Target Corporation (TGT) Q1 2019 Earnings Report, Transcript and Summary

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 22, 2019. I would now like to turn the conference over to Mr. John Hulbert, Vice President, Investor Relations. Please go ahead, sir.

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

Thanks, John. We're really pleased with our first quarter financial performance, which reflects continued progress on the strategic initiatives we began rolling out more than 2 years ago. Since that time, we've seen a meaningful acceleration in our business. In fact, the first quarter marked Target's eighth consecutive quarter of comparable sales increases. In the first quarter, comparable sales growth of 4.8% was a bit ahead of our expectations. As Mark will cover in more detail, this was driven by broad strength across all our merchandising categories, particularly in Toys and Baby. We also saw strength across channels in the first quarter. Store comparable sales were up 2.7% while comp digital sales were up 42%, adding 2.1 percentage points to the company's comp growth. As John will cover in more detail, we're seeing a really positive guest response to our same-day digital fulfillment services, which drove well over half of our digital sales growth in the quarter. Our ability to offer these same-day services, which deliver high levels of satisfaction, is a result of our strategy to put stores in the center of fulfillment. In fact, our stores handled more than 80% of our first quarter digital volume, including all of our same-day options combined with digital orders shipped directly from stores to guests' homes. Across both our stores and digital channels, sales growth continues to be driven primarily by traffic. Specifically in the first quarter, comp traffic was up a very healthy 4.3% on top of 3.7% a year ago. On the bottom line, our first quarter performance was also stronger than expected. Against an expectation for a slight rate decline, our operating margin rate increased about 20 basis points in the quarter. This performance reflected the benefit of disciplined expense control combined with a favorable mix of digital fulfillment. Altogether, the first quarter earnings per share grew more than 15% at the top end of our guidance range. In our final Financial Community Meeting in March, we talked about our work over the last few years to create a durable model for Target, one that will drive continued engagement and relevance with consumers and support a financial model based on growth on both the top line and the bottom line. In the first quarter, we saw the benefit of this new model. Early in the quarter, we experienced some choppiness in daily sales results driven by unfavorable weather conditions in different parts of the country. And towards the end of the quarter, we saw the impact of late spring weather in our seasonal businesses. Against this backdrop, our business performed really well, benefiting from multiple drivers, including strong holiday performance in the Valentine's Day and Easter periods, along with the reliable everyday traffic in our Food, Beverage and Essential categories. Beyond short-term weather fluctuations, we continue to see a healthy economic backdrop for our business, which is evident across multiple metrics, including employment, wage growth, consumer spending and overall sentiment. Against this backdrop, Target continues to grow traffic and sales more quickly than the market, resulting in share gains across all of our key merchandising categories. And while the team has accomplished an incredible amount over the last few years and we're pleased with our current performance, we are not slowing down. Our stores and supply chain teams continue to roll out and scale up an interesting leading suite of digital fulfillment options. And as John will cover in more detail, our guests are responding enthusiastically, driving rapid growth of our same-day options, including Drive-Up, in-store pickup and Shipt. At Shipt, we continue to grow the number of marketplace participants, driving scale and relevance to the platform. In the first quarter, both CVS and Petco launched nationwide on the Shipt marketplace. Our merchandising teams continue to deliver newness through existing brands while adding new brands to supplement our assortment. In the first quarter, the team launched 3 new owned brands in intimate apparel; a new natural owned brand in Essentials; innovative national brands, including Flamingo and Welly in personal care; and our new Home brand, Sun Squad, to help our guests celebrate the summer season. Our property teams continue to rapidly transform our store network. The team completed another 53 remodels across the country in the first quarter, and they're on track to deliver approximately 300 remodels this year. Guests continue to respond to these projects by shopping the remodel stores more often, driving incremental traffic and sales. And finally, our team opened 7 small formats across the country in the first quarter, allowing Target to serve new neighborhoods in metro areas like New York, Los Angeles, Chicago and Washington, D.C. and new markets like Santa Barbara, California. Before I turn to the outlook, let me comment briefly on the topic of tariffs. As you know, the trade situation has been fluid for some time, and we've been carefully monitoring negotiations to assess potential implications and our point of view has been consistent for some time. As a guest-focused retailer, we're concerned about tariffs because they lead to higher prices on everyday products for American families. Our team continues to monitor trade negotiations and develop contingency plans to help mitigate the impact of tariffs on our guests and on our business. It's important to note that Target's multi-category portfolio remains a competitive advantage. When there are external impacts to one business area or category, we're able to balance the impact across our business in ways not available to a single-category retailer. And as you see in our recent results, the teams has been able to manage through last year's tariffs with minimal impact, and we have plans in place to mitigate the impact of additional tariffs already scheduled for next month. As always, we remain focused on being priced competitively every day, delivering value for our guests while judiciously managing our margins. With that, let me turn briefly to our outlook, and Cathy will provide more details in a few minutes. For the second quarter, we're looking to deliver a low to mid-single-digit increase in our comparable sales. This expectation is a bit slower than our first quarter pace given that we're about to annualize over last year's closing of Toys "R" Us and Babies "R" Us stores across the U.S. On the bottom line, we expect to generate a mid-single-digit increase in operating income dollars, which will translate to even stronger growth in earnings per share. For the full year, we're maintaining our expectations for both comparable sales and earnings per share. The first quarter was a great first step in delivering our full year guidance, giving us continued confidence in our ability to deliver outstanding performance in 2019 and beyond. So now before I turn it over to John, I want to thank the entire Target team for their continued passion and tireless focus on delivering for our guests. It's because of their hard work that we're able to share these outstanding results with you today. Each and every day, I'm energized and grateful to work with this amazing team. Now I'll turn it over to John, who'll talk in more detail about our efforts to elevate the shopping experience for our guests regardless of how they choose to shop. John?

Thanks, Brian. As you know, for several years now, we've been focused on building and rolling out a comprehensive set of digital fulfillment capabilities, allowing us to provide our guests a convenient fulfillment option for every shopping journey. As a result of those efforts, Target now offers more digital fulfillment options across more of the country than anyone else in retail. Think about it, when guests are planning on being out in their neighborhood, they can shop on their digital device, and we hand them their order in an hour or 2. We offer in-store pickup in every one of our 1,851 locations, and we walk the order out to the parking lot in more than 1,250 of them. There are no fees for either of these same-day options. And of course, guests in more than 1,500 stores across more than 250 markets can order from Target through our Shipt personal shopping service and have their order delivered to their front door, kitchen table even their refrigerator if they want in only an hour or 2. Shipt offers unlimited free same-day deliveries from Target and more than 50 other retailers across the country for a $99 annual fee. There are nearly 100,000 Shipt shoppers delivering orders across the country today, and it's still growing rapidly as we welcome new marketplace partners and expand into new markets. In dense urban areas where we're building small-format stores, we offer a service in which guests who shop in store can ask us to hold their basket at checkout and deliver to their front door later that same day in a time window of their choosing. For this service, we charge a flat fee of $7 with no annual fee, and our guests love it. Once we solve the problem of carrying the order home, it frees them up to shop more, a lot more. Average basket size on these orders is more than 5x bigger than the average for these locations, and they include a very strong mix of items from our Home category. Beyond all these same-day options, when guests need to replenish their pantry, they can order a 45-pound shopping cart size box of essentials, and we'll deliver it the next day. For this service, we charge an industry-leading delivery fee of only $2.99 with no annual fee. And of course, guests can shop target.com on their desktop or mobile device, and we'll deliver their order to their front door in 2 days or less. There's no annual fee, and we don't charge a delivery fee if you have a REDcard or meet a $35 order minimum. To support all of these options, same day, next day, 2 day, our strategy puts our store teams and physical assets at the center of the bull's-eye. Now of course, like everyone else, a portion of Target's digital orders are and will continue to be shipped from upstream fulfillment centers. And other items will continue to be shipped directly by our vendors. But given our strategy, assortment and the way our guests like to shop, the vast majority of our digital orders are already being handled by our store teams, whether that means shipping packages out of the back of the store, delivering orders at the front of the store or in the parking lot or having a Shipt shopper bring it to their front door. Despite the success we're already seeing, we continue to hear questions about the long-term viability of keeping our stores at the center of fulfillment. Our answer is empathic: We are confident that this is the best long-term solution for Target. But I also want to emphasize that this is already a highly effective strategy today. Digital accounted for more than $5 billion of Target's sales last year, and our stores fulfilled about 2/3 of that volume. This year, given our digital growth trajectory and the rapid adoption of our same-day services, we are on track to grow Target's digital sales by more than $1 billion in 2019 and fulfill an even higher percentage of this volume from our stores. So I want to emphasize that we're not talking about a theory. This is reality today, and it's a meaningful and growing part of our retail business. We've said many times that using our stores as digital hubs enhances our speed and reduces costs. And importantly, moving to store fulfillment does not increase the frequency of split shipments. In fact, even though store fulfillment continues to grow rapidly, the rate of split shipments this year is running lower both in our stores and in total compared with last year. Let me add quickly. Like everyone else, we have a continued opportunity to realize cost savings by reducing the frequency of split shipments even more. That is one reason why we are focused today on developing an enhanced inventory planning and control system, which will deliver increased precision in our inventory allocation, reducing the number of occasions when a split shipment is needed. Importantly, from a guest perspective, moving fulfillment into stores has delivered high levels of satisfaction. Specifically, we are seeing stable to improving Net Promoter Scores on mature fulfillment capabilities like pickup and ship to home. And we're seeing unusually high Net Promoter Scores for newer same-day services like Drive-Up and Shipt. One reason for high guest satisfaction is that store fulfillment increases our reliability. At our contact centers, which handle guest questions about their digital orders, we've seen meaningful declines in our contacts per order and contacts per unit even as we have rapidly launched new services and moved the bulk of fulfillment into our stores. In fact, contacts per unit in 2019 have been running 50% lower than we were seeing only 2 years ago. Given the high level of satisfaction associated with our new fulfillment options, we're also seeing a rapid change in the mix of our digital sales. Specifically, in the first quarter, well over half of our digital growth was driven by same-day fulfillment options, in-store pickup, Drive-Up and Shipt. Put another way, these 3 services drove more than 1/4 of our total company comp growth of 4.8%. Importantly, our analysis indicates that the new services like Drive-Up and Shipt are driving incremental trips for Target rather than simply replacing other forms of shopping. Specifically, first quarter digital sales from in-store pickup increased more than 80% from a year ago even as Drive-Up and Shipt grew even faster. And let's not forget the conventional in-store shopping, which continues to account for the vast majority of our sales, continues to see increased traffic and comp sales as well. This reflects a key aspect of our strategy. While we quickly establish ourselves as a leader in terms of convenience and digital fulfillment, we are equally focused on maintaining the leadership position of our in-store shopping experience. That's why we're remodeling 300 stores a year, keeping us on track to complete 1,000 remodels by the end of next year. These projects elevate the look and feel of the store, create more compelling displays in key categories like Apparel, Home, Beauty and Food and Beverage, and reconfigure space in operations to support all of our new digital fulfillment options. Remodeled stores continue to experience incremental sales in the year following completion of the remodel, and we've been measuring another incremental growth in the second year as well. Beyond the physical environment, we're making significant changes to the operating model in our stores, finding efficiencies that reduce nonguest-facing activities and allow us to devote more hours to helping our guests. We are staffing our stores with category experts in areas like Apparel, Beauty, Electronics and Food and Beverage who can move beyond task and share their expertise with guests, providing advice and perspective to help them find the best products to meet their needs. Some of these experts were already on our team, but this new model allows them to focus on their passion rather than serving as a general athlete across multiple categories. In other cases, we're hiring category experts, who have gained experience at other retailers and who are excited to come to our team and participate in our growth. And all these changes have been enhanced by our commitment to reach a national minimum wage of $15 an hour by the end of 2020. Only a couple of years ago, Target's national minimum was $10 an hour. That has already increased to $12 today, and we announced that we're moving to $13 next month. While this decision obviously involve some cost pressure, we have successfully controlled expenses to manage the P&L impact even as we've added guest-facing hours in our stores. Looking ahead, our work on store replenishment will deliver additional cost savings as we move store backroom activities upstream into our distribution facilities and those facilities where we realize scale efficiencies and automate a portion of those tasks. Over time, this work will enhance our inventory allocation, delivering higher in stocks while reducing safety stock across the chain. And it will free up additional space in our stores to accommodate further growth in digital fulfillment. These replenishment efforts are still in the early stages, and it will take years, not quarters, to roll out this new model across the chain. But we are very encouraged with the results we are seeing in our test of this new model in Minneapolis and our Perth Amboy facility. And we'll continue to test and learn as we expand this model to more of the chain over the next several years. So before I turn the call over to Mark, I want to pause and thank our team for all the amazing results we're seeing across the business. These results were years in the making, and a lot of our teams' efforts were behind the scenes. But those efforts were necessary to create the strong foundation that's enabling everything we're seeing today. Clearly, our guests are happy with the results, which was evident in our strong performance on both the top line and bottom line in the first quarter. Mark?

Thanks, John. As Brian mentioned earlier, we are really pleased with the quality and breadth of the growth we've been seeing across our business, and that is certainly true of our category performance. For more than a year now, we've been seeing broad sales strength and market share gains across multiple dimensions, including both our style and frequency businesses during holiday periods and in between, across both owned brands and national brands and all 5 of our core merchandising categories. Across our core categories, we saw the strongest first quarter growth in our Essentials and Beauty and Apparel categories, both of which saw comp growth of more than 5%. In Essentials and Beauty, which comped more than 7%, results were led by Baby, over the counter and Beauty and Cosmetics. In Apparel & Accessories, we saw particular strength in intimates and sleepwear, Baby and swim. Among our other core categories, comp growth was about 3% in each of our Food and Beverage, Home and Hardlines categories. Within Food and Beverage, we saw growth in every subcategory, but it was the strongest in adult beverages, which comped mid-teens this quarter. In Home, results were led by kitchenware, storage and décor. And in Hardlines, results were led by double-digit growth in Toys. To build on this strong performance, we continue and invest in newness and differentiation both in existing brands and by launching new ones across our curated assortment. In the first quarter, we completely transformed our assortment presentation in intimates and sleepwear and launched 3 new brands: Auden, Stars Above and Colsie. All 3 of these new brands are size inclusive and designed to make guests at any age feel confident and comfortable. In addition to launching these brands, we redesigned both the digital and in-store shopping experience in ways designed to make shopping easier and more inspiring. The guest response to these changes has been phenomenal. And as I already mentioned, these categories delivered standout performance in the quarter. In Essentials last month, we launched a new natural owned brand, Everspring. This entire line of more than 70 items is made from plants, renewable materials and recycled paper. The packaging includes graphic icons that allow guests to quickly understand product attributes and what ingredients are not in the formulation. In fact, all Everspring products qualify for Target Clean, a new symbol we have designed to both simplify and indicate products formulated without chemical ingredients that guests may want to avoid. Everspring products were developed by our internal design team and feature carefully selected scent profiles, including citrus and basil. Prices in the assortment range from $2.99 up to $11.99, and the entire assortment on average is priced nearly 20% below comparable products in the marketplace. This new Everspring initiative complements other strong Q1 launches that are exclusive to Target natural brands, like Flamingo and Welly that Brian mentioned earlier. In February, we announced that we were introducing toddler sizes into our art class brand, which we first launched in 2017. Art Class brings a versatile, fashion-forward aesthetic to kids' apparel, and we know that many parents are looking for a diverse range of styles and aesthetics for their younger kids as well. We're excited to feature this new toddler assortment in more than 1,100 of our stores and on target.com at a time when many competitors in this category are closing their doors. And we also recently introduced a new seasonal owned brand, Sun Squad, to help guests celebrate the pure joy of summer. Again, developed by our internal design team, this assortment features more than 600 items from pool floats to larger-than-life sprinklers, beach totes and coolers designed to encourage families to get outside, create lasting memories and make the most of the summer season. We've priced these items to deliver amazing value with some items priced below $2. And in Food and Beverage, following the wildly successful launch of our California Roots brand, we recently added The Collection to our wine assortment. The Collection brand offers high-quality wine at an affordable price, combining the very best of carefully harvested grapes featuring 5 premium varietals at $9.99 per bottle. And last week, we're excited to announce that we're introducing men's grooming items under our Goodfellow & Co brand name. This men's brand has seen an amazing response since we launched it in the fall of 2017 driving strong market share gains at our men's apparel assortment. Given that men are increasingly doing their own shopping for grooming and personal care items, we want to ensure the Target is their destination for those categories. The assortment here features more than 30 products priced between $3.99 to $16.99 and again positioned about 20% lower than comparable men's premium brands. And finally, of course, we just launched our much-anticipated limited-time collection of products from vineyard vines. This collection of more than 300 items includes apparel, accessories and swim for the whole family, along with a distinctive assortment of home and outdoor items. The style is unmistakable, and the prices are amazing, ranging from $2 to $120 with the majority of items priced below $35. We launched this collection last weekend in all our stores and on target.com, and we maximized the impact by presenting all the assortment together near the front of our stores. The response both in our stores and online exceeded our expectations, and our team did a great job accommodating the surge in traffic. Altogether, the vineyard vines launch is already one of the most successful in our history. When you combine that insight with the better-than-expected results we're seeing from our owned brand and exclusive brand launches, you gain a deep appreciation of how our guests respond to newness and inspiration in our assortment. So I want to thank my team for everything they're doing to deliver the results we've been seeing across the whole team, design, sourcing, buying, operation. And that thanks extends to all of our vendor partners, too. I'm really excited to see their alignment, their energy and their collaborative passion to inspire our guests. It's because of their work that we're so confident as we look ahead. We're ready for the upcoming holiday and seasonal events, including Memorial Day, Father's Day, the 4th of July and the beginning of Back-to-School. But we're also focused on the categories that sustain our business in between these life events, including our Essentials and Food and Beverage categories. These categories are the focus of our Target Run and Done marketing campaign and our continued work to ensure we remain priced right daily. When we incorporate our merchandising efforts into all the other initiatives that are driving our business, remodeling our stores, delivering convenience with new fulfillment options, elevating service in our stores, reaching new neighborhoods with our small format stores, something really special happens for our guests. Target becomes more relevant to them, and they choose to shop us more often. Guest traffic is the ultimate reward for our efforts. With that, I'll turn it over to Cathy, who will provide more detail on our first quarter financial performance and outlook for the rest of the year. Cathy?

Thanks, Mark. As Brian mentioned, our first quarter financial performance was ahead of our expectations on both the top line and the bottom line. Our comparable sales growth of 4.8% was on the strong end of our expectations for a low to mid-single-digit increase, and our EPS of $1.53 was just beyond the top end of our expected range. Store comparable sales growth of 2.7% drove just over half of the total company comp, while comparable digital growth of 42% contributed another 2.1 percentage points. Among the components of comparable sales, first quarter traffic growth of 4.3% was the primary driver, combined with an increase in average ticket of 0.5%. Our first quarter gross margin rate of 29.6% was about 20 basis points lower than last year. Among the drivers, digital fulfillment and supply chain costs accounted for about 50 basis points of pressure, which was offset by about 30 basis points of benefit from merchandising initiatives implemented by Mark and his team. Our first quarter SG&A expense rate of 20.8% was about 30 basis points better than a year ago. This rate improvement was better than expected and driven by a number of factors, including a small benefit from the timing of marketing expense compared with last year, along with cost efficiencies in our technology operations. Overall, we saw excellent cost control across the company, which allowed us to offset continued pressure from higher wages across the country. As expected, we also saw a small leverage benefit on depreciation and amortization expense in the quarter. Altogether, our first quarter operating income margin rate was about 20 basis points better than a year ago and better than our expectation for a small rate decline. As a result, first quarter operating income dollars were 9% higher than a year ago. Interest expense of $126 million was $5 million or 3.3% higher than last year, and our effective tax rate from continuing operations was essentially flat to last year. Diluted shares declined about 4% compared with a year ago, reflecting the continued benefit of our disciplined approach to capital deployment. Altogether, our GAAP earnings per share from continuing operations of $1.53 were 15.1% higher than a year ago, while adjusted earnings per share of $1.53 were 15.9% higher than last year. Turning to cash flow. Our operations generated more than $300 million of cash in the first quarter. This was down from a year ago as the benefit of higher profitability was more than offset by a decline in payables. This quarterly result was a timing issue related to our elevated inventory position at the beginning of the quarter. For the year in total, we expect to maintain payables leverage at approximately the same rate as in 2018 and generate strong cash flow from operations. We deployed first quarter cash from operations, proceeds from debt issuance and cash on hand to fund $655 million of CapEx, $330 million in dividend and the repurchase of $277 million of our shares. We were pleased with the results of our March debt transaction in which we issued $1 billion in 10-year debt ahead of our upcoming $1 billion maturity in June. This deal benefited from our strong credit ratings and the current momentum in our business, which allowed us to price the notes very attractively. And finally, I want to close my discussion on the first quarter with an update on our after-tax return on invested capital. Excluding discrete tax benefits from federal tax reform in both years, our trailing 12-month after-tax ROIC was 14.1% in the first quarter compared with 13.5% a year ago. We're pleased with both this absolute performance and the relative improvement from a year ago as we continue to focus on driving long-term value through our operating and investment decisions. Now let me turn to our guidance for the second quarter and the rest of the year. As Brian mentioned, we expect to deliver a low to mid-single-digit increase in our second quarter comparable sales. We expect this will be somewhat slower than our first quarter comp growth given that the tailwind from Toys "R" Us and Babies "R" Us will annualize in a few weeks. We expect a slight amount of leverage on our operating income margin rate driven by relatively small changes in our gross margin, SG&A and D&A expense rates. This performance would lead to a mid-single-digit increase in second quarter operating income dollars and EPS performance in a range centered around $1.62. At the midpoint of this guidance range, we would deliver high single-digit growth in GAAP EPS from continuing operations and double-digit growth in adjusted EPS. For the full year, we are maintaining our previous guidance for both comparable sales and EPS. The strength of our first quarter performance has reinforced our confidence that we can meet or exceed these full year expectations, and we are looking forward to delivering strong performance in 2019 and beyond. As I've mentioned before, we have made a lot of progress in the 2 years since we initiated a number of important changes to our operating and financial model. We made to these changes to accelerate our progress in rolling out new fulfillment options to rapidly improve our own brand assortment, transform more of our stores faster and, perhaps most importantly, accelerate investments in our team. At that time, we told you we were confident that these were the right decisions to change the pace of our near-term performance and position Target for long-term success. We also expressed confidence that an acceleration in our operating performance would translate into strong financial performance following the transition to this new model. And today, it's great to be able to go beyond expressing confidence and actually demonstrate how this new operating model is successfully delivering relevant growth and profitability. I'd like to thank our team for their work to enable this strong performance and to everyone on the call for continuing to follow us on this journey. Now I'll turn it back over to Brian for some closing remarks. Brian?

Thanks, Cathy. In a moment, we'll move to your questions, but I want to spend a minute and wrap-up with what we covered today. And what I hope you've heard today is that we're really happy with the path we're on, a path again well over 2 years ago. And today, our business is generating strong performance across the board from traffic and sales to operating income and EPS. To get to where we are today, we decided to make some bold changes over the last couple of years, but I want to emphasize something important about those decisions. When we made them, we explicitly focused on taking a different path than our competitors. We said we would open stores when others were closing them. We said we'd invest billions of dollars in our shopping experience and in our team when others were pulling back. We said we'd use our stores as digital hubs because it delivers speed and convenience for our guests, and it aligns with our digital strategy. We said we'd invest in differentiation when others were simply looking for scale. And we said we'd maintain our balanced, multi-category assortment, one that's unique in U.S. retail. So when we get asked today why aren't you doing what others are doing? The answer always starts with the fact that we're not trying to be like everyone else. At Target, we perform best when we're pursuing our own path, not when we are chasing someone else. And our first quarter performance is a clear example of the benefit of that approach. So with that, I want to thank you for your time today. And now we'll move to your questions.

[Operator Instructions] Our first question comes from Edward Yruma with KeyBanc Capital Markets.

Great. This is Sarah McCann on for Ed. Can we click down on where you saw the cost savings in the tech expense bucket that drove some of the SG&A leverage in the quarter. And then how would you score your ability to offset those digital fulfillment and supply-chain costs going forward?

We are experiencing technical difficulties. You will hear silence until the conference resumes. [Technical Difficulty]

Thank you all for standing by. The call will now resume. And our first question was coming from Edward Yruma with KeyBanc Capital Markets.

This is Sarah McCann on for Ed. We were just hoping to click down a little bit more on where you saw the cost savings and the tech expense bucket that drove some of the SG&A leverage in the quarter. And then how do you score your ability to offset those digital fulfillment and supply-chain costs going forward this year?

Sarah, I'll quickly answer that. This is Cathy. As we said on the -- in the prepared remarks, we did see some favorability in our tech operations. As you know, they continue to be working on just the most important things and then being really effective and efficient in their work. So that's providing some benefit. We saw some general cost control across the entire company. We saw some marketing timing, and we saw that being offset by some of the wage pressure we were seeing. All of that said, plus 30 basis points improvement in year-over-year SG&A.

And Sarah, why don't I have John Mulligan spend a few minutes talking about the benefits that we're seeing as fulfillment moves to some of our same-day services.

Yes, I think the thing we're most excited about in the digital business, Sarah, is that just guest preference, as we observe it, the fastest-growing things -- the fastest-growing services we provide are in same day, that's Order Pickup, Drive-Up and Shipt. Those are also our most profitable services that we provide through the digital channel. So as they continue to grow meaningfully faster than the rest of digital, we expect our digital profitability to improve. So we're really excited because the guest preference is meeting up with exactly the capabilities we have, and they happen to be the most economically feasible for us going forward.

The next question comes from Chuck Grom with Gordon Haskett.

Congrats on a good quarter. Just to follow up on that. John, the digital fulfillment cost have been kind of running in the roughly 50 bps -- 70 basis points of pressure over the past few quarters. Would you expect that to begin to abate given that the penetration of the more profitable parts of the digital business are going to start to grow? And then, Cathy, just as a follow-up, could you just review the second quarter margin assumptions again for us? I know you're saying slight leverage on the operating margin line, but I didn't hear the exact components across gross margins, SG&A and depreciation.

Yes. Let me start. So for second quarter, we said that we would see slight leverage in our operating income margin, so just a little bit there, and relatively small changes in all 3 of the subcomponents, so think gross margin, SG&A and depreciation. So pretty much just a pretty consistent quarter where we're already expecting to be supported by that top line of low to mid-single digit. And then it'll end up in a mid-single-digit increase in op income dollars. So pretty much consistent with what we just said.

And I think, Chuck, stepping back from perhaps the basis points of gross margin. I think we've been very consistent in saying that we see great benefit in using the stores as hubs. I think that's where we see we're able to bring great speed to our consumers. Same day, we just talked about that. Next day, 2 day, whatever it is, we can do all that through the stores. It's faster and it's more efficient for us from an economic perspective. So we feel really good about the path we're on. We feel great that same day is growing much, much faster than digital and the benefits that will bring to us economically. So we think we've got a really good path forward to continue to build on what we've already built from a capabilities perspective.

Yes. Chuck, let me add on. I think you should expect to see our Q1 performance really serve as a proxy for our performance over the balance of the year. Low to mid growth in comps, mid-single-digit improvement in operating income and high single-digit improvement in EPS, and I think that's going to be kind of the pattern for the balance of the year.

I think to summarize there, too, we just grew digital at 42%. And we grew op income dollar and rate both expanded.

The next question comes from Edward Kelly with Wells Fargo.

Nice quarter. I just wanted to -- I want to start with comps. Can you just give a little bit more color on cadence of comps throughout the quarter, especially the choppy start and the better finish, what you're seeing so far in Q2? And then I wanted to ask about second quarter guidance and how you're thinking about this comparison. Low to mid singles is an acceleration even at the low end, and you left the possibility of the high end open, which is, I guess, remarkable to know. Can you just maybe talk about the optimism behind that as well?

Yes, and I'll start. I know we saw very consistent performance throughout the quarter. Actually, we talked about in our prepared comments some strength that we saw from a digital standpoint as we exited the quarter. But across our entire portfolio, we saw market share gains, very consistent comp performance both in-store and from a digital standpoint. And we expect that to continue in Q2. We did during -- wisely, as we talked about guidance. We're now going to lap the closures of TRU in the second quarter, so we'll see some moderation in the growth that we've experienced in Toys and Baby. But I think we have a very clear plan for the balance of the year going into the second quarter. We're very confident that we're going to continue to see market share gains and a consistent rhythm of comp increases, operating income improvement and that's going to flow through to EPS. So a very consistent set of performance drivers throughout the quarter that'll extend into Q2.

And just one follow-up on Chuck's question about the gross margin. If we think about the impact of fulfillment on the margin relative to the dollar growth that you're seeing in digital, that relationship, I guess, seems to be improving. And I guess could you maybe just talk about the underlying efficiency in terms of what's happening with orders that are sort of filled year-over-year as well as how the mix is impacting that line item? And how we should sort of think about the opportunity for improvement going forward there?

Well, I'll go back to some of the points that John made during our March Investor Conference. As we move digital fulfillment from upstream DCs to stores, we see a significant reduction in expense, and we talked about a 40% reduction. When we go from an upstream DC to some of our same-day fulfillment offerings, like Order Pickup and Drive-Up, we see a 90% reduction in costs. And as John talked about, those were the fastest-growing parts of our digital fulfillment during the quarter, and we expect that to continue. That's clearly where we're seeing the guest preference. We saw tremendous amount of growth in Order Pickup despite the fact that we've been offering that for almost 5 years now. We're seeing dramatic acceleration in the Drive-Up offering and very strong performance from Shipt. So those were much more favorable from a expense standpoint, and they're preferred by the guests. So as that continues to mature and grow, we're going to see some of the benefits flow through our P&L.

Our next question comes from Robbie Ohmes with Bank of America.

Great quarter. I'm actually going to ask 2 questions, one was just a follow-up, Brian, on your answer there. The -- I get this question all the time. As you keep shifting digital fulfillment to the stores, how are you -- how is the store SG&A not exploding or offsetting? Just maybe a little more color on how you're getting those dramatic savings, the 40% and 90% reductions. And then I'll just tell you. The second question is on the second quarter, I'm just curious how you're -- let me say it this way. Some of your competitors are not doing as well as you might have done, and they might have a lot of excess inventory in things like apparel. I'm just curious what you think the environment is going to look like with a lot of your -- some of your large competitors not in great positions right now.

So why don't I let John start by talking about some of the process improvements we've made in store and the way we're leveraging technology and systems to drive even greater efficiency as we fulfill those orders. And then I'll come back and talk about the competitive environment.

Yes. Robbie, I think the first thing I'd say is we are investing payroll into the stores to take care of the fulfillment that is going on. The one thing we don't want to do, and we have been clear about this, is pull payroll off the sales floor to take care of what's going on in the backroom. So we have put additional payroll in the backroom. And of course, that payroll gets reclassed to gross margins because it is part of our fulfillment expense. But to Brian's point, I think the other thing the stores team has done an outstanding job of is continuing to refine their processes and introduce new tools that allow our teams to get more efficient, particularly in backroom operations, logistics of the store. So we're able to pull hours out of there, either let them fall to the bottom line or, more importantly, we have reinvested a significant amount of those hours back into the sales floor to create a better service environment. And we'll continue to work on that. The stores have great plans. They continue to do that. As we do more upstream and supply chain, we will continue to pull those back office, backroom logistics kinds of hours out of the store, either centralize them upstream and make them more efficient or process optimize them, bring better tools from our technology partners to the stores so that they get better and better. And that's a loop that we've been on for quite some time. So the stores teams, the technology teams have done an outstanding job of continuing to manage our overall store expense.

And Robbie, if we turn to the overall retail environment, we're seeing a very consistent and healthy environment across the U.S. I think what we're seeing right now is the bifurcation of winners and losers, and I think our performance now speaks for itself. We're on eighth consecutive quarters of growing comps. We've seen consistent market share gains across all of our categories, and we're performing both from a store standpoint and a digital standpoint. So we feel really good about the progress Mark and his team made from a merchandising standpoint, the reaction we're seeing to our own brands and the execution that we're seeing in store. So we think we're well positioned to continue to grow share in this environment. And I think what you are just seeing is you're seeing the emergence of winners who have been investing in their business, that are adapting to this new omnichannel environment and unfortunately, those that are ceding share that have not been able to invest and evolve to the new consumer environment.

Our next question comes from Joe Feldman with Telsey Advisory Group.

I wanted to ask, as you guys start to lap the Toy business, Toys 'R' Us from last year, the other -- I know it has a comp impact, but it also, if I recall correctly, had a gross margin impact negatively when it happened just because Toys are lower margin. How should we think about that sort of benefit, so to speak, as you start to cycle that this year as it relates to the gross margin?

Mark?

Yes. Look, I mean it does provide a high level of stability going to second and more in third and fourth quarter. I mean we've been buoyant across the board because of our healthy mix and the strength of our owned brand margins, so that's helping to [indiscernible] mix. This will be a further stabilization point. But the one real benefit that we can utilize and continue to build on is the traffic that we've been building, which has gained market share for us in critical businesses like Baby, Kids and Toys, and the halo effect of that really began last year and it's continued all the way through into this strong quarter.

That's great. And if I could follow up maybe on some of the newer initiatives you guys have in place and if you could -- like the Circle loyalty program test that's going on and the new e-commerce marketplace, and just things like that, that you're working on. Maybe just an update on how those performed during the quarter.

Joe, still, again, in the early stages. We've expanded our Target Circle program to a number of new markets. We are very pleased with the way the guest is reacting, and we certainly think that it's something we're going to expand over time. Our Target Plus program off to, again, a very good start, great response from vendors. But we're in the early stages. We want to make sure we stay focused on curating the right assortment by category for our guests. So more to come going forward, but both initiatives being well received, and we'll continue to look at expanding those over time.

The next question comes from Michael Lasser with UBS.

Two questions. One, how will you factor in the move to 25% tariff on the current lift into your guidance? And how will your guidance change if we go to 25% tariff on an entire set of products that are imported from China? And my second question is, given all this traffic that you're seeing from in-store fulfillment and same-day pickup and Shipt, how are you converting more items into the basket for those guests that are coming into your stores to pick up orders? And what can you do to improve that conversion?

So Michael, I'll start with the topic of tariffs. And as I said in our prepared remarks, obviously, we've been monitoring this very carefully. It has been a fluid situation for quite some time now. Our point of view hasn't changed. And as we think about tariffs, we reflect on the impact it could have and will have on American families that are going to be paying higher prices. But I think our teams have done a very good job of trying to mitigate the impact in the short term. And as I think about where we sit going forward, one I'll start with our multi-category portfolio is a huge advantage in this environment. And our ability to flex our focus from category to category is something that's somewhat unique to Target versus single-category retailers. We also have, Michael, a very experienced and talented sourcing team that works in over a dozen offices around the world that focuses on this each and every day. They work with some very sophisticated vendor partners that for years now have been working to diversify their manufacturing base. And those are big advantages for us going forward. I'm going to let Mark and John talk about the fact they were actually with those vendor partners just last week making sure that we're constantly looking at evolving our plans to anticipate some of the changes in the environment. So we're watching this very closely. But we have the advantage of a multi-category portfolio, a very talented and experienced sourcing team that operates around the world and sophisticated vendor partners that have been looking at ways to diversify their manufacturing footprint for years now. Mark, you were there last week, as was John. Any feedback from those meetings?

Yes. Michael, I'll share with you. But John and I and others were in Asia last week meeting with our global vendors, not just China, our Asia-based vendors, and clearly tariffs was a point of discussion. Our current actions are not reactive. They're responsive, and we've been planning these for some time looking at the level of potential change and working with our deep vendor base, we have trusted partnerships and leveraging our current strength of performance to build opportunities to diversify, to work through price changes, and again, as Brian said, a very sophisticated and elevated team who have been anticipating change. And I think when you look at our Q1 results, where we've been able to effectively mitigate those risks from prior announcements, I think it bodes well for how we look to manage this moving forward.

Michael, this is Cathy. Maybe I'll just answer, too, to be clear that the anticipated 25% increase that will go in place in June is contemplated in our guidance. So to be clear there. And then you had asked the question, and Brian and John should answer, too, but on converting our basket or converting those same-day services. And as we shared, we're seeing a lot of incrementality in those same-day services. And as the kind of fact that's pretty amazing is the 80% increase in Order Pickup while we're well into that journey. That just shows that we're deepening our relationship and being more relevant for our guests so that they're choosing Target more often as we provide convenience and ease.

I think Cathy hit on it, Michael, that certainly, when people come in for pickup in-store drives traffic. A percentage of them go on and buy something else in the store. But our focus really is on being true to the mission that they have. If it is Drive-Up, we give them bag and they're on their way, and we're not going to bother them with a sales pitch. If pickup, they want to get in and out, that's great, too. And then when they come to store, and they get their Starbucks and they work the whole racetrack, we'll provide a great set of experiences there. So we want to meet them wherever they are, and to Cathy's point, continue to drive that engagement with Target.

Michael, it gets back to our focus on being America's easiest place to shop. To John's point, we want to make sure we meet the guests on their terms, make it really easy and convenient for them to shop with us. And we know some days, they're going to be pulling in our parking lot and hoping to be out of there in minutes. Other days, they're going to come in, grab that cup of Starbucks and enjoy walking the racetrack and seeing what's new and exciting this week at Target. So we've got to make sure we're playing on the guests' terms and I think our strategy right now is meeting the guests right where they want to be.

Our next question comes from Kelly Bania with BMO Capital.

Just maybe a quick one on the guidance for the year just given the strong start. How much of maintaining that just has to do with conservatism, conservatism in Q1, tariffs or maybe any other factors you're seeing in the business?

Kelly, I think, again, I think we were really clear back in March that we felt very good about 2019. I think our first quarter validates our guidance for the full year. And we feel very confident about the fact that we've got guidance that's realistic. We're going to continue to focus on execution each and every quarter. So no change in our guidance. We've got confident that we're going to deliver, as we said, low to mid-single-digit comps, mid-single-digit expansion of operating income throughout the year, and that's going to flow through to high single-digit EPS with very strong return in invested capital. So we feel really confident about our outlook for the second quarter and the full year, recognizing it's still early. We're sitting here in May. But we're off to a very good start. The guest is responding incredibly well to our merchandising offerings, our owned brands, our fulfillment options. And we're going to continue to stay very focused on execution each and every week of the year.

Okay. If I could just add one follow-up, just on your ship-to-home model. Obviously, a lot of competitors in the market moving more towards a next-day ship-to-home model. And obviously, Target, having a lot of success with the same day and pickup and Drive-Up and -- but just curious, and I guess you have seen next day with restock, but do you feel like you need to match this service more broadly on a wider assortment? And can this be done, if so, from your stores? Or does this need to be done from an FC down the road?

I'll go back to some of the point that John Mulligan's made. Clearly, as we talk to the consumer, we talk to the guest, we know how important convenience and speed is, and that's why several years ago, we made the decision to put our stores at the center of our fulfillment strategy. And you're seeing that pay off right now. Obviously, we're seeing a growing desire for our guest to take advantage of some of our same-day services and very strong growth with order online, pickup in store, Drive-Up, take advantage of over 100,000 Shipt shoppers that can bring that order to your home within hours. But -- and as we look at the benefits of shipping from our stores, even today, on any given day, upwards of 50% of our orders are delivered next day, and it's using our stores and their proximity as that advantage in our overall strategy. So we think we're very well positioned today. We're leveraging the fact that we're so, so close to the guest with our 1,851 locations, and ease and convenience as a big part of our strategy. So John, I don't know if there's anything else you'd add. But I think our decision years ago to put our stores at the center of our fulfillment strategy is paying off with accelerated growth up over 42%, tremendous growth in order online, pickup in stores and dramatic acceleration in areas like Drive-Up.

Our last question comes from Seth Sigman with Crédit Suisse.

I wanted to follow up on a couple of points. I guess just first looking at the comp trends, transactions growth, very strong. Over the last couple of quarters, your ticket growth has been less of a contributor to comps. And you have a number of initiatives that you talked about throughout the call that, in theory, should be supporting bigger baskets. And I think some others in the industry have also talked about a little bit of inflation coming through. So just curious how you guys are thinking about the drivers of ticket. And how we should be thinking about that?

As we sit here today, we're very, very pleased with the overall basket performance. But what's happening is we're seeing acceleration in traffic. The guests are simply shopping us more frequently, and we're meeting more of their needs each and every day. So I think the most important barometer is we're putting great traffic growth on top of strong traffic growth from last year. I think the 2-year stack on traffic is 8%. And we're seeing the guest engaged in more categories, shopping more often. And we're really pleased with the composition of our overall results. So we're going to continue to build off of that. Guests are responding well to the offerings that we're bringing each and every week. And we're driving more footsteps to our stores and business to our site, and we're going to continue to leverage that in the second quarter and beyond.

And then just if I could follow up on tariffs. I'm thinking specifically about the flow of inventory. If I go back to the third quarter, I think you had some challenges maybe related to the ports and you also talked about some incremental cost at that point. What are you seeing today? And do you feel like you're more prepared to avoid some of the margin pressure that you experienced back then?

So going back to last year, we made some very specific surgical decisions to invest in inventory, specifically in categories like Toys and Baby and holiday as we are preparing for the season. So we did incur some of those challenges you just talked about. It was very strategic, very specific to categories, and we feel like we're in a very strong position from an inventory standpoint as we go into the second quarter and the balance of the year. Operator, with that, we're going to close our first quarter earnings call. Thank you for joining us today, and we look forward to talking to you later in the year.