligan:
And I think Kathee's exactly right, not ready to give a lot of guidance on sales, profit and how it will all work out. But I would tell you, broadly, regardless of where the profit margin rates end up, pushing incremental sales across our existing assets will be a very good thing for return on invested capital, and we're very excited about that. And with that, I think we have time for one more question.
Operator:
Your final question comes from the line of Joe Feldman with Telsey Advisors Group.
Joseph Feldman:
A couple of quick things. I guess, I was curious as to, Kathee, the change in the organizational structure under you in merchandising. And like, I guess, what really prompted this now versus 6 months ago or next month or waiting for -- and a formal hire of a CEO in place?
Kathryn Tesija:
Well, I think that the point is that we want to accelerate newness and innovation in this interim period. Here, we've talked about interim doesn't mean idle. We are approaching our business with as much passion and focus on improving results as we always have. And in terms of this structure, I think, as John mentioned, focusing on our top 3 priorities and having this merchant team really focused on the U.S. -- improving U.S. performance and leveraging deep functional expertise to be able to speed up that innovation and newness. So for example, putting all of our Style business together, both merchandising and design, all under Trish Adams; having our essentials and Hardlines business all under Jose Barra; having all inventory and all operations under Keri Jones; and then our omnichannel efforts all under Casey Carl, are really important to be able to leverage that expertise and move very quickly in improving our results.
Joseph Feldman:
Got it. And that makes a lot of sense. And if I could follow up, was this something that Gregg was reluctant to doing, and that -- did that have anything to do with the timing?
Kathryn Tesija:
I'll just tell you that the board has been very supportive on these changes. We've talked at length about getting the right people in the right chair to be able to drive our performance. And we're really pleased with this structure and the people that we have leading these teams.
Joseph Feldman:
Got it. And then just the one last thing I wanted to ask, and I apologize if I missed it in the discussion today. But as far as the price investments go, where -- are they more in the consumables side, the discretionary side? Where are there areas you think you need to, I guess, make an investment?
Kathryn Tesija:
As we've been focusing on irresistible deals for our guests, we've invested in both sides. I gave you the example of the Coke ad that we ran in, I think, it was in March, but we've also done broad categories on the want-side like the Ultimate Spring Break Sale or our Baby Sales. We're looking at really needs and wants, and how do we invest in both sides to be able to delight our guests. And we've had great success in both categories.
John Mulligan:
Well, that concludes our First Quarter 2014 Conference Call. Thank you, all, for your participation.
Operator:
Thank you for participating in today's conference call. You may now disconnect.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation Fourth Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded Wednesday, February 26, 2014.
I would now like to turn the conference over to Mr. Gregg Steinhafel, Chairman, President and Chief Executive Officer. Please go ahead.
Gregg Steinhafel:
Good morning, and welcome to our 2013 fourth quarter earnings conference call. On the line with me today are Kathee Tesija, Executive Vice President of Merchandising; and John Mulligan, Executive Vice President and Chief Financial Officer.
This morning, I'll provide a high-level summary of our fourth quarter results and strategic priorities for the year ahead. Then, Kathee will discuss category results, guest insights and the holiday season. And finally, John will provide more detail on our financial performance, along with our financial outlook for 2014. Following John's remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following this conference call, John Hulbert and John Mulligan will be available throughout the day to answer any follow-up questions you may have. Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in the 8-K we filed this morning. Finally, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP results is included in this morning's press release posted on our Investor Relations website. Target's fourth quarter financial results reflect better-than-expected U.S. segment's performance through the first 3 weeks of the holiday season, followed by meaningfully softer results following our December 19 announcement that criminals had gained access to guest payment card data in our U.S. stores. In total, fourth quarter comparable sales decreased 2.5%, consistent with our updated guidance in January. Throughout the quarter, our team managed the business extremely well, adjusting both inventory and expenses to match the rapidly changing pace of sales. As a result, our U.S. operations generated fourth quarter adjusted earnings per share of $1.30, at the high end of the updated guidance we provided in January. In Canada, we worked diligently to leverage holiday traffic in an effort to clear excess inventory. Markdowns resulting from this effort drove a very low gross margin rate, but allowed us to reduce average inventory per store in Canada by approximately 30% between the beginning and end of the fourth quarter. Canadian segment EPS dilution was $0.40 in the quarter, $0.05 better than the updated guidance we provided in January. We're pleased that our early cycle Canadian stores have seen the most improvement giving us confidence that we'll continue to see continued improvement across all our Canadian stores in 2014. Fourth quarter GAAP EPS of $0.81 reflects U.S. and Canadian segment performance, along with costs related to our recent restructuring and data breach, along with small accounting and tax matters. As we've worked to address the impact of the mid-December data breach, we have put the welfare of our guests at the center of every decision we've made. We've communicated early and often, providing the best information we had about new facts in ongoing -- on the ongoing investigation. We consistently assured our guests that they would have 0 liability for any unauthorized charges on their card accounts resulting from the breach. We increased fraud detection for REDcard holders and extended free credit monitoring and identity theft protection for any guest who has ever shopped one of our U.S. stores. We are truly sorry for the impact this breach has had on our guests, team members and other stakeholders. And I want to reiterate that we are committed to making things right. Yet we know these initial steps are part of a longer process. We continue to listen to our guests, and we know that this incident and recent security breaches at other companies have shaken their confidence in both Target and the U.S. payment system more broadly. To rebuild guest confidence, we are committed to an end-to-end review in cooperation with third-party experts to understand how the breach occurred, the identification and acceleration of solutions to provide enhanced protection in the future and engagement with third-party experts to protect the industry and consumer from future threats. Accordingly, we are taking the following steps. We are conducting an end-to-end forensic investigation of our processes, systems and personnel, to make informed decisions on potential security enhancements; we're accelerating the adoption of advanced chip-enabled technology, investing more than $100 million to equip our stores and to issue Target-branded smart chip credit and debit cards. We have long supported this more secure technology, but broad adoption in the U.S. market has been elusive. We believe that recent events will help the industry to reach a tipping point toward accelerated adoption in the U.S., and we are investing to ensure that Target is a clear leader in driving this change. We're working collaboratively with a broad set of stakeholders in the payment card space, including banks, retailers, trade associations, payment processors and networks, to share and advance best practices and foster future innovation. We helped launch, and will be an active leader in, a retail industry, cybersecurity and data privacy initiative. In addition, we are investing $5 million in a new coalition with the Better Business Bureau, the National Cyber Security Alliance and the National Cyber-Forensics & Training Alliance, to advance public education around cybersecurity and the dangers of consumer scams. While we can't yet assess the full impact of this crime against Target and our guests, we are pleased that sales have started to recover from the trends we observed following breach-related announcements in December and January. Importantly, because we are in a strong financial position, we expect to absorb any near-term financial impacts, while continuing to invest in projects that are key to our long-term success. Our company has a long history of innovation, disciplined management and a strong long-term financial performance and we are committed to upholding the principles, which have sustained this company's success for many decades. And while 2013 was a disappointing year financially, we've entered the new year with the right plans in place to grow profitably and generate meaningfully improved financial performance in 2014 and beyond. In the U.S., we've demonstrated our ability to manage the business with discipline and generate strong financial performance even in a challenging environment. In fact, Kathee will outline in more detail, we were very placed with our holiday season results prior to the announcement of the data breach. In preparation for fourth quarter, we made changes to our holiday promotions and marketing and we were pleased that our in-stocks were running at all-time highs. As a result, U.S. segment fourth quarter sales were running ahead of -- were running ahead of plan prior to December 19. Looking ahead, we will apply the insights we gained in the holiday season to connect with our guests by delivering merchandise and promotions thoughtfully designed to appeal to them based on what's on their mind at each point in the year, moving Target beyond compelling, to becoming irresistible for our guests. We made enormous progress in our multi-channel efforts throughout 2013, as we meaningfully increased conversion both on our website and on our mobile apps. We acquired CHEFS Catalog, Cooking.com and DermStore, extending our online assortment by providing our guests access to additional high-end brands in key home and Beauty categories. We launched Cartwheel, our unique mobile savings tool, which has far exceeded expectations in both adoption and engagement. And we accelerated our investments in flexible fulfillment. As a result, throughout the year, growth in our digital traffic and sales outpaced industry averages. We launched in-store pickup chain-wide at the beginning of November, and with very little marketing, this new offering became a meaningful driver of digital traffic and sales. Our stores teams did an outstanding job delivering great service, when guests arrived to pick up these orders, and this is particularly impressive since we launched the service during the busiest time of the year. We will continue to invest in systems, data and processes to enhance our flexible fulfillment capabilities in 2014 and beyond. In our stores, we are committed to enhancing the guest experience by adding dedicated service to key categories like Beauty, Baby and Electronics. And by providing training and technology that allows our stores team to go beyond providing basic service to solving problems for our guests. And we're continuing to pilot innovations to our store formats. Based on the initial rollout of the CityTarget format and the high single-digit comparable sales we're seeing in our second year CityTarget stores, we're analyzing opportunities to reduce the size and enhance the flexibility of this format, opening up a wider universe of potential sites in dense urban areas. While the work on CityTarget continues, we've also developed a separate smaller format called Target Express. At about 15% of the size of one of our general merchandise stores, we believe this design provides us with a fantastic opportunity to expand into new trade areas, providing a convenient solution to guests who can't easily visit one of our other formats. While we expect to offer a carefully curated assortment in frequency categories like Food, healthcare, Beauty and other household essentials, Target Express will also offer discretionary categories, including home, Electronics and Seasonal. Throughout the store, we will feature our own brands, which offer guests an unbeatable combination of quality and price. We plan to open our first pilot location of this format here in our home market in July, so we can carefully study both operational and financial results before we determine our plans to expand this format to other markets. Throughout the organization, we continued to find new opportunities to optimize expenses. Freeing up resources, we can apply to new initiatives. In 2013, our teams saved approximately $200 million by reprioritizing their activities and finding more efficient ways to get things done. Our expense optimization efforts are not a short-term project but a complete overhaul of the way we work. And the team continues to find new opportunities. As a result, we expect the benefit of our expense optimization efforts to reach $1 billion in annualized savings by 2015. I'm proud that our entire team has embraced this effort to transform how we work. In Canada, the team has moved from a year focused on opening a record number of stores to optimizing the business in run state. As we enter 2014, with a much cleaner inventory position, the team's #1 operational focus is on in-stocks, ensuring we have the right quantity of each item in the right place at the right time. In addition, we continue to invest in technology and training to enhance both the tools our team uses and their ability to deploy it most effectively. We're also continuing to implement innovative marketing and merchandising programs in Canada to raise awareness for our frequency categories, like Grocery, household essentials, Beauty and health care. Throughout 2014, we will focus on conveying the depth and breadth of our assortment in those categories and the unbeatable value we provide to our every day pricing, 5% Rewards, price match and our flyer. With enhanced guest awareness of our unbeatable prices, combined with the benefit of improved operations, we expect guest shopping frequency to build throughout 2014, driving improvement in sales and profitability. While 2013 will clearly be remembered as a challenging year, I am proud of the team's efforts to transform our business and position the company for long-term success. And I want to sincerely thank the Target team for their tireless effort to help our guests recover from the data breach. While there is much more work to be done, I'm inspired by their singular focus on our guests and making things right. As a result, I'm confident we will look back on this incident and see that we emerged from it even stronger than before. Now Kathee will provide more detail on our fourth quarter results, and key initiatives as we enter 2014. Kathee?
Kathryn Tesija:
Thanks, Gregg. In our last conference call, we outlined our plans for the holiday season and mentioned that fourth quarter sales were on track through the first half of November. As we progressed through Black Friday week and the first 2 weeks of December, guests continued to respond to our promotions and sales ran ahead of our plan. Following the data breach announcement and the rapid change in the pace of our sales, the team reacted quickly, making nimble adjustments to minimize excess inventory. This quick response allowed us to end the year with a clean inventory position and while our fourth quarter gross margin rate reflected the additional clearance activity resulting from the sales slowdown, our team did a great job minimizing the impact.
As we built our holiday plans, our goal was to cut through the clutter and reach our guests with compelling offers on exciting merchandise. Specifically, we aligned our weekly deals and events so guests were receiving a clearer message across all channels. And because our guests are budget-conscious and love to find deals, we intentionally layered promotions across our circular, Cartwheel and our catalogs to provide unbeatable value. We used our direct channels to drive urgency at key points in the season and we offered more broad, attention-getting promotions, like 40% off sweaters. Consistent with past years, we featured hot deals on key items, but attracted more attention by offering deeper discounts on fewer items and we were very pleased with the guest response. For the quarter overall, our nondiscretionary categories generally saw the strongest sales performance. However, among our more discretionary categories, Electronics saw an increase in fourth quarter comparable sales, led by mobile phones, tablets and video game hardware and software. We also saw relative strength in our Sporting Goods and Housewares categories. Our digital channels had a very strong holiday season. Thanksgiving was our biggest digital sales day ever, with mobile devices accounting for a full 25% of those sales. We were recently recognized as having the most browsed app by a smartphone and tablet in 2013, and Mobile Commerce Daily just named Target Mobile Retailer and Commerce website of the year. This is the second time we've been named Mobile Retailer of the Year and we're pleased to be the only retailer to be honored with the award twice. An important factor in our digital success was the fourth quarter rollout of the opportunity to buy online and pick up in store. In-store pickup requests represented about 10% to fourth quarter digital orders, but they peaked at a much higher rate before Christmas, as guests relied on the service as a great solution for last-minute gift shopping. About 30% of store visits to pick up an online order resulted in store shopping on that same trip, and the size of that store transaction was much larger than an average store trip. While we rolled out this capability with an external commitment to have orders ready in 4 hours or less, our team quickly attained our internal goal to have most orders ready in 1 hour or better. Our survey showed consistently high levels of guest satisfaction with this service, and this capability has accelerated our mobile conversion rates. We're also pleased with the continued growth of Cartwheel, our digital social savings app, which ended 2013 with over 5 million users who've already saved more than $43 million. Younger guests are particularly engaged by Cartwheel, as more than half of its users are millennials, a much higher percentage than they represent in our overall guest base. Redemption made from Cartwheel are more than 10x higher than we see in other direct channels like receipt marketing and e-mail, and our analysis indicates that it's driving incremental trips and sales. Our pre-Black Friday deals resulted in one of the biggest days ever for Cartwheel, as they drove 1/3 of our active users into Target stores on the Wednesday before Thanksgiving. We continue to work to enhance the Cartwheel experience. We recently added the ability to scan bar codes to find out if there's a Cartwheel deal on an item and added the capability to sign up for Cartwheel directly through a Target account and e-mail, while continuing to provide access to the app through Facebook. As Gregg mentioned, we continued to listen to our guest to understand how we can help them move beyond the data breach and feel confident in shopping at Target. While sales have started to recover in recent weeks and sentiment metrics have begun to improve, most notably among our best guests, we continue to invest to ensure this recovery continues. Beyond our efforts in data security and chip-enabled technology, we're applying insights from the holiday season to make our merchandise, stores and digital channels even more irresistible to our guests. We continue to innovate in ways that differentiate both our product assortment and the guest experience, and we're investing in pricing and promotions to make our value proposition even stronger. We're very pleased with the response to PETER PILOTTO for Target, our most recent designer partnership, which launched earlier this month. His collection, which features a limited-edition assortment of women's apparel, accessories and swimwear, is available at most of our U.S. and Canadian stores and on target.com. We've also partnered with Net-A-Porter.com to offer a curated assortment of the collection to fans across the globe. With lots of social media buzz, we saw long lines outside many of our urban stores on the morning of the launch. And the collection quickly became Net-A-Porter's fastest selling collaboration in history. Based on last year's results, Target and Sports Illustrated are once again partnering in support of the magazine's annual swimsuit issue, which is celebrating its 50th anniversary this year. Target is the exclusive mass retail advertiser and official marketing partner for the issue. This year's partnership includes a new 20-page flip cover that celebrates swimsuit style over the past 50 years and features Target's limited-edition swimwear collection. The collection launched at Target stores and on target.com February 17 in advance of the issues on-stand date, and includes 10 black, gold and ivory swimsuits priced from $15 to $30. Earlier this month, we began offering AMBAR, a new apparel collection designed with the Latina guest in mind. AMBAR's set in 50 U.S. stores this month and is also available on target.com. The line of Apparel & Accessories features vibrant prints and flattering cuts and silhouettes. This stylish and affordable collection has items ranging from $17 to $40. This spring, Target will introduce an assortment of premium skincare featuring 7 notable brands, 4 of which will be exclusively sold at Target. 29, both by Lydia Mondavi, Borghese, LANEIGE and MD Complete by Dr. Zelickson, alongside industry favorites, Vichy, La Roche-Posay and Own Skin Health. These brands will be merchandised in 2 distinct sections, dermatological skincare and specialty skincare, and they've already launched on target.com. We'll begin rolling out these assortments to 749 U.S. Target stores beginning in March. So what's likely to be the biggest Blu-ray and DVD release of the year, Target will offer an exclusive edition of Catching Fire, the second film in the Hunger Games trilogy, in stores and on target.com next month. The Target-exclusive Blu-ray edition includes 45 minutes of exclusive content from never before seen footage and cast interviews to a behind-the-scenes look at the making of the film. This spring, award-winning singer Shakira is teaming up with Target for her 10th studio album and our exclusive deluxe edition, featuring 3 bonus tracks, hits stores on March 25. We announced the partnership and kicked off album preordering with a special spot during the 56th annual Grammy awards in January. Last month, we became the exclusive retailer to feature Beats Music playlists. Beats Music is a curated digital music streaming service that allows its users to peep into the personal music libraries of their favorite artists and brands and have them create playlists just for them. By subscribing to Target's playlists, guests can expect a varied mix of songs inspired by Target's rich heritage of music and the taste of the millions who shop for albums at Target each year. In December, we launched the Awesome Shop, a beta site that features the top Target products recently pinned on Pinterest. The site lets guests explore, get inspired and see what other guests love just like they do in stores. Awesome Shop highlighted the best of the best by only featuring items with a target.com review of 4 stars or better. We're also leveraging Pinterest in another unique way to collaborate with 3 of the sites most influential pinners on a series of a party planning collections that will make it easy to throw a Pinterest-worthy event. Joy Cho of Oh Joy!, Jan Halverson of Poppytalk and Kate Arends of Wit & Delight, will each create limited time only collections launched over the course of 2014, including party décor, paper products and serving pieces, designed in their signature aesthetic. Beyond differentiated merchandise, we continue to provide enhanced service in key areas of the store. Based on guest response to last year's launch, we've expanded the Target Beauty Concierge program to more than 300 stores across the country with new markets, including New York, New Jersey, San Francisco and Dallas-Fort Worth. These Beauty consultants are brand-agnostic and provide guests with detailed unbiased information and a friendly face in what can often be an intimidating category. We also continued to see great results from the pilot of our new Baby layout, a completely redesigned shopping experience that offers guests inspiring, insightful solutions, combined with the great value they've come to expect from Target. This new layout features a dedicated service desk with a knowledgeable baby advisor to help guests navigate the area and provide unbiased product information. Digital screens and iPads feature inspiration and interactive comparison tools, and BabyCenter content such as buying guides and product reviews. We've also incorporated an in-department registry kiosk for expecting moms or guests looking to give a gift. Merchandise displays have been lowered so guests can more easily interact with large products like travel systems and strollers. We've removed barriers to enhance navigation between Apparel, gear and Baby essentials, and we've highlighted the availability of additional online-only items in key categories. This summer, we plan to grow from 30 stores to more then 200 locations, featuring this enhanced Baby experience. And based on encouraging initial results, in 2014, we'll expand our test of using mannequins in Apparel in our larger format U.S. stores to elevate the store experience, create an enhanced sense of discovery and bring our unique designs to life. We also continue to augment our digital capabilities, driving traffic and sales to all of our channels. Online, our top priority in 2014 is continuing to improve the guest experience. All of our efforts will be designed to make things simple, seamless and enjoyable for our guests. To support this priority, we continue to hire external talent with deep functional expertise in online merchandising, site merchandising, mobile and analytics. We've recently made enhancements focused on search, product information and checkout, making it easier for guests to browse and purchase. In addition, now nearly all store products are viewable online, making this the only place that guests can view Target's full assortment. Importantly, we're making enhancements, while continuing to focus on stability and speed. As a result, target.com consistently ranks in the top 10 for retailer site availability and performance. Given the profile of our guests, mobile is more important at Target than for many of our peers. For example, Target's guest traffic from tablets and mobile phones is greater than our traffic from traditional computers, and the shift toward mobile shows no signs of slowing down. In fact, usage of the Target app doubled in the short period between last summer and the end of the year. To maintain our strong momentum in mobile, we are testing and learning from new features, including list building, mapping and Cartwheel capabilities launched during the holiday season. We're improving conversion by streamlining checkouts and enhancing product information and Dynamic Content, and we're investing to amplify the in-store mobile experience by rolling out guided maps, in-store search and expanded assortment chain-wide later this year. We also continue to invest in our flexible fulfillment capabilities, which combine the strength of our digital, store and distribution assets, to provide speed and convenience for our guests. These capabilities allow our stores to add value in new ways, serve our guests as both showroom and fulfillment centers. Following the holiday season success of in-store pickup, we're moving quickly to roll out the capability to ship online orders from our stores this fall. This new capability will create multiple benefits for both Target and our guests, including shorter shipping times, reduced expenses, lower markdown rates and improved in-stocks. And because our investments in flexible fulfillment drive greater utilization of our existing stores and distribution center assets, we expect to earn an outstanding return on these investments over time. And finally, we're pleased with initial performance of Target Ticket, our streaming video service, and we continue to invest in features to better serve guests changing needs and behaviors, both inside and outside their home. In 2014, we will coordinate our promotions across channels to provide irresistible video offers across our stores, target.com and Target Ticket. While our fourth quarter results softened following the December 19 announcement of the data breach, we are pleased with the guest response to our holiday season merchandising and marketing efforts and we're confident in our plans for 2014. As always, our focus remains on our guests, helping them regain their confidence in Target, while delivering irresistible content and experiences in every channel. We believe that our efforts will drive a continued recovery in the pace of our sales and position Target for profitable growth in 2014 and beyond. Now John will share his insights on our fourth quarter financial performance and our plans for the coming year. John?
John Mulligan:
Thanks, Kathee. Our fourth quarter financial results reflect strong efforts by our team to handle separate challenges in both our U.S. and Canadian segments. In the U.S., comparable sales declined 2.5%, consistent with the updated guidance we provided in our January press release. This sales performance reflects a 5.5% decline in transactions, partially offset by an increase in average ticket. Prior to the announcement of the data breach, fourth quarter comparable sales were running positive, reflecting the success of our holiday merchandising and marketing plan. Immediately, following news of the breach, sales turned meaningfully negative, but began to recover in January. And while it's impossible to measure precisely, we believe we would have seen even more improvement, had there not been extreme weather across much of the country.
Fourth quarter sales penetration on our REDcards was 20.9%, up 5.4 percentage points from a year ago. While the rate of increase slowed down following the breach, year-over-year penetration continued to grow hundreds of basis points through the end of the quarter. Fourth quarter U.S. EBITDA and EBIT margin rates were down more than a percentage point from last year's rates, which we were revised to reflect combined results from our former U.S. Retail and Credit Card segments. These profit margins were below our expectations going into the quarter, driven almost entirely by gross margin rate, which declined about 20 basis points from 1 year ago. This performance reflects about 20 basis points of benefit from this year's change in vendor payments, offset by higher-than-expected markdowns, related to the 10% off weekend we offered prior to Christmas, as well as the impact of clearance markdowns at the end of the holiday season. Margin mix was somewhat less favorable than in the recent quarters, driven by strong sales in Electronics. While below our expectations, fourth quarter U.S. segment gross margin rate was remarkably strong, considering the team had to rapidly manage excess inventory in the middle of the quarter, when we experienced a sudden change in the pace of sales following the data breach announcement. Our fourth quarter U.S. segment SG&A rate was 18.4%, about 110 basis points above last year's revised rate. About 50 basis points of this headwind was related to the Credit Card portfolio, reflecting a smaller asset base, last year's reserve release and this year's profit-sharing arrangement with TD Bank. Another 20 basis points of headwind was driven by this year's change in vendor payments. The remaining unfavorability reflects the deleveraging effect of negative comp sales. The fact that we experienced only 40 basis points of deleverage reflects strong control of variable expenses, given the magnitude of our comparable sales decline. In the Canadian segment, sales came in just below expectations. Importantly, as Gregg mentioned, we took advantage of holiday traffic to clear through a significant amount of excess inventory in the quarter. And while we expect some small lingering issues with long lead receipts this year, the Canadian segment ended 2013 in a much cleaner inventory position, paving the way for smoother operations in 2014. In all, the segment drove $0.40 of EPS dilution in the fourth quarter, better than the expectations we provided in our January press release. Turning now to our consolidated metrics. Fourth quarter interest expense was 21% lower than last year, reflecting the continued benefit of debt retirement, funded by the proceeds from the sale of the Credit Card portfolio. We paid dividends of $0.43 per share in the quarter, an increase of more than 19% from fourth quarter 2012. This was the 185th consecutive quarter in which our company has paid a dividend. And 2013 marked the 42nd year of annual dividend increases, a track record few companies can match. Consistent with last quarter, we didn't purchase any shares in the fourth quarter, reflecting current performance and our desire to maintain our debt rating in the middle A range. This approach aligns with our long-standing point of view on capital deployment. First, we invest what we believe is appropriate in our core business; second, we support the dividend, which we've grown annually for more than 4 decades; and third, we use share repurchase to return cash within the limits of our middle A rating. We believe a middle A rating is strategically important, as it supports our ability to reliably deliver on our unbeatable pricing strategy over time. In addition, our balance sheet provides the flexibility to maintain our long-term focus in the face of unexpected events like the data breach, enabling investment and strategic initiatives like flexible fulfillment, while we deal with a temporary setback in traffic and sales, along with other costs related to the breach. In addition to operating results in the U.S. and Canada, our fourth quarter GAAP earnings reflects several items that reduced EPS by approximately $0.09. These items include charges related to our January restructuring, data breach-related costs, net of an insurance receivable and a continued reduction in the beneficial interest asset, partially offset by a small benefit from the resolution of income tax matters. Combining fourth quarter results with performance in the first 9 months of 2013, yields full year results that reflect the impact of clear successes and certain challenges. In our U.S. segment, full year comparable sales declined 0.4%, well below our expectations going into the year. This reflects a tougher-than-expected consumer environment, including the impact of the payroll tax increase, which just annualized last month, the fourth quarter impact of the data breach and recent headwinds from unfavorable weather, as you've heard from many other retailers. On our U.S. sales, we earned a gross margin rate of 29.8% in 2013, up about 10 basis points from 2012. This rate reflects about 20 basis points of benefit from this year's change in vendor payments, combined with very strong underlying margin performance in the face of softer-than-expected sales. Throughout the year, Kathee's team did a great job managing inventory, resulting in outstanding in-stock levels, while avoiding unnecessary clearance markdowns. Our full year SG&A expense rate in the U.S. was 20%, up about 90 basis points from last year's revised rate. Contrary to what you might initially think, this reflects outstanding performance, in light of softer-than-expected sales and some notable challenges representing more than $600 million of incremental pressure, including Credit Card portfolio income, which as you know, reduces our SG&A rate, about $400 million lower than 2012, reflecting profit-sharing with TD, prior-year reserve reductions and a smaller asset base this year. And more than $200 million of expense pressure from incremental investments in technology and supply chain, to support our multi-channel efforts. Without these impacts, our SG&A expense rate would've been slightly higher than 2012, but would've been neutral without this year's change in vendor payments. This is better expense performance than we'd expect on a decline in comparable sales, and was driven primarily by 2 factors. Outstanding performance by our stores organization, which continues to provide outstanding guest service, while delivering productivity increases; and our company-wide expense optimization efforts, through which our teams are finding better ways to work, while de-prioritizing less productive activities. As Gregg mentioned, the team continues to find new opportunities to optimize expenses. And we expect to reach $1 billion in annualized savings by 2015, helping to fund our drive -- helping to fund our efforts to drive profitable growth over the next several years. For full year 2013, U.S. REDcard penetration grew nearly 6 percentage points to 19.3% of sales, as more and more guests increased their level of engagement and their spending with Target. Penetration in Kansas City, where we began offering REDcard Rewards 1 year ahead of the rest of the country, continues to run well ahead of the U.S. overall. Importantly, as part of our broader effort to rebuild traffic and sales in 2014, we will work to reaccelerate REDcard growth in light of the recent slowdown in growth we've seen following the data breach. In Canada in 2013, we generated just over $1.3 billion in sales on 124 stores, which were opened on average, for a little more than half the year. These sales were well below our plan going into the year, leading to greater-than-expected markdowns on a meaningful amount of excess inventory. Expense rates were unusually high as well, as a result of opening early-cycle stores with too many payroll hours, incurring incremental expense related to clearing inventory and experiencing less leverage on fixed expenses. In the face of these challenges, the team worked tirelessly to improve operations and work through excess inventory throughout the year, clearing the way for an acceleration of sales and profitability beginning this year. Our earliest-cycle store continued to outperform later-cycle stores. It adds confidence that our operations will continue to become more efficient, as our business matures. And having dramatically reduced the congestion in our Canadian supply chain, we will increase the intensity of our marketing message in 2014 regarding value and assortment in our frequency categories. Over time, we expect this will lead our Canadian guest to choose Target more often in these categories, driving meaningful increases in traffic and sales. Turning to capital deployment. Our total capital investment was about $3.5 billion in 2013, somewhat lower than expected, as U.S. CapEx of about $1.9 billion was approximately $300 million lower-than-anticipated. This outcome doesn't reflect the change in strategy, but is simply a result of a lower-than-expected cost for certain projects and retiming of suspending into 2014. Having sold our Credit Card portfolio for about $5.7 billion in March, we've significantly reduced our net debt position in 2013, including the early retirement of high coupon debt. And importantly, even in the year of peak CapEx and dilution related to the Canadian segment, combined with the impact of impact softer-than-expected U.S. sales, we still had the capacity to return about $2.5 billion to our shareholders in the form of dividends and share repurchase. With that as context, let's turn now to our outlook for 2014. But before we get to the numbers, I want to discuss the change in our reporting and guidance practices in 2014. Given that our Canadian segment is now fully operating, beginning with the 1st quarter of 2014, we will no longer exclude Canadian segment performance from adjusted EPS. To allow for appropriate comparison, last year's adjusted EPS will also reflect Canadian segment performance as well. With that, let's turn to our full year outlook beginning with sales. While trends have improved the recent weeks, severe winter weather had been a headwind and we continue to see the impact of the data breach on guest sentiment and traffic. We believe that we'll continue to see muted trends in the next few months, but the breach impact will diminish throughout the year as we engage in a vigorous effort to address our guest concerns and provide irresistible content and offers driving visits to our stores and digital channels. In addition, while economic trends are improving, we continue to expect our lower- and middle-income guests to shop very cautiously in 2014. With that backdrop, our current view is that U.S. comparable sales will grow in the range of 0% to 2% in 2014. On those sales, we expect a U.S. segment EBITDA rate of 10.1% to 10.3%, meaning EBITDA dollars should grow between 5% and 8% this year. Among the drivers of EBITDA margin, we expect gross margin will improve 30 or 40 basis points from our 2013 rate of 29.8%, reflecting improved clearance markdown rates and more significantly, the gross margin benefit of our expense optimization efforts. These benefits will be partially offset by the impact of additional promotional activities and continued investment in 5% REDcard Rewards. We expect the U.S. segment SG&A expense rate slightly better than last year's 20% rate, reflecting continued discipline expense control and the benefit of our expense optimization efforts, offset by our continued investments in distribution and technology in support of our multi-channel efforts. We expect these expensed [ph] investments to be worth $0.05 to $0.10 of incremental EPS pressure in 2014. In Canada, we expect total sales will be approximately double our 2013 experience, as we annualize last year's 124 openings and begin generating comparable sales growth in mature stores. On those sales, we expect to earn a much higher gross margin rate in a range approaching 30%, but clearly, we'll continue to see some near-term volatility until the Canadian business matures. While we expect to see better fixed expense leverage in 2014, the SG&A rate will likely remain well above our long term outlook, in a range approaching 40%. All together, this would lead to a Canadian segment EBITDA margin rate of minus 8% to minus 10%, representing more than $400 million of expected EBITDA improvement from 2013. We expect U.S. capital expenditures of $2.1 billion to $2.3 billion, up slightly from actual 2013 spending. The mix of U.S. CapEx will continue to tilt from investments in new stores towards supply chain and technology, as we accelerate our multi-channel efforts and continue to find a limited number of new store sites that meet our strategic and financial criteria. I should also note that U.S. CapEx reflects incremental investment related to our recent decision to accelerate deployment of chip-enabled card readers to all of our U.S. stores before the end of the year. In Canada, we expect 2014 capital expenditures in the $300 million to $400 million range, down more than $1 billion from peak spending in 2013. We expect once again to raise our annual dividend in the neighborhood of 20% this year, which will mark our 43rd consecutive annual increase. And even with a tempered outlook for near terms, traffic and sales, and understanding there will be further costs related to the data breach, our current outlook current envisions share repurchase capacity of $1 billion to $2 billion in 2014, beginning later in the year as our business stabilizes and we have more clarity on potential breach-related costs. All together, these expectations would lead to full year adjusted EPS representing results from operations in the U.S. and Canada of $3.85 to $4.15. This estimate excludes approximately $0.07 of dilution related to the continued reduction in the beneficial interest asset. These 2014 expectations represent an improvement of more than 20% from combined U.S. and Canadian segment results in 2013. Please note that our full year outlook does not include potential additional costs related to the data breach beyond what we already recorded in the fourth quarter, as they are not estimable at this time. While I realize this may result in a wide range of speculation on the magnitude of these costs, given that our investigation of the breach is ongoing, it would not be appropriate to say anything more about it than we already have this morning. Regardless of the ultimate dollar amounts, as Gregg mentioned, we have the financial strength to move beyond these near-term impacts, while we continue to invest in the future. And as always, we're focused on what's most important, addressing the concerns of our guests and helping them to feel confident shopping with us. Now let's briefly turn to our first quarter outlook. In the U.S., we expect first quarter comparable sales in the range of flat to down 2%. So far in February, comparable sales have been running within that range, ahead of our forecast and nearly flat to last year. And I should note, while growth isn't running where it had been earlier in 2013, REDcard penetration so far in February has been running hundreds of basis points ahead of last year. On our first quarter U.S. sales, we expected EBITDA margin rate of 9.7% to 9.9%. In Canada, we expect to generate first quarter sales in the range of $400 million to $450 million, with EBITDA of minus $150 million to minus $170 million. In light of this near-term operating outlook, we don't expect to have the capacity to repurchase shares in the first quarter, but we expect to resume this activity later in the year. All together, our expectations would lead to first quarter adjusted EPS reflecting operating results in the U.S. and Canada in the range of $0.60 to $0.75, excluding $0.02 related to the reduction in the beneficial interest asset and any potential costs related to the data breach. While this has been a challenging year, we are proud of the work of our team and believe we have the right plans in place to generate meaningfully improved performance in 2014. As we focus on making Target irresistible for our guests both today and over time, we believe we will be grow profitably for many years to come. With that, we'll conclude today's prepared remarks. Now Gregg, Kathee and I will be happy to respond to your questions.
Operator:
[Operator Instructions] Your first question comes from the line of Sean Naughton with Piper Jaffray.
Sean Naughton:
I guess, on the same-store sales trends for February, being down in that 0% to 2% range, probably a little bit better than people expected, I guess, just over time, Target has been on an aggressive campaign to drive frequency with REDcard and remodeling more stores towards food. But given that PFresh is maturing here and the credit breach could curb some of the willingness to sign up for REDcard and online taking a bigger portion of the retail landscape, how should we think about some of the big initiatives or the big picture initiatives to drive same-store sales trends in 2014 and beyond?
Kathryn Tesija:
Sean, I think a lot of the things that I talked about today with products, as well as with in-store experience and our mobile experience, those are really the key things for us to help drive people to shop at Target beyond the Food that you talked about and of course, the REDcard.
Sean Naughton:
Okay. And then just on the Food, I guess, aspect of things, how are you on the in-stocks in that particular category? Are you happy with the products we have out there on the shelves today?
Kathryn Tesija:
Yes, in-stocks have been rock solid for quite some time and in terms of products, I would tell you that we're always making adjustments to what we carry in stores. We learn what's selling and what trends are picking up steam, things like organics and better-for-you products. So that's a never-ending thing that we work on.
Sean Naughton:
Okay. Great. And just one last thing, you mentioned the online and the flexible fulfillment. I think that all of those can now be viewed online, which is great for the consumer. But when do you think -- or is it going to be possible for all of those products for buying online and picking up in-store?
Kathryn Tesija:
We are expanding the assortment right now. I don't have a date for you in terms of when we'll get our whole assortment up online. And right now, we're focusing on the most popular items and categories. So we recently added pets, for example, and we'll just continue to expand as we learn more and more about that program.
Operator:
Our next question comes from the line of Matthew Fassler with Goldman Sachs.
Matthew Fassler:
I've got 2 questions, and the first relates to inventory. I know you've cleared a lot of inventory in Canada. Your year-on-year number is still, across the corporation, across the enterprise, is still up quite substantially, relative to sales. So if you could comment on sort of the composition of that inventory and your thought process for its impact on margin going forward?
John Mulligan:
Sure. Inventory, up about 10% year-over-year and you could roughly think about that split about equally between Canada and the U.S. Canada, obviously, we're just in a different place than we were 1 year ago. We build inventories all year as we opened stores. I would tell you in Canada, we feel much, much better. We feel very good about the progress we made in the fourth quarter, clearing excess inventory. The average inventory per store in Canada from the beginning of the quarter to the end of the quarter went down about 30%. So we still have some lingering issues in Q1 with some long lead receipts, but feel very good about the inventory there. In the U.S., I would tell you, the merchant team did an outstanding job reacting to the change in sales and our inventories are in excellent shape. This is the time of year where, in February, we are changing lots of things in the store. And frankly, depending when you snap the line, for year end, relative to our receipts, we see inventory move around a little bit. If you go back over the past couple of years, our inventory per store in the U.S. is up about 3% versus 2 years ago. So this is really more timing than anything else and we feel very good about the inventory position.
Matthew Fassler:
That's very helpful. And then my follow-up relates to capital allocation and specifically to buyback. I know that you alluded to the company's desire to maintain its current credit rating and that you spoke about resuming buybacks as the year progressed, presuming that you're on plan. I just want to talk about what your thought process is for contingencies, and that based on the numbers we've looked at, it seems like you're a long way from coming close to the edge on your current credit ratings. So what would it take for you not to do that $1 billion to $2 billion? It seems like that should be well within your financial capacity, even if, frankly, the numbers are a bit light of your current guide.
John Mulligan:
Well, we should go offline and review where you are -- where you think we are versus our credit rating and where we think we are versus our credit rating. We've actually run pretty close to our credit rating not just last year, which was even higher, but for the past several years. So our view is that we think we can do, given our plans, between $1 billion and $2 billion. We need to see our business results improve over the next couple of quarters. We're starting to see that in February, as we alluded to. And then also, get a little bit of a view into what the potential costs are that may be coming our way as a result of the breach. But given all of that, we still think somewhere in $1 billion to $2 billion, beginning probably in the back half of the year, for the year makes sense.
Matthew Fassler:
And just finally, I know you're not going to quantify the cost of the breach, but it sounds like, in thinking about the capacity to buyback stock, you have somewhere internally a sense of that number that would enable you to pursue that course?
John Mulligan:
We -- as we said, it's not estimable at this time what the potential cost of the breach is. And given where we are in the process, it'd be inappropriate for me to speculate.
Operator:
Your next question comes from line of Greg Melich with ICI (sic) [ISI] Group.
Gregory Melich:
I had a couple of questions. Just a quick follow-up on the breach costs. You showed a net -- you got some insurance payments from the breach costs that you had. Is that a -- should we expect that -- or do you have any insurance for these potential costs whatever they may be? Or is that sort of a one-off in the quarter? And then I have a follow-up.
John Mulligan:
Just to be clear, that was insurance receivables. So we haven't actually received payment, but we feel pretty -- we feel very likely to receive payment for a portion of the expenses we incurred in the fourth quarter. What we can say about insurance right now is at this point, we think there's $44 million of insurance that we'll receive and to the extent that number changes, we'll be back to you to provide more information.
Gregory Melich:
Okay, great. Then bigger picture on REDcard and traffic. I mean, if traffic was down 5.5% in the quarter. Presumably, post the breach, it was down, pick a number, like 7% or 8%. Is it fair to say that traffic has recovered back to what it was in January and February or where we are now? And how is REDcard seasoning? Those people have now had it for 3 or 4 years. How are those people behaving following the breach?
John Mulligan:
Yes, on traffic, your view of what happened post the breach is pretty accurate. And we have seen traffic continued to improve and firm up and definitely throughout February, we've seen traffic firm up. And as we said, sales have improved and a big part of that has been traffic. On the REDcard, what we've seen -- and Kathee talked about this a little bit, in our core guests, REDcard guests, they have continued to shop with us and we've seen very strong sales from that. REDcard penetration continues to grow meaningfully, hundreds of basis points year-over-year. And to the extent we're not growing where we used to, that's driven by new accounts. So the guests who have REDcards continue to shop our stores.
Gregory Melich:
So it's more of the penetration growth from new people signing up or from people that signed up shopping more?
John Mulligan:
As has been the case over the past couple of years, the penetration growth comes from new accounts.
Operator:
Your next question comes from the line of Matt Nemer with Wells Fargo Securities.
Matt Nemer:
I'm just wondering if you could provide a little more color on the comp spread that you're seeing between states that have been severely impacted by weather and some of your warmer weather states?
John Mulligan:
Great question, Matt. And it's -- analyzing weather isn't a perfect science. I would tell you when we see -- in the Midwest, in the Northeast, when we've see these weather patterns go across the country, the spread is significant between the 2. But ultimately, as that passes, we see them restabilize and everything come back to normal. But the difference while it is going on is pretty dramatic. It's in single digits difference, but it would be high-single digits.
Matt Nemer:
Okay. And then secondly, as you -- you gave some great detail on your investments in digital and e-commerce this year, as you enable Click and Collect and fulfillment from store, are there any significant investments you need to make in terms of inventory accuracy in the store? And could you just give us maybe a bit of color on how that's running in terms of being able to pick up in store?
Kathryn Tesija:
We're always working on inventory accuracy and that is a combination of how we use our systems, as well as the processes in-store. And so it's been less of an issue to date. As we get into some of the additional categories, things like Beauty where there's a lot of SKUs, we've got to make sure that the accuracy is there. I will tell you, Apparel, while we've had good results there, it's a little bit harder partly accuracy, but partly being able to find the exact size when it's not in a planogrammed environment. So there are a few challenges for us to figure out. But overall, I would tell you that our guest response has been very positive and the survey comments that they hand back to us, they really love the service. So yes, we will keep working on accuracy to make sure that we can fulfill as many orders as possible. But so far, we're very pleased.
Matt Nemer:
Okay. And then lastly, your SG&A per foot in the U.S. was down pretty substantially in the fourth quarter versus the last few years. How should we think about SG&A per foot on a full year basis for '14 in the U.S.? Should it -- is that a number that can keep relatively flat? Or is there just some inherent inflation there that we should expect?
John Mulligan:
First, the comparison to last year, we have to be a little bit careful. There's a 53rd week in there that's a relatively low-volume week, which creates a little bit of distortion year-over-year. But I think, as I said, we continue to work very hard on store productivity, ensuring that we're driving great guest experience and in-stocks, but also improving our productivity. And then all of the expense optimization efforts continue to go on. And some portion of that will fall to the bottom line, some portion of that goes to gross margin and some portion of that gets reinvested in the business as we invest in multi-channel technology supply chain. But I think flat to up slightly is probably about the best way to think about it.
Operator:
Your next question comes from the line of Bob Drbul with Nomura.
Robert Drbul:
I just had a couple of questions. First, on -- did you give a number on the online business in terms of the increase that you had in the fourth quarter?
Kathryn Tesija:
We didn't give a number, but I'll tell you, it was very positive, above the industry and slightly above 20%.
John Mulligan:
But like the rest of the business, it was impacted by the breach as well.
Robert Drbul:
Okay. Okay. And then when you look at the full year, at your plan, you gave a lot of details. In terms of, like the sales recovery that you have, what are the key factors that give you the comfort and confidence in the recovery over this year, as you plan the earnings and sales trajectory?
John Mulligan:
Well, it's -- from our perspective, we've got to up our game on all fronts. It starts with delivering great content, great in-stocks, our team is more engaged than ever from a service standpoint, both on the sales floor and at the lanes. And we're going to deliver, as Kathee said, just some eye-popping irresistible deals, so we're going to really up the ante as it relates to making a statement on our unbeatable pricing proposition, which we have. I mean, we price match the competition and we run our circulars and with our 5% REDcard Rewards program, our pricing -- our value proposition is unbeatable. So we're just going to call greater attention to that and selectively, we're going to go out and be more aggressive in that regards. And so it's the combination of all of those elements.
Robert Drbul:
And then on the gross margin outlook for Canada, can you just talk about the mix assumptions in there and sort of -- also like the ramp from where you finished fourth quarter to get to that 30% number for the year?
John Mulligan:
Sure. Mix in Canada continues to be stronger in Apparel and home. And we expect that to moderate through time. We ultimately think the mix there will be stronger than what we see in the U.S. But a lot like our high-volume stores in the U.S., our urban stores in the U.S. we see a higher mix of home and Apparel sales. That will moderate through time because we want to drive the frequency categories. That's what we're working on the team in Canada. Ultimately if they're successful in driving conversion in commodities, Grocery, Food, all those categories, we'll see that mix moderate. I think we'll see margin -- we except to see some volatility, Q1, for instance the margin rate won't be at 30%, but it will be a significantly improved from the 4.4% we recorded in the fourth quarter. So we'll make progress and you should expect to see that throughout the year, and of course, back in fourth quarter next year, we'll be down a little bit from that 30% as is typical in our U.S. business given that time of year.
Operator:
Your final question comes from the line of Chris Horvers with JPMorgan.
Christopher Horvers:
A couple of random questions. So could you perhaps breakout how much was the explicit impact of the 10% off deal that you did after the breach and right ahead of Christmas?
John Mulligan:
Chris, we don't break out promotions individually. It was a big-time of the year and the number was relatively large. But in the big scheme of the fourth quarter, I would tell you it's not material.
Christopher Horvers:
Okay. And then on the cost savings side, I guess how much of the $1 billion is done so far? And what has been the big drivers this year that have taken those costs out?
John Mulligan:
There's $200 million that we recorded in 2014. We'll annualize on that -- oh, '13, excuse me. We'll annualize on that next year. And the savings came from all over the corporation. There were savings in gross margin around transportation expenses, that will grow again in 2014. There were savings, really it's hard to pin it down. It was literally across the entire organization where we looked at things. We looked at how we sourced product and aligning our non-retail product that we sourced and serviced it and making that look more like we do in merchandising and we saw significant savings there from our sourcing. There's more to do there and we'll see that grow in 2014 as well. But as Gregg said, it was literally across the entire organization where we were focused on stopping things that we didn't need to do. If we need to do them, improving productivity.
Christopher Horvers:
And then one last one. How would have the -- if you had chip technology in your stores, this past year, how would the breach outcomes change? Would it have stopped the actual theft of the Credit Card data? Or would it have stopped the personal information disclosure?
John Mulligan:
The chip technology makes it such that using the account numbers without the card becomes very much more difficult. And so the desire to obtain those card numbers goes down significantly. What we've seen in other countries that have adopted chip technology is fraud rates go down dramatically for in-store transactions. And I think in the U.K. or Europe, I can't remember exactly, down like 60% once chip technology was enabled. And so the desire -- those account numbers just become less desirable.
Christopher Horvers:
But didn't the breach actually come from systems internally, not necessarily coming from the card readers?
John Mulligan:
You know what, Chris, we're in the middle of an investigation and we can't talk about the specifics. We continue to learn. There'll be learnings that come out of that investigation and from those learnings, we'll take action. And that's about what we can say today.
Gregg Steinhafel:
Okay. Well that concludes Target's Fourth Quarter 2013 Earnings Conference Call. Thank you, all, for your participation.
Operator:
Again, thank you for your participation. This does conclude today's conference call. You may now disconnect.
Operator:
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 Thursday, November 21, 2013. I would now like to turn the conference over to Mr. Gregg Steinhafel, Chairman, President and Chief Executive Officer. Please go ahead, sir.
Gregg Steinhafel:
Thank you. Good morning, and welcome to our 2013 third quarter earnings conference call. On the line with me today are Kathee Tesija, Executive Vice President of Merchandising; and John Mulligan, Executive Vice President and Chief Financial Officer.
This morning, I'll provide a high-level summary of our third quarter results and strategic priorities for the remainder of the year; then Kathee will discuss category results, guest insights and plans for the holiday season; and finally, John will provide more detail on our financial performance, along with our financial outlook for the fourth quarter and the year. Following John's remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following this conference call, John Hulbert and John Mulligan will be available throughout the day to answer any follow-up questions you may have. Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Finally, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP results is included in this morning's press release posted on our Investor Relations website. Target's third quarter financial results reflect continued strong operating performance in the U.S., despite an environment in which traffic and sales remain challenging. Comparable sales increased 0.9% in the quarter, near the low end of our guidance, and our U.S. operations generated adjusted earnings per share of $0.84, near the midpoint of our expected range. We continue to manage our business thoughtfully, investing to maintain our relevance over the long term while we focus on disciplined execution to drive current performance. We continually work to anticipate and respond to the ever-changing needs of our guests as we monitor the economy and the competitive landscape. GDP continues to grow at a painfully slow pace, while household income and consumer spending remain constrained. In particular, lower- and middle-income households are shopping cautiously as they work to stay within tight, very tight household budgets, which have seen additional pressure from this year's payroll tax increase. And consumer confidence, which has been generally recovering since the recession, took a dramatic step backward in October during the government shutdown. This decline was particularly evident in lower- and middle-income households, and we saw lower-than-expected sell-throughs on Halloween merchandise. Not surprisingly, in this environment, our competitors have become increasingly focused on promotions, both to gain the attention of value-conscious consumers and to clear heavy inventories of discretionary categories. Our results show that guests continue to consolidate trips, as evidenced by a slight decline in our third quarter transactions, which was offset by an increase in average ticket. Given their focus on value, guests continue to respond to initiatives that connect them with Target and allow them to save even more off our already low prices. We're very pleased with the rapid growth of 5% REDcard Rewards, as penetration grew beyond 20% in October and averaged just below 20% for the full quarter. And the response to Cartwheel, our digital coupon portable, has been remarkable. Cartwheel now has nearly 3 million users, most of whom access it exclusively on their mobile device. Even though we launched Cartwheel only 6 months ago, guests have already saved more than $14 million. We continue to generate strong operating margins in our U.S. segment, which is especially notable in an environment where sales growth is slow and consumers and competitors are focused on promotions and value. Inventory and in-stock levels in the U.S. remained healthy, and expenses remained very well controlled. Teams throughout the organization are contributing to our expense optimization efforts, finding innovative ways to reduce expenses, which we can reinvest to drive future growth. In addition, our stores' teams have done an excellent job increasing productivity while delivering a great guest experience. In the third quarter, we opened our eighth CityTarget, and we continue to be pleased with the results from this new format. We opened our first CityTarget stores more than a year ago, and we're seeing very strong comparable sales growth in these locations as we raise awareness of our frequency categories and communicate the breadth of our assortment and the great values we deliver across the store. In Canada, we're nearing the end of this year's unprecedented market launch. Earlier this month, we opened an additional 31 stores, our largest cycle so far. And with 2 remaining stores opening tomorrow, we will reach our goal to open 124 Canadian Target stores in 2013. The Target Canada team has shown remarkable energy and perseverance, allowing us to open a record number of new Target stores across Canada less than 3 years from the announcement of our agreement to purchase leasehold interests from Zellers. With this final cycle of openings behind us, the team is completely focused on improving operations in run state, enhancing systems and processes to better deliver the full Target experience to our new Canadian guests. The Target Canada team is energized and prepared for the holiday season and preparing to enter 2014 with improved in-stocks and a much better inventory position. We continue to see a very strong mix of our higher-margin Home and Apparel categories in Canada. However, third quarter gross margin rate in Canada was unusually low as the team worked diligently to eliminate excess inventory and enhance flow throughout the supply chain. This activity led to heavier third quarter markdowns and higher-than-expected dilution of $0.29 in our Canadian segment. Process improvement efforts and inventory cleanup will continue in the fourth quarter as well. As we gain experience in operating Canadian stores and accumulate sales histories by item, by location, inventory flow and allocation will become much more reliable and accurate, setting the stage for improved sales and operating efficiency in 2014. Given that this is our first holiday season in Canada, we will focus on delivering everything that's special about the season while continuing to emphasize that our prices in Canada are unbeatable. Over time, we are confident that the Canadian consumers will recognize that Target's combination of low everyday prices, compelling discounts in the flyer, price matching policies and 5% REDcard Rewards savings offer an unbeatable value in the marketplace. While our initial sales and profits in Canada have not met our expectations, we remain enthusiastic about the Canadian market and confident in the long-term success of these stores. They are located in densely populated, vibrant trade areas. And based on 50 years of experience building stores and entering markets in the U.S., we continue to believe that our Canadian segment will contribute meaningfully to Target sales and profits over time. We also believe the sales shortfalls and earnings dilution from excess inventory and startup costs will moderate next year, leading to a significant improvement in the Canadian segment profitability in 2014. In the U.S., it's clear that the holiday season will be highly promotional and that consumers will be laser focused on value. In past holiday seasons, we have consistently offered compelling value, investing billions of dollars in low prices. Yet we believe we have an opportunity to communicate this focus on value more clearly to the marketplace. As a result, this holiday season, we will be much more overt in our price messaging across our market -- marketing vehicles, stressing our unbeatable combination of Everyday Low Prices, deep discounts on promotions, our Price Match Policies and our 5% REDcard Rewards program. And while we're entering the season with guarded expectations for sales, we feel very good about our inventory levels, merchandising and marketing plans, and we expect to deliver profitable fourth quarter sales while offering unbeatable value for our guests. While we all know about the loss of 6 shopping days between Thanksgiving and Christmas this year, at Target, we're entering the holiday season with cautious optimism as we annualize over last year's election and consumer uncertainty surrounding the fiscal cliff. Based on our results a year ago, we're investing our merchandising and marketing resources with a stronger focus on key holiday categories like Toys and Electronics. In particular, given our market share in video game hardware and software, we expect to benefit this holiday season from the most meaningful platform launches in more than 7 years. In addition to fourth quarter merchandising and marketing plans, teams across the company have been preparing for the full chain rollout of in-store pickup, the first of multiple efforts to deliver flexible fulfillment for our guests. The team has moved quickly to roll out this capability, growing from a limited second quarter test with Minneapolis team members to all of our stores earlier this month. The initial response from our guests have been encouraging, and we're looking forward to measuring their response throughout the holiday season, providing valuable insights as we prepare to roll out additional capabilities in 2014. We entered 2013 with an ambitious agenda as we committed capital and expense to transform the company and create value over time. Throughout this year of transition, both in the U.S. and Canada, our team has been remarkably resilient, energetically embracing every challenge as they work to position Target for long-term success. Our entire team is focused on developing Target's multichannel capabilities while offering merchandise and experiences to create loyalty and position Target to deliver strong performance in any environment. Now Kathee will provide more detail on our third quarter results and outline initiatives for the fourth quarter and beyond. Kathee?
Kathryn Tesija:
Thanks, Gregg. We are pleased with the ability of our team to manage the business in the third quarter, maintaining profitability in a soft sales environment while we continue to develop digital capabilities that allow us to connect with our guests in new ways.
Across our merchandising categories, we saw a relatively balanced mix of third quarter sales between lower-margin and higher-margin categories. Among the lower-margin categories, need-based areas like Food and health care continue to outpace our overall comp. And Electronics had a greater -- had a great quarter, driven by sales in mobile devices and video games. Our discretionary higher-margin Apparel and Home categories both saw small declines in comparable sales. In Apparel, third quarter trends were strongest in Jewelry, Accessories and newborn/infant/toddler. In Home, sales trends were strongest in Domestics. In our digital channels, we saw very strong growth in Apparel, Hardlines and Beauty. Early in the quarter, we were pleased with the comparable sales results in our Back-to-School categories, which outpaced both the industry and our overall results. Results were particularly strong in supplies, which saw a big increase in penetration of our up&up brand. Performance in Back-to-College was also stronger than average, both in-store and online. In September, our collaboration with Phillip Lim was one of our most successful to date. Sell-through levels were very strong overall, and particularly high in our digital channels. The most popular items in the collaboration include handbags, men's shoes and women's dresses. In October, this year's calendar shift benefited comparable sales, as a portion of Halloween-related sales moved into the month from November last year. However, as Gregg mentioned, in conjunction with the government shutdown and pullback in consumer confidence, we saw a slowdown in our sales trends, leading to the lower-than-expected sell-throughs on Halloween merchandise at the end of the quarter.
We continue to see remarkable guest engagement with Cartwheel. In response to guest feedback, we moved quickly to integrate Cartwheel into the Target app, for both Android and iOS, in time for the holiday season. Now guests can find Cartwheel deals in 4 places:
on their shopping lists, on the product listing page, on the product detail page and the "what's in store" content section.
Beyond Cartwheel, we're very pleased with the progress we're making in our digital channels. We continue to see double-digit growth in overall digital traffic and triple-digit growth in mobile. This is notable because mobile is a much higher percentage of our digital traffic compared with some of our closest competitors. We're also seeing improved conversion on both the traditional site and on mobile, as we continue to benefit from investments to improve search and navigation. As we survey our guests and monitor the overall consumer environment, we continue to see anxiety regarding the economy and the ability to stay within household budgets, particularly, among lower- and middle-income consumers. In October, a very high percentage of our guests were aware of the government shutdown and concerned it would hurt the economy. In addition, a meaningful portion indicated they were changing their shopping behavior in light of their current financial situation. This was evident in our guest metrics. In the third quarter, we were pleased to measure a year-over-year increase in the number of guests shopping with us, but this increase was offset by a decrease in their average shopping frequency. We even heard from some guests that they were cutting trips for fear they would be tempted to spend too much, a behavior we first observed in the recession. In light of this environment, we're entering the holiday season with a cautious outlook for sales and a very liquid inventory position. Specifically, at the end of the third quarter, our average inventory per U.S. store was up only 1%. We believe this position is appropriate, as it protects against the downside in a tough environment, knowing that our base inventory is large enough to enable sales well beyond our fourth quarter plan if the season turns out to be unexpectedly strong. As we look ahead to the rest of the holiday shopping season, we're excited about our plans to deliver on both sides of our Expect More. Pay Less. brand promise, beginning with our plans for next week. On Thanksgiving, we're expected -- we're excited to open at 8 p.m. based on the response to our Thursday opening last year and the higher number of families who shop together, making Target part of their family tradition. This year, we've pushed our opening time up by 1 hour to help accommodate our guests and remain competitive in the marketplace. Of course, on Black Friday, we'll offer hundreds of doorbuster deals, including some of Target's lowest prices ever on Electronics, Toys, home décor, fashion and more. These deals will be available while supplies last in-store and at target.com from Thanksgiving day through Saturday. We've also integrated Cartwheel into our plans. When guests redeem any Cartwheel offer this Sunday through Wednesday, they'll unlock one additional offer card to select a Cartwheel deal of their choice. Also, next Wednesday, Cartwheel will feature Black Friday-like deals on about 30 items, including some of the season's hottest Toys and Electronics. And no matter how, where or when they want to shop, guests will find Black Friday deals in stores and at target.com, with even more deals available throughout Cyber Week. target.com will feature 15 online-only daily deals for 2 straight weeks beginning Sunday, November 24. The only exception will be Thanksgiving Day, when hundreds of Black Friday deals, including almost all of the in-store deals, will be available starting in the early-morning hours. Also, on the 2 days before Thanksgiving, target.com will be running a special REDcard preview sale, with 25 exclusive offers for REDcard guests in items ranging from Electronics and Entertainment to Toys and Housewares. Guests can also use Target's mobile app throughout the holidays to review the weekly ad, make shopping lists, check item availability at nearby Target stores, find store maps and more. To raise awareness of our outstanding offers, we're increasing media weight over last year and concentrating efforts during the entire week of Black Friday with TV, digital, cinema and radio support. This will be the most digitally enabled holiday campaign in our history, with an enhanced presence in the channels where we know our guests are most engaged. And finally, next week, we will be testing a special offer in Northern California stores where all Apparel and accessory items will be 40% off from the time we open on Thanksgiving through close of business on Saturday. This offer will be available in 89 stores and will include women's, men's, kids, baby apparel, along with Jewelry, accessories and Shoes. The only exclusion is clearance items. We'll monitor response from the test to determine whether to extend a similar offer in other markets in future years. In Electronics this season, we're very excited about the highly anticipated platform launches from Sony PlayStation and Xbox, bringing newness to a category which hasn't seen meaningful change in many years. We're also featuring the hottest new headphones from Beats by Dr. Dre and wireless speaker systems from Sonos. For this year's Toy catalog, we'll feature more than 500 items. We're offering more than $100 of coupon savings. In addition, we're offering free shipping on every item in the catalog until November 27. These savings are on top of the 5% guests receive when they use their REDcard. In Beauty, we recently launched a complete line of bath and body products from our long-time Beauty partner, Sonia Kashuk, including 4 beautiful scents created by Sonia in collaboration with French perfume house, Robertet. The line is available in stores and online and will include gift sets for the holiday season. In Home, guests continue to respond to the unique, affordable designs from Nate Berkus. New for this season, we've rolled out exclusive Nate Berkus holiday collection in bedding, gifts and decor, available in stores and target.com. Also new in Home this season, we're excited to feature high-end kitchen items from Vitamix and Nespresso.
In Entertainment, we continue to offer our guest exclusive content from a wide spectrum of artists and genres. In October, we launched exclusive albums from artists including:
Mary J. Blige, The Head and the Heart, Paul McCartney, The Avett Brothers and Kelly Clarkson. In November, we added exclusives from
And in Grocery, we're following up on the recent success of Target-exclusive Pumpkin M&Ms with a wide variety of big-brand holiday treats, including exclusive items from M&Ms, OREO and Hershey. Beyond the fourth quarter and the holiday season, our team continues to develop services and multichannel capabilities to delight our guests and keep Target relevant over time. We are pleased with the initial response to our Store Pickup program, which became available in all U.S. stores on November 1. Early results indicate that guests are using this service to reserve high-ticket items, such as iPads and weekly ad items, to ensure they get the item before it sells out. Top categories for in-store pickup include Baby, furniture and Electronics, and our strongest markets has been New York, Chicago and Seattle. Following the strong guest response to our Chicago test of our Baby 360 layout, which features added service and enhanced presentation, last month, we extended the test to an additional 20 stores across the country. We'll continue to monitor sales and registry trends in these stores to determine future rollout plans. We're also excited about results from our Beauty Concierge program, which we extended this month to another 95 stores in new markets across the country, including New York, New Jersey, San Francisco and Dallas-Fort Worth. This program is exceeding its sales goals, and we're seeing particular strength in core categories like cosmetics, skincare and hair care. While Target Ticket is still new, since its launch a little over a month ago, we've driven millions of page views to the site. Visits consist of a blend of new and existing users, who come back to review the new movies and TV shows that are continuously added. The number of Target Ticket accounts has exceeded our expectations to date, and we're excited to continue introducing this service to new guests as it expands and evolves in 2014. In late September, following a 3-month team member pilot, we rolled out a subscription service that allows guests to order baby diapers, training pants, wipes and formula to their doorsteps on a recurring schedule. Target's subscription service has unique advantages, including free shipping and easy in-store or online returns, 5% off subscription purchases when using Target credit or debit card and a compelling assortments that includes national brands and popular owned-brand products like up&up diapers. Based on the initial guest response, we plan to expand our subscription service to more categories by the end of the year to learn more about guest interest in this type of service. For example, we'll be adding a limited assortment from categories like coffee, personal care, paper towels and toilet paper.
And finally, last week, Pinterest added tools which allow us to highlight the most-pinned items. We'll be integrating top pins on target.com in 2 ways:
we'll feature top-pinned items on key category pages, and if guests click on a link to a product that is no longer available, they will see top-pinned products alternatives in the same category. And in our stores, we'll use signing to highlight top-pinned items throughout our assortment.
While we are cautious about the near-term sales outlook, we are confident in our fourth quarter plans and believe we're taking the right steps to position our business for long-term success. Our guests rely on Target to help them save money and stay within their budgets, but they also expect us to surprise and inspire them in new ways. That is the essence of our Expect More. Pay Less. brand promise, which guides our efforts every day. Now John will share his insights on our third quarter financial performance and our outlook for the fourth quarter. John?
John Mulligan:
Thanks, Kathee. Our third quarter financial performance reflected continued strong execution in our U.S. segment and higher-than-expected dilution on our Canadian segment as we continue to refine operations and clear excess inventory.
This morning, we reported adjusted EPS of $0.84, near the midpoint of our guidance, despite comparable sales near the low end of our planned range. Our GAAP EPS of $0.54 was below expectations, reflecting $0.29 of dilution from our Canadian segment. In the U.S., comparable sales trends were fairly consistent throughout the quarter. As Kathee mentioned, trends were softer than expected in October as consumers witnessed the dysfunction in Washington. However, on a reported basis, this weakness was offset by the calendar shift, which moved a meaningful amount of Halloween sales into the third quarter. Our sales continue to be driven by a small decline in transactions, which is being more than offset by an increase in average transaction size. In the third quarter, this increase in basket was entirely driven by an increase in average retail per item, driven largely by Electronics, which, as Kathee mentioned, saw a much stronger comp in the third quarter than we saw earlier in the year. Sales penetrations on our REDcards continue to grow as more and more guests understand the compelling value of our 5% Rewards program and decided to deepen their relationship with Target. We continue to see a consistent response to households who apply for and activate a new REDcard, increasing their spending at Target by about 50%, on average, as they respond to the ability to save with REDcard Rewards. Third quarter U.S. segment EBITDA and EBIT margin rates were consistent with the guidance provided at the beginning of the quarter. Among the drivers of EBITDA margin, we saw a moderate decline in gross margin rate, reflecting the rate impact of 5% Rewards and a small mix impact from our remodel program, combined with underlying rate pressure, driven largely by seasonal markdowns. A portion of these markdowns were driven by the calendar shift, which moved Halloween clearance sales into the quarter, with the remainder driven by lower-than-expected sell-throughs on Halloween merchandise. Third quarter U.S. segment SG&A rate was somewhat better than expected at about 70 basis points higher than last year's revised U.S. segment rate. Among the drivers of this increase, the Credit Card portfolio drove about 60 basis points of pressure, consistent with the results in the first 2 quarters of the year, reflecting a smaller portfolio, last year's reserve release and this year's profit-sharing arrangement with TD Bank. And, consistent with our prior quarters, we experienced about 20 basis points of pressure related to this year's change in vendor agreements. This means that outside these 2 factors, the underlying U.S. Retail business generated a small amount of SG&A expense leverage on a 0.9% comparable sales increase, overcoming ongoing pressure from investments in technology and supply chain to support our multichannel efforts. This is outstanding performance, better than we'd expect over time, and reflective of the company-wide expense optimization efforts, which we've been discussing with you throughout the year. In our Canadian segment, we opened another 23 stores in the third quarter, even as we continued to work to refine operations and improve performance. In the quarter, the team made a lot of progress in their efforts to begin to rationalize our inventory position, update item counts in stores and distribution centers and improve network flow. As a result of these efforts and recognition of incremental inventory reserves at the end of the quarter, we saw a much-lower-than-expected gross margin rate in the Canadian segment of about 15%. Clearly, this is not the rate we expect over the long term, particularly as we continue to see a much richer mix of sales in our higher-margin Home and Apparel categories in Canada. However, we do expect pressure on Canadian segment gross margin to persist in the fourth quarter as we continue to do whatever it takes to enter 2014 with improved operations and a notably better inventory position. Obviously, expense rates in Canada are unusually high due to startup costs, incremental activity to clear inventory and lower-than-expected initial sales. While expense rates are expected to improve over the next several years, we expect meaningful improvement in 2014 as we move past first-year startup costs, we gain efficiencies through systems and process improvements, and we drive sales increases to our efforts to drive shopping frequency. Turning to consolidated metrics. Third quarter interest expense declined $27 million or 14% from last year, as we continue to benefit from the debt retirement following the receivable sale. We returned $271 million to shareholders through dividends in the third quarter, marking our 184th consecutive quarterly dividend since we became a public company in 1967. You've likely noted that we did not repurchase any of our shares in the third quarter. While we remain committed to share repurchases over time, we have consistently maintained that we will govern the pace of repurchases, with the goal of maintaining our strong A credit rating. As a result, in the third quarter, we took a pause in our share repurchase activity in light of the incremental dilution we're currently experiencing in the Canadian segment. Looking ahead, we will continue to monitor our results while maintaining a dialogue with the debt rating agencies, and we will resume the program when conditions are appropriate. I should emphasize that, given the compelling increase in free cash flow we expect next year, we believe we'll have the capacity within our rating objectives to return up to $4 billion through share repurchase in 2014. Now let's turn to our expectations for the fourth quarter and resulting metrics for the full year. In the U.S., we're planning for approximately flat comparable sales, given there are 6 fewer shopping days between Thanksgiving and Christmas, the current state of the consumer and the expectation for a very promotional and competitive environment. As Kathee mentioned, we have ample base inventory to generate much stronger sales than planned if consumer demand turns out to be stronger than expected. And while most of the season is still ahead of us, I can tell you that so far in November, sales have been right on our forecast, supporting our expectations for the quarter. Notably, the pace of our digital sales growth so far this month has been on plan and much stronger than we've seen so far this year. Fourth quarter U.S. segment EBITDA margin rate is expected to be down slightly from last year. On the gross margin line, we expect to see year-over-year improvements, reflective of the comparison against last year's unusually high seasonal markdowns, this year's change in vendor payments and in comparison to last year's 53rd week, which added a relatively low gross margin week to the quarter. We expect the fourth quarter U.S. segment SG&A expense rate to be a full percentage point above last year's revised rate of 17.3%. About half of this increase, or $110 million, is related to the Credit Card portfolio, driven by its smaller size comparing against a small reserve release last year and this year's profit-sharing arrangement with TD. The remaining expense pressure in the U.S. segment reflects the change in vendor payments, investments in technology and supply chain and a lack of leverage on flattish comparable sales growth. In the Canadian segment, we expect another meaningful acceleration in sales dollars, reflective of the stores we opened in the third quarter, additional openings this quarter and the surge from holiday-related sales. We expect gross margin and expense rate pressures to continue as we move beyond a record year of store openings to refining operations and clearing inventory in preparation for 2014. Our forecast is for the Canadian segment dilution in the range of $0.22 to $0.32 in the fourth quarter. In the U.S., we expect fourth quarter adjusted EPS in the range of $1.50 to $1.60. As you'll recall, last year's 53rd week added $0.05 to $0.10 to adjusted EPS in the fourth quarter and full year. Adjusting for this benefit, this year's expectation would keep us flat to down slightly from last year's performance on an apples-to-apples basis, despite an expected $110 million headwind from the Credit Card portfolio.
Combining our expectations for adjusted EPS, Canadian segment dilution and a $0.02 impact from the reduction of the beneficial interest asset, we expect fourth quarter GAAP EPS in a range centered around $1.26. For the full year, our expectations are for adjusted EPS in the $4.59 to $4.69 range, down slightly from last year's performance of $4.76, reflecting outstanding operational discipline when you consider that:
it reflects more than $400 million in lower expected earnings from the Credit Card portfolio, driven by a smaller asset base, annualizing last year's reserve reductions and the profit-sharing arrangement with TD; it reflects more than $200 million of expense pressure from incremental investments in technology and supply chain to support our multichannel efforts; it's comparing against last year's 53rd week, which added $50 million to $100 million to last year's pretax earnings.
Combining these factors, we faced a headwind in the neighborhood of $700 million this year, of which, we've offset a meaningful portion in a tough environment with expected comparable sales of less than 1% for the year. As a result, we are very pleased with the operating discipline reflected in our expected 2013 results for the U.S. segment. In Canada, we have accomplished a great deal, and we remain confident in the long-run potential for these stores. In the near term, however, dilution has been higher than expected as the team works diligently to refine operations, enhance inventory flow and position the segment for meaningful improvement and profitability throughout 2014. For the year, our expectations are for Canadian dilution in the range of $0.95 to $1.05. Combined with the net accounting impacts from debt retirement to Credit Card sales and nonrecurring tax benefits, our outlook in the U.S. and Canada leads to an expectation for full year GAAP EPS in a range centered around $3.52. While the economic environment for the next year remains quite uncertain and beyond our control, we feel good about our plans for 2014 for a number of reasons that are within our control. In Canada, we'll move past startup expenses from this year's market launch, and we're confident in our plans to rationalize inventory, drive sales and improve operations. In the U.S., we've demonstrated our ability to continue to manage the business with discipline, regardless of the economic environment, including our continued focus on expense optimization. And we feel very good about our plans regarding capital deployment, as we expect to have a dramatic increase in share repurchase capacity, driven by a reduction of Canadian CapEx of more than $1 billion, meaningful improvement in Canadian segment EBITDA and continued strong cash flow generation by our U.S. business, with U.S. CapEx essentially flat to 2013. As of today, we expect the combination of factors will allow us to repurchase up to $4 billion of our shares in 2014 while continuing to grow the dividend and maintain our A credit ratings. With that, we'll conclude today's prepared remarks. Now Gregg, Kathee and I will be happy to respond to your questions.
Operator:
[Operator Instructions] And our first question comes from the line of Greg Melich with ISI Group.
Gregory Melich:
I wanted to start right with REDcard and traffic. That's a trend this year that has sort of gotten locked in at this down 1% to 1.5%, and you just gave some goals a few weeks ago where comps would be 2% or better over the next few years. How do you get to the 2% over time if traffic's still down 1% to 1.5%, or what initiatives with REDcard or anything else that you have which will really get that traffic stabilized?
John Mulligan:
So I'll start, Greg. I think a couple of things. One, I think, first of all, the stress on low-income consumers is certainly playing a role. We've seen that all year long. The payroll tax increase has been a portion of that, for sure. I think we get to cycle past that in January, and we'll get better information about what that looks like going forward. But beyond that and the things that we actually control, as you said, we continue to see meaningful growth in REDcard. That continues to drive 50% lifts in sales, all of that driven by traffic. Kansas City is above 25% penetration now, so it continues to grow hundreds of basis points a year. And then beyond that, I think it's all about our multichannel initiatives and everything we're doing there. And as I said, we're starting to see strong digital sales growth. That, combined with the flex-fulfillment activities that we're implementing now, piloting a little later this year and will begin to roll out next year, we think all of that put together will continue to drive meaningful traffic increases.
Kathryn Tesija:
And the only thing that I would add, Greg -- this is Kathee -- is just that as guests are consolidating their trips and they're coming less frequently, it's really important for us to get them to shop around the store and to buy more. And you do see in our basket that we've been able to accomplish that for the past several quarters as well. So we will stay focused on how do we ensure that we get more of their wallet when they do come.
Gregory Melich:
And maybe a direct follow-up to that. I know that with all the multichannel initiatives, and you outlined them all on the call, how have you changed how store managers and associates are incentivized so that they give the sort of level of service to the online guest that's coming in to pickup in-store? Do they get credit for that, or how should we look for that to be changing going forward?
Gregg Steinhafel:
Yes, they do. They get total credit for anything that is bought online, picked up in-store, or things that are in-store, where there's an extended aisle sale and it's in it. So we're incenting this. Actually, we have a parallel environment where both teams, both our dotcom team and our store teams, get credit for growing the business in a collaborative way. So there's no penalties or there's no internal conflict at all as it relates to who's going to get that credit for the sale. So we're double-crediting everybody from an internal standpoint, and then we take it out at the an enterprise level to make sure that it all washes through on a consolidated basis.
Gregory Melich:
Is that true if I have it shipped to my home?
Gregg Steinhafel:
If it's shipped to your home from the store, yes.
Operator:
And your next question comes from the line of Wayne Hood with BMO Capital.
Wayne Hood:
Kathee, just on the average ticket size -- Gregg was talking about transactions, but just to get to the ticket. I mean, there's sequentially been a pretty nice acceleration in AUR throughout the year, and you talked a little bit in the third quarter, Electronics impacting that with the UPT being down. As you plan the business into the fourth quarter, would you still expect your AUR to be up kind of 3% and UPT to be down? Or how should we think about the dynamics that's driving average ticket? And also, that points to -- if AUR is up, which points people are maybe buying up -- you're moving them up, how do you square that with a consumer that's constrained?
Kathryn Tesija:
Most of what's driving it up for the fourth quarter will be those hot categories like Electronics that are most popular in the holiday season, and there's a lot of newness there that drive up the average selling price. So think of iPads, think of all the new video game consoles and games, which Target does very well with. And we are really excited about that business for the holiday season. So I would anticipate it will continue into the fourth quarter.
Gregg Steinhafel:
Yes. So think of it more as a change in the mix of what we're selling at this time of year, versus trading up within category.
Wayne Hood:
Got it. And then my kind of question related to this, Kathee, and it gets back to the trip issue. With what you've seen with Cartwheel, what trips is that group -- you've seen an extra trip, and how do you really jump on that at a faster rate to drive trips the way you did with REDcard?
Kathryn Tesija:
Yes, first, I would tell you it's pretty early. I think we've got about 6 months in with Cartwheel. But as we mentioned, very excited. We have got over 3 million users right now that are very engaged. I think it's helping trips. I also think it's really helping basket because they're using Cartwheel in the store, on their mobile device, looking for deals on things that they want to buy, and they're adding more to their basket. So it's still really early to see trends, but we are very excited about it and are talking about it more and more. We're going to be using Cartwheel as one of our vehicles to help drive value this holiday season. And hopefully, more and more people will hear about it and sign up for it. But we think this is a big success story for us that we can continue to grow.
Operator:
And your next question comes from the line of Sean Naughton with Piper Jaffray.
Sean Naughton:
I have a couple of core questions here on Canada, and I think most of them are related. John, I think you talked about the gross margin being impacted by some inventory issues in Canada late in the quarter. Can you just give us a little bit more color there on what happened there? And then maybe also outline where are some of the pockets of excess inventory that you're looking to move through? And then just secondly, are there any signs of hope in the business or glimmers of hope that you can kind of point to, whether it's by region or category, that are kind of going better than expected at this point in that market?
John Mulligan:
There's always hope, Sean. We're highly confident that we're going to be successful. To your inventory question, we talked a lot last time about, given the sales shortfall and the fact that we planned inventories to protect on the upside, given all the excitement, there's a pretty large inventory overhang. And as the teams have worked hard over the past 90 days, assessing the best way to handle that, and it depends on the various categories, about the best way to handle that, we've clearly seen some markdowns come through. We're taking advantage of that, actually, to drive value messaging in Canada and get across how sharp our prices are. And then we're also assessing what of the inventory do we think we're going to sell, ultimately, below cost or end up salvaging because there's just flat-out too much of it. And that's the inventory reserves that we assess at the end of the third quarter. We do that every quarter anyways, as a matter of course, and we'll do that again at the end of the fourth quarter. But that was a large piece of what happened at the end of the third quarter. I think as far as lumpiness of inventories, as you'd expect, it's the long-lead categories where we tend to be lumpy. The stuff that turns quicker or that is domestically sourced, we can, obviously, shut down receipts much, much quicker. But stuff that is long lead -- and we'll see this continue, actually, a little bit in the spring. And here, think about categories like bikes, where those are a long-lead item and it just -- we can't get out of the receipts once we've made commitments. So those are the type of items that'll take us a little bit longer to clear through. I think on signs of hope -- we wouldn't call it hope, but on signs of our execution starting to improve, we are seeing, and I think this is consistent with what Gregg said, as we start to get sales histories, we can start to replenish stores more accurately, balance our inventories and meet guest need when they need that. And we're starting to see success there. As we look at our current results, we're pretty much hitting our current forecast, but we're seeing much stronger results in the cycles that have been open longer. Cycle 1, Cycle 2, Cycle 3 have actually begun to exceed our expectations a bit. So we're a little bit hopeful -- not hopeful, we're optimistic that we are seeing the right trend with those cycles improving, and we believe we'll continue to see that as we get more age behind the Cycle 4 and Cycle 5 stores.
Sean Naughton:
That's helpful. And then just secondly, in terms of expense optimization in the U.S. business, looks like you did a great job of controlling that there in Q3, maybe even below what you would expect moving forward. Do you feel like you're in the right position now there? And what type of comp do you feel like you need right now to leverage that SG&A moving forward, maybe in Q4 and then kind of the first half of 2014?
John Mulligan:
Yes, I think our efforts on expense optimization continue to be very successful. The teams are very engaged across the company and continuing to look for new ideas of ways that we can reduce expense. And I think part of this is about lowering our center of gravity that you're referring to. But a big part of it, too, is in reinvesting that in other parts of the business. And you've really seen that this year. We had significant incremental investments in technology, supply chain. That will happen again next year, particularly around technology and flexible fulfillment. We'll make SG&A investments, and expense optimization really allows us to offset that. So I think leverage probably hasn't changed a whole lot, somewhere between that 1 and 2 range, but it gives us a lot of capacity to invest in the business as we continue to grow our multichannel capabilities.
Operator:
And our next question comes from the line of Matthew Fassler with Goldman Sachs.
Matthew Fassler:
My first question relates to Canada. What kind of insight can you give us into the average number of stores opened over the course of the quarter as it relates to timing of openings, just to give us the ability to measure an accurate sales productivity number. We obviously try to get sales per store and sales per foot, but the growth is moving so quickly on such a small base that it's very easy for those numbers to get distorted.
John Mulligan:
We agree with the last part of that comment, and we've continued to say it's very early here, and we're going to see it move around again in the fourth quarter, given we see the surge in holiday sales. I don't have the exact weighted average on the store timing, Matt. But John Hulbert will get that to you -- we can get that to you today.
Matthew Fassler:
That would be very, very helpful. Second question I would ask relates to the Electronics business. Clearly, the video cycle is here and is very prominent, and I know that mobile is still a relatively new business for you. If you look at the legacy consumer electronics businesses, and you mentioned tablets, where I know you had a fairly high-profile promotion recently, and TV and other businesses that have less kind of industry-wide going on year-on-year, what's your experience, then, in those categories, or what was it in the third quarter, and what's your sense of the promotional environment here in Q4?
Kathryn Tesija:
Well, Matt, I'd say it's strong overall. Certainly, that varies by category, but there are a lot of great trends in our business in Electronics. I mentioned a couple that we're excited about for Black Friday and going into Cyber Monday and the rest of the holiday season. Things like Beats by Dr. Dre, that -- the whole headphone category has been fantastic, and that's a lead item. Speaker systems, like Sonos, have been fantastic. So there are many different categories that are performing well. Some are a little bit softer, like cameras. But in total, a really strong business in Electronics right now.
Operator:
And your next question comes from the line of Chris Horvers with JPMorgan.
Christopher Horvers:
Wanted to follow up on the Canadian and gross margin and just your thoughts about how that proceeds going forward. I think originally, you had talked about the Canadian gross margin being above the U.S. I always interpret that as maybe a couple of hundred basis points above the U.S. rate. But you have these competing factors right now, where the markdown pressure is a negative but the mix factor is a positive. So as you look into the crystal ball, how do you think -- how might your -- are your gross margin expectations shifting based on those 2 competing factors over what the long-term opportunity could be relative to your original expectations?
Gregg Steinhafel:
Yes, Chris, this is Gregg. Over the long term, our expectations haven't changed at all. What we're experiencing now is, and as John talked about it, it's those long lead time businesses that are markdown sensitive, particularly Home and Apparel, that we have to exit, and it's costly to do so. Remember, the first cycle of stores didn't open until April. And the second cycle followed shortly after that, and that was only a handful number of stores. By the time we really got a good, clear indication in terms of where the sales were going to level out for this year, in our long-cycle businesses, and think 6, 7, 8 months, these receipts were already planned and in production and on the way. So it's really the lump of inventory that we've got to work through. And once we do that, we're very confident that we're going to be back in the mid-30s, like we talked about, in terms of the overall gross margin because our mix continues to be strong. And we're very pleased with that, and we don't see any signs of that abating. Now it might come down a little bit as we get more aggressive in terms of building that trip frequency. And we'll start those efforts in earnest when we turn the corner in 2014. But on an absolute basis, we're really pleased with where we are in Home and Apparel. And we've got to get through this next quarter and the early part of the beginnings of 2014 until we really get that sales history developed by item, by store and eliminate some of the huge variability that we have in the supply chain so that we can get a more even balance between receipt flow and what we're selling. And at that point in time, we fully believe that we're going to be back to where our initial expectations were from a gross margin standpoint.
Christopher Horvers:
And then, you mentioned that some of the early-cycle stores were starting to, I guess, exceed your expectations a bit. You had a really interesting chart at the Analyst Day that talked about where they expected ramp in the stores initially, versus where it's sitting now. Could you just reference for us what you mean by exceeding your expectations a bit? Is that versus, I guess, your original expectation on new year, first-year sales or versus what you rethought?
Gregg Steinhafel:
No, these are against the new, most recent level-setting expectations that we shared at the Analyst Day that said that they're not where they were when we originally planned the business, but now that we've had enough experience, we see where they were, and we established and rebooted, essentially, our expectations for Canada. So against that new, most current forecast, what we're seeing is encouraging signs out of those earlier-cycle stores. They are exceeding these newer, revised forecasts more than the later-cycle stores because they've had a chance to operate on their own. They're 6 months into it now. The inventories are flowing better, in-stock levels have improved, the guest is getting used to our stores, they're converting from more of a browser to a shopper. And so it's still very, very early, but we like what we see in some of those early-cycle stores. And so at this stage, we're just encouraged by the fact that they're performing better against most revised, revised forecast.
Christopher Horvers:
And then one just quick last one. Can you just share with us what your share in the gaming category is in the U.S.?
Kathryn Tesija:
I don't know that number off the top of my head. It is definitely higher than our typical market share, but we can get back to you with that number.
John Mulligan:
It's much higher than our aggregate store or Electronics market shares.
Operator:
And your next question comes from the line of Jason DeRise with UBS.
Jason DeRise:
Yes, it's Jason DeRise here from UBS. Can I ask, I guess, about the comps? I just want to get your thoughts on a few of these items, if you would maybe quantify them. So one is the -- how much of the shift from the timing of the calendar between Q3 and Q4 in your reporting benefited the current quarter that was reported and pulled forward from Q4? And then get your thoughts about if you think there's any impact on your comps from SNAP, whether that's directly in your Food sales or your general merchandise sales. If you could quantify what kind of uplift you expect from video games? And also, one thing that didn't come up yet, but lower fuel prices, how you're thinking about that?
John Mulligan:
Well, that's a lot of questions. On the third quarter, I think, clearly, Halloween moving into the quarter benefited it. I would remind you that we also said, at the end of last quarter, our Back-to-School week moved out of the quarter into second quarter. That benefited second quarter. Net-net, probably a wash, maybe 10, plus or minus 10, 20 basis points. I don't really know, but net-net, a wash. Let's see, WIC -- any time there's a decrease like that, there's an impact. But for us, Grocery, Food is about 20% of our business, roughly, and it's a very different kind of trip for us than most grocers. So certainly, there's an impact. But for us, meaningfully, that's just not -- again, this is a small impact relative to what we might see at other retailers who sell significantly more food as a percentage of their business than we do. And then Electronics, what was the question on Electronics, I'm sorry?
Jason DeRise:
I guess, the video game cycle itself, what kind of comp uplift you would expect just from that? And the last part of that was about fuel prices coming down, if you see that as a benefit for yourselves or not?
Kathryn Tesija:
Well, we don't necessarily talk about categories and how big they are. But with 2 new console releases and all the games that will go with them, as you know, it's been a declining category for several years, given the maturity. It's been over 7 years since we had a new console. So having 2 in the same year is very meaningful for the category. It's also very meaningful for Electronics and the store. So we think it's going to be one of the biggest gifts -- gifting category of the year, and we will certainly benefit from that.
John Mulligan:
And then on fuel, there's no question that, in a time when, particularly, lower-income consumers have very constrained budgets, having less -- having to spend less on fuel, it helps in some way. For us, I'll tell you, through time, we have looked at this many, many ways, and it's really hard to quantify fuel price moves in our sales. There's times when fuel prices are going up in a good economy, and that's good for everybody, which is different than today. So it's hard to quantify. But overall, lower fuel prices is definitely good for consumers. It just puts more money in their pocket.
Jason DeRise:
If I can ask one more about comp trends, the Apparel part of the business. I mean, it sounds like the branded stuff is going well for you. Can you talk about your private label trends in Apparel? Is that maybe where some of the weakness is and what you're doing to try and turn that around?
Kathryn Tesija:
Apparel, I think, was -- most of what we have is owned-brand product and exclusive designer partnerships that we do. So that is the bulk of our business. Certainly, we do a lot of basics with branded manufacturers, Hanes, for example. But our comp in Apparel was down slightly. It was much stronger online, so we're seeing some shifting happening there. We are pleased with the new releases that we've had. Phillip Lim was probably our best designer launch ever, very clean sell-throughs, both in stores and online. Our launch of our holiday product is off to a good start, while it's still early. So we're feeling pretty good about Apparel overall. I would say that the softest part of Apparel has been in kids. And we are working on ways to make sure that we can drive that business and have the right price-value relationship for our guests to help drive better market share gains. But the rest, I feel pretty confident in.
Operator:
And our final question comes from the line of Paul Trussell with Deutsche Bank.
Paul Trussell:
Just looking at the U.S. business from a gross margin standpoint, if we exclude the vendor agreements accounting shift, I think gross margins would have been down about 50 basis points year-over-year. Can you just kind of prioritize or rank for us the impact from markdowns versus category rate pressures and other factors, and just how we should think about that going into the fourth quarter, given the promotional intensity?
John Mulligan:
The 50 basis points is about right, and I would say about half of that was due to the ongoing pressure we've seen for several years now related to REDcard and the store remodel program. The other half, like we talked a little bit about, was really related to markdowns we took given the Halloween sell-through that we saw. And we saw sales soften up, like we said, in the middle of the quarter. Given everything that was going on with consumer confidence and in Washington, we saw sales soften up a bit. And really, just some promotional markdowns to sell through our Halloween inventory. I think as we think about fourth quarter, as we talked about, it's going to be very promotional, there's no doubt about that. But the primary driver of our performance versus last year is, last year, we took significant clearance markdowns last -- which you'll see be the primary variance year-over-year in our gross margin rate.
Paul Trussell:
Okay. So improved performance on gross margin in 4Q versus 3Q?
John Mulligan:
Yes.
Gregg Steinhafel:
Absolutely.
Paul Trussell:
Got it, got it. And then just lastly, on Canada, you mentioned that there was a lot of investment -- or a lot of markdowns in inventory. Is some of the gross margin hit also related to price investments being made in certain categories? If you can just give us an update on that, along with a reminder, John, on what the drag was from startup expenses in Canada this year.
John Mulligan:
Yes, we haven't disclosed the drag from startup expenses all year long. So we haven't really talked about that a whole lot. As it relates to price investments and markdowns, I think it's all -- we view that as all one big bucket, really, and it's really the total value message we're able to give to the guests in Canada right now. And as we said, we have a little bit of excess inventory. We'll take advantage of that. To be sure, we're giving a great value message. But beyond that, as we look at our pricing in Canada on like items, we are right on where we want to be. We are locally competitive and right on the price leaders in Canada. So we feel really good about our pricing in Canada on like-for-like items.
Gregg Steinhafel:
Great. Well, that concludes Target's Third Quarter 2013 Earnings Conference Call. Thank you, all, for your participation.
Operator:
And thank you. This concludes today's conference call, and you may now disconnect.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation's Second Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, August 21, 2013. I would now like to turn the conference over to Mr. Gregg Steinhafel, Chairman, President and Chief Executive Officer. Please go ahead, sir.
Gregg Steinhafel:
Good morning, and welcome to our 2013 Second Quarter Earnings Conference Call. On the line with me today are Kathy Tesija, Executive Vice President of Merchandising; and John Mulligan, Executive Vice President and Chief Financial Officer.
This morning, I'll provide a high-level summary of our second quarter results and strategic priorities for the rest of the year, and Kathy will discuss category results, guest insights and upcoming initiatives. And finally, John will provide more detail on our financial performance, along with our outlook for the third quarter and full year. Following John's remarks, we'll open up the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following this conference call, John Hulbert and John Mulligan will be available throughout the day to answer any follow-up questions you may have. Also, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Finally, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP results is included in this morning's press release posted on our Investor Relations website. Target's second quarter financial results reflect strong U.S. profit performance in spite of soft traffic and sales. Our second quarter comparable sales increased 1.2%, below our expectations going into the quarter, but nearly 2 percentage points ahead of our first quarter pace. As a result, we delivered second quarter adjusted EPS of $1.19, at the high end of our expectation going into the quarter. Our GAAP EPS of $0.95 was in the middle of our expected range, reflecting higher-than-expected dilution of $0.21 from our Canadian segment. As we monitor the economy and consumer sentiment, we continue to see a mix of signals in which emerging optimism is balanced with continuing challenges. This year's payroll tax increase continues to affect spending, particularly among lower- and moderate-income households, and household formation in the younger demographic groups remained stubbornly negative. Recent job growth numbers have been encouraging, but labor force participation and income growth remained weak. And while emerging strength in the housing and automotive sectors is a long-term positive, the near-term spending on these big-ticket items is crowding out other spending, particularly in today's environment in which access to consumer credit remains tight. As you've heard from mall operators and other retailers, we continue to see the impact of trip consolidation in U.S. households, as our second quarter comp was entirely driven by an increase in basket size, partially offset by a small decline in traffic. Second quarter sales in our digital channels grew in the teens overall, with mobile traffic and sales continuing to grow at a triple-digit pace. Second quarter operating margins in the U.S. were quite strong, especially in light of the pace of our sales. We delivered a healthy gross margin rate as we saw a relatively balanced mix of sales across categories, and our merchant teams did a great job managing inventory and price investments. In addition, we continue to benefit from a very disciplined management of expenses, particularly in our stores. In fact, excluding the impact of the decline in the contribution from our Credit Card portfolio, U.S. Segment operating margins increased from last year's second quarter. Altogether, we feel very good about our second quarter U.S. Segment performance as we overcame softer-than-expected sales and the year-over-year impact of Credit Card profit-sharing to deliver a 6.1% increase in adjusted earnings per share. These results demonstrate the resilience of our team and our operating model in the face of a challenging economic and consumer environment. In our Canadian Segment, we've reached the halfway point in our 2013 market launch. We opened another 44 Canadian Target stores in the second quarter, putting our total at 68 today, on the way to our goal of operating 124 Canadian stores by year end. Launching our Canadian Segment has required a massive effort from teams throughout the company, including building a completely new supply chain infrastructure and integrated technology solution, completely reconstructing former Zellers locations, transforming them into brand-new Target stores; hiring and training more than 15,000 Canadian team members; and creating unique merchandise strategies and assortments to fit the preferences of our Canadian guests, including a very strong presence in our Home and Apparel categories. The teams' execution on these efforts has been excellent. As a result, our Canadian stores have seen strong initial traffic, and the mix of our sales in Home and Apparel has been even higher than expected. However, now that we've successfully opened 68 stores in Canada, we need to drive trips and conversion in frequency categories like health care, food and other basic commodities. Sales in these categories have grown much more slowly than we expected, causing overall sales and profit momentum to build more slowly as well. Multiple surveys indicate that our prices are very competitive and right where they need to be when compared to competition in local markets. Yet, we know there is a gap in guest awareness of how low our prices really are. As a result, we are deploying multiple tactics to help our guests better understand the great value and convenience we provide in these categories. Over time, we expect these efforts will drive greater awareness of the assortment and value we provide on these frequently purchased items, leading our Canadian guests to regularly shop Target for a balance of both wants and needs. Our expectations are informed by our experience in launching the PFresh remodel program and CityTarget format, as well as our historical experience entering new markets in the U.S. In many of these markets, we saw a similar pattern in which sales momentum was slower than expected at the launch, but grew rapidly in the first several years after opening, resulting in achievement of our fifth-year sales goals. For the stores we've opened, the team in Canada is working to adjust inventory and store staffing to match the pace of sales in each individual location. And for the segment in total, we have updated the expected timing of earnings accretion. Having said that, we remain highly confident in our strategy. We are very pleased with the look and feel of these new stores, and we have an outstanding Canadian team. We've invested in this segment to position it for long-term success, and we continue to believe we'll achieve our longer-term financial goals in Canada. Across the company, we are moving quickly to position our business to succeed in a rapidly changing retail environment. This requires our team to stay laser-focused on near-term execution, while simultaneously allocating resources and effort to initiatives that will drive longer-term sales growth and profitability.
Recent examples of this include:
The beta launch of Cartwheel, our mobile coupon platform on Facebook that has experienced rapid growth since its launch in April. This platform, which integrates our stores and mobile into guests' social networks, has seen very high levels of guest engagement. In fact, our partners at Facebook have told us that engagement statistics for Cartwheel are among the best they have seen in the beta stage of any app, both within and outside the retail space.
We're also providing meaningful resources to enhance the flexibility of our fulfillment network, which includes our stores, regional distribution centers, online fulfillment centers and import warehouses. In addition, we're investing in data systems that will provide a single, holistic view across vendors, items or distribution infrastructure and stores that will allow us to more efficiently and seamlessly fulfill guest demand in whatever channel they choose. And we're pleased with our recent agreement to acquire the DermStore Beauty Group. This unique opportunity, which follows our acquisitions of chefs.com and cooking.com earlier in the year, provide us insight into the superior online experience DermStore provides, along with access to brands, content and resources that are valuable to our guests. As we look to the remainder of the year and beyond, we're taking steps to drive guest traffic, both today and over time. We're steadfast in our commitment to provide value to guests who continue to shop cautiously, investing in everyday low prices and even lower prices in our weekly circular and flyer, combined with compelling discounts available on Cartwheel. We reinforced this commitment to value with price-matching policies for both online and local print ads from competitors. And 5% REDcard Rewards and Pharmacy Rewards allows guests to save even more off our already great rate prices. The continued rapid adoption of both of these programs demonstrates the value they provide for our guests. Beyond low prices, we work to differentiate our assortment and guest experience by partnering with designers and others to provide unique, unexpected, value-added products and services. For example, in our stores, we're adding service elements to categories including beauty and electronics. And outside our stores, we will continue to explore acquisition opportunities to augment our digital capabilities, content and brand. Additionally, we're building the digital acumen of the organization through hiring and collaborations with leading technology partners. For example, our recently opened technology innovation center in San Francisco provides us the opportunity to benefit from technology talent in the area and rapidly explore opportunities that can be brought to Target, accelerating the pace of our innovation and adoption of emerging technologies and trends. And we're building the capability to operate stores in smaller spaces, particularly in urban markets. We're analyzing results in our first 7 Save Target stores to understand where in the stores we have the ability to reduce space even more, allowing us to further shrink the size of this store format. Ultimately, we believe we will succeed over time by providing value to our guests in a world of "and," where we provide the ability to conveniently shop in stores and digital channels, enjoyable shopping for both wants and needs, access to great design and low prices and the ability to save money with an ethical company that supports the communities where we operate. At Target, we've long understood the power of "and," which is summed up by our brand promise to expect more and pay less. We believe this promise is more relevant than ever in today's environment, and we are committed across the organization to delivering on it, everyday, in every channel. Before I turn the call over to Kathy, I want to take a moment to thank the Target team for their outstanding effort in this challenging environment. The team has already accomplished a lot this year, successfully launching a record number of stores outside the U.S. for the first time, selling our Credit Card portfolio to an outstanding partner in TD Bank and preserving profitability in a softer-than-expected sales environment in the U.S. Throughout the organization, we are focused on becoming more nimble, moving quickly to test and learn from new initiatives. I'm proud of this team and confident that our efforts will position Target for long-term success. Now Kathy will provide more detail on second quarter results, outline initiatives for the third quarter and beyond. Kathy?
Kathryn Tesija:
Thanks, Gregg. We're very pleased with the ability of our team to manage inventory and profitability in our U.S. business during a quarter in which consumers shopped cautiously and competitors promoted heavily to clear excess inventory.
In our second quarter U.S. results, we saw a relatively narrow spread in comparable sales between the strongest and softest performing categories. Not surprisingly, sales in less-discretionary areas like food, health care and household essentials grew somewhat faster than the company average. However, sales in our Home category also grew faster than the company average, driven by particular strength in our Domestics and Stationery categories. Among the other more discretionary categories, second quarter comparable sales in both Apparel and Hardlines declined slightly. Within Apparel, our children's categories had the strongest results, while the more discretionary women's assortments experienced softer results in the face of a very promotional environment. We continue to deliver excitement through limited-time partnerships with influential designers who help us differentiate Target in support of our "Expect More. Pay Less." brand promise. In the second quarter, we were very pleased with the results of our collaboration with Lauren Bush Lauren and FEED USA, featuring products in Home, Sporting Goods, Stationery, Apparel & Accessories. Beyond the merchandise, this unique program reinforced our commitment to communities, as Target provided more than 10 million meals for U.S. families through this collaboration. We're also very pleased with the initial results for the beta launch of Cartwheel, a differentiated mobile experience that delivers value for our guests. We launched the Cartwheel app on the iOS and Android platforms in June, and it's already a top-20 lifestyle app in the Apple Store. Cartwheel is growing rapidly. It currently has more than 1 million users who have saved more than $2 million so far. Among active users, more than 50% have completed multiple Cartwheel transactions, demonstrating the power of the program to drive sustained guest engagement. As expected, guests are searching for deals while they're shopping in stores, and we've seen redemption rates in excess of 50% for offers downloaded by guests while they're shopping. We're pleased with these initial results, and we'll apply what we've learned to improve both the Cartwheel experience, as well as the development of our multichannel experiences in the future. Beyond new mobile experiences like Cartwheel, our overall mobile sales and traffic continue to grow at a rapid pace. To build on this momentum, we're investing to enhance speed, search, product information and checkout on our mobile site. And this fall, we'll begin testing other innovations to enhance the in-store mobile experience, including WayfinD, wayfinding and improved search. And we continue to invest to further integrate the shopping experience across channels. Based on successful results from our team member test of buy online and pick up in store, we are moving quickly to begin offering this option for guests in the third quarter. We'll begin in the Minneapolis market before expanding the rollout to other markets. We expect to complete the rollout to all stores by the holiday season. Simultaneously, we are planning team member tests of other flexible fulfillment capabilities, which will begin later this year, including the ability to deliver online orders from stores as early as the same day and the ability to pay in one store and pick up in another. Based on the results of the team member tests, we will look to move to guest-facing tests next year. And beyond investments to build on our own digital offering, we continue to monitor the landscape to identify opportunities to augment our capabilities through acquisitions. The recent decision to acquire DermStore reflects the strategic opportunity for Target to learn from their online expertise, customer service, content development and product curation, which combine to create an exceptional online beauty experience. In addition, DermStore's broad assortment of prestige and dermatology brands will complement Target's product offering. We continue to approach the economic and competitive environment with longer-term optimism but near-term caution. While overall consumer confidence statistics have improved this year, it's notable that optimism among lower-income households is lagging behind. And as Gregg mentioned, this year's payroll tax increase and consumer spending on autos and housing are crowding out spending on other goods and services. For example, in surveys regarding expected spending on Back-to-School and Back-to-College items, consumers indicate they intend to spend less than a year ago by focusing on sales, discounts and reusing items they already own. As a result, in preparing for the third quarter and beyond, we're building flexibility into our inventory plans and creating merchandise and marketing programs focused on driving traffic and sales with compelling offers, innovative partnerships and key seasonal programs. Target is known for delivering key seasons for our guests, and only the fourth quarter holiday season is bigger than Back-to-School and Back-to-College. This year, we've created a multilayer strategy to deliver a great guest experience and outstanding value. For Back-to-School, we're offering parents a convenient one-stop shop for all the must-have items on their shopping lists at a price -- at a range of price points to accommodate a variety of household budgets, including hundreds of unique items in fashion, school supplies and accessories for less than $20. In fact, we have nearly 400 items for $1 or less, clearly demonstrating our commitment to deliver value. Our Back-to-School direct-mail catalog includes more than $25 worth of coupons, and we've increased the number of online coupons this year as well. And of course, parents who use their Target REDcard will receive 5% off their entire purchase and free shipping on every order from target.com. To support our Back-to-School merchandising, [indiscernible] broadcast themes in various lengths and languages, which focus on telling stories around iconic school moments that make kids feel like real-life heroes. In addition to the unique Kids Got Style Instagram program, Target celebrated kids as the most original style leaders. Earlier this month, parents could Instagram a picture of their children showing off their individual style. Target's stylists use select photos as inspiration to create Kids Got Style mood boards of colors, fashion items and supplies inspired by each child's unique style, which were posted to Instagram, Facebook and Twitter. Parents were tagged so they can view and share their photos to their social networks as inspiration for the new school year. Because we know that quality education is the #1 social priority for our guests, it's also the #1 focus of our giving programs. So following last year's success, we're excited about the return of our Give With Target program, through which Target will donate $5 million to schools across the country. Last year, our guests impacted more than 30,000 schools through donations from this program, which were used to purchase classroom resources like electronics, office supplies and storage and organization products. New this year, Target is inviting guests to allocate the full donation, double the amount designated by guests last year to schools of their choice. For Back-to-College, we've created innovative resources and new live experiences, both online and in person, to provide the inspiration and tools to make shopping fun and easy. Last month, Target introduced a first of its kind online live experience, featuring popular YouTube personalities in life-sized virtual dorms. From July 15 through 18, visitors were invited to shop Target products from the dorm rooms, enter to win college gear and interact with the roommates. Also online, we've created uStyler, a style-focused design resource that puts students in the driver's seat as they put together their unique dorm room look. Looks can be named, saved and shared on their favorite social media sites, where their friends are able to shop them. And we've created The Checklist, a customizable list of key products available in-store and at target.com to help students shop for small-space living. On campus, Target is hosting 95 shopping events for incoming freshmen around the country as part of welcome week festivities. These events include after-hour shopping events, which provide free bus transportation to and from our store, where students will be able to shop for everything they need and want. Halloween is also a key season for Target, and the holiday falls in our third quarter this year. We plan to deliver this season with a multichannel approach focused on driving traffic and growing our market share. We'll offer a comprehensive assortment of costumes and accessories for the whole family, including parents, kids and pets. We'll offer a dominant presentation in our stores and extend the assortment on target.com. In Home, Target's product design and development team has created an innovative collection of Halloween décor, ranging from classic to scary, to help mom decorate her home inside and out for the big night. As Gregg mentioned, we're increasingly focused on differentiating our store experience through enhanced service. The baby category is already one of our signature strengths, but we believe we have an opportunity to further deepen relationships with guests who are entering this life stage. Expectant parents establish new shopping habits, and it's a time when they're looking for easy shopping solutions to save time. As a result, we're continually exploring new ways to elevate the shopping experience for expectant parents. For example, in 10 Chicago stores, we are testing an interactive shopping experience, which features accessible product displays, including feature fixtures with manikins to showcase outfits and allow guests to touch and try out products. There's also a collaboration center in the area where guests can fit comfortably, access the registry or get personalized assistance from a team member. Digital tools on hand, such as iPads, also provide guests easy online access to product information. Another part of the store where we see an opportunity for enhanced service is our Beauty area. Based on results from our Chicago market test of the Beauty Concierge program, we rolled out the concept to an additional 200 stores in the second quarter, including stores in L.A., Washington, D.C., Baltimore and Minneapolis markets. These beauty consultants are brand-agnostic and provide guests with detailed, unbiased information on all beauty and personal care categories in the store, including product attributes and ingredient benefits, serving as a knowledgeable source and a friendly face in what can often be an intimidating category. We believe this program serves to differentiate Target in the beauty space while still meeting guests' needs for value and convenience. And of course, in the third quarter, we will continue to introduce unique merchandise throughout our assortments to deliver newness and excitement for our guests. For example, this fall, we're excited to be partnering with Phillip Lim. Phillip is a designer we've been watching for years. His aesthetic is chic yet understated, and his focus on democratizing beautiful fashion makes him a perfect fit for our brand. Beginning September 15, Target will offer a limited-edition collection of Apparel & Accessories, including an assortment of bags, shoes and scarves for men and women, at most Target stores and target.com. Prices will range from $20 to $300, with most items under $50. The entire Phillip Lim for Target collection will be presented in the women's apparel department when it debuts in our stores, allowing guests to find the entire collection in one easy-to-shop area of the store. After the first week, we plan to move items to their respective departments within the store. In late September, we will launch a new line of men's pants from Haggar called Haggar H26. Haggar is a premium brand in men's pants, and we're excited to offer a no-iron premium khaki in a classic fit, performance slack in a classic fit and original chino in a straight fit. And in Beauty, earlier this month, we expanded our hair care assortment with the exclusive launch of Toni & Guy Hair Meet Wardrobe, a premium hair care line introduced in the U.K. in 2011. Available for the first time in the U.S. at Target Stores and on target.com, Hair Meet Wardrobe includes a full range of shampoos, conditioners, hair accessories and styling tools and range in price from $5 to $40. And finally, we continue to feature exclusive partnerships with influential artists, reigning Academy of Country Music Entertainer of the Year, Luke Bryan, teamed up with Target for his latest release, Crash My Party, which was out last week. The Target-exclusive deluxe edition of the album contains 4 bonus tracks. And following last spring's success, we're thrilled that, once again, we're partnering with Justin Timberlake to release a special edition of the continuation of his third studio album, The 20/20 Experience, 2 of 2, featuring 2 exclusive bonus tracks. Guests can pre-order the album now on target.com or purchase online or in stores beginning September 30. While we continue to experience the impact of cautious consumer spending and trip consolidation, we continue to innovate across all our channels to provide our guests unbeatable value and unique experiences. We are confident we have the right plans in place for the third quarter, and we're moving quickly to ensure we stay relevant in an increasingly digital marketplace. Now John will share his insights on our second quarter financial performance and our outlook for the third quarter and the full year. John?
John Mulligan:
Thanks, Kathy. We're very pleased with our second quarter U.S. Segment financial performance, as the team generated outstanding profitability despite softer-than-expected traffic and sales.
Second quarter U.S. Segment comparable sales increased 1.2%. Sales strengthened somewhat as the quarter progressed and were further rated by this year's calendar shift, which moved some early Back-to-School sales into July. Like many other retailers, we continue to see the impact of trip consolidation among U.S. consumers, as average transaction size drove more than 100% of our comparable sales growth, reflecting increases in both item per basket and average retail per unit. Year-over-year penetration of sales in our proprietary debit and credit cards grew nearly 600 basis points in the second quarter. And for the first time in our history, debit penetration moved beyond credit. The debit card has proven to be the engine that has propelled REDcard Rewards beyond our initial stretch goals. It is the right product for a large set of guests who simply don't want another credit card in their wallet. We continue to measure the change in household spending when guests begin using one of our debit or credit cards. And we continue to see, on average, a 50% increase in household spending when guests apply for and activate one of our cards. Second quarter gross margin rate in the U.S. was 31.4%, up slightly from last year. As I outlined last quarter, this year, we've made changes to our vendor agreements regarding payments received in support of our marketing programs, which create equivalent year-over-year increases in our U.S. Segment gross margin and SG&A expense rates. These changes raised our second quarter gross margin rate by only 20 basis points -- by about 20 basis points. Excluding the benefit from vendor payments, gross margin would've declined slightly as our growth-driving REDcard Rewards and PFresh remodel programs created moderate pressure, which was partially offset by rate improvements within merchandise categories. The merchant teams also did a great job managing receipts in the face of softer-than-expected sales. At the end of the quarter, average inventory per store in the U.S. was up only 1.8% from a year ago. As expected, on the SG&A expense line, we continue to see the impact of a smaller contribution from the Credit Card portfolio, which we sold to TD Bank in March. And while we tried to do a thorough job last quarter explaining the impact of the sale and the associated change in our segment reporting, we have received feedback from some of you that we could have done a better job. You know who you are. So to provide greater clarity this quarter, let's go back a year and revisit our second quarter 2012 U.S. Credit Card Segment results, in which we earned EBIT of $143 million. This segment EBIT reflected the impact of $74 million in profit-sharing with the U.S. Retail Segment, which were described as loyalty program charges in our financial statements.
So in total, the corporation earned EBIT from the Credit Card portfolio of $217 million:
$143 million in the U.S. Credit Card Segment and $74 million in the U.S. Retail Segment. Importantly, all of this $217 million is reflected in the revised 2012 results for our new U.S. Segment.
Moving now to the second quarter 2013. We received profit-sharing of $183 million from TD, which was partially offset by approximately $65 million of our expense to service accounts on their behalf, meaning, second quarter contribution from the Credit Card portfolio was about $118 million, down about $100 million from a year ago.
Two other things are important to remember:
first, not all of the year-over-year decline in credit contribution were driven by the sale to TD, as the portfolio is smaller than a year ago and we're annualizing a $30 million reserve release in the second quarter 2012. Second, outside the U.S. Segment, we continue to offset some of the impact of profit-sharing, as we have deployed proceeds from the sale to reduce our net debt position and repurchase shares.
With that as context, we can turn to our second quarter U.S. segment SG&A expense rate of 20.6%, which was up from 20.2% in last year's revised U.S. segment. More than 100% of this increase, or about 0.6 percentage points, was driven by the decline and the contribution from the Credit Card portfolio. In addition, we continue to experience expense pressure from this year's incremental investments in technology and distribution in support of our multi-channel efforts. And finally, the change in vendor payments increased our SG&A expense rate by about 20 basis points. Offsetting these multiple pressures, we benefited from favorable leverage of compensation expenses, including incentive compensation and store payroll. And we continue to benefit from our company-wide expense optimization efforts, which are identifying opportunities to increase productivity throughout the organization. Altogether, our second quarter U.S. segment EBITDA and EBIT margin rates were down only slightly from last year's revised U.S. results. However, without the headwind from the Credit Card portfolio, those rates would have increased slightly. These results are outstanding and notably better than we could have expected in a quarter in which sales fell well short of our expected range. In our Canadian segment, sales accelerated from the first quarter as we continue to open stores at a robust pace. However, we've seen a slower-than-expected ramp up in sales following the grand opening rush, particularly in our frequency categories. Second quarter REDcard penetration in Canada was 2.3%, and consistent with our U.S. segment, debit penetration was slightly ahead of credit. As we've seen in the U.S. since the launch of the program, we expect REDcard penetration to continue to grow in Canada, driving incremental sales across all categories. The Canadian segment earned second quarter gross margin of $87 million, or 31.6%, reflecting a very favorable mix of sales in the home and apparel categories, offset by the impact of some inventory clearance. Second quarter SG&A expenses were $207 million, reflecting both ongoing operating expenses combined with meaningful start-up expenses as we prepare to open new stores. Altogether, second quarter dilution attributable to the Canadian segment, including depreciation, amortization and interest expense recorded outside the segment, was $0.21 compared with our estimate of $0.16 going into the quarter. Even in a year where we are making meaningful investments in distribution, technology and our Canadian market launch, we have been able to return a large amount of cash to our shareholders through dividends and share repurchase. In the second quarter, we paid dividends of $231 million and repurchased more than $900 million worth of our shares. Year-to-date, we've paid dividends of nearly $0.5 billion and repurchased shares worth nearly $1.5 billion. And we were pleased to announce in June that our Board of Directors had approved a 19% increase to our quarterly dividend from $0.36 to $0.43 per share. As a result, 2013 will mark the 42nd consecutive year in which this company has increased its annual dividend. Now let's turn to our expectations for the third quarter and full year. In the U.S. segment, we're expecting third quarter comparable sales in the range of 1% to 2%. While this outlook is somewhat ahead of our second quarter pace, it is supported so -- by our experience so far in August, and it reflects the benefit of this year's calendar shift, which moves the Halloween holiday into October from last year's fiscal November. We expect a small decline in the gross margin rate compared with last year, reflecting the impact of our growth initiatives, partially offset by the benefit of the vendor payment shift. We expect our third quarter SG&A expense rate will be approximately 21.4%, reflecting about 60 basis points of pressure from a lower credit portfolio contribution and continued pressure from our multi-channel investments and the shift in vendor payments, partially offset by the ongoing benefit of our expense optimization efforts. Altogether, these expectations deliver a third quarter EBITDA margin rate about a full percentage point below last year's third quarter revised U.S. segment EBITDA margin rate. In Canada, the team continues to refine operations in the stores already opened, ensuring that inventory and expenses match the current pace of sales in each individual store. It's important to note that we're still very early into our market launch. And as Gregg mentioned, we're deploying multiple tactics to drive sales in our frequency categories over time. However, given that we had initially positioned our expense structure, fulfillment network and inventory to support potential upside to our initial sales forecasts, we are incurring markdowns and higher-than-normal operating expense rates as we adjust to the current pace of sales. This has raised our dilution expectations for the segment through the end of the year. Specifically, for the third quarter, we expect the Canadian segment will drive $0.22 of dilution to our consolidated earnings per share. In total, we expect third quarter adjusted EPS of $0.80 to $0.90 and GAAP EPS of $0.55 to $0.65, reflecting Canada dilution along with $0.03 of expense from the unwind of the beneficial interest asset resulting from our credit card portfolio. For the full year, we have become incrementally more cautious in our U.S. sales outlook given our own recent results and those of our competitors. We now expect a full year comparable sales increase of about 1%, down from our prior outlook from an -- for an increase of 2% to 2.5%. We believe planning for this pace is appropriate and will help to mitigate downside risk of taking a more aggressive inventory position. As always, Kathy's team remains prepared to chase business if the U.S. environment strengthens unexpectedly. Even with our more tempered sales expectation, we believe full year adjusted EPS will remain in the $4.70 to $4.90 range we provided previously, although our expectation has moved to the low end of that range. We expect full year GAAP EPS will be approximately $0.95 lower than adjusted EPS, reflecting $0.82 of dilution from the Canadian segment, combined with a net $0.13 of dilution from the Credit Card portfolio sale and associated debt repurchase. Beyond this year, we expect the year-over-year EPS performance in the Canadian segment to improve meaningfully in 2014. While Canadian segment sales are starting from a different base than we expected, we have ample experience with U.S. market launches to give us confidence that we can drive stronger sales increases in the next several years and ultimately reach our longer-term sales and profit goals. As we said many times, our experience in opening Target stores for more than 50 years has shown that we're much more accurate when estimating fifth year sales than first year sales. We're still very confident in our Canadian strategy, stores and team and continue to believe the segment will generate $0.80 or more of EPS in 2017. And finally, beginning next year, we expect to see a meaningful increase in cash available for dividends and share repurchase. Our U.S. operations continue to generate very strong cash flow. In addition, we expect capital expenditures in Canada to fall more than $1 billion in 2014, while U.S. capital expenditures are expected to stay essentially flat. The resulting increase in free cash flow will allow us to continue growing the dividend at our current 20% annual rate and meaningfully grow share repurchase from the current pace while maintaining our goal to preserve our current strong investment-grade credit ratings. That concludes today's prepared remarks. Now Gregg, Kathy and I will be happy to respond to your questions.
Operator:
[Operator Instructions] And our first question comes from the line of Sean Naughton with Piper Jaffray.
Sean Naughton:
I guess just first question on the comp. John, I think you mentioned that it did get steadily better throughout the quarter. Any additional color you could give us there? And then I guess on -- were there any regional differences that you could potentially isolate in terms of where some of the transaction weakness was in the quarter?
John Mulligan:
I think on the -- sequentially -- yes. I mean, it improved month-to-month within the quarter. None of the quarters were negative, which, compared to first quarter, was significant progress. July was notably the strongest, but a portion of that certainly was attributable to that back-to-school week moving in from August last year. So we did see it strengthening, but I wouldn't want to overplay that. And certainly, a portion of it is attributable to the calendar. Geography-wise, we have not seen anything meaningfully different in aggregate across the quarter. In any one week or day, there's differences depending on when back-to-school starts in various portions of the country, but nothing meaningful across the country.
Sean Naughton:
Okay, got it. And then I guess you talked about some lower advertised prices in circular. Is this really just in Canada? Or is it also in the U.S.? And is that some of the gross margin pressure that you're thinking about in the second half as you've done a very nice job in terms of rate improvements in between categories over the last, call it, 4, 5 quarters here?
Gregg Steinhafel:
Well, I would say -- this is Gregg. In the U.S., we continue to offer hot pricing. There isn't going to be a meaningful change in our strategy because day in and day out, we have unbeatable prices. When you take a look at our -- the fact that our prices are competitive, the price-match policy both online and in-store and our REDcard's performance day in and day out, we have a very strong value proposition. And our circular pricing is even more aggressive than that, and we take market-leading positions. In Canada, we know that we have an opportunity to break those shopping habits, and we've got a focus on driving need-based trips. So there in particular, we will sharpen up our pricing and make sure that we are taking more of a market leader position. Our REDcard penetration is still very, very small there, and we expect that to grow over time. But it's more in Canada that we're going to make sure that our prices get more noticed than they have been up to this point. Part of that was a conscious plan on our part to make sure that we really won in home and apparel, and we feel real good about where we are in those 2 businesses today. So we're proud of that fact. Now we have to just turn on the gas a little bit on the other side of the equation to make sure that we're getting the Canadian guests to understand what great values we offer on frequency categories and break some of those well-established habits.
Sean Naughton:
Okay. And then just real quick, on the dilution in Canada, obviously, up quite a bit here in 2013 from the initial expectation. Any way or ability to paint us a picture? I know you still remain confident on that 5-year outlook on the progression towards that $0.80 in 2017.
John Mulligan:
So I'm not entirely clear where you're going. Is it that, why are we confident about the $0.80, or what will we see happen here as we go forward, Sean?
Sean Naughton:
Yes. So I guess the question is, is there an ability to say that the Canadian business will be -- you believe the Canadian business may be accretive in 2014?
John Mulligan:
So in 2014, I think it's very early here. We've given you our best view. I think when you step back, we've been operating 60-some stores for, on average, about 2.5 months. And so we've given you our best information here for 2013. And clearly, sales are a little bit short of where we
[Audio Gap] so we need to work through some of the inventory and optimizing the business and optimizing our expense structure. I think as we look forward, getting the other 56 stores open, getting through a holiday, we'll certainly provide a lot more information about where we expect to be. But in 2014, I think we expect to see meaningful improvement in the profitability of Canada. We'll cycle past all the start-up expenses, we'll have our inventories more in line with sales patterns that we now have some information on. Our expense structure will be optimized to the sales level, and we'll start to grow sales. So I think we'll see meaningful improvement in 2014, but I would say, probably from this perspective today, unlikely that we'll see profitability on the full year. And we'll be back to provide a little bit more information on what that looks like and the cadence throughout the quarters, again, as we get a little bit more information this year, get the stores open, get new markets and get through a holiday season, most importantly.
Operator:
Your next question comes from the line of Greg Melich with ISI Group.
Gregory Melich:
I wanted to follow up on Canada and touch on the U.S. Just to make sure I got that right or maybe ask it a different way, John, if you look at the incremental Canadian dilution this year, how much of it is related to those items of clearance? How much of it would be related to, if you will, start-up costs or advertising? And how much of it do you think is just a different margin structure in the business to drive that frequency in trips?
John Mulligan:
Yes. I think parsing that all out is difficult. I would say, the second one, incremental marketing and advertising, is not material to the total move from where we were to where we are today. I think the biggest driver of the change in profitability are -- dilution this year comes from we had a set of sales expectations. We -- as we entered in the market. And we also, given all of the excitement that we saw building over 2 years, we protected on the upside from an expense standpoint and from an inventory standpoint, and then sales have been somewhat disappointing. And so we need to work through those inventories. There's some clearance activity, there were some excess inventory this quarter as well, that we worked through, and we need to rightsize the entire expense structure for what's -- for the sales numbers that are currently -- that we're currently operating at. So I think that's the vast majority of it. I don't think we see -- I know we don't see going forward a change in the overall -- our view of what the margin rates were going to be. EBITDA or EBIT rates were going to be in Canada over the long term. We feel very good about gross margin. And frankly, we expect gross margin will deteriorate a little bit as we begin to drive these frequency categories. You don't see that in this quarter's results because there was a fair bit of clearance and excess inventory that we moved through, but we expect margin rates will come down as we grow sales in those frequency categories. But net-net, that will be good for the business and start to apply leverage against the fixed expenses that we've built for the business.
Gregory Melich:
Okay, great. And then second, turning to the U.S., Kathy was helpful to go through all the initiatives you have and it seems like the issue that is bigger than anything is traffic staying negative versus what you guys would have probably hoped or expected a year or 2 ago. If we think about the traffic side of it more specifically, what in the back half do you think is going to help stabilize and improve that traffic trend? Or is it just the way it is now, that -- the strip consolidation and that's the way the consumer is, and if we're going to get comp, it needs to be with more items and top line?
Kathryn Tesija:
You're right, Gregg. Traffic was our issue, and I do think that somewhat that is the way it is right now. We're seeing a lot of trip consolidation across all guests. I think the part that I'm pleased about is that when you look at our basket, we are seeing that they're buying more units from Target, as well as increase selling price, and they're trading up into higher price-point product. So that's great. I think as we move forward, the thing that we're focused on in driving traffic is really making sure that as they're consolidating and they're doing more in one store, that we're offering that compelling value. And Gregg talked a lot about all of those components, but that we make sure that, that continues to be rock solid, as well as the innovative product. And I mentioned a lot of those that we have coming like Philip and Hagar. And in our seasonal categories, we've got a lot of new stuff coming. So that's key. And then I guess the third thing that I would add is just making sure that our in-store experience remains outstanding, because we want them to be pleased when they come and continue to consolidate their trip and to do more at Target. So we have great service everyday. But in addition to that, some of the new things that we're doing with flexible fulfillment, like buy online, pick up in store, I think will be fantastic in the back half. And then we're also looking at really upping the in-store experience in key categories like beauty and the tests that I described in baby. So it's a combination of those 3 things.
Operator:
Your next question comes from the line of Matt Nemer with Wells Fargo Securities.
Matt Nemer:
Just a quick follow-up on Canada and then a couple on the U.S. business as well. Could you just talk to the inventory overhang in Canada, the clearance that you spoke to? Is that primarily also on frequency items? Or is that more a discretionary product?
Gregg Steinhafel:
The inventory overhang is a function of the shortfall, primarily in some of the seasonal categories. So think of -- even though Apparel and Home was strong, the variability by store and the fact that some of our seasonal categories, like lawn and patio, didn't perform at the level that we were expecting. So it was not in the basic categories or the nondiscretionary, it's primarily in a subset of the discretionary categories. But it's one of those things where it's more obvious because it's such a large number of stores, but it's the same kind of fine-tuning that we go through every time we open a new store here in the United States and they have experienced for years and years. There is always a tremendous amount of fine tuning and getting the right match of sales volatility, variability, assortment and aligning that with inventory. What we're seeing in Canada is just -- there's such a big critical mass that it stands out and is far more obvious, but it's no different than what we've experienced here.
Matt Nemer:
Okay, great. And then in terms of the average transaction size, could you just elaborate on which categories are benefiting from the larger basket and the trade up that you alluded to?
Kathryn Tesija:
Yes. I think that we're seeing larger basket in many different areas they're shopping. As I said, doing more in 1 store, so shopping around the store. In terms of the selling price, we're seeing strength in trading up to higher price points in back-to-school. We're seeing strength, for example, in home with Threshold, where they're buying that better product versus opening price point products. And then we're also seeing some softer sales in our 1 spot at the front of the store, which is very Seasonal and Impulsive product. So that combination, I think, is driving that selling price.
Matt Nemer:
Okay, great. And then just lastly, if we look at some of the omni-channel and multi-channel initiatives that are launching in the back half, is there any way to quantify the potential impact or, potentially, in your survey, where you could talk to how much demand there is for these products, specifically on click and collect or buy online, pick up in store? I know that's half of the volume in some cases for some of your competitors online businesses. Could you just talk to how big you think that could be for you in the back half?
Kathryn Tesija:
Well, we don't have a number that we can share on that. We have, as you know, been testing it with team members. I think the key for us is just the convenience for guests to be able to buy it online. But then, they want to pick it up in-store. Sometimes, they don't want it delivered and sitting on their doorstep, but oftentimes they want to be able to get other things in the store, either that go along with that core item or just the rest of their list. So we think it will be very interesting to our guests. It certainly has been with our team members, but we haven't quantified the sales number yet.
Gregg Steinhafel:
Yes. I would just say, this is a -- we're in a learning environment right now. We'll be able to give you a lot more specifics after we get through the holiday season. And for us to try and quantify at this stage would be -- it would be a shot in the dark. So we really don't want to speculate how our guests are going to use that and -- but we'll be back at the end of the holiday, and we'll give you a lot more color around the adoption, the acceptance rates by our guests.
Operator:
And your next question comes from the line of Deborah Weinswig with Citi.
Deborah Weinswig:
Speaking about the spending in the first half of the year versus the back half of the year on marketing, in light of the competitive environment, can you just help us think about how that spending might take place in the back half versus the first half of the year?
Gregg Steinhafel:
There's not really a meaningful difference in terms of the rate of spend first half, second half. We didn't overspend or underspend the first half to shift dollars to the second half. We've always felt that the allocation of resources by quarter by half has been pretty appropriate, and our spend is going to be similar in those kinds of percentages. What we have seen is -- we've ramped up our spend in the digital channel. It's a less expensive channel. It gives us a different guest and broader reach. And we've become far more efficient in the use of our marketing dollars. So I think we're getting the same or more "bang for our buck" for essentially the same investments that we've made in the past.
Deborah Weinswig:
Okay. And then with regards to Canada, can you elaborate a little bit on the announcement this week with regards to the Metro partnership in Canada?
Gregg Steinhafel:
Yes. We're excited to have Metro as a partner to run our pharmacies in the Québecian province in the eastern part of Canada. We think they are a great partner. They run a terrific business, and we're thrilled to have them as our partner.
Deborah Weinswig:
Okay. And then lastly, it seems like you have a unique opportunity with the REDcard to -- your communications I think between Canada and U.S., you have almost 20% of your customer base? Can you talk about, through email and text, what you're doing in terms of personalization?
Kathryn Tesija:
We're doing a lot with both email and text and -- but I would tell you, Deb, that we're in the beginning of that journey. We think there's a lot more that we can do. But we're doing things with personalization in terms of seasonal and timing, but also product categories that resonate with our guests. And we're seeing great results. We've upped, particularly e-mail, a lot this year, and it's really paying off. And so we're on a journey, and we think that there's a lot of headroom there, and we will go after that in a big way.
Operator:
Your next question comes from the line of Jason DeRise with UBS.
Jason DeRise:
Here at UBS. I wanted to ask about Canada's gross margin. Again, I know there's been a few questions already, but if you did better on the -- more of those discretionary items, and I guess there were some shortfalls store-by-store in terms of certain seasonal items coming through, I mean, is this -- how is this, I guess, affecting maybe some of your plans? Are you adding more planograms? Is that going to add to some of the SG&A costs to service all these stores if it's just different demand for different products and just reflecting how diverse Canada actually is? Or is that just weather effects? And what have you learned from that process?
Kathryn Tesija:
I don't think that we'll be adding a lot of planogram versions. I think we're still tweaking what's on those planograms, but I -- we understand that, and we've got many different versions throughout Canada for all of their differences across geography and their guests. But I think what Gregg was talking about was, number one, getting the buy right by store in all of those categories, and then some of the seasonal categories were softer. So making sure that we get that buy right going forward, that has less to do with the planogram itself. And then in addition to that, as we're driving more trips with our frequency categories, that's the side that's been weaker, we think that traffic will also help sales throughout the store, because the guest clearly likes our differentiated merchandise on the apparel and home side. So it's kind of a combination, but it's more about the buy than it is about planograms.
John Mulligan:
The other thing I'd add, Jason, is if you step back to where we were 3 months ago, the gross margin rate was a little bit above 38%. And the 2 things we said at that time, I think, are still appropriate. One, it's going to be noisy here early by quarter because it's just naturally that way as we're opening up stores. But two, don't expect us to operate at that higher level. While the mix was very favorable, we hadn't gone through any seasonal clearance. And so seasonal clearances is going to naturally bring that rate down. This quarter, a little bit more than we would have expected. But there again, I said we're working through some excess inventory given our sales levels. So we expect through time that the gross margin rate will normalize at a reasonable level, that ultimately will allow us to deliver EBITDA margin rates at, say, 12% in Canada like we've talked about all along.
Jason DeRise:
Okay. And then I guess I wanted to ask on the U.S. side about the efforts to increase service, omni-channel, flexible fulfillment and all of those things. Obviously, that cost a lot to implement. And the way I see it, and you can correct me if I'm wrong, you're very centralized already. So should we think about this is just necessary to keep sales growing and maybe it comes in at a lower margin? Or are there areas that you can offset that impact?
Gregg Steinhafel:
I would think of it as this way. In our business at any given point in time, there are investments that we have to make to continue to get better at what we do, whether it's a service or supply chain or technology investment or investments in the guest experience. And so this is -- I mean, we're calling attention to this, but these are investments that we're going to make in the business because we want to provide a great experience, which means our expense optimization efforts, as they have in the past, have to more than offset these kinds of investments. So we look at it all in holistically, and we're saying, "Hey, we've got to get leaner and meaner in certain parts of the organization and then get -- become more efficient." And we demonstrated that last quarter. We were very, very rock solid in our expense and our productivity, and that affords us the ability to -- and the capacity to get more aggressive and do some of these kinds of things and invest in transforming the business to the future.
Jason DeRise:
I guess -- could you maybe elaborate on that? I know that you talked a bit about the -- that there's the compensation accrual and that, that helped, then you also mentioned that you're better on payrolls. I mean, is that something where you think there's more room to go in terms of the in-store labor? Or is that something where you really wouldn't want to push too hard on because of the potential implications on revenue? And if that's the case, where else could the savings be if it's not the store?
John Mulligan:
Jason, we said at the beginning of the year, the investments in multi-channel and everything we were doing would be $0.20 to $0.25 of incremental dilution or incremental expense in our business. And we said at that time that through our expense optimization efforts, we expected to offset virtually all of that in the year. We do that in a variety of ways. The stores have continuously, over a long period of years, looked for ways to increase productivity faster than wage rate and faster than sales, so lowering our expense rate. And we think there's opportunities to continue to apply technology to improve productivity in our stores. But what Gregg was talking about, our expense optimization efforts are across the entire organization. Headquarters, distribution, supply chain, everywhere we operate, we are looking for ways to take expense out so that we can afford to invest in the business.
Gregg Steinhafel:
Great. Well that concludes Target's Second Quarter 2013 Earnings Conference Call. Thank you all for your participation.
Operator:
Thank you. This does conclude today's conference call. You may now disconnect.
Operator:
Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation's First Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, May 22, 2013. I would now like to turn the conference over to Mr. Gregg Steinhafel, Chairman, President and Chief Executive Officer. Please go ahead, sir.
Gregg Steinhafel:
Good morning, and welcome to our 2013 First Quarter Earnings Conference Call. On the line with me today are Kathy Tesija, Executive Vice President of Merchandising; and John Mulligan, Executive Vice President and Chief Financial Officer.
This morning, I'll provide a high-level summary of our first quarter results and strategic priorities for the rest of the year. Then Kathy will discuss category results, guest insights and upcoming initiatives. And finally, John will provide more detail on our financial performance, along with our outlook for second quarter and the full year. Following John's remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following this conference call, John Hulbert and John Mulligan will be available throughout the day to answer any follow-up questions you may have. Also as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. And finally, in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure. A reconciliation to our GAAP result is included in this morning's press release posted on our Investor Relations website. Our first quarter earnings fell short of our expectations, as we faced a choppy and challenging environment caused by unfavorable weather and this year's payroll tax increase. Our U.S. business generated softer-than-expected sales and traffic, particularly in our Seasonal categories as we experienced one of the coldest spring seasons on record, following record warmth a year ago. While we are not satisfied with this quarter's performance, we remain highly confident in our strategy and our team's ability to deliver strong results going forward, across a broad range of conditions. In the first quarter, our U.S. segment generated adjusted earnings per share of $1.05, down 5% from last year's outstanding performance. Our first quarter GAAP earnings per share were $0.77, $0.28 lower than adjusted EPS, driven primarily by $0.24 of dilution attributable to our Canadian segment. As we mentioned in our fourth quarter call, this year, there are several notable changes affecting our financial reporting, which John will cover in detail in a few minutes. In the quarter, comparable-store sales declined 0.6% from last year's 5.3% increase. First quarter comparable transactions were down 1.9%, following last year's increase of 2%, keeping us essentially flat on a 2-year basis. In much of the U.S., traffic in our Seasonal categories was unexpectedly soft, as guests held off purchasing spring items in the face of cold and wet weather. Our merchandising teams did a great job reacting to the pace of sales in these categories, retiming receipts and adjusting them downward, so we are still in a healthy inventory position today. Despite the weather impact on Seasonal categories, sales and traffic in our digital channels continue to grow at a robust pace. Overall, first quarter digital sales grew in the high teens and increased more than 20%, net of our most seasonally-sensitive categories. Target's mobile traffic and sales continue to grow at a triple digit pace, with mobile traffic representing more than 30% of our digital traffic in the first quarter. We're pleased with these results as mobile is rapidly becoming the key platform for digital commerce across all of Retail, and we know that Target guests have a particular affinity for mobile engagement. After 2 years of preparation, in March we opened our first 24 Canadian stores in the greater Toronto area, and we're very pleased with the reception we received from our new Canadian guests. We experienced an unexpectedly strong surge in sales as guests were eager to see their newly-opened Target store. The mix of sales in Home and Apparel was even higher than expected, as guests shopped our assortment of stylish own brands and national brands, responding to the outstanding value we provide on both. Now that we are beyond the grand opening surge in this first cycle of stores, we're encouraging our new Canadian guests to make Target a preferred destination for categories throughout the store, including Food, Health, Beauty and household essentials, as these categories play a key role in driving trip frequency over time. As it is already in the U.S., REDcard Rewards will be a key differentiator for Target in Canada, and we're encouraged that REDcard penetration of sales in our Canadian segment was ahead of plan in the first quarter. 2 weeks ago, we opened over second wave of 24 Canadian stores in British Columbia, Alberta and Manitoba. And we're very pleased with the initial guest response in these markets and the ability of our teams and systems to accommodate the increasing volume of traffic and sales. We plan to open another 20 stores in Canada later in the quarter, on the way to operating 124 Canadian stores by the end of the year. This means we expect to open more Target stores in our first year in Canada than we opened in our first 10 years in the United States, an incredible accomplishment that has required unprecedented effort by teams throughout the company. In the U.S., we opened 6 new stores in the first quarter, including an additional CityTarget location in Los Angeles. We now operate 6 CityTarget locations in 4 cities, and we continue to be pleased with the results in these stores. Sales have essentially met our expectations, and the mix of Home and Apparel has been better-than-expected. Similar to our Canadian stores, we are focused on our CityTarget stores on driving sales and visits in our frequency and commodity categories, changing guest habits and inspiring them to visit us more often for both wants and needs. In the first quarter, we also closed the sale of our U.S. Credit Card receivable portfolio to TD Bank Group and began deploying proceeds to reduce debt and repurchase shares. We're very pleased to have reached the right agreement with the right partner, in a transaction that removes these more volatile assets from our balance sheet. The portfolio continues to perform well, generating meaningful income for Target through our profit-sharing arrangement with TD. As we look ahead to the second quarter and the remainder of the year, we remain cautiously optimistic about both the macroeconomic environment and consumer behavior. Both of these business drivers continue to reflect slow, uneven growth and ongoing crosscurrents of positive and negative indicators, just as they have for the past few years. For example, while we're pleased that the housing market has stabilized and jobless claims have been declining, we're mindful that household formation and job growth remain particularly weak among younger demographic groups. In addition, guests continue to face the headwinds of this year's payroll tax increase and a meaningful lack of income growth. With these considerations in mind, we remain focused on strategies that position our business for profitable growth, both today and in the long term. We continue to invest in initiatives that integrate multiple channels like our recent beta launch of Cartwheel, the result of our collaboration with Facebook, along with tests of same-day delivery with Google and eBay. And we're testing opportunities within our own supply chain that will leverage our existing store and distribution assets to provide additional services and capabilities our guests value most. We're investing to drive adoption of our 5% REDcard Rewards and Pharmacy Rewards loyalty programs, which have proven to be unique and powerful differentiators, and sales drivers for Target. Both of these programs offer guests the opportunity for even greater savings, leading them to shop more merchandise categories more often. We're investing in efforts to better serve all of our guests, driving traffic and sales by segmenting our stores and assortments to match local tastes and preferences. And we continue to offer digital innovations that create a link between our stores and social media. We're continuing to pursue new and differentiated merchandise in all of our assortments, including our recently-announced partnership with Warner Bros. and DC Entertainment to feature Justice League merchandise across multiple categories. Kathy will provide more detail on programs like these, that create a sense of discovery for our guests while deepening their loyalty for Target. Beyond the value we provide on exclusive well-designed merchandise, we've continued to invest in Everyday Low Prices, which we reduce even further in our weekly ad. In addition, we stand behind our prices with policy to match local competitor print ads, as well as our largest online competitors. And for REDcard Rewards and Pharmacy Rewards, our most loyal guests have the opportunity to save even more. Throughout the company, we take a disciplined approach to the deployment of cash, combining strong financial rigor and capital investment decisions, with a focus on returning cash to our shareholders through dividends and share repurchase. And of course, none of our efforts would be possible without the outstanding work of our more than 360,000 team members who greet and serve our guests every day, carefully manage inventory and expenses in this challenging environment, and proudly represent our brand in the communities where they live. In spite of first quarter tax increases, unseasonably cold weather and challenging prior year comparisons, our underlying business continues to be stable and healthy. Our team is focused on driving outstanding results across categories, channels, regions and guest segments every day, even while we continue to position our business for success, with investments in new stores and formats, and more flexible ways of serving our guests. We believe that our outstanding team, aligned in support of a well-defined strategy, will drive strong performance both this year and over time. Before I turn the call over to Kathy, I want to take a moment to thank Terry Scully, who retired from his role as President of Target's Financial and Retail Services team in April. Terry has been a valuable member of the Target team for nearly 35 years and under his leadership, the Financial and Retail Services team has played a key role in strengthening guest loyalty and delivering substantial profitable growth for Target. Over the last few years, Terry and his team have worked tirelessly to find the right partner to purchase our Credit Card receivables portfolio, culminating in this quarter's sale. And finally, I want to pause to express our condolences to the residents of Moore, Oklahoma, including Target team members, guests and their families who were affected by this week's devastating tornado. We have been working with emergency responders, community organizations and local schools to evaluate immediate needs and ways that Target can help. And yesterday, we announced that Target is donating $250,000 in support of relief efforts; $200,000 of cash and in-kind donations to emergency responders and community organizations, including the Red Cross and the Salvation Army; and $50,000 to support rebuilding efforts at the 2 elementary schools that were badly damaged by the tornado. Now Kathy will provide more detail on first quarter results and outline initiatives for the second quarter and beyond. Kathy?
Kathryn Tesija:
Thanks, Gregg. Those of you who listen to our conference calls over time know that often, when we're asked about weather impacts, we point out that on average, the weather is average. This has certainly proven true in the last 2 spring seasons. Last year, it was an unusually early and warm spring across much of the country; we saw very strong sales in our Seasonal and weather-sensitive categories.
This year, in the face of a cold and late spring, sales were quite soft in those same categories. And while we are committed to delivering strong results in all types of environments, we believe it's important to understand the impact of this year's weather on our first quarter sales results. Specifically, first quarter comparable-store sales in weather-dependent categories like Seasonal Apparel, lawn, patio and Sporting Goods, lagged the rest of our assortments by 6 to 7 percentage points. This sales gap was even wider in areas of the country which experienced below-average temperatures, and was much smaller in areas that experienced much more normal spring temperatures like the Western U.S. Looking more broadly at our category results, first quarter comparable-store sales continue to be strongest in less discretionary categories such as Food, Health, Beauty and household essentials, all of which experienced low single-digit increases. Our Home and Apparel categories were both down in the low single-digits, and Hardlines saw a mid single-digit decline in comps. Within Hardlines, Electronics continues to see softness in video games, along with televisions, particularly in the -- early in the quarter, as last year's 53rd accounting week moved Super Bowl-related sales out of the quarter. As Gregg mentioned, our guests continue to shop cautiously, planning their spending and sticking to shopping lists, as they continue to feel the burden of economic pressures. Recent guest surveys indicate that 3/4 of our guests are aware of this year's payroll tax increase. And among those, the majority have noticed the impact of the tax increase on their paychecks and indicate that it's affected their spending. Basket data confirms that needs-based trips have been increasing, while wants-based trips, focused on discretionary categories, have been declining. And notably, recent data from the Conference Board indicates that while sentiment among consumers regarding their current situation has been improving since late last year, consumer sentiment regarding the future has been declining in recent months. To drive traffic and sales in this environment, we know it's more important than ever to provide value to our guests on a high-quality, differentiated assortment delivered through a convenient shopping experience. In the digital space, we continue to apply a test-and-learn approach when rolling out applications and capabilities, so we can determine what works best for our guests. We're pleased that our digital traffic grew faster than industry benchmarks again this quarter. We continue to explore ways to integrate digital technologies with social media and our stores to provide a unique shopping experience for our guests. This quarter's beta launch of Cartwheel, which we developed in collaboration with Facebook, is a perfect example. This first-of-a-kind experience gives guests a fun way to save on hundreds of items throughout our stores. Upon authenticating this application through their Facebook profile, guests receive 10 spots to fill with deals of their choice from among hundreds of items throughout our store. Depending on the product, the deals feature a range of discounts and expiration dates, and guests can switch between offers at any time. Deals are redeemed at checkout in our stores, either by scanning a single barcode on a mobile device or a printout from our desktop computer. Guests can share Cartwheel with their friends on Facebook to show off their latest finds and see what their friends are buying. And the more guests interact with Cartwheel by choosing and redeeming deals and sharing those deals with friends, the more offers they unlock for themselves. We launched Cartwheel in beta, and we're encouraging guests to provide feedback so we can make ongoing realtime enhancements to the Cartwheel experience. Initial sign-ups for Cartwheel have exceeded expectations. Thousands of guests signed up in the first week, and we saw a meaningful increase when we added a link to Cartwheel on target.com. More than 10% of guests who have signed up already have redeemed Cartwheel offers in one of our stores. Also this quarter, we launched a Beauty Box test to understand our guests' appetite to pay for samples of beauty product. We tested this offer on Target's Facebook Style page and sold-through our inventory within a week. In addition, the offer generated favorable media coverage and positive feedback in social media. Based on these results, we will continue to explore ways to surprise and delight guests with box-based offers that support our Expect More. Pay Less. brand promise. In March, we were very pleased to announce our agreement to acquire CHEFS Catalog and assets of Cooking.com in 2 separate transactions. These e-commerce acquisitions are aimed at expanding Target's presence in the growing cooking and kitchenware market. We've combined the assets of Cooking.com with CHEFS Catalog to create a new wholly-owned subsidiary, which will continue to operate the 2 brands under their current names. We believe these transactions present a strategic growth opportunity to serve guests who are increasingly looking online for cooking solutions to make their lives easier, from utensils and cooking -- cookware, to recipes. These strategic transactions provide us a great way to address this growing opportunity and provide expanded online options for our guests. In select markets, we're continuing to test same-day delivery in partnership with Google and eBay. Our focus in these tests is to understand the level of guest engagement and its fulfillment opportunity. These projects, which are still in the test phase, continue to provide valuable information on the store backroom capabilities and processes needed to support this offering. And as we mentioned last quarter, this year, we're launching our own test of fulfillment -- flexible fulfillment in the Minneapolis market. This month, we launched a test in which team members are given the opportunity to order online and pick up in-store. We will use our team members' feedback to improve the process and experience before the pilot becomes guest-facing later in the year. 2 other team member pilots, pay in store to pick up at another store, and pay online and ship from store, are planned for late in the year. In both our stores and online, we feature great designers and brands and continue to roll out new unique merchandise that creates a sense of discovery for our guests. Our goal is to show guests that design means more than fashion, and that great design doesn't have to mean high prices. In Home, we continue to be pleased with results from our partnership with Nate Berkus. The collection includes a growing list of products in a wide range of categories, including bedding, bath, accessories, lighting, rugs and stationery. We also continue to see great results from the rollout of the Threshold brand, which is replacing Target Home, our largest owned brand. We debuted Threshold last fall, and guests continue to respond to this fully redesigned, high-quality collection that's inspiring them to update their homes. To celebrate this new brand, earlier this month, Target constructed a life-sized dollhouse in New York's iconic Grand Central Terminal, where guests could explore a 2-story, 7-room dollhouse, decorated with more than 3,500 pieces from the Threshold collection. Select furnishings were tagged with QR codes to be shoppable right from the dollhouse. In our stationery category, we're excited about our collaboration with Todd Oldham on the Kid Made Modern collection, which offers creative activity kits and supplies to inspire kids through art. The collection has a clean, simple and fresh design that's gender-neutral and age-appropriate to inspire all children and parents. We launched this collection of creative design tools late last year and set a new collection this spring. Following our successful first quarter partnership with Prabal Gurung and Kate Young, we recently announced our latest design collaboration with Lauren Bush Lauren and the rollout of the Feed USA + Target collection. In late June, we'll feature a lifestyle collection of stylish products in Home, Sporting Goods, stationery, Apparel & Accessories. The collection, which reflects a modern Americana aesthetic, while supporting an important cause, includes more than 50 products across a range of price points, with most items less than $25. Each item in the collection has an associated number of meals listed with it and with each sale, Target will donate the monetary equivalent of that number of meals to Feeding America, the nation's leading domestic hunger relief charity and a partner of Target since 2001. During the time that the products will be available, we expect to provide more than 10 million meals for families across the U.S. In Canada, we've been very pleased with results from our partnership with Roots Outfitters, an iconic Canadian brand that offers quality craftsmanship and comfortable styling on a line of apparel for men, women and kids. And we're very excited that we recently announced the fall partnership with Beaver Canoe, a member of the Roots Canada family, to offer an exclusive collection of cabin-chic apparel and home items in our Canadian stores this fall. Entertainment had a great first quarter, including the release of our exclusive deluxe version of The 20/20 Experience from Justin Timberlake. The strength of the guest response put this release among the top 3 at Target in the last 10 years. We followed this success with releases of exclusive albums from The Band Perry and Michael Bublé in April. In Electronics, we've partnered with WIRED Magazine to offer a custom, curated assortment of consumer electronics and gadgets tested by their editors, featuring their expert tips on usage and key features. And in April, Target became the exclusive mass retailer to debut the Beats by Dr. Dre neon Mixr Headphones, available in eye-catching green, orange, pink, yellow and blue. We've long known the value we can create through segmentation of our stores and assortments based on store location and demographics. We continue to develop tools and processes that allow us to further localize assortments and experiences to match the specific markets where our stores are located. We are focused on providing a deeper presence of locally relevant products and brands across the store, including categories like Food, Beauty, Home and entertainment. And we continue to invest in unique multi-channel experiences like Cartwheel, that allow guests to choose their own offers and further integrate their Target experience into their social networks. Now John will share his insights on our first quarter financial performance and our outlook for the second quarter and full year. John?
John Mulligan:
Thanks, Kathy. As Gregg mentioned, we're disappointed with our first quarter financial performance. Sales in the U.S. were softer than expected, even relative to updated guidance we provided in April, causing our reported earnings per share to fall short of our updated guidance as well.
Adjusted earnings per share, which measures the results of our U.S. operations, were $1.05, representing a 5% decrease from last year. First quarter GAAP earnings per share were $0.77, reflecting losses on early retirement of debt, which reduced our EPS by $0.41, EPS dilution related to our Canadian segment of $0.24, and net accounting gains of $0.36 related to the sale of our Credit Card portfolio. Before I turn to our segment results, I want to remind you of a couple of factors that will be affecting our financial reporting this year. First, with the sale of our receivables, beginning with the first quarter, we are no longer reporting a Credit Card segment. And we now have 2 reportable segments, a new U.S. segment and a Canadian segment. In the first quarter, we began recognizing profit-sharing payments from TD, net of operating expenses, within SG&A expense in the U.S. segment. To provide context, in an April 16 8-K, we provided revised quarterly segment reporting for fiscal years 2010 through 2012, in which Credit Card revenues, net of expenses, from our former U.S. Credit Card segment were recognized within SG&A expenses in the new U.S. segment. In this year's financial reporting, revised 2012 U.S. segment results will be presented as prior year results. To provide additional context, this year's rate analysis includes a comparison to last year's performance in the historical U.S. Retail segment. For simplicity, to the extent that's possible, in my discussions today, I will focus only on this year's U.S. segment results compared with last year's revised U.S. segment results. Second, as I mentioned in our conference call -- last conference call, we've made changes to our vendor agreements regarding payments received in support of our marketing programs. As a result, in fiscal 2013, these payments will be recognized as a reduction in our cost of sales rather than a reduction to SG&A expense. This change is expected to create equivalent year-over-year increases in our U.S. segment gross margin and SG&A expense rates of 20 to 25 basis points, without affecting EBITDA and EBIT margin rates. With that as context, I'll turn to the first quarter performance in our new U.S. segment. Total sales increased 0.5% on a 0.6% decline in comparable-store sales, combined with the contribution from new stores. Among the drivers of comparable-store sales, traffic was down 1.9%, partially offset by a 1.3% increase in average ticket. Our first quarter traffic decline essentially offset a 2% increase a year ago. As we told you at the time, we believed first quarter 2012 traffic was unusually strong due to the warm weather, and that proved to be the case as full year 2012 traffic was up 0.5%. While we expect traffic will continue to be challenging given our near-term outlook for the economy and the consumer, we don't expect to continue to see traffic declines of the magnitude we saw in the first quarter. With the added pressure on household budgets from the recent payroll tax increase, the simplicity and compelling nature of our 5% REDcard Rewards discount is clearly attracting an increasing number of guests. The penetration of sales on REDcards reached 17.1% in the first quarter, up from less than 12% a year ago. While discounts from this program continue to put pressure on our gross margin rate, this investment pays back through the benefit of increased loyalty and sales. We continue to see households increase their spending more than 50% on average when they begin using a REDcard. And in Kansas City, which is a year ahead of the rest of the country, penetration is above 20%. And the rate of increase has shown no sign of slowing down. Our U.S. segment gross margin rate was 30.7% in the first quarter, up about 50 basis points from a year ago. The change in recognition of vendor payments explained about 20 basis points of this increase. The remainder of the improvement was driven by rate increases within categories, which more than offset continuing gross margin rate pressure from our sales-driving REDcard Rewards and remodel programs. Every year, Kathy's team works hard to incrementally improve gross margin rates within categories. And the year-over-year benefit from these efforts can vary meaningfully from quarter-to-quarter. In the first quarter, the magnitude of category rate improvement was stronger than normal, and we're expecting to see a more modest benefit in upcoming quarters. Our first quarter U.S. segment SG&A rate of 20.3% was about 130 basis points higher than last year's revised U.S. segment rate. The primary drivers of this variance are about 50 basis points resulting from lower earnings on the Credit Card portfolio, and about 40 basis points related to technology, including our multi-channel efforts. In addition, the change in vendor payments drove the rate higher by about 20 basis points and of course, with lower-than-expected sales, we saw less overall expense leverage than we anticipated. On this last point, it's important to note that our first quarter results reflected meaningful store productivity improvements, and the entire organization did a great job controlling expenses. As I mentioned in the last call, we're anticipating incremental expense pressure from technology investments throughout 2013. And we plan to offset that pressure through disciplined expense management across the enterprise as the year progresses.
Also, I think it's important to provide more context for the decline in our earnings from the Credit Card portfolio because the portfolio continues to experience outstanding performance. However, there are 3 separate reasons which drove lower earnings from the Credit Card portfolio in the first quarter:
First, the asset is smaller than a year ago; second, we're annualizing a $35 million reserve release in the first quarter of 2012; and finally, we began sharing portfolio profits with TD after the sale closed in March.
Notably, among these 3 reasons, profit-sharing drove less than 1/2 of the year-over-year reduction in Target's earnings from the Credit Card portfolio. And we expect all of these pressures will continue for the next several quarters. Moving down the U.S. segment P&L, we reported a first quarter EBITDA rate of 10.4%, about 80 basis points lower than last year's revised U.S. segment rate. With about 50 basis points related to our Credit Card portfolio, that means our U.S. Retail operations accounted for only a 30 basis-point decline in the EBIT rate compared with last year, which is relatively stable when one considers that sales were unexpectedly soft this year, and we were annualizing a 5.3% comp last year. In our Canadian segment, we generated $86 million in sales from 24 stores that were open, on average, a little more than 1/2 the quarter. Whenever we open a new store in the U.S., there is a rush of traffic and sales as curious guests shop it for the first time. But the rush in Canada exceeded our expectations. The first quarter gross margin rate in Canada was more than 38%, which is much stronger than our long-term expectations for a couple of reasons. First, in new stores, we experienced a strong initial mix of Home and Apparel sales, as guests tend to shop these categories on their first trip to these stores. In addition, given the short time these stores have been open, they have not yet experienced any meaningful transitions or clearance activity. So this quarter's Canadian gross margin rate didn't reflect the impact of markdowns we'd expect to see over time. The first quarter Canadian segment P&L was dominated by start-up expenses related to the 100 additional stores we're preparing to open later in the quarter. For the quarter, Canadian segment operations drove $0.24 of dilution to our consolidated earnings per share. With the sale of our Credit Card portfolio in March, we recognized a pretax accounting gain of $391 million, of which $166 million was cash received in excess of book value and $225 million was related to a beneficial interest asset. This asset effectively represents a receivable for the present value of future profit-sharing payments we expect to receive from TD on the Credit Card balances transferred at the time of the sale. Going forward, a portion of the profit-sharing payments from TD will be applied to unwind the beneficial interest assets. We expect to fully unwind it in 3 to 4 years and expect to reduce its size by about 50% in the first 12 months following the sale. Also following the portfolio sale, we began deploying proceeds to retire debt and repurchase shares. Concurrent with the sale, we repaid, at par, $1.5 billion in funding that was previously backed by the receivables. We also launched debt tender offers to repurchase another $1 billion in high coupon debt, which led to losses recorded in interest expense of $445 million in the quarter. Of course, these tender offers created a meaningful economic benefit not reflected in the accounting for these losses. During the quarter, we also paid off commercial paper that we had used to provide short-term funding following the $2 billion in debt maturities last January. Finally, there's another $500 million maturity in June, which we expect to fund with proceeds from the sale. We're pleased that with the completion of the sale, we were able to remove these more volatile assets from our balance sheet and quickly reduce a meaningful amount of debt that was funding them. Over time, we expect to apply the remainder of the proceeds from the portfolio sale to repurchase shares. In the first quarter, we invested $547 million to repurchase 8.5 million Target shares at an average price of just over $64. For the full year, we continue to expect to invest in more than $2 billion to retire shares, and we'll continue to govern the pace of execution in support of our goal to maintain our strong investment-grade credit ratings. We paid first quarter dividends of $232 million, marking the 182nd consecutive quarterly dividend we've paid since becoming a public company. We will recommend that the board approve an increase in the dividend later this year, which would make 2013 our 42nd straight year in which we increased the annual dividend. Now let's turn to our expectations for the second quarter and the year. In the U.S., we remain cautious about the near-term sales environment given the economic and consumer challenges Kathy and Gregg just mentioned earlier. Yet with the recent weather challenge behind us and an easier comparison from last year, we expect second quarter comparable-store sales will recover into the 2% to 3% range. So far in May, we have continued to see cautious buying behavior from our guests, but the pace of sale has supported our view of the quarter. In the U.S. segment, we expect the second quarter gross margin rate will be up slightly from last year, driven entirely by the change in recognition of vendor payments. We expect our second quarter SG&A expense rate will be just over 21%, nearly a full percentage point higher than last year's revised U.S. segment rate, driven primarily by a smaller benefit from Credit Card income and the change in recognition of vendor payments. This would put our second quarter EBITDA margin rate at about 10.5% and with expected leverage on D&A, an EBIT margin rate of 7.5%. In Canada, second quarter sales will ramp up meaningfully from the first quarter pace, yet start-up expenses will continue to dominate the P&L. As a result, for the quarter, we anticipate expenses from our Canadian operations, including interest expense, measured outside the segment, will create $0.16 of dilution to our earnings per share. We continue to expect Canadian dilution will come down further in the third quarter, and by the fourth quarter, we expect our Canadian operations will be slightly accretive to our consolidated earnings. Altogether, we expect second quarter adjusted EPS of $1.09 to $1.19. We expect our GAAP EPS will be $0.19 lower than adjusted EPS, in the range of $0.90 to $1, reflecting $0.16 of dilution due to Canada and $0.03 of dilution related to the unwind of the beneficial interest asset related to the receivables sale. For the year, we have an even more tempered view of sales than we did 3 months ago. Without some unexpected improvement in the economy and the consumer, our full year comparable-store sales will likely grow in the 2% to 2.5% range, somewhat below the 2.7% we outlined at the beginning of the year. This updated view of sales has also tempered our view of full year earnings per share, causing us to take our expected range for adjusted EPS down $0.15, to the $4.70 to $4.90 range. We expect full year GAAP EPS to be $0.58 lower than adjusted EPS, in the $4.12 to $4.32 range, reflecting Canadian segment dilution, losses on early debt retirement and net gains from the Credit Card portfolio sale. Longer term, we continue to feel very good about the health of our business and the steps we are taking to keep our business relevant over time. We continue to invest in our remodel program, loyalty initiatives, technology, the integration of our store and digital experience, the new CityTarget format, and our Canadian segment. Yet even with those initiatives, we continue to expect to generate far more cash than we need to invest in our business, giving us the opportunity to return billions of dollars to our shareholders through dividends and share repurchase. As a result, we continue to expect Target will deliver earnings per share of $8 or more by 2017, combined with a dividend of $3 or more that same year. That concludes today's prepared remarks. Now Gregg, Kathy and I will be happy to respond to your questions.
Operator:
[Operator Instructions] Your first question comes from the line of Peter Benedict of Robert Baird.
Peter Benedict:
Just a couple of questions. Just on the U.S. gross margin performance, can you give us a sense of maybe what that REDcard impact was in the quarter?
John Mulligan:
The rate impact of the REDcard, Peter?
Peter Benedict:
Yes, John.
John Mulligan:
Yes, the combination of that, with the store remodel program, very consistent with what we've seen over the past several quarters, somewhere between 25 to 30 basis points of impact.
Peter Benedict:
Okay, that's helpful. And then just a longer-term question, I mean, you kind of said for the year, you're now thinking 2% to 2.5%. I assume that still has a pretty modest view for comping in the fourth quarter. A, is that correct? And then secondly, just when you think out beyond, I mean, do you guys think that maybe 2% to 3% is the longer-term comp profile for the business? Or do you think it could still be north of 3%, just when you think of a more normalized environment on an annual basis?
John Mulligan:
Yes, I think your view of Q4 is right. I think, in particular, this Q4 will be particularly difficult given the 53rd week and the way the calendar shifts this year. You'll recall, we're going to lose 6 business days between Thanksgiving and Christmas this year, which will make the comp feel much more difficult than it otherwise might. I think over the longer term, we just continue to think a 3% comp is about the right place to be. If you look again at our company over 15 years or 20 years, if you net out the contribution of new store annualization, we essentially ran a, pretty consistently, a 3% comp over time through good times and tougher times. So we think in an economic environment that might just be a little bit better than today -- it doesn't have to improve drastically, but a little better than today, we think a 3% comp makes sense.
Peter Benedict:
Okay, that's helpful. And just one last housekeeping. On the Canadian D&A, what do you think the run rate is for that once you get out -- you've opened a bunch of the stores. Once you get towards the end of the year, what kind of run rates were you thinking about for Canadian D&A?
John Mulligan:
I think you'll continue to see D&A grow throughout this year as we continue to put significant assets into service, and we'll provide a little bit more color, I think, as we get later into the year and have a little bit more clarity about sales, margin and the entire P&L, we'll provide a little bit more clarity about the entire P&L for Canada.
Operator:
Your next question comes from the line of Sean Naughton of Piper Jaffray.
Sean Naughton:
In terms of just dissecting the comp in Q1, transaction trends, as you mentioned, were relatively stable on a 2-year basis and did improve from Q4. But the units per transaction were down 50 basis points, and I think that's the first time since '09. Just wondering what would explain that decline given the increase in the remodel program from Q1 last year?
John Mulligan:
Actually, Sean, I'm not quite clear on your question. Units per transaction in the first quarter were up year-over-year. So help me with that again?
Sean Naughton:
Oh, I thought that was the -- I thought they were down 60 basis points, maybe I'm missing something.
John Mulligan:
No, selling price per unit was down 60 basis points.
Gregg Steinhafel:
And that was mix related.
John Mulligan:
Right, entirely mix, but units were up consistently for some of the reasons you described.
Sean Naughton:
Okay, got it. And then I guess, Gregg, you touched briefly on the price matching. Just curious if you are seeing the number of requests for the price match change at all? And has there been any competitive response to that in the marketplace?
Gregg Steinhafel:
Both the stores with the matching of competitors, physical ads and the online match has been fairly stable and has not grown materially over the last quarter. So it still represents a very small portion of our transaction, and that's because our everyday price and our promotional prices are so strong. There is generally not much of a gap, if any. So we continue to watch our competitive prices on a day-in and day-out basis and move where we have to be competitive in the marketplace. And so we expect, over time, this not to change all that much.
Sean Naughton:
Okay, great. And then just lastly on digital, you're obviously seeing some nice traction, nice growth outside of the Seasonal categories. Can you talk about just the impact on margin for that sale today? Is it dilutive or is it accretive to the margin? And what do you think that can be -- how are you planning that over time?
John Mulligan:
Yes, I think first, I'd start with how we think about this longer term. And we think about, from a longer-term perspective, sales through all of our channels, regardless of the channel, you need to generate a return. I think -- and a return on investment that's similar to what we see in our current U.S. store base. What we see today is -- honestly, we're learning a lot about that channel, and a lot of this depends on how we're going to ultimately settle on a supply chain that our guest wants to interact with us, how much is ship from store, how much is ship to store, that will have a significant impact, ultimately, on the EBITDA margin rates of that particular channel. But I think, once again, depending on where those EBITDA margin rates land, sales or capital will move around. And we feel very confident that we'll get back to a return that makes sense. Having said all of that, I think as it relates to the rates embedded within that channel, we feel very comfortable that ultimately, we'll get back and operate it at that 10% EBITDA rate that we've said is part of our long-range plan.
Operator:
Your next question comes from line of the Matt Nemer of Wells Fargo Securities.
Matt Nemer:
First, I'm wondering if you can comment on sales in geographic areas that had more neutral weather like Florida? Were the transactions and the comps positive in those markets?
Kathryn Tesija:
We did see better results in areas that had more normal weather, so that would primarily be the West Coast. And they were toughest in those Seasonal categories where we saw weather off the most, and that would be primarily in the Midwest. So we did see quite a swing between the different geographies.
Matt Nemer:
And then in terms of the second quarter guidance, do we assume that there are some incremental markdown risk in Seasonal categories? You did mention that within categories, the rate improvement would be a little softer in the second quarter than the first quarter. So just wondering what the markdown risk is in the Seasonal categories?
Gregg Steinhafel:
Yes, like we said, the teams did a very good job of responding to the sales shortfall and retiming receipts and making cancellations. We're going to know a heck of a lot more in the next 30 days as we see what happens and what -- how the sales of these categories play out before we have to take markdowns in the 4th of July. And if we get really good weather and we have good sell-throughs, then we're going to be right back on plan. If things stay damp and cool for an extended period of time, there might be some risk. But where [ph] -- we don't expect to see significant risk whatsoever. So we're talking about things on the edges right now.
John Mulligan:
Yes, Matt, the only thing I'd add is it's a little bit hard to see, with the inventory on the balance sheet. The inventory per store in the U.S. is essentially flat to last year. All of the inventory build year-over-year is attributable to Canada. So we feel really good about where the inventory positions are in aggregate.
Matt Nemer:
That's very helpful. And then just lastly, if we look at your operating expenses in the U.S. Retail segment, growth -- dollar growth accelerated a little bit versus the last few quarters. I'm assuming a lot of that is technology investments. But given the more moderated view of comps for the full year, could we see the dollar growth potentially come back down a little bit?
John Mulligan:
Yes, I think you're right. First of all, the vast majority of that is multi-channel technology. And we've said, a little bit of missed timing here, we expect to offset that on the year with expense savings and improvements we're making in our business, but the investment coming a little bit ahead of that. To your second point, I think that's absolutely right. And it's interesting, we said this last year, when our sales accelerate or decelerate rapidly from our expectations, we tend to see our SG&A lag both directions. It doesn't climb as fast when sales go up, like last year, and it doesn't come down quite as quickly when we see sales decelerate. And as we adapt to wherever sales are going to be, you'll see our SG&A settle in at a more appropriate level.
Operator:
Your next question comes from the line of Colin McGranahan of Bernstein.
Colin McGranahan:
First question on Canada, I understand that the gross margin rate at 38% is not the long run rate. But where do you think that settles out? And was the 38% above where you expected, even kind of adjusting for the mix that you saw?
Gregg Steinhafel:
Yes, I would say, out of the blocks, 38% was a little higher than we expected because the mix was a little better than we expected out of the blocks. Now whether it's in Canada or the U.S, clearly, when we open a new store, we get a higher gross margin rate, but the mix was even higher than the higher -- than we expected. So we do expect that to settle down and be slightly higher than what it is in the U.S. because we expect the mix to be a little bit better than it is here in the U.S.
Colin McGranahan:
Of course, and as the consumables business ramps up, mix is down, but from a productivity perspective, can you tell anything yet on these first stores that are open in terms of opening expectations relative to what you had thought? Or was it just too much hoopla that you can't discern anything yet?
Gregg Steinhafel:
Well, I wouldn't call it hoopla. I would just say that the guests were very, very excited, and we experienced tremendous surges in sales. And it's just very, very early to draw any conclusions. And we really wanted to deliver a great experience, and so to a certain extent, we went in with staffing levels to make sure that we were taking care of the guests both at the front end, that we had the right team members there for the supply chain, and we had the right teams on the sales floors. So we know that over time, and in our run-state condition, we have to work hard at making sure that we get our productivity levels where the business model dictates them to be. And we know our gross margins will settle in, and we've got to become more productive and run the business. Over time, our consumables share will grow because that's the hardest trip to change with the guests. And so we're going to continue to focus on those frequency-oriented categories, so that we can not only get the good mix that we're getting, but we want to now start driving more trip frequency into the store. And we didn't want to come out of the blocks by hitting those categories too hard because we wanted to make sure that we led with our strength. And we wanted to make sure that all the supply chains and the operational disciplines were in place. We feel very confident now that they are. So we're ready to start making those kinds of adjustments in merchandising, in supply chain and in store operations to start refining the model.
Colin McGranahan:
Okay. That's helpful. Secondly, on the credit, I actually thought the contribution, $105 million, while you said it was -- you explained it was large, it seemed to me it was higher than I would have expected, especially given the bad debt reserve release last year. Is there anything there that reflects the $105 million profit share?
John Mulligan:
I think the one thing I'd remind you is we only had a half a quarter's worth of profit-sharing with TD. Next quarter, we'll have a full quarter's worth of profit-sharing with TD.
Colin McGranahan:
So the $105 million was really a $210 million quarterly run rate?
John Mulligan:
No, no, no. Because that's net of our operating expenses as well.
Colin McGranahan:
All right. I'll follow up offline with you on that, John.
John Mulligan:
We can take it offline and walk through that in detail, Colin.
Colin McGranahan:
And then finally, just coming back to SG&A, the dollars were up, I think, $233 million. If I'd x out the credit difference of $36 million, the vendor allowance of $13 million, the technology spend, it still looks like the growth is pretty healthy. John, I know you mentioned that there's a lag just in terms of how quickly you can get after that if sales are disappointing. Would you also expect your -- some of the expense things you're doing in a longer-term basis to impact that? And I guess my question is, can we see better performance out of that line, because it sounds like 2Q guidance doesn't get us there?
John Mulligan:
Yes. No, question in that -- what we're seeing. I think we talked about this a little bit 3 or 4 -- or 5 weeks ago when we were together. You'll see the ramp-up in our expense initiatives throughout the year and through next year, actually. Many of them are a little bit longer lead times to pull out expense, all the easy stuff we've done a long, long time ago. So we do expect, through time, SG&A will come down and manage to a level that is more appropriate.
Operator:
Your next question comes from line of Bob Drbul of Barclays.
Ronbert Drbul:
I guess the question that I have for you is a twofold, but it revolves around traffic. When you look at the initiatives that you have in place, REDcard and PFresh, and you consider -- I understand the sort of, the seasonal piece, Q1 this year versus last year. But when you think conceptually, traffic was down in the fourth quarter, and that was down again in the first quarter, how do you sort of get us comfortable with essentially the efficiency and the effectiveness of these initiatives over the longer-term period? And the second question that I have is when you -- the lower comp assumption for this year, can you maybe just break down the traffic component in that new 2% to 2.5% expectation?
Gregg Steinhafel:
I'll take the first one. I think the traffic -- this was a -- it was a disappointing quarter for us. We had very, very strong traffic last year. There was pluses and minuses throughout 2012. And we expect traffic trends to get stronger as the year goes on. And we have all of our initiatives designed to not only deepen the relationship but build frequency. So we'll perhaps be a little bit more aggressive on price. You have to look at the competitive environment. It was a little bit more aggressive than it had been in the past, where there was more emphasis on price, and that, I think, impacted a little bit. But overall, we really expect to be able to generate traffic levels that are flattish, give or take, over normalized periods of time.
John Mulligan:
Yes, Bob, and the only thing I'd add, I don't think we need to run traffic numbers like we did last year in the first quarter to generate that 3% comp. I think if you look over the past several years, about 0.5 point of traffic combined with ticket gets us to a 3% comp. And that's about the formula that we feel really good about.
Kathryn Tesija:
The only other thing that I would add is, this time of year, our Seasonal categories can be a big traffic driver for Target. And clearly, they weren't in the quarter, and they were last year. So all of the things you mentioned, 5%, PFresh, help us all year long. But during key Seasonal categories -- key Seasonal timeframes, we need those categories to drive traffic as well.
Operator:
Your next question comes from the line of Deborah Weinswig of Citigroup.
Deborah Weinswig:
A lot of conversation regarding mobile and digital traffic, can you also talk about what conversion was like during the quarter?
Kathryn Tesija:
Our conversion has been improving over the past year, Deb. And we were up slightly in this quarter as well. So we're really pleased with the improvements that we've made on the site. But I'll tell you, we still feel we have a long way to go with conversion, and we are very committed to continuing to work on our navigation and our search function and the basic functionality of our site to continue to make big improvements there.
John Mulligan:
I think the only thing I'd add, Deb, is we have a little bit of a mixed headwind, which is positive from our perspective. Mobile, in general, has a much lower conversion rate than the site. And our mobile is growing much, much faster than the site. We think that's good because we think that's where things are going, and it also shows that she is spending a lot of time with us on our -- on the mobile applications we have. But conversion is just naturally lower there, and so it creates a little bit of a mixed number as we look at the aggregate.
Kathryn Tesija:
So if you look at conversion on our site, it's up to last year. If you look at conversion on mobile, it's up to last year, but because of the big growth in mobile, to John's point, conversion comes down slightly in aggregate.
Deborah Weinswig:
All right. And then maybe just a broader question, can you just talk about how you're positioning yourself in terms of taking advantage of the Affordable Care Act?
John Mulligan:
I think we've said it a couple of times, the Affordable Care Act, the changes for us will be relatively -- well, they won't be relatively, they will not be material externally. We're still continuing to work through all the regulations and what we will exactly do, but it won't be material changes to what we're doing today or financially, from a financial perspective.
Deborah Weinswig:
Okay. And I think Gregg touched on segmentation and how you're looking to match local taste and preferences. Where are you -- I know there was a lot of work done in Canada, but where are you domestically in terms of that?
Gregg Steinhafel:
Well, we feel good about where we are. I mean, we've been working on this for a long time, and we continue to deploy resources to get better and better at that. So this is just a long-term initiative that we have to continue to focus on, whether it's in food, whether it's demographics, whether it is ethnic groups. We've just got to continue to get better at our localization efforts. And we think we've made good progress there, and we are going to continue to focus on it.
Deborah Weinswig:
But was there anything that you learned from Canada that you could go back and apply to the U.S.? Or was it exactly what you expected and you're just continuing on the path?
Kathryn Tesija:
I would just say, Deb, I think it's a little early to learn from Canada and bring that back to the U.S. I will tell you, though, we learned a lot from CityTargets that we applied to Canada. So as you know, those stores are in dense urban areas, and so are our Canada stores -- so we took a lot of that learning and the testing that we did last year and applied that to what we're doing in Canada. And throughout this year, of course, we'll be reading the Canada results and bringing that back to the U.S. But the same teams work on localization for both countries.
Operator:
Your final question comes from the line of Chris Horvers of JPMorgan.
Christopher Horvers:
A couple of questions. First, on the top line, can you -- in the Home and Apparel categories, can you talk about the stack comps that you had in the first quarter and broadly, how that has trended -- those categories have trended over time, past few quarters?
Kathryn Tesija:
Well, when we look at the stack comps, we feel a lot better about it. Since you're just looking at this quarter, both were positive, if we look on a stack basis. Going forward, our compare in second quarter is not as nearly as difficult as our first quarter, so we would expect our comps to improve. And over time, we want that 2-year stack to improve. We're not happy with flat or up slightly. We want to make sure that we're making progress there. But it was, on a 2-year basis, better.
John Mulligan:
I think I'd just add a little color to that. I think Apparel, for instance, the 2-year stack is around a 2, running that consistently through time, we'd feel really good about running 2s in Apparel. And as Kathy said, Home is positive, and that's a big improvement from where Home has been over the past several years. So on a 2-year basis, we feel good about both those businesses.
Christopher Horvers:
That's great. And then also -- and thinking about the EPS pressure from Canada, can you talk about how much the expenses in the first quarter are onetime in nature, pre-opens and so forth? And as you think about the guide for the second quarter, a similar question, how much of that expense pressure is actually something that goes away in future quarters?
John Mulligan:
Yes, that's difficult to parse out, and the example I would give you is exactly what Gregg said, where we started with the stores stacked very heavily. We know through time, we have to refine that model. Is that onetime expense or operating expense? Certainly, the expenses related to hiring team members early and training them as the next cycle of stores will open up. That is all onetime and will drift away. What I'd tell you is, through time, we expect, ultimately well down the road, to get to an SG&A rate that makes sense and productivities that are very similar to the U.S. So as I said before, as we get a little bit more clarity, right now, expense dominates the P&L in Canada. And as we get more clarity on sales, margin, operations later in the year, we'll provide a lot more color about how we expect those stores to operate.
Christopher Horvers:
And then one final one. Just in terms of being in the stores, it seems like at times, you're actually too thin on inventory in some of the discretionary categories, whether that's Home and Apparel. And what's the internal discussion around balancing rate versus balancing sales? And do you think that you've leaned too far towards the rate side?
Kathryn Tesija:
This is something that we are always looking at and adjusting. But I guess I would tell you I don't feel like we've gone too far. Our inventory, as John mentioned, our average inventory per store is flat to last year. It's actually up a bit in apparel, given the softer sales in the first quarter. So we're always looking at that. We look as much at out-of-stocks as we do in-stocks, in trying to improve those stores. So it's a constant focus for us, and we can always improve. But I feel pretty good about where we are right now in terms of in-stocks.
Gregg Steinhafel:
Okay. Thank you. That concludes Target's First Quarter 2013 Earnings Conference Call. Thank you all for your participation.
Operator:
Thank you for participating in today's conference call. You may now disconnect.