Ladies and gentlemen, thank you for standing by. Welcome to Target Corporation's second quarter earnings release conference call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, August 17, 2022. 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 2022 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 minutes, Brian Christina, John and Michael will provide their perspective on our second quarter performance and our outlook and priorities for the remainder of the year. 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 quarter and his perspective on the back half of the year. Brian?

Thanks, John, and good morning, everyone. Back in June, we announced that our team would be undertaking a bold effort to rightsize our inventory position in the categories through which demand patterns have rapidly changed. While this decision had a meaningful short-term impact on our financial results, we strongly believe it was the best path forward. Consider the alternative: we could have held on to excess inventory and attempted to deal with it slowly, over multiple quarters or even years. While that might have reduced the near-term financial impact, it would have held back our business over time. Of course, this decision would have driven incremental costs to store and manage the excess inventory over a longer period. But much more importantly, it would have degraded the guest experience. It would have cluttered our sales force and hampered our ability to present new, fresh and fashionable items, the ones our guests expect from Target. Just as importantly, the extra inventory would have presented an ongoing burden to our supply chain and store teams, as they face the distraction of working around it day after day. Instead of taking that passive position, our team chose a more decisive path, aggressively reducing the inventory we already owned and cutting back on receipts for the back half of the year. And today, with those decisions behind us, we're in a much better position as we head into the fall season. As you'll hear in more detail, we've meaningfully reduced our ownership and commitments in categories where we've seen softening demand. This has allowed us to strengthen our inventory position and in-stock position in the categories that are driving our growth, most notably in Food & Beverage, Beauty and Essentials. Regarding the financial impact of those decisions, Michael will provide more details in a…

Thanks, Brian, and good morning, everyone. Despite the tough environment we are facing today, I continue to be pleased with both our top line performance and the underlying market share we're seeing across our business: namely, across all 5 of our core merchandising categories. We saw unit share gains in the second quarter, providing clear evidence that our guests are finding more and more ways to satisfy their wants and needs with every Target Run. As Brian mentioned earlier, the inventory actions we announced in June involved incredible collaboration across teams at headquarters, stores and throughout our supply chain network. And I'm proud to say that together as one team, we accomplished what we set out to do. By moving through excess units, we were able to realign our broader inventory portfolio to those categories our guests are most focused on, including frequency categories like Food & Beverage, Everyday Essentials and Beauty as well as all things new, seasonal and fashion-forward. To accomplish that goal, teams analyzed and built action plans to aggressively work through excess inventory at every point along the product journey, from vendor to guests. This included rigorously reforecasting expectations for the balance of the year and beyond and determining where to reduce future receipts and orders. In some cases, they meant working with vendor partners to reduce our fall receipts in light of our updated expectations. It also meant quickly building compelling promotional plans to drive unit velocity for product we already owned, all with a focus on providing great value and generating excitement for our guests. And throughout the execution of these action plans, our teams remain steadfast in their guests-first focus, refusing to compromise the shopping experience in our stores or online. As you heard from Brian, the short-term profit implications of these decisions…

Thanks, Christina. In past calls, I've described how our operations team is always focused on two things at the same time. Of course, they're always focused on short-term execution and problem-solving to ensure we provide a convenient, consistent and inspiring experience for our guests. In addition, our team works every day to deliver on our long-term vision and aspirations, ensuring our operations are ready to support our future plans. While this dual focus on both near-term and long-term priorities has always been present, it's been especially notable this year, given that we've been operating in a very unique environment. In terms of the short term, and as Brian and Christina mentioned earlier, our work to quickly rightsize inventory require determination, commitment and coordination between multiple teams across the company. And given the need to protect the guest experience, there was no higher priority than delivering against this near-term plan. At the same time, our team remains passionately focused on the long-term investments we're making in our future. These investments include our work to modernize and expand our store footprint, increase upstream capacity in our supply chain, automate distribution center processes to reduce store workload and enhance our last-mile fulfillment capabilities by opening sortation centers and integrating them into our Shipt network. And fortunately, as Brian highlighted, the strength of our business allows us to continue funding these long-term investments even in the face of the challenging external backdrop we're facing today. I want to first turn to our work on inventory. And I'm happy to report that our team has made remarkable progress over the last few months, causing conditions in our supply chain to improve significantly. More specifically, and to provide some helpful context, over time, we want to keep our DC network operating at or below 85% of…

Thanks, John. As John mentioned, we often ask our team to be mindful of both short-term and long-term considerations when making decisions. And given the unique circumstances we've been facing, this quarter, we faced a decision with meaningful implications for both. As Brian outlined earlier, if we had decided not to deal with our excess inventory head-on, we could have avoided some short-term pain on the profit line, but that would have hampered our longer-term potential. Instead, because of the path we took, our quarterly profit took a meaningful step-down, but our future path is brighter. Our operations are healthy, our store and DC teams have more flexibility to maneuver and we're ready to feature both the fresh assortment and uncluttered shopping experience our guests expect and deserve. That passionate commitment to the guest experience is one of the many reasons we've now seen 21 consecutive quarters of comparable sales growth. While normally our income statement gets the most attention, I want to start my remarks today with the balance sheet and specifically, our inventory position. And as I dig into the detail, I want to acknowledge upfront that this kind of analysis is a relatively complex exercise because of the growth and volatility we've experienced over the last couple of years, because of the broad and diverse assortment that we sell and the fact that our business is seasonal from quarter-to-quarter. More specifically, given that our inventory position throughout the pandemic was far from optimal, focusing on year-over-year growth numbers isn't very helpful right now. As a result, we often base our inventory analysis on growth trends compared with 2019, a pre-pandemic year when our inventory and sales trends were much more in sync. With that as context, I want to zero in on one of the questions I'm…

Thanks, Michael. I often tell my team that leadership and performance are tightly linked over time, but that leadership often appears first. That's why I'm extremely proud of the leadership our team showed in the second quarter. After they took a hard look at our owned inventory position and the amount that was building up across our industry, they opted to make the hard choice: get in front of the problem and address it head-on. They made that decision with the full knowledge it would have a profound impact on our near-term profitability. They also knew there was another path. We could have avoided attacking the problem and avoid some of the pain in the short run. But instead, our team chose to lead. They knew the best path for our guests and for our teams in our stores and distribution centers was to take action and improve the condition of our inventory and operations quickly. That path would allow the entire Target team to move ahead without facing the ongoing burden of excess inventory holding us back. So the team quickly developed the [ bolder ] plan, which we announced in early June, just over 2 months ago. And in the intervening weeks, teams across the company worked tirelessly to take the plan and make it a reality. That's the reason we're positioned to deliver a strong improvement in our profitability this fall despite an environment that's far from ideal. Because of our team's leadership, our business today is much better positioned to perform, and I couldn't be more proud and grateful for the courage they have shown. So with that, I want to thank you for listening into our call today. And now Christina, John, Michael and I will be happy to take your questions.

[Operator Instructions] We're now ready with our first question from Christopher Horvers with JPMorgan.

You talked about an encouraging start to back-to-school. Can you talk about what you've seen in July and August? A lot of retailers like you have talked about improving trends. So what does that mean for how you're thinking about the back half comps? And does that reflect the current trend in the business, as you said in the guidance? Because I guess the question we have is, is the risk -- how did you incorporate the risk that the bounce in trend that you're seeing now is just that episodic event-type spending that you've been highlighting all year?

Chris, thanks for joining us this morning. I'll let Christina talk about some of the back-to-school and back-to-college trends and Michael to build on guidance. But before we start, based on the length of our prepared comments, we are going to ask for some additional time for Q&A. So operator, we're going to extend the time for this call to make sure we cover as many questions as possible. Christina, do you want to start by talking about some of the back-to-school and back-to-college trends we're seeing?

Yes. As I shared earlier in my prepared remarks, we're optimistic about what back-to-school and back-to-college mean. This -- during seasonal times is when Target really shines, the reason being that our multi-category portfolio makes us even more relevant, the opportunity to buy kids uniform, backpacks, the school -- the lunch kit and everything that goes in it and, of course, all the supplies. And so they've always -- seasonal moments have always been a good proxy for the strength of the total portfolio. And so as we're seeing good early trends, albeit there's a lot of business left to be done, we believe that, that is a good indicator of the strength of the potential for the fall. The other thing to look at, of course, is how we have performed to date, and our traffic and unit share growth that we've seen across the portfolio holistically gives us confidence in the guest choice of Target as their retailer of preference.

Chris, I'll let Michael talk about guidance. But one of the things that really stands out for me as I look at our position today, is that continued strength in traffic and the growth we're seeing in units across our entire portfolio. I'd also recognize, based on the actions we've taken with our inventory position, if you walk our stores today, it is clear that we are prepared for back-to-school and back-to-college, and we're really standing tall in those categories. Mike, do we want to talk about the guidance?

Yes. And I'll build off the comment you just made, Brian. When we look at the quarter, Chris, a lot of the trends we see in Q2 are informing our view of the back half of the year. And I think Q2 is a pretty good proxy for some of those top line assumptions that we have in the back part of the year. The consistency of traffic for the year across the months of the quarter, I think that's the thing that we look at really closely that gives us a lot of evidence that even as shopping habits have changed and category trends have changed, we've seen a consistent draw to more and more shoppers shop in our stores and shopping us online. And that consistency of traffic is the thing that gives me lot of optimism as I look to the back half of the year even if we can't sit here today and predict every twist and turn.

Chris, I'll add one final point. As we talk to our guests, when we talk to consumers, while there's certainly a cautionary environment in front of us, but one thing that seems to be very consistent is a guest and consumer who says they want to celebrate the holiday seasons. So we certainly expect that they are going to be celebrating Halloween this year and actively trick-or-treating and hosting parties with friends and family. We know they're looking forward to Thanksgiving, and they're going to look forward to celebrating the Christmas holidays. And that comes out each and every week as we survey consumers and talk to our guests. So that gives us great optimism for our ability to perform during these key holiday seasons.

Got it. And so my follow-up is just, Michael, you talked about the phasing of the operating margin. So the interpretation is that the fourth quarter is going to look a lot more consistent with what you did last year, maybe a little bit below. So the third quarter comes in well below that 6% -- around 6%.

Yes. You -- as I said in my remarks, I expect to -- we sit here today, expecting a fourth quarter, it looks more like the fourth quarter we've seen in the last couple of years. And so I think that's a 6.8% last year and a 6.5% the year before that. That's the right range around which we set our expectations for the fourth quarter. And obviously, to get to a 6% in total, that implies a lower number in the third quarter. And the driver there is, like I talked about in remarks, some of the costs of our inventory actions do spill over into the third quarter. And we'll continue to manage the elevated fuel and freight costs and kind of how those net against pricing action and things like that over the balance of the year. But we feel good about that range, around 6%, and we'll continue to watch the macro environment really closely.

The next question is from Edward Yruma with Piper Sandler.

Two from me. I guess first, on the variance relative to your previous expectations in terms of the inventory actions, were there specific areas where you had to cut deeper or cost more to get out of inventory positions? And then as a broader question, one of your peers talked about some changes they're seeing in their customer base. I guess are there any noteworthy changes that you're seeing? Are there customers trading down or trading into Target?

And I'll start, and then I'll turn it over to John to talk about some of the inventory actions, but I really want to start by recognizing our team. I think as we sit here today, over the last few weeks since our announcement in June, this has been a collaborative effort, and the team has accomplished so much to put us in the right place as we get ready for the back half of the year. So based on the work that the teams have done across our supply chain system, in merchandising, in finance and supply chain, in stores, the team has accomplished more than we expected in a short period of time and put us in a better position from an inventory standpoint than we might have expected back in June.

Yes. Ed, I'll just add on it. I think largely, we're on track with what we thought at the -- when we came out with the announcement earlier in Q2. A little bit of it cost us a little bit more in promos or clearance to move some inventory. But I think the work the team did in a very short amount of time to size what we needed to take care of is largely in line with where we are today, and we feel really good about where we're at. As Michael said, a little bit spilled over into Q3, and that's really just timing more than anything else. We just didn't get to it. But the work that's been done, we're really proud of. And I would say, from my position, we did exactly what we set out to do. We got rid of the inventory we needed to, the operations are in a much better place. There's a little bit more to do here in Q3 that will clean up. And I think the one thing I'd add on that I don't want to get lost is the amount of receipts that were cut from discretionary categories in Q3 and Q4, and that is just huge for us, again, because of the uncertainty in those particular categories. And if sales end up a little bit higher, we'll have a little bit higher sell-through, and that will be a great day. But that really derisks those categories going forward. So we feel great about the work that's been done over the past few months.

And Ed, maybe I can add a little bit to the question about the customer. As I shared in my prepared remarks, our guest is still demonstrating that they have spending power. The choices that they're making to balance their budget is what we're watching. And so obviously, we're moderating our investment in some of those discretionary businesses, and we're leaning very much into Food & Beverage, Essentials, Beauty, but also select portions of the portfolio and discretionary that have stayed resilient, whether it's toys, luggage, seasonal moments, fashion-forward apparel. And so it's really about reading the guests listening to them and continuing to support a level of agility in the business model. And in terms of other choices that they're making, I think traffic and unit share are the best barometer for their investment in Target. We're still growing traffic, and we're growing unit share in every major category, which to me says that our relevance is high with the guests right now and they're managing their budgets as best fit and they're finding options at Target.

Our next question is from Steph Wissink with Jefferies.

Just wanted to ask a follow-up question on pricing for the back half. Just give us some sense of how you're thinking about promotionality. I think you've mentioned in your prepared remarks that consumers were responding to some of the promotions you were putting out. So just give us a sense of what you factored into the guidance in terms of heightened levels of promotions.

Thanks for the question, Steph. I mean we always know as we get to the back half of the year, it's a promotional environment. The holidays always are, and so we factored that in accordingly. And we see a consumer in the current inflationary environment that's focused on value. And like we've said many times in these calls, we think about pricing first through the lens of our guests. We want to make sure the guests can find great value on shelf, online and the way that we're priced and we feel good about where we've struck that value equation. And I think the traffic we're seeing speaks to the fact that guests see it, too.

And Steph, I'd only add that Christina and her team have done a wonderful job as we plan for the back half of the year, of ensuring that we have great value for our guests but also that we have exciting newness. And I think that combination is a winning formula for us as we think about the back half of the year.

Our next question is from Michael Lasser with UBS.

My first question is how much did the clearance and promotional activity contribute to the C-store sales growth in the first -- in the second quarter? And if you do see more downside than upside risk to the guidance for the back half of the year, why didn't you just moderate the guidance a little lower for the back half?

Sure, Michael. Thanks for the question. While the kind of counterfactual with every elasticity of where Q2 would have landed, it is a little bit of more art than science. We think that the net dollar impact of our markdowns is probably negligible all in, in the second quarter. And of course, we took some markdowns to move through some product, but we think that probably net-net, that didn't move our top line comp a lot. As we think about the back half of the year, we're informing the back half based on the trends that we're seeing now in the business. And as we've talked about, some of those trends that we saw change at the end of Q1, we've seen persist into Q2, and we factored that in to our thinking for the back half of the year. We'll continue to be mindful of what's clearly in an uncertain environment for the economy and the consumer. And to the point Christina made earlier in Q&A, we'll stay close to those trends, and we'll adjust accordingly. And that's why taking the inventory actions we did to give us some room to operate and to give us some flexibility in the system will be important in an uncertain environment.

Okay. My follow-up question is there's obviously a lot of moving pieces with what's happening at Target right now. But isn't a lot of this just transitional and setting the set stage to grow better 2023 really somewhat independent of the macro environment? So with that being said, could you size the impact to your margins from all the inventory actions that you're taking this quarter, next quarter that are temporary and will be isolated to this year and won't repeat next year? Can you give us a better sense of what the ongoing profitability of the business is?

Michael, I'll start by saying, I think your summary really captures the actions we've been taking today really to make sure that we continue to build on the traffic we're seeing in our stores and the visits to our site, the strength we're seeing in unit market share gains; but importantly, the investments we made to ensure we have a great guest experience in the back half of the year and going into 2023. So the bold, decisive actions were really to make sure we continue to build on our current momentum, the great relationship we have with our guests, the momentum we're building from a market share standpoint and providing our guests with a great Target experience every time they shop. That will continue and set us up well for 2023. As far as sizing it, we'll certainly come back to all of you as we think about guidance for next year, but we certainly expect to see a more normalized environment from an operating profit standpoint as we move into 2023 and continue to build on the momentum and the investments we've been making in our business for years.

The next question is from Simeon Gutman with Morgan Stanley.

Following up on actually Michael's question, is there any way you can quantify some of the structurally higher costs in labor in the DC? Just as a way to back out, that might be the one driver that stays in gross margin. But then in theory, you should recapture most of what's happened this year.

Yes. I mean there's probably a piece in each bucket, Simeon. As we've grown the business, obviously, we invest more labor in moving the product to support that growth, and that's a piece of some of that growth there. And then it also costs us more when we're full. And our supply chain was full in the second quarter. And so there's a piece of that, that will result in improved productivity over time as we get some of that inventory out of the system. To Brian's point, we'll come back and unpack next year when the time is right to do that. But I expect to see both of those drivers present as we do so.

And maybe just a quick follow-up. You mentioned Q4 profitability should look more Target-esque. Does that mean -- like what's the assumption for mix in that fourth quarter relative to where we are today?

Yes. We aren't breaking out a specific assumption for mix. But I think if you look over the last couple of quarters, you see mix isn't a big driver of our margin results. And so I wouldn't think about it markedly any differently as we project ahead.

Our next question is from Kelly Bania with BMO Capital.

Curious if you could just help us dissect the gross margin a little bit between the promotional activity, the inventory impairment versus the cost of storing and moving this excess inventory. Because I think it would just be a little helpful for investors to interpret that comp and traffic number and just how you're thinking about that traffic and comp as the promotions moderate into Q3. And it sounds like Q4, you're planning for very little promotional activity. So I was just wondering if you could kind of parse some of that out to help us think about that.

I'll maybe start at the end of your question. We expect Q4 to be promotional. It always is. And our plans plan for promotions that will provide great value to our guests and those seasonal moments that matter. That's been true in every Q4 in my 18 years here, and I expect it not to be any different this time around. With respect to unpacking the margin, I'll go back to some of what I said in my comments. And we were, year-over-year, 9 percentage points down, 7 of that is mostly driven by inventory actions and you see incremental markdowns as a piece of that. You also see the cost of some of those receipt cancellations that John talked about earlier. And then you see about 1.5 points of pressure from supply chain and digital. And a piece of that is related to us being heavier in the system and that drives some costs. A piece of that is the elevated freight and transportation rates that we've talked about previously, that will continue to kind of maybe move up and move down based on the day, are definitely elevated versus any historical measure. And you can see over that -- see that is a piece of that year-over-year pressure, too.

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

My question was on inflation in food and consumables. And can you give us any number on how much inflation you guys saw in the second quarter, but also the 2 half guide you guys have given us. What's the inflation tailwind you guys are expecting in food and consumables? And also related to that, you guys talked about the focus on everyday pricing. Is there any incremental margin pressure from the frequency items or the focus on everyday pricing being sharp?

Yes. I mean we've seen persistent cost inflation in food. And I think across the industry, you've seen price move with that. That's been no different here at Target. We are really mindful of making sure that we feel good about our price gaps, definitely do today in food. And if you zoom out from the food-specific piece of that, again, I'll come back to traffic. If you look at what drove our growth in the second quarter, there were some puts and takes within basket between ASP and units. But the story was traffic. And so again, that gives us evidence that we're getting that value equation right for our guests.

And is the inflation component within same-store sales in food and consumables? Is that similar to sort of the numbers we're seeing in the CPI for food at home?

I think that's generally in the right ballpark. Obviously, there's some mix implications there if you're comparing retailer to retailer. But we've seen persistently high inflation in food. And I think that's a trend that's been with us for a while, and we don't expect it to change anytime soon.

And sorry, just to clarify, the pricing, folks, are you -- would you say you guys are investing in price in food and consumables? So maybe taking a lower margin in the grocery part of your business than maybe historically you would have.

No. Maybe I'll add a little context here. We're consistently evaluating our complete value proposition to the consumer. And so part of that is price. And in the consumables categories, we've had a little bit more flexibility to move with the market because it's domestically replenished and bought every single day. And so we have absolutely moved up in some retail. But the way we counterbalance total value proposition is by looking at, of course, what else produces value, compelling promotion, an incredible owned brand portfolio that allows the guests to opt-in to whatever price point is right for them and a maniacal focus on balancing our good, better, best and opening price point options. And that, the combination of those things, are yielding more unit share growth at Target, which means the guest is actively engaged in the offering that we're providing and, of course, that traffic that Michael pointed to.

And Robby, as Christina noted, the strength of our owned brand portfolio in this environment is a really important element of how we deliver value to our guests each and every day. And in Food & Beverage, our Good & Gather brand now is a $2 billion brand that continues to see very strong growth. So that's just one way we deliver value to our guests each and every day at Target.

Our final question is from Oliver Chen with Cowen.

On the topic of back-to-school, what would you speak to as factors that are most different this year versus last year as you get ready for that? And secondly, on the inventory actions, as they relate to third quarter, what's left to do there? And might you have to take deeper promotions than you thought previously? The consumer is requiring a lot of discounts to respond to promotions more than other retailers thought in many cases. Would love any thoughts there.

Oliver, I'll start, and I'll let Michael finish up, but I think the one big difference today, as we sit here today and think about back-to-school and back-to-college is certainty. I think we know across the country, children are going back to school. They'll be in classrooms. They're going to be back on campus. So I think that element of certainty is very different from what we've faced over the last couple of years. And again, we expect to see a very solid back-to-school and back-to-college season because we know children are going to be in classrooms and will be back in campus, and Target's a place they go during this important back-to-school and back-to-college season.

And then, Oliver, kind of what's in some of the Q4 actions we still have to take, just to provide kind of an example there. If there's seasonal product, it's a natural time to leave our store within Q3, and we'll continue to work through some of that inventory then. And so that's an example of some of the work still to be done. But kind of in where we started, we feel really good about our inventory position as we exit the second quarter. And we accomplished what we set out to do from an inventory perspective.

So operator, that concludes our second quarter call. We look forward to talking to many of you over the next few weeks and seeing you later this year, so thank you.