Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation first quarter earnings release conference call. [Operator Instructions] As a reminder, this conference is being recorded, Wednesday, May 23, 2018. 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 first quarter 2018 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 first quarter performance, outlook for the full year and progress on our long-term strategic initiatives. Following their remarks, we'll open the phone lines for a question-and-answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Cathy and I will be available to answer your follow-up questions. 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 first quarter performance and our priorities going forward. Brian?

Thanks, John, and good morning, everyone. We are really pleased with the performance of our business in the first quarter, which demonstrates the resilience of our multi-category portfolio. Our traffic growth, up 3.7%, is the strongest we've seen in more than 10 years, reflecting healthy increases in both our stores and digital channels. Comparable sales growth of 3% was consistent with our guidance, driven by strength in Home, Household Essentials and Food and Beverage. This demonstrates the benefits of maintaining a balanced portfolio as strength in these categories offset the impact of a late spring on our temperature-sensitive categories, which have accelerated dramatically as we entered the second quarter. We also benefited this quarter from the launch of 3 new owned or exclusive brands in Home and Apparel and a successful limited-time partnership with Hunter. In our digital channels, we continue to see strong trends even as we compare over rapid growth in past years. For the first quarter, Target's digital channel sales grew 28%, on top of 21% a year ago. While our operating income continues to reflect some near-term headwinds driven by last year's investments to transform our business, we are benefiting from accelerated traffic and sales and federal tax reform legislation enacted late last year. As a result, our earnings per share grew more than 9% in the first quarter, and we're expecting strong EPS growth for the remainder of the year. Given all the changes we've made in our business, we are seeing multiple drivers of the recent acceleration in our performance from our investments in stores, supply chain, new brands and our team, even our ongoing partnership with CVS. Everything is contributing to our success, and our guests are responding. As a result, given our current trends and our plans going forward, we expect that…

Thanks, Brian, and good morning, everybody. When you think about the work we're doing across the operations team, you quickly see that it's all about modernizing how we work, both our operating model and how we use our physical assets. On the physical asset side, the good news is that we started with a strong base of well-designed, well-located and well-maintained stores and distribution facilities, but they are optimized only for store shopping. Similarly, we already have the best team in retail, but they were trained in routines and processes focused primarily on tasks and designed exclusively for guests who are shopping our stores. Now let me be clear: store shopping remains very important and will continue to be so in the future, but it's no longer the only way people choose to shop. So for both our physical assets and our people, we are modernizing how we work, which includes a meaningful investment to continue providing the best of what physical shopping means today. At the same time, we are reorganizing virtually everything we do to ensure we provide convenience, speed and reliability in all the ways that our guests want to shop. Across our supply chain, we're testing and rolling out new processes designed to make us faster, more nimble, more accurate and reliable. Last year, we told you about our new facility in Perth Amboy, New Jersey, which provides a clean slate where you could develop and refine a completely new way to replenish stores, and the results have been impressive. Out-of-stocks on items in the store served by the Perth Amboy facility have been running about 40% lower than our previous benchmark. These results were accomplished by applying a new inventory positioning logic, developed by our data and analytics team that allows us to send the…

Thanks, John. At Target, everything we're doing is focused on our guests. You see it in our work to elevate the guest experience as we invest in our teams and remodel our stores. You see it in our new small formats where we tailor the assortment to fit the needs of the neighborhood. You see it in our work to deliver more convenience with a rapidly expanding menu of fulfillment options. And it's reflected in our work to modernize the supply chain where we are working to increase reliability and drive trust. In merchandising, we focus on our guests by working to elevate their assortment, delivering the right balance of quality in owned brands with outstanding national brands. We differentiate Target by developing and curating new, innovative products and exciting new owned brands, which deliver an unbeatable combination of quality and price. We elevate the key moments in the lives of our guests, including holidays and seasonal moments like Back-to-School and Back-to-College. And of course, we focus on value, ensuring our assortment is priced right daily while delivering clear, impactful promotions and drive awareness through our marketing. While there is much more ahead, I'm really pleased with the results our team is already delivering. In the first quarter, we launched 3 new owned or exclusive brands: Universal Thread in women's denim, Apparel & Accessories; Umbro in Kids and Sporting Goods; and Opalhouse in Home. In addition, we delivered Hunter for Target, an exciting limited-time partnership with an iconic British brand. And the guest reaction to all these new brands has been fantastic. In terms of value, multiple metrics show that last year's efforts are continuing to drive results. Across our frequency categories, where we are seeing share growth, unit share continues to grow faster than dollar share, a positive leading…

Thanks, Mark. Last year, we embarked on a multiyear journey to transform our business and position Target to generate profitable long-term growth. We said 2017 would be an investment year. And last year, our team delivered everything we planned to accomplish and more. We've now moved into 2018, a transition year in which we expect to achieve stability and earnings from our core business. And I'm happy to say, with 1 quarter in the books, we are on track to deliver on both our strategic goals and financial guidance for this year. Our first quarter comparable sales growth of 3% compares favorably to our guidance for a low single-digit increase. This was driven by a 3.7% increase in traffic, offset by a small decline in average ticket. Our first quarter digital growth of 28%, on top of 21% last year, compounds to more than 50% over the last 2 years. Target's traffic has been accelerating for a year now. And as Brian noted, first quarter growth of 3.7% was the strongest at Target in more than 10 years. Also notable, the prior quarter's traffic growth of 3.2% was equal to the second-highest pace we've seen in the last 10 years. Traffic is a key focus for us, and seeing growth at historic highs gives us increased confidence that we're pursuing the right strategies and making the right investment to best position Target for long-term success. Our first quarter gross margin rate of 29.8% was down about 20 basis points from last year. This was a bit below our expectations as the mix impact of late spring weather caused a later-than-usual surge in higher-margin, temperature-sensitive categories. As temperatures warmed up in mid- to late April, we saw the beginning of that surge, and it has continued into this quarter. With this…

Thanks, Cathy. Based on what you've heard today, I hope you can see why we are so encouraged by what we're seeing in our business. Target has always thrived by being different, by being the best version of ourselves, not another version of someone else. And we've earned the deep loyalty of our guests because we are different, because we deliver a unique assortment and experience, one that's optimistic, aspirational and full of possibilities. But being different means always changing. Right now, we're investing to deliver differentiation that matters in today's world, focusing on convenience, digital brands, our operating model, small formats and the look and feel of existing stores. And we're investing in our greatest differentiator, our team, because human touch still matters even in a digital world. Thanks for your time today. Now John, Mark, Cathy and I will move to your questions.

[Operator Instructions] The first question comes from Matt McClintock from Barclays.

I was wondering if we could start with just traffic, the best traffic that I've probably seen in my career. And it's also the best traffic -- one of the best traffic results probably across the retail industry. Could you help us parse out the strength that you're seeing there? Because you have a lot of things going on right now, is Drive-Up having a material benefit? Is Shipt having a material benefit? Or are we just -- is that traffic result really just the build of your merchandising initiatives over the last year?

I think you've summarized it well. I think as we sit here today, we feel really good about the traffic that we've generated in the first quarter and the acceleration of that traffic as we go into Q2. And as we've said in some of our prepared remarks, it's really the combination of all of these initiatives working together. And for several years now, I've talked about the importance of traffic as a true indicator of the health of our business and the guest reaction to our key strategic initiatives. So they're all coming together well. I think the guest is reacting to our new remodels, to the new brands, to our new fulfillment options, to what we're doing from a digital standpoint. All of these elements have come together, and the guest is rewarding us with increased traffic. So we felt great about the traffic number growing by 3.7%, the best traffic growth we've seen in over a decade. And importantly, that traffic growth is continuing as we go into Q2. So it's really the culmination of all of the initiatives coming together and the guests recognizing the changes we're making at Target.

And then if I could have a follow-up, just on the remodels themselves. Partially why the traffic number is so impressive is you're doing some major remodels that I would assume are taking a lot of stores down and pretty much out of commission, right? So can you help me think about the negative impact from remodels this year now that you've done 50 and you're going into another 100 into this quarter? Is that in line with your expectations? Or are they -- is it a little bit more of a drag than you thought? Or are you doing those ahead of expectations?

Matt, the remodels is performing exactly the way we had planned. Obviously, there is a disruption during the construction period. But our team is getting better and better at minimizing the disruption, accelerating the remodel time frame. And the guest is reacting very well as we complete these remodels. So the remodel initiative is working exceptionally well for us. We're generating the 2% to 4% lift that we're projecting, and the guest reaction has been superb.

The next question comes from Oliver Chen.

We were curious about the delivery options and becoming America's easiest place to shop. You've done a really good job with all the innovation there. How would you prioritize the options that customers have in terms of driving the financial algorithm, in terms of which ones may be more important at the top of your list for driving our models? Also, as we think about the fill-in trips and the Pay Less. part of the equation, what are your thoughts about fill-in versus stock-up, and how you're positioned with respect to the back half of the year and where you see opportunities? It sounds like the customer perception scores have gotten better with respect to value.

Oliver, a number of different questions, so I'll try to unpack each one of them. But as we think about the overall experience and making sure that we provide ease to our guests, we're taking a very balanced approach. We want to make sure we provide a great in-store experience. It's why we're investing in remodels, investing in our team, investing in specialized services in the store. And then we recognize that from time to time, our guest is looking for alternative ways to shop. So we want to make it really easy for them to order online and conveniently pick up in one of our stores. We're seeing a great reaction, as John mentioned, to our Drive-Up service. And as we expand that service, we continue to hear the guests talk about how much they enjoy that. Obviously, with Shipt, we're now in over 70 markets, and the guest reaction has been superb. And our ability to deliver goods to their homes in now minutes is being very well-received. So we want to make sure we provide a great experience no matter how the guest wants to shop. And I think more and more of the initiatives that we're rolling out, whether it's Drive-Up or Shipt, what we're doing with the expansion of Restock, all being very well-received. But importantly, we're seeing a very positive reaction to the in-store experience. And while we feel great about the overall traffic numbers and the comp numbers, what's really encouraging is guests are coming to our stores and enjoying that experience, and they're shopping the full portfolio while they're there.

And a quick one, Cathy. It's really encouraging that the business trends have picked up with improving weather. However, the mix impact on the gross margin wasn't quite where you wanted it to be. Just what gives you conviction on the guidance in terms of where you can be in relation to diving into some of your comments?

Yes. As we said, clearly, every -- much of the first quarter played out exactly as we would have planned and hoped for. Other than that late temperature-sensitive category, which drove some mix pressure, we've seen that all come back into the beginning -- end of April and the beginning of this quarter, and so we're really confident. And then in addition, we have a number of initiatives we started last year that will start to cycle over about -- thinking about our price and promo reinvestments and stuff, give us confidence toward the back half of the year, and then some cost initiatives.

The next question comes from Edward Kelly with Wells Fargo.

Could you provide a little bit more color on the impact you think weather may have had within Q1 and the benefit that this, plus the calendar shift, will have within Q2? I'm just trying to get a better understanding of the cadence of the comp. And then as we think about progressing through the back half of the year, you've imposed, may I guess, the comparison seems like maybe it's a little bit harder. Just how should we think about the progression this year?

Yes. So the weather, we do -- obviously, because of our multi-category assortment, we have great strength. We saw some really strong trends in Home, Essentials, Beauty, Food and Beverage, which are great. It was those really temperature-sensitive categories that we did see a little bit of challenge there in early April, which came straight back. So I would tell you the strength of that tells us, and we can see it, where weather was happening, we could see the strength and/or not. So really strong confidence around the multi-category assortment coming through throughout the year. And I'm sorry, Ed, what was the second part of your question?

Just how we think about the calendar impact and the underlying Q2 comp?

Yes. Yes, so we saw a little bit of benefit -- or a little bit of benefit in Q1, a little bit more benefit in Q2. But obviously, that's all contemplated into our guidance. And that gives us additional confidence into the guidance we've given.

And then, Cathy, can I just go back to -- on the margin side? So Q1 was a bit softer, I guess, than expected and mix had something to do with that. But you expect an improvement throughout the year as we think about EBITDA margins, let's look at it like that, I guess, to try to minimize the D&A impact. But it does seem like digital will continue to ramp and be important. Wages obviously going $12 an hour, a headwind. Can you just give us a little bit more detail on, as we progress through the year, what drives the improvement in the year-over-year margin relative to sort of what we're seeing in Q1?

Yes. So Q1 really did play out much as we would have expected. Obviously, the really strong traffic drove some great comp sales. We are investing in the SG&A that we said we were going to invest. So that was really very, very consistent. And in all fairness, gross margin played out exactly as we would have expected, except for a little different mix. And so a little bit stronger Essentials and Beauty and Food and Beverage, a little bit weaker with the temperature-sensitive categories that came back toward the end of the quarter. And so it's just literally a mixed conversation in Q1. What gives me confidence going through the rest of the year, we'll continue to invest in our business, as we've said, for the long term. That's consistent. We've got gross margin plans, obviously, as we cycle over some of those investments last year as well as those cost initiatives, which we've got planned and have planned into our guidance.

Ed, I'll just reinforce the point, we're very confident in our full year guidance, both from a comp standpoint and an EPS standpoint. And as Mark alluded to in his comments, the reaction to our owned brands in Apparel and Home has been very strong. We've got a number of new brands we'll launch over the balance of the year, and we certainly expect that's going to influence the mix of our business as we go into Q2, Q3 and the holiday season. So we're very confident with the way the business is performing. We're seeing a very strong start to Q2, acceleration off of what we consider a very strong start to the year in Q1. And it gives us increased confidence in our full year guidance.

The next question comes from Seth Sigman from Crédit Suisse.

Just a couple of follow-up questions here on the margins. Aside from the mix, as we're looking at, I guess, first, the price investments you've been making, remind us when do you actually cycle fully those price investments? And regular price was up $1 billion, I think, you said year-over-year, which seems pretty meaningful. Should we interpret that as the biggest changes are done, and you feel pretty good about the value proposition, and we could see that benefit as you move through the year?

Yes, Seth, Mark here. Thanks. What we're seeing is a cycle over our LY. We really were starting to implement price changes right at the very end of Q2 leading through Q3 and really maturing through Q4. So we're still in an evolutionary process, and we start to see that balance out by Q3. So there's some benefits again into the mix and private value to LY still in Q2 with stability going from Q3 onwards.

Okay, that's helpful. And then on the digital and fulfillment cost, part of the outlook, I think, included the benefit from more ship-from-store to mitigate some of the cost pressures. Can you update us on that, give us a sense of the impact that fulfillment may have had on gross margin this quarter? And is that also something you expect to improve through the year?

Yes. So I think nothing new here, really. Digital fulfillment sales have put pressure on gross margin as that continues to grow faster than the rest of the business. But on the other side of that, as you pointed out, as we continue to ship more from our stores, that is the, first, the fastest way to ship for our guest; and second, it's the most efficient from a cost perspective for us. And the other thing I would point to is when we introduce things like 2-day shipping, we see lift in units as well. And so as we increase units, the cost per unit to fulfill goes down dramatically. The same is true with Shipt, where those basket sizes are almost double the average basket size that we see in the chain, and so the cost per unit to fulfill goes down meaningfully. And so that's one thing. Mike McNamara and the digital team are focused on is continuing to drive -- as we lower the actual cost to deliver, the team continues to focus on driving the average basket size to lower the cost per unit and improve the unit economics across all of our digital business.

The next question comes from Greg Melich with MoffettNathanson.

I really had a bigger-picture question maybe to help frame the great traffic results, but also for the cost involved. So I think if we look at EBIT dollars were down 10% in the first quarter, and you have this best traffic in years. But given the investments you made last year, it sounds like by the back half, to get to your guidance, EBIT dollar should be going up mid-single-digit. Is my -- does my math sound right, Cathy, given all the restatements that that's what we should be seeing?

Yes. Yes, no, Greg, you're right on.

Got it. And then sort of a housekeeping question. The week that shifts, a week that's in July or for Back-to-School versus a week in May, is that typically 20% bigger, 40% bigger? Just something there so we can do the math on the comp shift.

Yes, Greg, so just think about it this way, we literally just map week for week. So the first 13 weeks of this quarter were the first 13 weeks and just kind of roll that out. Obviously, it does pull a little bit of Back-to-School, Back-to-College, which is why you're seeing some inventory come through as well, but we're not going to quantify that.

Okay, great. And then just the last, maybe a bit of big-picture question on the margins. If you think about it, given this surge in traffic and you think about a few years out, if you could keep the traffic up here, would you be willing to let the margin rate continue to slip to, I guess, around 6% now to 5% if that's what it took to keep this sort of traffic number? And I'll leave it.

Greg, I think, again, the guest is reacting to the changes we've made throughout our experience, whether it's the new brands, which I think are going to continue to deliver great results and deliver very strong margins for us. The multi-category strength we saw in the quarter is something that we feel really good about. We've been talking about this for some time. But seeing strength in Home, in Household Essentials, in Beauty, in Food and Beverage, the guest is reacting to our offerings, and they're shopping multiple categories at Target both in-store and online. So we expect that to continue. And as we remodel more stores, as we open up stores in new neighborhoods, as we continue to offer great new brands and new services, we expect traffic to continue to grow. So we think traffic was one of the highlights in the quarter, but we also feel really good about the fact that we grew comps to 3%, our digital channel grew by 28% and our EPS grew by over 9%. So we feel like all of the key initiatives are coming together, and we're delivering very solid results that are in line with our plan for 2018.

The next question comes from Scott Mushkin from Wolfe Research.

So I just -- not to beat a dead horse here on the comp cadence, but I'm getting lots of e-mails, so I figured I'd do one more. As we look at the back half of the year, is it going to step down because of the calendar shift and the tough compares? Is that the expectation?

Scott, we're expecting again low single-digit comp growth throughout the year. We're seeing really strong acceleration as we go into Q2, so we expect to see comps grow as we go into the second quarter. But our guidance is something that we got great confidence in, and we expect to see solid comp expansion throughout the year.

All right, perfect. Then my second question is regarding kind of the store operations. The in-stock levels, at least according to our research, are coming off, especially consumables. And I think you made some changes at the store in how you're managing it. I just wondered if you could maybe explain what's going on at the stores and why maybe we're seeing some better in-stock conditions at the store.

Yes, why don't we let John talk about some of the changes we're making with our store operating model?

Yes. The store team has been going through a process of modernizing our store operating model. It's out in -- it's in pilot right now in what we would call 26 districts across the country. I mean, really the idea here is to get experts in the areas where they know the business. So we have food people who know the Food business, and they are accountable for the totality of that business. They do the restock. They do intraday restocking. They own price change. They own everything that goes on in that business. Similarly, in Apparel or Beauty or Electronics, and they also have expertise to help the guest understand those specialty businesses, and that's a big part of what we're doing, too. But as they own the business, and we've seen this in Beauty over the past 52 weeks for the team, we are further ahead in Beauty, we see out-of-stocks improve because the same person is in that area every single day, and they own it, and they make sure it's stocked. So some great progress there. We're a little bit further in areas like Food and Beauty than we are -- and Apparel than we are in a couple of others. But that's the focus across the entirety of the store operations. And I would say, Scott, too, that's been a big part of our out-of-stocks. There's also some things we're doing upstream as it relates to inventory positioning, improving our speed of recovery across the chain as well. So there's a lot of moving parts there as it relates to out-of-stocks, but obviously, as you know, it's something we are very, very focused on.

And John, how many store is it in right now? And what's your expectation as we get through the end of the year?

It depends on -- there's lots of moving parts. Beauty is across the entire chain right now, and Food and Beverage operating model is probably across most of the chain as well. Some of the other pieces, we're testing different changes across about 1/4 of the business. So it's in various stages, and we'll continue to refine it and roll that out across the chain as we move forward.

Look, Scott, this is a part of the investments we've been making in our store teams over the last few years. It was just a few years ago we rolled out visual merchandising across the entire chain, investing in Beauty, and we're seeing great results as a by-product of that. Special resources behind Food and Beverage, and that's certainly improving both our performance, helping us grow share, but also improving the in-stock condition. So we'll continue to make those investments over the balance of the year. But importantly, the guest is responding to those changes, and they've been a very important part in driving the comp increases we saw in the first quarter.

The last question comes from Chris Horvers from JPMorgan.

So I'm going to take a shot at the shift question. So as you think about the shift, does it impact as you offset come in 3Q, or does it impact in 4Q as well? And then on the e-commerce front, does Drive-Up and Shipt show up in digital comp or the store comp? It seems like they're scaling over the year, so does that mean that digital growth actually accelerates throughout the year? Because it seems like the big helper in 1Q was more the free ship versus these other fulfillment options, which are still being rolled out.

Yes. So Chris, things like Shipt and Drive-Up show up in our digital comp, and we've talked about this a lot. From a guest standpoint, I don't think they really care how we account for it. They just care about the fact that we've got these great convenient services that we now offer them throughout the year. So that is part of our digital comp. It's part of the strong performance we're seeing in digital. And we expect that to continue over the balance of the year. Cathy, you want to talk about the shift one last time?

Yes. With regards to the calendar, so it's again really simple, just map week for week is what we do, which means you're going to see a little bit -- we saw a little bit of benefit this quarter, a little bit more next quarter, a little less -- a little headwind in Q3 and a little bit more in Q4, and it's kind of that throughout the course of the year.

Good. Well, we appreciate you joining us today. Hopefully, you sense the confidence we have in our business. We feel great about the start of the year in Q1, the acceleration we're seeing in Q2 and our confidence in our full year guidance. So operator, that concludes our first quarter 2018 earnings conference call, and I thank all of you for joining us.