Thank you. Good morning and welcome to our 2013 Q3 earnings conference call. On the line with me today are Kathy Teshaw, 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 Q3 results and strategic priorities for the remainder of the year. And Kathy 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 Q4 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 3rd 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 has 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 3rd 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 3,000,000 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 $14,000,000 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.
Remain 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 Q3, we opened our 8th City Target and we continue to be pleased with the results from this new format. We opened our 1st City Target 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 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, Q3 gross margin rate in Canada was unusually low as the team worked diligently to eliminate excess inventory and enhanced 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 Q4 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 start up costs will moderate next year leading to 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 1,000,000,000 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 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 4th 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 Q4 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 insight 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 multi channel capabilities, while offering merchandise and experiences to create loyalty and position Target to deliver strong performance in any environment. Now, Kathy will provide more detail on our Q3 results and outline initiatives for the Q4 and beyond.
Kathy?
Thanks, Greg. We are pleased with the ability of our team to manage the business in the Q3, 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 3rd quarter sales between lower margin and higher margin categories. Among the lower margin categories, need based areas like food and healthcare 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, 3rd 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 and Up brand. Performance in back to college was also stronger than average, both in store and online. In September, our collaboration with Philip 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 included 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 Greg 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 list, 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 Q3, 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 the tough environment, knowing that our base inventory is large enough to enable sales well beyond our 4th 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 Payless 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 decor, 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 the 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. Targetdot 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 results 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 Doctor. 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 percent guests receive when they use their RedCard. In beauty, we recently launched a complete line of bath and body products from our longtime beauty partner Sonia Kashuk including 4 beautiful scents created by Sonia in collaboration with French perfume house, Rabote. 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 the 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 guests exclusive content from a wide spectrum of artists and genres. In October, we launched exclusive albums from artists including Barry J.
Blige, The Head and the Heart, Paul McCartney, The Abbott Brothers and Kelly Clarkson. In November, we added exclusives from Celine Dion, Avril Lavigne and James Blunt. And on December 3rd, we'll release the Target exclusive version of country star Jake Owen's new album Days of Gold, which includes 4 bonus tracks. And in grocery, we're following up on the recent success of Target exclusive pumpkin M and M's with a wide variety of big brand holiday treats including exclusive items from M and M's, Oreo and Hershey. Beyond the Q4 and the holiday season, our team continues to develop services and multi channel 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 add 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 have 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 haircare. 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 assortment that includes national brands and popular own brand products like Up and Up Diapers. Based on the initial guest response, we plan to expand 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 product alternatives in the same category. And in our stores, we'll use signing to highlight top pinned items throughout our assortments.
While we are cautious about the near term sales outlook, we are confident in our 4th 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 Q3 financial performance and our outlook for the Q4. John?
Thanks, Kathy. Our Q3 financial performance reflected continued strong execution in our U. S. Segment and higher than expected dilution in 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 Kathy 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 3rd 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 3rd quarter, this increase in basket was entirely driven by an increase retail per item driven largely by electronics, which as Kathy mentioned saw a much stronger comp in the Q3 than we saw earlier in the year. Sales penetrations on our red cards continue to grow as more and more guests understand the compelling value of our 5% rewards program and decide to deepen their relationship with Target. We continue to see a consistent response to households who apply for and activate a new red card, increasing their spending at Target by about 50% on average as they respond to the ability to save with RedCard Rewards. 3rd 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. 3rd quarter
quarter U. S. Segment SG and
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 results in the 1st 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 two factors, the underlying U. S. Retail business generated a small amount of SG and A expense leverage on a 0.9% comparable sales increase overcoming ongoing pressure from investments in technology and supply chain to support our multi channel 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 Q3, even as we continue 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 persist in the Q4 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 start up 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 1st year start up costs, We gain efficiencies through systems and process improvements and we drive sales increases through our efforts to drive shopping frequency. Turning to consolidated metrics, 3rd quarter interest expense declined $27,000,000 or 14% from last year as we continue to benefit from the debt retirement following the receivable sale. We returned $271,000,000 to shareholders through dividends in the Q3, 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 Q3. While we remain committed to share repurchase over time, we have consistently maintained that we will govern the pace of repurchases the goal of maintaining our strong single A credit rating.
As a result, in the Q3, 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 $4,000,000,000 through share repurchase in 2014. Now let's turn to our expectations for the Q4 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 Kathy 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. 4th quarter U.
S. Segment EBITDA margin rate is expected to be down slightly from last year. On the gross margin lane, 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 the comparison to last year's 53rd week, which added a relatively low gross margin week to the quarter. We expect the 4th quarter U. S.
Segment SG and A expense rate to be a full percentage point above last year's revised rate of 17.3%. About half of this increase or $110,000,000 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 Q3, 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 point 3 $2 in the 4th In the U. S, we expect 4th 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 point 10 dollars to adjusted EPS in the Q4 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 $110,000,000 headwind from the credit card portfolio.
Combining our expectations for adjusted EPS, Canadian segment dilution and a $0.02 impact from the reduction in the beneficial interest asset, we expect 4th 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 $400,000,000 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 $200,000,000 of expense pressure from incremental investments in technology and supply chain to support our multi channel efforts. It's comparing against last year's 53rd week, which added $50,000,000 to $100,000,000 to last year's pre tax earnings. Combining these factors, we faced a headwind in the neighborhood of $700,000,000 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, the credit card sale and non recurring 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 $1,000,000,000 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 $4,000,000,000 of our shares in 2014, while continuing to grow the dividend and maintain our single A credit ratings. With that, we'll conclude today's prepared remarks. Now Greg, Kathy and I will be happy to respond to your questions.
And our first question comes from the line of Greg Meulich with ISI Group.
I want to start right with RedCard and traffic. That's a trend this year that's 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 of traffic still down 1 to 1.5? Or what initiatives with RedCard or anything else did you have to really get that traffic stabilized?
So I'll start, Greg. I think a couple of things. 1, 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 100 of basis points a year. And then beyond that, I think it's all about our multi channel 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 bit later this year and we'll begin to roll out next year. We think all of that put together will continue to drive meaningful traffic increases. And the only thing that
I would add, Greg, this Kathy, 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.
And maybe a direct follow-up to that. I know that with all the multi channel initiatives and you outlined them 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 guests that's coming in the pickup in store? Do they get credit for that? Or how should we look for that to be changing going forward?
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 enterprise level to make sure that it all
washes through on a consolidated basis. And our next question
comes from the
line of Wayne
Huynh with BMO.
And your next question comes from the line of Wayne Hood with BMO Capital.
Kathy, just on the average ticket side, Greg 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 in AUR throughout the year
and you talked a
little bit in the Q3, electronics impacting that with the UPT being down. As you plan the business into the Q4, 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 you 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?
Most of what's driving it up for the Q4 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 Q4.
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.
Got it. And my kind of question related to this Kathy 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?
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've got over 3,000,000 users right now that are very engaged.
I think it's helping Trips. I also think it's really helping Baskets 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 Baskets. 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.
All right. Thank you very much.
And your next question comes from the line of Sean Naughton with Piper Jaffray.
Great. Thanks. I have a couple of part 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?
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 they're just flat out too much of it. And that's the inventory reserves that we assess at the end of Q3. We do that every quarter anyways as a matter of course. And we'll do that again at the end of Q4, but that was a large piece of what happened at the end of Q3. 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 will 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 Greg said, as we start to get sales histories, we can start to replenish stores more accurately, balance our inventories and meet guests' 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're 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.
Okay. That's helpful. Thank you. And then just secondly on the in terms of expense optimization in the U. S.
Business, looks like Fed 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 and A moving forward maybe in Q4 and then kind of the first half of twenty fourteen? Thank you.
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 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 and A investments and expense optimization really allows us to offset that. So I 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 multi channel capabilities.
Okay. Thank you.
And our next question comes from the line of Matthew Fassler with Goldman Sachs.
Good morning. My first question relates to Canada. What kind of insight can you give us into the average number of stores open over the course of the quarter as it relates to timing of opening 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.
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 4th quarter given we see the surge in holiday sales. I don't have the exact weighted average on the store timing map, but John Hulbert will get that to you. We can get that to you today.
That'd be very, very helpful. That'd be very, very helpful. The 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 been in those categories? Or what was it in the Q3? And what's your sense of the promotional environment here in Q4?
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 next and the going into Cyber Monday and the rest of the holiday season, things like Beats by Doctor. 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.
Okay. Thank you so much.
And your next question comes from the line of Chris Horvers with JPMorgan.
Thanks. Good morning. I wanted to follow-up on the Canadian in 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 it as maybe a couple of 100 basis points above the U. S. But you have these competing factors right now where the markdown pressure is a negative and 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?
Yes. Hi, Chris. This is Greg. Over the long term, our expectations haven't changed at all. What we're experiencing now is and as John talked Yes.
Hi, Chris. This is Greg. 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 1st cycle stores didn't open until April and the second cycle followed shortly after that.
And there 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 the mix continues to be strong and we're very pleased with that.
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 20 14. 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.
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 the 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 1st year sales or versus what
you rethought?
No. These are against the expected the new most recent level setting expectations that we shared that 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 the most revised forecast.
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?
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. It's much higher than our aggregate store or electronics market shares.
Okay. Appreciate it. Thanks.
Yes. We'll get back to you on that one.
And your next question comes from the line of Jason DeRise with UBS.
Hi. Yes. It's Jason DeRise here at 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 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'd quantify what kind of uplift you expect from video games? And also one thing that didn't come up yet, but the lower fuel prices, how you're thinking about that?
Well, that's a lot of questions. On the Q3, I think clearly Halloween moving into the quarter benefited. I would remind you that we also said at the end of last quarter, a back to school week moved out of the quarter into 2nd quarter that benefited 2nd quarter. Net net, probably awash maybe 10 plusminus10, 20 basis points, I don't really know, but net net awash. Let's see, on WIC, anytime 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.
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?
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 in the store.
So we think it's going to be one of the biggest gifting categories of the year and we will certainly benefit from that.
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 and 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.
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 to turn that around?
Apparel, I think was most of what we have is own 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. Philip 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.
Okay. Thank you.
You're welcome. We have time for one more question.
And our final question comes from the line of Paul Trussell with Deutsche Bank.
Good morning. 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 Q4 given the promotional intensity?
The 50 basis points is about right. And I would say about half of that was due to the ongoing pressure we 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 remade 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 Q4, 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 which you'll see be the primary variance year over year in our gross margin rate.
Okay. So improved performance on gross margin in 4Q versus 3Q experience?
Absolutely. Yes.
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 start up expenses in Canada this
year? Yes. We haven't disclosed the drag from start up 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 I 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.
Thank you.
Great. Well, that concludes Target's 3rd quarter 2013 earnings conference call. Thank you all for your participation.