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 18, 2021. 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 2021 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer; Christina Hennington, Chief Growth Officer; John Mulligan, Chief Operating Officer; and Michael Fiddelke, Chief Financial Officer. In a few moments, Brian, Christina, John and Michael will provide their perspective on our second quarter performance and our outlook and priorities for the third quarter and beyond. 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, Michael 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 most recently filed 10-K. 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 the first quarter and his perspective on our outlook. Brian?

Thanks, John, and good morning, everyone. Our second quarter performance showed that Target's leadership position is stronger than it's ever been, fueled by a one-of-a-kind strategy, resilient operations and a passionate, world-class team. As you know, we've been investing for years to build the durable model that's in place today, one that puts our guests first and leverages all of our assets and capabilities to serve their evolving wants and needs. After years of investment and effort in building this model, it's clear that we've only begun to scratch the surface of what's possible over time. In the second quarter, our business continued to perform and grow on both the top and bottom lines, even as we comped over record performance a year ago. Of course, seeing growth on top of growth is nothing new. Our business is already delivering consistent increases in sales and profitability in the years leading up to the pandemic. This was followed by a dramatic acceleration in 2020 and this year's continued growth. In the second quarter, Target's comparable sales increased 8.9% on top of a record 24.3% growth a year ago. As a result, second quarter total sales have expanded more than 36% or more than $6.6 billion over the last 2 years. On the bottom line, we earned second quarter adjusted EPS of $3.64, up nearly 8% compared with last year and double our performance 2 years ago. As we described last quarter, guests have emerged from a year in which digital was the primary growth driver, and they're now returning to our stores in droves. As a result, the majority of our second quarter growth was driven by the stores channel, where comps grew 8.7% on top of 10.9% a year ago. In addition, traffic accounted for more than 100% of our…

Thanks, Brian, and good morning, everyone. Our guests is at the forefront of every decision we make. By listening intently to them, anticipating their wants and needs and building our strategy around them, we can drive deeper engagement, trust and a stronger preference for Target over time. We built our same-day capabilities with that guest-first focus. And as we've shared before, when guests try services like Drive Up or Shipt for the first time, their overall spending increases, including an increase in conventional store shopping. In other words, digital engagement drives more engagement in our stores, providing us with more and more opportunities to surprise, delight and inspire them. This is one example of many showing how growth today creates a platform for additional growth in the future. And of course, we wouldn't be where we are today without the best team in retail. So I want to take a moment and thank our entire team for delivering superior performance in a continued volatile environment even as they face ongoing challenges presented by the Delta variant, product cost inflation, supply chain bottlenecks and more. Target's second quarter performance also demonstrates the strength and durability of our business model. Our unique, multi-category assortment offers the right balance of what our guests want and need even as they change, sometimes rapidly. As a result, despite record-setting growth last year, all 5 of our core merchandising categories grew again this year, proving that there's still plenty of runway ahead. Second quarter results were strongest in apparel, which delivered mid-teens growth on top of low double-digit growth last year. Within apparel, swim, kids and young contemporary all delivered comps in the low 20% range. Food & Beverage delivered low double-digit growth in the second quarter. Performance was led by our bakery, cafe and deli…

Thanks, Christina. As I've mentioned before, I'm an engineer by training. So it probably comes as no surprise that I'm naturally interested in machines and automation. And obviously, when our team works to optimize Target's operations, both for today and in the future, we have access to every available tool and technology, robotics, automation, machine learning, artificial intelligence and more. But when we choose to invest in technology, we're not looking to remove the human element from the Target experience. Instead, we're investing to enhance the productivity of our team members, freeing them up to focus on what's most important, like serving our guests. This is another example of the power of and how it runs through every part of our business. The choice doesn't have to be about people or technology. We can invest in both people and their productivity. Here's one way to think about it. In our 2015 annual report, we reported that Target had around 341,000 team members as we entered 2016, a year in which our business generated just over $69 billion in sales. 5 years later, our 2020 annual report showed that we had about 409,000 team members going into this year, representing about 20% growth in the number of team members over that 5-year period. However, based on our results so far and our expectations for the back half of the year, our business is positioned to deliver more than $100 billion in sales this year, representing growth of 45% or more compared with 5 years ago. So even as we've added nearly 70,000 people to our team, we've also benefited from a significant increase in their productivity, creating financial capacity to provide enhanced service for our guests and make significant investments in pay and benefits. And as Brian mentioned, our team has…

Thanks, John. After a record year in 2020, the theme of this year's performance has been growth on top of growth. Of course, we laid the groundwork for this year's growth through the investment decisions we were making years ago in our stores, owned brands, supply chain, technology and our team. And today, we continue to see a host of opportunities to invest in our future. That certainly includes the capital we're investing in support of our stores and supply chain and the investments we're making in our team, including recently announced team member bonuses and our new debt-free education assistance program. And while the return on team member investments isn't measured as a distinct line in our financial statements, they're the most important investments we make. Total sales grew 9.4% in the second quarter, driven by comp growth of 8.9%. Within the quarter, May saw the smallest increase this year, given that it was comping over a 33% increase a year ago. On a 2-year basis, results were much more consistent throughout the quarter, as we saw 2-year growth in excess of 30% across all 3 months. As Brian mentioned, with guests spending more time out of their homes, we've seen them shopping more often and making slightly smaller trips. Specifically, traffic grew 12.7% in the second quarter, partially offset by a 3.4% decline in average ticket. However, given that last year's comp growth was primarily driven by average ticket, on a 2-year basis, we've seen double-digit increases in both traffic and ticket since 2019. As Brian also mentioned, the store channel has been our primary growth driver this year. Specifically, store comparable sales grew 8.7% in the second quarter. And given that store comps increased 10.9% last year, we've seen compounded growth of our in-store sales of more…

Thanks, Michael. Before we move to your questions, I want to pick up on Michael's last point, which is the way we've been able to synchronize every aspect of our strategy. A few years ago, we embarked on a project to better articulate our company purpose. Across our team, there was already a strong sense of who we are and what we stand for, but we wanted to put it into words distinctly. Out of that work came the purpose we articulate today: to help all families discover the joy of everyday life. Those words have deep meaning for our team: families, discovery, joy and the word all, which represents our strong commitment to inclusion across every aspect of our business. Some might ask if everyone at Target already had a strong sense of purpose, why go to the trouble of putting it into words? The answer is the alignment that it creates, alignment of our strategy and alignment of our team. In the same way we had a focus on what really matters most in our articulation of our purpose, we're relying on that purpose to focus both our strategic work and our everyday activities. If we find ourselves working on something that doesn't advance our purpose, we can set it aside and relentlessly focus on the things that will move Target forward. That kind of focus has enabled the performance we're reporting today, and it's behind all of our investments, strategies and activities as we look ahead. With that, let's move to Q&A. Christina, John, Michael and I will be happy to take your questions.

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

Two questions. My first question is, can you talk about what you're seeing in back-to-school so far? Are you seeing any effect from Delta on purchasing patterns? And how are you thinking about growth in the different categories as you move forward relative to the second quarter?

Chris, we're off to a really strong back-to-school start, and it is broad-based right now. Christina and Michael, John and I were out in stores yesterday, and we were seeing guests shopping our entire back-to-school assortment. I think we've got a great assortment at a tremendous value, and we're off to a really strong back-to-school and back-to-college season.

Got it. And then a follow-up, Mike, on the gross margin. Can you talk about how you're thinking about the gross margin in the back half overall? And within that, what are the puts and takes? Does that -- do the product and freight headwinds persist or perhaps elevate? And to what degree are you assuming higher clearance and promotion levels to drive the 8% or more operating margin outlook?

Yes. Chris, you've heard us talk over time about all the levers we have within the business to offset some of those puts and takes. And I think the second quarter is a really good example of that. If you take out the sales return adjustment in last year's actuals, margins were essentially flat year-over-year. And so we found some good offsets there and feel really good about our profit performance. I actually think that same theme comes through loud and clear if we zoom out a little bit and look at a longer time period. If you go back to first half of this year versus first half of 2019, 2019 gross margin rate was 30.1% for the Q1 and Q2 season. We're sitting at 30.4% right now in Q2 and 30.2% for the spring. And so a lot's happened over the last 2 years, and we feel really good about our ability to manage the profitability of the business. And I think that bodes well for the back half of this year and beyond.

The next question is from Paul Lejuez with Citi.

Two quick ones. Just curious on the inflation front, if you can maybe talk about the cost pressures that you're seeing in the food grocery category versus general merchandise, any quantification that you might be able to provide. And also wanted to go back to private label performance. You mentioned it grew faster in 2Q. Curious what sort of the gross margin tailwind that provided. And how do you see private label performance playing out in the second half? Is that going to be a continued gross margin driver for you?

Well, let's have Christina talk about the strength we're seeing in our owned brand performance and how we're managing costs in this environment.

I'd be happy to take that one. Let's start with owned brands. As you know, owned brands are a huge part of our strategic imperative and desire to continue to differentiate in the market, bring great quality products to our guests. And so our commitment is to continue to accelerate our owned brands at a faster rate than our base, and that is what exactly what we saw in the second quarter. That's the pattern we've been on. And as long as we continue to find unique opportunities to meet the guests' needs, that's going to persist. And so you also know that owned brands represent a big portion of our sales mix, but even a bigger portion of our gross margin. So that creates tailwind for us on the profit side. And then going back to your first question on costs, yes, we're seeing cost pressures on product costs as well as freight. But going back to Michael's point, this is what we do every day. We manage the profitability of the business by leveraging the full suite of levers that we have to offer great value to our guests while delivering on the financial expectations you have.

The next question is from Karen Short with Barclays.

So I wanted to just ask, you look at your sales productivity, you're up more than 40% on a sales per square foot basis since 2017. So I guess what I'm wondering is, with this higher productivity, how should we think about kind of the long-term margin structure? Or maybe said a little differently, would you look to lean into investments going forward? Or could we expect a little more sustainability in terms of the higher operating margin structure?

If I step back from your question a little bit, Karen, at the end of the day, growth powers so much of our margin equation. And that's why we're so focused on investments that drive growth. And you can certainly see that in the improved productivity. That comes to bear. And the math we do on new stores, that comes to bear for how we adjust our store footprint in a remodel. And so you'll see us consistently focused on investments that drive growth. With that growth comes good productivity on a per square foot basis, and we can translate that growth to good bottom line profit.

Karen, Michael summarized it well. I mean our theme for this quarter was growth on top of growth. But you should expect that theme to continue going forward. We're going to continue to invest in our stores. John talked about the remodel plans that we have in place. We'll continue to invest in new, highly productive stores, invest in our brands, invest in our fulfillment services and invest in our team. And our focus on continuing to drive consistent growth and market share expansion quarter after quarter will be a theme you'll hear for years to come.

Okay. And then just you also commented on the 70 basis points of gross margin pressure from higher product and freight costs. On the product front, can you maybe just give a little color on what you're seeing on the cost inflation versus the retail inflation? And are you absorbing some of that cost inflation?

Yes. I think Christina said it well, our teams are experts at managing the puts and takes across the business. So if we rewind the clock a couple of years ago, we'll be talking about tariffs and how we offset that. And I feel really good about how our teams manage any complexity in the business. To underscore something Christina also said, value matters, and we'll be laser-focused on making sure our guests find incredible value on our site and in our stores. And so we've done a lot of hard work to invest in solid price perception. And we want to make sure that our guests continue to find that value going forward, inflation or not.

The next question is from Scott Mushkin with R5 Capital.

I guess the first one I have is, obviously, you're holding a lot of cash on your balance sheet. You guys talked about the new share repurchase. But what is the ideal level of cash for you guys to hold? And what do you do with what you got now, I guess, in more of the short term?

Yes. Well, the answer to that question, priority 1 has been and always will be invest in the business. And continuing to invest to drive growth is the first use of that cash. Our second capital priority is to support the dividend. We announced just last month a north of 30% increase in our per share dividend. And we have the good fortune of a business that continues to generate a lot of cash as we grow. And so that gives us capacity for share repurchase as well. Over time, you'll see us carry less cash than that $7.4 billion we have today to be sure. Optimal and normal times, it's something closer to flat to a little north of that cash on the balance sheet, depending on the period of the year we're in. But we want to be prudent about how we kind of step back into the sweet spot of our middle A credit ratings.

Okay. Great. And then my second question is really, I guess, more strategic over the next 12 to 18 months. Brian, I think you went over just what tremendous work the team has done. But if you step back and look at the next 12 to 18 months, what are the biggest, I guess, initiatives going forward that would drive outsized growth, that market share gain compared to competitors?

Scott, It will be a very familiar theme to you. We're going to continue to invest in remodeling our stores. And despite the progress we've made, and we've remodeled just about half our stores today. So you'll continue to see us invest in remodels. We've got a very strong pipeline of new stores that we'll be rolling out over the next few years. We'll continue to invest in our brands and our owned brand performance. You'll continue to see us continue to invest in Drive Up and pickup and the expansion of Shipt. And we'll continue to invest in our team, again, all built around that thematic of growth. And as we think about the key metrics going forward, you'll hear us talk about traffic, and we felt exceptionally good this quarter about driving traffic growth of almost 13%, continue to drive strong comps in both our stores and digital channels. And we'll continue to make sure we always are laser-focused on market share gains. So those themes will be very consistent going forward. The investments we make in our stores, our brands, our fulfillment channels and our team will continue to drive traffic to our stores and visits to our site, continue to drive strong comps that equate to market share gains across our entire portfolio. So that's our continued commitment for not just the next few quarters but for years to come.

Perfect. And what a tremendous job you guys have done.

The next question is from Michael Lasser with UBS.

Target continues to see outsized gains in traffic. Over the last 90 days, has there been any change in the nature of the pattern of traffic, more weekly traffic versus weekend, especially as consumers go out and travel and do other activities? And how are you expecting your traffic to unfold over the next couple of quarters as you guide to high single digits for the back half of the year?

Michael, maybe I can jump in on this one. Traffic has been very consistent, and it's been consistently strong. And we're very excited about the early momentum in back-to-school and back-to-college as well. What I would tell you is that the strength of our portfolio allows us to flex between patterns in consumer behavior changes that are more at the micro level, not at the aggregate level. The aggregate has been consistent and healthy. But there are behavior changes within businesses. We've talked about the fact that last year, there was a bigger need for household essentials and people were stocking up. Now we're seeing less of that, and we're seeing more the return to going out. And therefore, they're wearing dresses and beauty products, and luggage business has been very strong. So there are patterns underneath, but the macro and aggregate is that Target is outpacing the industry. And it's really led by broad-based strength across all of our businesses.

And Michael, I would just come back to -- I know there's been lots of questions about the impact of the Delta variant. And we watch this very carefully. We're obviously very focused on safety. But we continue to see a very optimistic consumer, certainly shopping with caution and they're wearing masks more and more across the country. But we're seeing tremendous resilience in the consumer today. And our traffic patterns, I think, represent that, as we see this consistent flow of traffic into our stores. So a very resilient consumer. And we're seeing that as we start the third quarter. That traffic pattern and that resilience is continuing.

My follow-up question is, after 1.5 years past the start of the pandemic, you've comped the comp, you've seen really sizable returns on the investments that you've made and you've entered into a stable operating rhythm. So why wouldn't Target now be able to sustain at least an 8% operating margin over the long run? Is there something unique about this current environment such as a low level of promotional activity that might return in the future that would weigh on Target's profitability?

Yes. So Michael, there's always something unique in the environment. I can't remember one of these calls where there wasn't a specific good guy or bad guy on the margin line we weren't talking about. And so I think what matters most is our ability to put together a P&L that hangs together great, and that always starts with sales growth. And so while we aren't in a position today to share a new algorithm, go forward, we'll be centered on continued sales growth and continued market share gains. And with those, I'm confident in our team's ability to put together a P&L that translates into a bottom line we'll all feel good about.

The next question is from Edward Yruma with KeyBanc Capital Markets.

I guess, first, just to click down a little bit on the ship-to-home that you said was negative, was that just a symptom of kind of tough compares and the decision with consumers see that same-day digital services? And then I guess as a broader question between the really strong growth you've had in Target Circle and your digital businesses, you have a lot more data on your consumer today. I guess how are you acting on that on a real-time basis? And kind of what have you learned?

Ed, this is John. On the ship-to-home, I think you hit right on it, there's really 2 things going on. Just tremendous growth last year in ship-to-home at -- particularly early in the second quarter last year. So very, very strong growth, and we're just comping over that. I think the second thing, and probably more importantly, is the continued growth in our same-day services, tremendous growth in Shipt, in Order Pickup and Drive Up. And the growth in Drive Up is truly remarkable, but the one I like to look at is Order Pickup. We started that 6 years ago, and it continues to grow meaningfully quarter after quarter, year after year after year. So all 3 of those are acting incrementally each year and not taking business away from each other. And as you know, the thing we love about that, it's great service for our guests. They're our highest-rated services. Drive Up is the single highest-rated service we have. But also for us, it's fast and very, very efficient. And we love the margin that comes along with those products. So as we've grown our digital businesses over the last several years, and in particular over the last 18 months, the same-day services have grown significantly faster, and that's good margin for our digital business.

And Ed, I can jump in on the Target Circle component. As you accurately reflected in your question, it's been a great program for us, and we're up to over 100 million members in Target Circle, 100 million. It's quite substantial. And what primarily this is about is obviously making sure that we are more relevant to our consumer in giving them great deals, more personalized offers and relevancy that they appreciate. And so as an example, in the second quarter, guests benefited from $70 million of savings from the 1% earnings on purchases plus another $600 million worth of savings from the promotional offers. So in our commitment to offer affordability, accessibility, Target Circle is just another amazing proof point that we'll keep building on.

The next question is from Steph Wissink with Jefferies.

Congratulations on the results. My question is about the second half OpEx, and just trying to bridge your comments on operating margin for the year to the second half plans on a year-over-year basis. And I think, Christina, you might have mentioned that marketing as a focus for the back half. Maybe talk a little bit about how much you spend on emphasizing your same-day services versus how you plan to communicate to the consumer your value message in some of your key categories of emphasis.

Steph, I might start. I think you've actually answered the question for us. You'll see us balance our messaging in the holidays around obviously, affordability, great value. We'll certainly emphasize our same-day services, and we know how important they'll be for the guests during that holiday season, and the strength of our multi-category assortment. So it will be a very steady stream of great product news, great service news and will underscore value.

And does that conclude your questions?

I did have one follow-up. I'm just trying to understand the OpEx spend for the back half. Could you just give us some context around, is that the step-up in marketing is what we're seeing in terms of the year-over-year offset versus prior year? Is there something else happening in operating expenses if gross margins are going to be flat, but operating margins are going to be down a bit to the prior year?

Yes. We aren't getting into the specifics for gross margin or SG&A. It's all wrapped into our expectation for that OpEx line on the year. And similar to the second quarter, I expect you'll see some puts and takes. I mean one of the things we're excited about in Q2 is to get back to a more normalized level of marketing spend because we kind of had to put our foot on the hose last year as we changed course in the early stages of the pandemic. And so we feel good about returning to what I view as a really healthy level of marketing investment that should power growth in the back half of the year.

The next question is from Robby Ohmes with Bank of America.

I was hoping you could comment on how much more items you have to go to add to Drive Up. So I think you guys said 5,000 items were added in 2Q. How much more is there to go on Drive Up that can kind of keep driving that super growth of that business? And then kind of related to that, grocery, you added a lot of fresh items on Drive Up. Did you add a lot of fresh items in general to the grocery mix? And maybe can you speak to how much further Target can go on grocery? I know historically you've said you're not really a full grocery destination. But are you moving towards adding enough items to be more of a full grocery shop?

Robby, first on the Drive Up question, I think there's 2 things there that really are driving growth. First is category expansion, like you said. And we continue to work our way through the through the categories there. There's work for us to do. We'd like to add things like clearance to Drive Up. And we'd like to add returns to Drive Up. And so I think there's a lot further we can go there from a category or product perspective. The other side is just improving the service itself, and you'll see us continue to do that. We added more Drive Up locations. We're adding canopies to help with the weather. We added numbered parking lots so that we can find your black SUV among the 12 black SUVs that sit out in our parking lot waiting for Drive Up at any given time. And we added substitutions. And we added the ability to add another driver to come do your pickup order for you. So I think you'll see us continue to innovate the service as well. So we see a long runway for us to continue to improve driveway (sic) [ Drive Up ]. And at the core of that, of course, is continued high execution from our store teams which leads to very, very high NPS scores that we see in Drive Up. And Christina, I'll let you talk about the food assortment.

Yes. The Food & Beverage business has been a real source of strength for us and continues to do exceptionally well, including our owned brands that we have launched. Good & Gather and Favorite Day are growing because they're just so relevant. They taste delicious. They look great. They're across the whole portfolio, and guests are finding them easily amongst the assortment. On your question about, is the assortment expanding? Or is it really the expansion on to Drive Up. The assortment is always going to be a curated point of view. But when a guest starts in the digital experience rather than the physical experience, there is much more understanding of who we are, and they quickly are converting because of that convenience in Drive Up to Target Food & Beverage. And I think you will see a lot of upside in the future from the success that we've built over the last several years in this business.

Our last question is from Kelly Bania with BMO Capital.

Just wanted to ask another question about EBIT margins clearly coming in higher than expected for the year. But just looking at the first half of 9.8%, it suggests something in the low to mid-6% range for the second half. And I realized Target's typical cadence is for lower EBIT margins in the second half, but this seems -- the magnitude of this deceleration seems to be about twice as much as the historical pattern. So just trying to get a sense of conservatism or costs in the back half. You called out the marketing expense, or just what you're planning for promotional activity in the back half. Maybe any color you could help with that.

You're right, Kelly, there's some seasonality to how profit flows through our P&L quarter-by-quarter, spring versus fall. We feel really good about the back half of the year and the growth we expect to deliver, and we think that yields 8% or north-of-there operating margins for the year. And so while getting too precise on any specific line, I think, would be an exercise in imprecision right now, we're really confident we'll be able to put that all together for a profit rate in the back half of the year that we feel good about.

Well, operator, that concludes our second quarter call. Thank you for joining us today. Enjoy the rest of the summer, and we look forward to talking to you later in the year. Thank you.