Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation second quarter earnings release conference call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, August 16, 2017. I would like to now turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.

Good morning, everyone, and thank you for joining us on our second quarter 2017 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; Mark Triton, Chief Merchandising Officer; and Cathy Smith, Chief Financial Officer. In a few moments, Brian, John, Mark and Cathy will provide their perspective on Target's second quarter performance and our plans and priorities going forward. Following their remarks, we'll open the phone lines for a question-and-answer session. As a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also in these remarks, we refer to adjusted earnings per share, which is a non-GAAP financial measure, and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalize operating leases. Reconciliations to our GAAP EPS from continuing operations and to our GAAP total rent expense are included in this morning's press release, which is posted on our Investor Relations website. With that, I'll turn it over to Brian for his thoughts on our second quarter performance and our priorities going forward. Brian?

Thanks, John. Good morning, everyone. We are very pleased with our second quarter performance, which gives us increased confidence that we are focused on the right long-term strategy. Our team is energized and remains on track to deliver the ambitious agenda we laid out for the year, including the physical transformation of more than 100 stores in 2017 on the way to transforming more than 600 stores over a 3-year period; nearly doubling the number of small-format stores this year in support of our goal to open more than 100 new stores in dense urban, suburban and college campus neighborhoods over a 3-year period; development and rollout of digital capabilities that will continue to drive Target's digital sales growth in excess of the industry; completely transforming our supply chain from end-to-end; creating a smart network of stores and distribution facilities that will allow fast, reliable fulfillment regardless of how our guests choose to shop; rejuvenating our own brand portfolio by launching 12 brands over a 2-year period, replacing brands that represent more than $10 billion of our current sales volume; investing in systems, training and additional labor hours in our stores, enabling our team to provide an even better experience for our guests; and enhancing our value perception among consumers by reducing promotions and highlighting the right everyday pricing in key categories. Later in the call, John, Mark and Cathy will provide more details on our efforts to advance each of these priorities. On our last conference call, I mentioned that beyond our focus on advancing our long-term priorities, we need to have equal focus on strong execution in every channel every day. That's why we're really proud of the execution of our team in the second quarter as they delivered better-than-expected performance in a continuing challenging environment. In particular,…

Thanks, Brian. Across all the operations team, we are focused on modernizing Target's network to create a complete, seamless, efficient and reliable menu of fulfillment options for our guests. And while we are still in the early stages of a multiyear journey, the team continues to move with unprecedented speed, developing skills and processes that allows us to develop, test and iterate much more quickly than we have in the past. Some of our fulfillment capabilities are already well developed. And in those cases, the team is focused on finding ways to increase our speed, reliability and reach. At the other end of the spectrum, we're in the early stages of testing completing new fulfillment options for our guests. In those situations, the work is fully focused on learning from our guests and vendor partners, understanding what is most important to our guests and beginning to evaluate reliable, repeatable processes that will allow Target to fulfill guests' rapidly evolving needs and expectations. Among our more developed fulfillment capabilities, we have offered in-store pickup of digital orders across all of our locations for years. But we continue to find opportunities to improve execution. And we're seeing continued momentum. Specifically, through the first half of the year, Store Pickup volume has grown more than 30% above last year. And in July, we saw more than 40% growth. As more and more of our guests respond to the convenience of order pickup, we are investing in system enhancements and store labor hours to continue to elevate the guest experience. These investments will be especially important in the fourth quarter holiday season, when guests are particularly time-pressured and rely on this fulfillment option even more frequently. Another way we can enhance the pickup experience is to offer a drive-up option, so guests don't need…

Thanks, John. As you've been hearing from many of our industry peers, this continues to be a challenging competitive and consumer environment. That's why we are particularly pleased by the ongoing progress we saw in the second quarter, when we gained further momentum in the areas that we're already performing well and saw improvement in the areas where performance needed more focus. And our growth has come from both stores and digital channels, wherever our guest wants to shop us. From a market share perspective, we saw broad-based market share gains across all our discretionary categories. In Hardlines, comparable sales grew between 3% and 4% in the second quarter, the strongest performance we have seen in 10 years. Growth in this area was broad-based, including double-digit growth in both video games, driven by Nintendo Switch, and Apple within Electronics. Toys grew more than 3% with board games continuing to be a strong highlight. This is an area where we already enjoy a leading market share position but continue to grow and take further share due to our focus on innovation and differentiation within our assortment. Our Apparel and Home categories both grew sales and market share in these tough markets. In Apparel, growth was widespread across subcategories as guests responded to fashion and newness, all underpinned by value through great priced-right daily items. We were particularly pleased with the ongoing positive performance in Kids, which continues to benefit from last year's launch of Cat & Jack and is now achieving strong year-on-year sales growth, and in our strong swim business. Like our performance in board games, we came into the year with the #1 market share in swim. And we extended our lead to become the clear destination for swim in the U.S. In Home, digital was an important growth…

Thanks, Mark. In the second quarter, our traffic sales and financial performance were all better than expected. Notably, the upside to our expectations was broad-based across the country, across channels and in all 3 months of the quarter. Second quarter comparable sales increased 1.3%, driven by a traffic increase of 2.1%. We are particularly pleased to see this growth in traffic, which reflects strong execution by our team and the early benefit of the work we are doing to transform our business. Our second quarter adjusted EPS of $1.23 was flat to last year. GAAP EPS was $0.01 lower than adjusted EPS, reflecting some small unfavorable tax items not related to our current operations. Both the GAAP and adjusted EPS lines reflect about $0.07 of favorability, resulting from the net tax effect of our global sourcing operations. This favorability was included in the adjusted EPS calculation because it reflects a structural benefit to our tax rate resulting from our operations. The amount recorded in the second quarter reflects the year-to-date benefit of our global operations on our tax rate. And we expect to recognize an ongoing benefit in the range of $0.02 to $0.03 in both the third and fourth quarters as well. Our second quarter gross margin rate was down about 40 basis points to last year, driven by increased fulfillment cost and the impact of our efforts to improve pricing and promotions. Merchandise mix had a slightly positive impact on our gross margin rate in the quarter, reflecting healthy performance in our signature businesses, balanced by broad-based strength in Hardlines. One note, beginning this quarter in our financial reporting, we have reclassified depreciation expenses associated with our supply chain, moving them into the cost of goods line on our P&L. This elective reclassification, which resulted from an internal…

Thanks, Cathy. Before we move to questions, I want to thank you for your engagement and reiterate our commitment to moving quickly, thoughtfully investing in our long-term growth and strong execution every day. While we expect that the near-term environment will remain choppy, we're confident in our 3-year plan to build an even better Target. And our second quarter progress reinforces that confidence. That concludes our prepared remarks. Now John, Mark, Cathy and I will be happy to take your questions.

[Operator Instructions]

Operator, before we start taking questions, I just want to make a couple of points. I recognize that our prepared comments today were rather lengthy, but we thought it would be important to give you a sense for the breadth of the work taking place at Target today, an update on our progress. And I hope we provided clarity around the key areas of focus over the balance of the year and as we go into 2018. So with that, we'd love look to open it up for your questions today.

Our first question comes from Matt Fassler with Goldman Sachs.

I have two brief questions for, I think, for Cathy. The first relates to the implied fourth quarter guidance, which seems quite subdued relative to a tough fourth quarter a year ago despite the fact that I believe you have an extra week in the quarter, and correct me on that if I'm wrong. And then the follow-up to that is just that you mentioned D&A moving higher. So if you could just give us some color on the magnitude of the move you'd expect of the restated D&A numbers.

With regards to both third quarter, fourth quarter and full year remainder guidance, as we said, we'll continue to move with urgency but plan prudently. And I think that's what you should expect from us. We are finding every time we see results coming from our investments, we're choosing to continue to invest to accelerate our transformation. And so that's how I would think about the backside of the full year. With regards to the reclassification we did on the supply chain depreciation expense, we posted a great schedule, John and the team posted today to the IR website, gives you 3 full years by quarter. You can see the bottom line, it's 30 to 40 basis points a quarter change. And you would see that -- the shift from D&A to gross margin.

We have that. But just in terms of the -- I think you said you expected D&A to be increasing at a faster rate as you accelerate the depreciation associated through upcoming remodels.

Yes.

Can you try to contextualize the expected increase, how much the pace of D&A growth will change?

Yes, so it is. It's related to our increasing store remodels as we accelerate some of the depreciation there. And for the full year, I was just quickly looking here, we're -- you'll see a little bit of continued pressure coming through, so it will pick up. But we'll follow up with some specifics if you need it.

The next question comes from Chris Horvers with the JPMorgan.

You had a very strong Electronics quarter. The Switch, which has been a huge hit, double-digit comps in that. And then Apple iPad sounded like they're bouncing back. So it seems like there's a material contributor to same-store sales. How do you think about the sustainability of this benefit? Presumably, the Switch moderates. But do you think the Apple benefits on tablet compares and the new phone? And what other categories do you think could come in and pick up for what the Switch has provided?

Mark, why don't you provide some insight into our view on Electronics?

Yes. Thanks, Chris. I think, firstly, just on the Apple comments, they weren't just driven by tablet. They were all driven across the broad in categories. And we had really strong showing in Q2 on the iWatch, which we worked with Apple on clearly. And we have a lot in our plans to Q3 and Q4 with potential new launches as I've outlined. So we think that there's still room for growth and continuing the trend. In terms of Nintendo Switch, we worked really closely with those guys as well to develop not only a product but a marketing campaign that the guests really responded to. And so we've been able to secure inventory and a plan all through to the fourth quarter, so feeling positive about sustaining a trend there.

And Chris, I think it's consistent with our focus on bringing newness to the guest, not only in Electronics but through our assortment. And I think Mark and his team have done a terrific job of working with our vendors and also building own brands that bring excitement and newness to our guests each and every day.

Understood. And then on the working capital CapEx side, you've seen some very nice benefits here on working capital this year. How do you think about this year, inventory outlook at the end of the year on the working capital benefit? And you raised CapEx a bit next year. Do you think that increased CapEx is largely offset by continued ongoing benefits in the working capital area?

So Chris, as we've said, we know that we've got a multiyear journey around the supply chain transformation, which will help that working capital continue to come through the business. And we want to just make sure we keep making that progress through time, so not going to commit longer term just yet as we -- it's really going to be associated with a lot of the supply chain transformation. On the increase in CapEx next year, again we're not giving all of next year guidance but thought important to signal where we were going with our CapEx.

Our next question comes from David Schick with Consumer Edge Research.

I really wanted to simplify into one question all these different tests and get at one issue, whether it's the roll -- test of curbside and same day, whether it's the rollout of in-store, all the work you are doing. Could you talk about all the new initiatives? And is it -- does it have more traction with existing customers, anything you can share, existing customers, capturing back more of their wallet? Or is it new customers that are new to Target as you go through these new initiatives?

David, I would tell you it's a combination of both. And overall, we're very focused on improving the guest experience, whether they're shopping in store or online, making sure that we deepen the relationship with existing and new guests. And we are very pleased with the traffic increases we saw during the quarter. We're honestly very excited about the work that Mark and his team are doing around bringing new brands to our guests. And we're recognize that to move forward and to continue to execute, we've got to continue to make sure we're providing fulfillment options that our guests are looking for today. So as John talked about during our prepared comments, we're very focused right now on testing and expanding different fulfillment options. We've seen some very positive responses to things like Target Restock. And we're going to continue to ensure that we could meet the needs of our guests matter how they want to shop at Target.

Just as a sort of an add-on to that, one of the things over the last decade that some retailers run into with all these attempts to reengage, a lot of which are very exciting, is either overdoing it or overcomplicating it. How are you guarding against at the store level the associates not being overwhelmed by these initiatives and managing through that?

It's a very important question. And I'm going to turn it over to John here to build on that. But we're trying to make sure we are very, very focused right now and that we have the guest in mind first, that the initiatives that we're bringing forward are guest-centered. But importantly, that we have the right focus on execution each and every day. And I think what we saw in the second quarter is a by-product of our focus on execution each and every day in our stores, online, in our supply chain. And I think you're starting to see that focus really connect with the guests.

Yes, I think the only thing I'd add, you're 100% right about the focus. I think the key challenge there for us is to continue to take work that is not guest-facing out of the store. And guest-facing work there is, like we said, the investments we're making in Food and Beverage, in Beauty, in visual merchandising. That includes things like order pickup and shipping from the store. But there are opportunities everywhere else to pull work out of the store. And I think the stores' teams have done a great job optimizing within the box. We need to continue to optimize upstream to help them take work out. And that's a lot of the testing we're doing today. Now I didn't talk a lot about it, but we have test going on in multiple parts of the company focused on taking work out of the store, so they can be focused on the guest.

Our next question is from Robbie Ohmes with Bank of America Merrill Lynch.

Brian, you guys have been mentioning the environment challenges, and we're seeing the very aggressive promotions out there in categories like Apparel. Your store traffic improved a lot this quarter. I'm just curious, are there -- can you give us any color, are you picking up more share from competitors' store closings than you would have thought? And then also as you shift more to EDLP while others are getting maybe more promotional, any insights from what you've seen so far in August that you can share with us on how all this is working out? And sorry, just to add on this also, and I don't know whether John Mulligan or Mark want to jump in on this, but as you pull back on the promos more, you shift more to EDLP, can you remind us where things like Cartwheel fit into that as you move forward and also how you see REDcard penetration playing out in your strategy?

So Robbie, there's 4 or 5 different questions there. And we'll try to unbundle each of them. But as Mark talked about during his prepared comments, during the second quarter, we saw very strong market share growth across a number of categories. We continue to see share growth in Apparel, in Home, in Hardlines. And one of the things that, I think, we felt best about in the quarter, and it's a by-product of the work we've done from a promote standpoint as we continue to see our businesses in Essentials shift back to regular-priced sales and the impact of our new marketing and advertising campaign, the Target Run and Done campaign, which has driven really positive reaction from the guests and accelerated our business in Essentials. So that was a real big highlight for us in the second quarter. And we've talked about this before. We're at our best when we balance both style and household essentials. And you're seeing that balance come to play in the second quarter. And we certainly are going to continue that over the balance of the year and into 2018. So it was a period of time where we feel good about the progress we're making as we pick up market share in many of our signature and style categories. We've seen growth in our Essentials businesses. And we'll build off of that as we go into the balance of 2017 and '18.

Sorry, Robbie, around Cartwheel. Cartwheel remains a really viable promotional vehicle and guest engagement tool for us. And what we're doing though, in the simplification of about pricing message and creating great priced-right daily items, is we're using Cartwheel, but we're reducing the amount of stacking that's coming in. And that's really helping us to clarify and simplify our message to guests about what true everyday value is as well as what's an exceptional promotion. So the rescoping of that has been tremendous so far. And really, our regular business is shining and our promotional business is rescoped in a great way.

And any chance we can get you guys to comment on August?

Obviously not.

Our next question comes from Bob Summers with Macquarie.

Just a handful of questions. You've had some recent hires in sort of the Food umbrella. I'm just curious as to how the new individual fit into the current strategy and whether this is a catalyst for a shift and maybe something more into the prepared food sort of side of the equation. And then secondly, if you're willing to comment, I'd love to know what the trends look like, the business trends look like in and around Prime Day?

Yes. Why don't we turn it over to Mark to talk about both Food and what we saw during that Prime period?

Thanks, Bob. I think that we outlined in our Q1 comment around the emergence of our strategy and that we're going to be on a journey of implementation as Jeff Burt joined us in the business. And Jeff has already come in and begun start testing and iterating new ideas and concepts on top of our strategies that are creating growth vehicles, so we're excited about that. The new people entering our business are just creating new strength against those strategic intents. So firstly, Liz Nordlie will add value to our own brand growth potential there and strengthen our efforts there as well as Mark Kenny, really with his expertise in general grocery but specifically in the convenient meal area and in bakery, et cetera. I mean, that is part of our ongoing strategic intent to strengthen and focus there. So these are key investments in our strategy and in our team, balancing them against existing talent. In regards to your query around Prime, we're really happy to see ongoing trends maintained during Prime period. And we had positive comps and a really strong growth in regular price business continuing through those days both in-store and online.

Our next question comes from Peter Benedict with Robert Baird.

Mark, just was hoping you could expand maybe a little bit on some of the merchandising assortment changes that you're making in the consumable side of the business, the Food area, particularly in pet food. What's going on there? And anything to note there from a remodel perspective?

Yes. Thanks, Peter. So let me start with pet. We announced this month the addition of Blue Buffalo to our assortment, which is the #1 brand in the U.S. and a really core assortment get. And so excited to add that into our mix, and we already have a lot of data from our guests who suggested they wanted to see that at Target. We also embarked on an agreement with BarkBox. So really refocusing our accessory and our total assortment of doing business inside pet. So an exciting uptick there because that brings further guest trips and conversion. Around the Food and Beverage area, in terms of general assortment, we're still working on there and more to follow.

That's helpful. And then just leveraging on that, when you think about the private brand introductions, I mean, good color on what's coming this year. But when you think about next year, is it going to continue to be in kind of the signature categories? Or should we expect some private brand introductions to start to emerge on the consumable side of the store?

I think that we've talked openly about a roster of more than 12 brands that we'll be bringing to life over a period of time. We've begun that journey. That continues into 2018. It highlights definitely the signature areas, but the strength, providing differentiation, exclusivity and therefore, preference that Target through this is applicable to many different areas. So we're looking at all areas and opportunities, and we have some plans in place.

Our next question is from Brandon Fletcher with Bernstein.

The only questions I have are essentially just on the pick for store concept. I just want to share a comment we had from an industrial engineer that was working for me a long time ago that it's about as efficient as a driver who takes 3 rights to take a left. There's a massive cost when you have people walk the store instead of it being your customers who walk back out on a simulated basis. I get incrementality. I get that you don't have to have the checkout cost and it offsets it a little bit. Is there something that's coming that you guys are confident on the operational side that will make pick from store the way you guys are doing it better than lots of other folks so that we don't face as much inefficiency? And similarly, will the remodels make those operational changes you think less difficult or more efficient in terms of cost structure?

I think any time you focus on just one slice of the total fulfillment, you lose picture for the whole thing, right? We're trying to optimize the total economics for Target. And those economics include investments, capital investments we might otherwise have to make if we don't utilize the existing assets. So I think we can point to any one slice and say, "This one is going to be better or worse." But again, we're optimizing total economic picture. And I'd have you think about that. I think the remodels, where they will really help us, and it's in conjunction with us taking inventory out of the backroom, is our ability to optimize that backroom more efficiently to drive more productivity as we ship from the store. And so that's the real opportunity as we go through the remodel cycle.

And so the micro fulfillment in the backrooms would be one of the benefits of remodels?

For sure. And in conjunction with operating changes to reduce inventory, like I was talking about earlier, and take work out of that -- other work out of the store.

Our next question is from Michael Lasser with UBS.

Can you quantify how much of the $1 billion of operating profit investment you plan to make has already been deployed thus far this year?

As you saw in the quarter, we are seeing the continued investment in both SG&A as well as gross margin. We also though are working really hard to make sure we can offset with efficiencies throughout the organization, where appropriate. And so you're seeing that -- you saw it come through in SG&A and in gross margin this first -- the second quarter, you saw in the first quarter as well to do that. So where we see the investments get the return that we expect and the results we expect, we're investing faster and heavier to accelerate the transformation. So I would say we're on path to what we said we would do. And you're seeing it come through in both Q1 and 2.

Your final question is from Kate McShane with Citi.

I wanted to just ask about promotions a little bit more, if you don't mind. I know matching promotions are fluid. But how much more work do you need to do in moving your categories and products to EDLP? And what way are these changes impacting the second half outlook? And I know you've mentioned that there's been challenges in the past in terms of conveying value to your guests. And I just wondered how this messaging has changed.

Yes. Okay, I'll take that one. So our promotional efforts are really a roll through the quarter event. And we began them in first quarter in April. And our second round of taking key items that comprise our guest basket and focusing on priced-right daily items really took hold and then second wave by end of July. The next round of that is through October. And that's when we'll be coming together to have a more concise in-store marketing campaign and regular cadence of new beverage to the guest to communicate value. So we think at that point that we have a strong base to maintain. And this is why in half 2, we've been prudent in how we forecasted our sales and margins based on also unit growth initially. We see trip growth initially. And we need to see that dollar growth balance out over time. But we know that we've been patient with that, hence some of our earlier discussions at the start of the year are about investing ahead of the curve.

Kate, I think promotions, along with many of the other things we've talked about, are still obviously in the early stages. Now we're excited about the results that we've seen with remodels. But we have hundreds of stores in front of us. We've seen great responses in some of our small formats. But again, we'll open up dozens of additional stores over the next couple of years. The brands that we've launched have been well received. But we're really just getting into the heart of the brand launches as we go into the back half of '17 and '18 as well as the pricing and promo work. So we're very pleased with the progress. We know we've got much more work in front of us. But we thought today would be a great chance to give you a progress report and give you a sense for the amount of work and the scope of work that's taking place within Target. So that concludes our second quarter 2017 earnings call. I really appreciate all of you participating, so thank you.

This concludes today's conference. Thank you for your attendance. You may disconnect your lines.