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.

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?

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…

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…

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…

[Operator Instructions] Our first question will come from the line of Wayne Hood with BMO Capital.

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.

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.

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.

Your next question will come from the line of David Strasser with Janney.

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.

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.

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?

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.

Your next question will come from the line of Matthew Fassler with Goldman Sachs.

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?

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.

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?

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.

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

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?

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.

And the same with the SG&A, out of that $650 million, it's more back end?

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.

Great. And if I could, Brian, welcome back to retail.

Thank you. Good to be back, Greg.

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?

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.

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

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.

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.

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.

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%.

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.

Your next question will come from the line of Matt McClintock with Barclays.

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?

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.

Our final question will come from the line of Simeon Gutman with Morgan Stanley.

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?

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.

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.