Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation Second Quarter Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, August 21, 2019. I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.

Good morning, everyone, and thank you for joining us on our second quarter 2019 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; John Mulligan, Chief Operating Officer; Mark Tritton, Chief Merchandising Officer; and Cathy Smith, Chief Financial Officer. In a few moments, Brian, John, Mark and Cathy will provide their perspective on our second quarter performance, our outlook and progress on our long-term strategic initiatives. Following their remarks, we'll open the phone lines for a question-and-answer session. This morning, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer your follow-up questions. And finally, as a reminder, any forward-looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also in these remarks, we refer to non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP numbers to the most directly comparable GAAP number are included in this morning's press release, which is posted on our Investor Relations website. With that, I'll turn it over to Brian for his thoughts on our second quarter performance and our outlook for the rest of the year and beyond. Brian?

Thanks, John. We are really pleased with our second quarter financial performance, which reflects the durable model we built over the last several years. In building this model, we focused on making changes to ensure we maintain long-term relevance with our guests while positioning our business to grow profitably over time. When we began this journey to transform our business in 2017, we said that 2019 would be the year when we'd be positioned to deliver profitable growth, and our results through the first half of this year has certainly fulfilled that expectation. On the top line, our business delivered second quarter comparable sales growth of 3.4%, driven primarily by traffic. This growth was on top of unusually strong comp growth of 6.5% in the second quarter last year, meaning that our comp sales have increased about 10% since 2017, our best 2-year stacked performance in well over a decade. On the bottom line, our second quarter profitability was well ahead of our expectations. Our business delivered double-digit growth in operating income, which translated into record high earnings per share numbers and more than 20% EPS growth over the last year. Among our sales channels, second quarter comp sales grew 1.5% in our stores and 34% in our digital channels. Within our core merchandising categories, we saw more than a 5% comp growth in both apparel and essentials. This reflects the broad value we deliver across all of our categories and the balance we achieved between our more discretionary areas like apparel, home and beauty and our less discretionary Food and Beverage and essential categories, which delivered consistent traffic throughout the year. Beyond our frequency categories, throughout the year, we focused on important seasonal moments in our guests' lives and unique partnerships that create excitement and sustain our brand. At…

Thanks, Brian. This quarter provided further evidence of the payback we're realizing on the investments we've made over the last several years to transform our assets, our capabilities and our team. This work has created an operational model that can generate growth on both the top line and the bottom line as you saw in our second quarter results. One place where it's easy to see the impact of our new model is in digital fulfillment where the mix is moving dramatically towards our same-day services, in-store pickup, Drive-Up and Shipt. In the second quarter, these 3 services accounted for more than 1/3 of our digital sales, up from about 20% last year. In other words, our same-day options are growing much faster than our digital sales. Specifically, combined sales for in-store pickup, Drive-Up and Shipt have more than doubled over the last year, accounting for nearly 3/4 of Target's 34% digital comp in the second quarter. That means that nearly 1.5 percentage points of the company's overall comp growth was driven by our same-day services. These are remarkable statistics, and they demonstrate how rapidly our guests are learning about and embracing these new convenient options. For many guests, they are becoming the go-to choice for their digital shopping because they offer unique advantages. They're immediate. They allow guests to shop and receive their order on the same day. They're convenient. Guests can choose where they receive their order, either at the front of the store, in the parking lot or at home. They're fast. Our standard is for Drive-Up guests to receive their order in less than 2 minutes, and our average is comfortably better than the standard. And finally, these services provide certainty. Guests don't have to wonder when a package will arrive at their house and what…

Thanks, John. As Brian mentioned earlier, we continue to focus on ways to deepen the engagement of our guests across multiple facets of our merchandising assortment, in discretionary and frequency categories, our owned brands and national brands and different shopping occasions, including life events, holidays and everyday shopping trips. Of course, the most visible indication of our guest engagement is our traffic growth, which we continue to see across both our stores and digital channels. Engagement can also be seen in the market share data, which continues to show gains across multiple dimensions of our business. Between our core categories, second quarter growth was strongest in Essentials & Beauty and in apparel, both of which delivered comp increases above 5%. Results within Essentials & Beauty was strongest in baby, beauty and over-the-counter. Baby has been one of our strongest share stories for the last year, and we saw continued gains in the second quarter. Beauty has also been on an amazing run as we've seen accelerating share gains for well over a year. In apparel in the second quarter, we saw broad strength across a host of categories, including intimates and sleepwear, Jewelry, accessories and shoes, baby and performance activewear. We were particularly pleased to see such strong trends at Target despite unfavorable weather trends during the quarter and soft sales conditions for the overall industry. As a result, we saw some unusually strong share gains across multiple parts of the apparel assortment in the second quarter. Among the remaining core categories, both our Food and Beverage and home assortments saw low single-digit increases in comparable sales. In food, results were led by adult beverages, which delivered another quarter of double-digit growth. In home, results were led by décor. In Hardlines this quarter, comp sales were approximately flat overall. Results…

Thanks, Mark. As Brian mentioned, we saw outstanding financial performance in the second quarter as our business delivered sales growth that was in line with our expectations and bottom line results that were well above our expectations. Our comp sales growth of 3.4% on top of 6.5% last year put our 2-year stacked growth at about 10%, our best performance in more than a decade. Within our sales channels, stores comparable sales grew 1.5% and our comparable digital sales grew 34% on top of 41% growth a year ago. Among the drivers of total comp growth, we saw a 2.4% increase in traffic combined with a 0.9% increase in average ticket. We have long said that we are focused on driving traffic because it is a key indicator of Target's relevance with consumers. That's why we continue to be encouraged that traffic is growing both in our stores and our digital channels. And notably, this quarter, we were facing a really strong traffic comparison of 6.4% a year ago, meaning that our business just delivered the strongest 2-year traffic performance we've ever reported. On the gross margin line, second quarter performance exceeded our expectations as the rate expanded from 30.3% last year, up to 30.6% this year. This was the first time in nearly 3 years that we have seen a year-over-year increase in our gross margin rate. This performance reflected the ongoing work of our merchant team to optimize assortment, cost, pricing and promotions across all of our categories. In addition, we saw about 20 basis points of benefit from category sales mix, reflecting really strong apparel performance combined with a moderating growth rate in toys and baby. These tailwinds were partially offset by about 30 basis points of pressure from digital fulfillment and supply chain costs. Even though…

Thanks, Cathy. Before we move to your questions, I want to take a moment and acknowledge that my first Target earnings call was almost exactly 5 years ago today. And I think we all agree that Target has changed a lot in those 5 years. During that time, we exited our Canadian segment, allowing our teams to devote all their energy to our U.S. operations. We sold our pharmacy business to CVS, a transaction that's generated value for both companies. We rejuvenated our owned brand portfolio, launching dozens of new brands across multiple categories. We went from simply selling on a website to integrating digital within every part of our business, positioning our stores at the center of the most comprehensive suite of digital fulfillment options in the U.S. We opened about 100 small format stores, reaching new neighborhoods in dense urban areas and around college campuses. And we made significant changes to our team and how we work both at headquarters and our stores. When I came to Target, I got an inside look at why this company had such a strong reputation for hiring and developing talent. Target has a unique and outstanding team, and I am truly grateful for the opportunity to work with them. But what's most amazing is the patience and optimism that this team has shown over the last 5 years as we've handled some significant challenges together. That's why it's so rewarding to be able to share the amazing results that this team is delivering today. At the same time, we are focused on the need to stay hungry, see around corners and continually innovate and reinvent ourselves. The pace of change in our business doesn't look like it's poised to slow down anytime soon, but I'm confident this team will continue to lead Target and the industry, allowing us to deliver outstanding results both this year and well into the future. So with that, I want to thank you for your time today, and now we'll move on to your questions.

[Operator Instructions] Our first question comes from Chris Horvers with JPMorgan.

This was obviously a big quarter for investors. You lapped Toys "R" Us. You had a register a glitch on Father's Day weekend that some people pegged that 50 basis point headwind to comps, you had the weather. So can you give any -- shed any light on the sort of cadence of the quarter in light of the weather? How material was the Father's Day weekend glitch and the impact to comps? And then more broadly, the gains in apparel and continued gains in baby, what would you sort of rank order the big drivers that are allowing you to gain that share?

Yes. Chris, I'll start. And I think as we look at the quarter, we saw very consistent performance throughout the 13 weeks of the quarter. And as I've said several times now, there's not one element that we can point to. We saw a very good response from both sides of our portfolio, both our style side and our essentials. Mark called out the strength that we saw in categories like apparel, but also strength in those household essentials that drive traffic to our stores and more and more visits to our site. So it was a very balanced quarter, strength across our entire portfolio. And I think the team's been just very focused on executing our plans both from a store standpoint and a digital standpoint, so it all added up to a very solid quarter. We think we delivered quality results throughout the quarter that led to traffic gains, up 2.4%, very strong comps, market share gains in many of our core categories, and overall, obviously, delivered very strong bottom line performance. So I can't point to one specific element. I thought we saw consistent strength and great execution each and every day. And the investments we made in store remodels, the investments we're making in new small formats continue to perform very well. As we continue to scale and mature our suite of fulfillment options, the guest is reacting, honestly, very well to those options. We continue to see a great reaction to both our owned brands and our national brand performance. But I think our team was just focused on executing our plan each and every day, and I think it ended up with a very strong quarterly success.

And then as a follow-up, we're hearing a lot from the apparel set that inventories in the apparel world are bloated given some of the channel shifts that they experienced and some of the weather in the second quarter. Obviously, your inventory is flat year-over-year. But could you perhaps talk about how you look at the health of your inventory, particularly in the more seasonally sensitive areas? And frankly, given the momentum in the business, do you think that you're in a good enough in-stock position to hit your guidance expectations?

Chris, based on the health of our business right now and the momentum we have going into the back half, we feel very good about our inventory position. Obviously, the strength of our performance in categories like apparel speaks for itself. But I think as we prepare for these big seasonal moments, I think we feel like we're in a great position for Back-to-School and Back-to-College. I would actually say it's the strongest position we've had in years as we get ready for the peak of college. And as we get ready for Back-to-School to continue to surge over the next few weeks, I think we feel very good about our position. And I think it's actually the best inventory position we've had in years in both of those categories.

The next question comes from Kate McShane with Goldman Sachs.

The first question I had was just about the timing of the expenses that were called out and why they shifted. And Cathy, I wondered if you could quantify how much favorability the asset impairment and the shift of expenses out of the quarter into Q3 benefited Q2?

Yes. Happy to. So first off, the magnitude of the expenses, both in marketing and our stores, as you've seen already beginning in Q2, we've got some amazing plans in Q3. So we've shifted some expenses to support those plans. And it's probably in the 40 basis points range, maybe a little lower -- sorry, $40 million range and maybe a little bit lower going from Q2 into Q3. So that's what you're seeing in the SG&A line, reflected on the SG&A line. And then you asked about -- I'm sorry, your second question was?

Impairment.

Oh, the impairment. Year-over-year, we did see it reflects the strength of our business actually that we had very low to no -- very little impairments this year versus what we've seen in the previous year. And so that was actually pretty significant, and you'll see that in the Q as well.

Kate, I'm actually glad you called that out. Actually, we were talking prior to the call. While there's lots of highlights that we've already covered in the quarter, one of the things that stands out for me is the health of our assets and the performance of our stores. And I think that showed up in the change in asset impairment during the quarter.

That's great. And then just as a follow-up, I know the tariff situation is very fluid, but if List 4 were to come to fruition on December 15, is that something that impacts 2019? Or is it really a 2020 impact?

Yes. Again, well, we're watching this very carefully. And obviously, we know there's been a number of shifts over the last few weeks. As it sits right now, this is largely a 2020 issue. So we've had all the current tariffs built into our guidance and our plan for the balance of the year. Mark and his team have done a sensational job of scenario planning as we get ready for the balance of this year and going into 2020. But as it's stated today, the impact of List 4 would be something that we'd realize in the first quarter 2020.

The next question comes from Robbie Ohmes with Bank of America Merrill Lynch.

Congrats on a great quarter in a tricky environment out there. I was hoping to get some of you to talk more about the digital growth outlook. So digital came in I think well above what a lot of people were looking for. How should we think about that growth going forward? I think you guys had pegged it around 25% for the year. Can you do a lot better than that? And maybe an update on how many store pickup locations and Drive-Up locations you're at. Are you maybe accelerating that? And are more categories coming into pickup and Drive-Up, like fresh produce, et cetera? Just any help you can give us there would be great.

Robby, why don't we let John kind of walk through some of the highlights of our digital performance, which again was very strong during the quarter, up 34% on top of significant growth last year.

Yes. Robby, good question on the kind of the same-day fulfillment. We're really excited about what we continue to see there across pickup, Drive-Up and Shipt. About 3/4 of the digital growth was represented by same day. It's 1/3 of the business now and growing very, very quickly. So we're excited about that. Pickup is nationwide, and it has been nationwide for several years. Drive-Up is very close to being nationwide. We'll be largely done here as we get through third quarter. And your question about fresh is a good one, something we're working hard on, piloting here in the Twin Cities and looking to understand the operational needs there a little bit more as we get through the back half of this year, and then be back to tell you more about how we plan to scale that as we get into early next year. But I think when you put those 3 together, Drive-Up, pickup and Shipt, you've got a great offering that our guest is clearly responding to. They are our cheapest fulfillment methods, so most profitable for Target. They are our fastest. And we really see guest adoption taking off. So we're excited about the combination there.

Yes. So Robby, as we noted during our prepared remarks, they represent 1/3 of our fulfillment, and it's growing at a rate of 2x versus last year. And as we continue to build awareness through our marketing campaign, what we're doing from an in-store standpoint, our network standpoint as well as our digital communication to the guest, we're building awareness, and we're seeing continued growth in that space. So we'd expect those fulfillment channels, which obviously, are the most profitable way to fill digital orders, to continue to grow over the balance of the year.

And then I apologize if I missed it, but what number roughly or range should we be assuming for digital growth for the year?

Robbie, it's something that we do not provide guidance around. But what we said for a number of years now is we expect to outgrow the overall industry by at least a rate of 2x. And as you've seen recently, we've been growing at 3x the average rate of the digital growth in the industry.

The next question comes from Peter Benedict with Baird.

Maybe a question for John. Can you give us a little more color on the store operating model that was kind of rolled out here? Just curious any more detail you can give us on how the operations are changing either front end or back end? Just curious what you can add there.

Yes. This is a journey the store team has been on for several years and really around raising our level of service in the stores. The biggest change is around the actual operating model itself. Historically, we kind of had a jack-of-all-trades model. You'd be a cashier one day, go do price change, go do some planogram sets. Whatever we needed, you would do in general. Today, we've gotten far more specialized. So people in the food area actually can speak about perishable. They're doing the ordering. They're responsible for that area. They're responsible for the out of stocks. Same for beauty, they can talk to our guests about beauty. They're in that area all day long. It's the only area they work in. They're responsible for the inventory that sits in the backroom related to that area and keeping the floor full and interacting with our guests. In apparel, more style, right, digital merchandisings, people who can make the great products that the merchants are developing look great in the store. In electronics, lots of product information. So a significantly higher level of expertise across the store in the categories where we need it. And then across the rest of the store, places like essentials and some of the dry goods, just keep it full all day long. That's your job, keep the store full. And so we're excited about actually implementing that across the chain this quarter. The teams continue to work through that, but the early results are very positive.

That's great. That's helpful. And then maybe for Mark, there's been a number of owned brand introductions over the last year or 2, a very healthy pace. How do we think about that going forward? Does that continue? Or have you guys reached the point here where you've addressed the areas and you're going to just see how a lot of these kind of play out?

Yes, Peter, I think we addressed this last quarter as well. I mean we expect the rate of change in newness to abate, but still sustain a level of newness to create interest for our guests. I think one of the things we're most buoyed by out of this quarterly performance has been a high degree of owned brand launches specifically in our home areas last year, and we had really strong traffic in growth, yet we're anniversarying that yet another quarter. And I think it just goes to show the building blocks that these owned brands build for us in terms of preference to Target but also help us create sustainable growth and long-term value.

Yes. So Peter, you will expect to see the rate of new brand introductions slow. But Mark and his team are very focused on bringing newness and innovation to the owned brands that we've launched over the last couple of years. So we'll continue to make sure those brands are on trend. We bring newness and freshness to those brands that have been successfully launched over the next couple of year -- over the last couple of years. And Mark and his team are really excited about some of the innovation we'll bring to those lines in 2020 and beyond.

The next question comes from Greg Melich with Evercore ISI.

Really 2 areas I wanted to dig into a little bit. One is on tariffs. Just to clarify, it looks to us that for List 4 for you guys might be 80% of what you import or you would have seen some experience from Lists 1 to 3. Is that the right sort of mix, 80-20, is the List 4 versus the first list? And then I had a follow-up on digital.

Greg, why don't we follow up with you off-line? That number is overstated. We'll circle back. But as we've said before, we've got a very balanced portfolio. Our sourcing teams have been working to diversify our network for a number of years now. But we'll come back and try to address some of that off-line.

Okay. Fair enough. On the digital, I did want to understand a little bit more just given that strength of traffic, about the nature of the customer. I see REDcard has been sort of flat, but you're -- are you getting a higher spend per trip from people using same day? Is it existing customers coming more frequently? Are you finding new customers as a result of this?

Greg, one of the things that we've highlighted now for several quarters is the strength in our traffic growth. And Cathy talked about the fact that in this last quarter, it is a record-high 2-year stack for traffic growth. So we're seeing our Target guests visit us more frequently, shop more categories. They're enjoying the changes we've made and the store experience, but they're also taking advantage of the convenience fulfillment options that we're offering. So as we look at the profile of our guests, they're still shopping our stores on a regular basis. But now we also gave them the convenience of ordering online and picking up in their neighborhood store. In over now 1,550 locations, they can place an order and pull into our parking lot. We have Shipt shoppers that will deliver within a couple of hours to their home. So we're seeing traffic and interaction and engagement with our brand continue to grow. And I think it's that wonderful combination of a great store experience, the suite of fulfillment capabilities that we're now offering that's driving greater engagement and greater traffic and visits to our stores and to our site.

The next question comes from Chris Mandeville with Jefferies.

Just sticking with the digital conversation, since you've already referenced your performance versus expectation and gave us a little color right there from Greg's question, I guess, I was just kind of curious about how same-day specifically is contributing to the comp. It was roughly, I think, 50% last quarter, now over 80%. Is there any way of breaking down the service modalities between pickup, Drive-Up and Shipt and they're contributing there? And then, Cathy, how did the service models in aggregate influence the margin in the quarter?

Well, I think we've said during the prepared comments that we're seeing honestly exceptional growth in our lower-cost digital fulfillment options. And one of the things that John pointed out very clearly during our last financial community conference is, as we shift our fulfillment from upstream DCs to our stores, we see our costs go down by upwards of 40%. When it moves to one of our same-day options, pickup in store, Drive-Up or Shipt, we see a 90% reduction in that cost. So obviously, as we're seeing the acceleration of our same-day convenient options, more guests opting to order online and pickup or use Drive-Up or Shipt, we're seeing the benefits of that flowing through our P&L.

Yes. So I was going to add on, as we shared in the prepared remarks, we're seeing, because of that shift, almost half the pressure that we saw the same time a year ago on our gross margin. So we saw -- we showed 30 basis points of pressure for fulfillment and supply chain cost this quarter, and that's almost half of what it was last year. So we're seeing that movement and the adoption towards those same-day services are closer to the store.

I think it might be helpful, John, go back and talk about some of the things we're doing from a productivity standpoint and efficiency standpoint at the store level to make sure that as we fulfill those orders, we're driving even greater productivity and efficiency throughout our system.

Yes. I think the store teams have done an outstanding job of initially getting these services up and running and providing a great guest experience. That's the place to start always and that's what they did. I think since that time, as we've begun to roll -- I mean, we have rolled these out and scaled them, the stores have done a great job going back, process re-engineering, adding tools, adding technology to make all that easier and faster for our teams. And so we talked about just the pick for Order Pickup and Drive-Up is 30% more productive this year than it was. Across the entirety of ship-from-store, it is 30% more productive than it was. And the stores, we continue to work on additional ways to be more productive, add technology, potentially add some additional automation in the back of the house to help them become more productive. So while we love the shift to the same-day experience because that is net better economics, we're also working hard within each one of those services to optimize the unit economics. And so great progress by our stores team.

Our last question comes from Michael Lasser with UBS.

Could you unpack the gross margin commentary about merchandising efforts to optimize cost, pricing, promotions and assortment? And the reason why is because I think there are questions about the sustainability of those factors. It does seem like you're expecting those to continue to drive benefit given your commentary around gross margin in the third quarter.

Yes. I'll start and Mark can add on to it. So first off, we had a terrific performance across the board by our team. So our merchant team, from assortment to cost to price to promo, they managed the business throughout the entire quarter from the beginning of the quarter with vineyard vines through Back-to-School, Back-to-College with a cyber event in the middle. So amazing performance across the border -- across the board. And by the way, we've got tremendous plans for Q3 and Q4 as well. So I would tell you that they're sustainable type of efforts that we continue to do. And then we've got a little bit of favorable mix with the strength of the apparel and the apparel categories and a little softening of the growth of toys and baby as we've now anniversaried the Toys "R" Us and Babies "R" Us exits. And so the combination of those gave us that really strong performance in gross margin this quarter.

And Michael, I mean, clearly, our owned brand strategy is working, and the marginal contribution is a benefit there. But I think that the agility and strength that Jill Sando and team brought to the apparel business in the quarter to the inventory management, markdown management and sales and share gains is definitely one of the strong contributors in our mix. But overall, everyone pulled weight and we had a great quarter.

So Michael, it's probably a good place for me to wrap up and really complement Mark and his entire merchandising team for the work that they've done. Now we've been talking now for multiple years about the benefits of our multi-category portfolio, and I think we're seeing that play out each and every quarter. It was a couple of years ago when we talking about the investments we made to be priced right daily, and our guest is responding to that and that's certainly flowing through into gross margin. So I think the exceptional work that the team has done to strengthen all facets of our portfolio, both our style and essential categories; the strength we're seeing across our multi-category portfolio; certainly the market share gains we're seeing in important categories like apparel; and combining that with the everyday value we're offering to our guests, being priced right daily is contributing to the margin stability and improvement we're seeing in recent quarters. So compliments to Mark and the entire merchandising team for the work that they've done. But the guest is recognizing it, and I think again, it's contributing to the traffic gains we're seeing in our stores, like increased visits to our site and the flow through that we're seeing throughout our P&L. So it's a great way for us to wrap up this call. I appreciate everyone dialing in this morning, and we look forward to talking to you next quarter. So thank you.