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.

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…

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…

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…

[Operator Instructions] And our first question comes from the line of Sean Naughton with Piper Jaffray.

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?

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.

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?

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.

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.

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?

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?

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.

Your next question comes from the line of Greg Melich with ISI Group.

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?

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.

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?

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.

Your next question comes from the line of Matt Nemer with Wells Fargo Securities.

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?

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.

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?

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.

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?

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.

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.

And your next question comes from the line of Deborah Weinswig with Citi.

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?

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.

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?

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.

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?

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.

Your next question comes from the line of Jason DeRise with UBS.

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?

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.

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.

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?

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.

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?

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.

Great. Well that concludes Target's Second Quarter 2013 Earnings Conference Call. Thank you all for your participation.

Thank you. This does conclude today's conference call. You may now disconnect.