Q2 2019 Earnings Call
Ladies and gentlemen, thank you for standing by welcome to the target Corporation second quarter earnings release Conference call.
During the presentation, all participants will be in a listen only mode. Afterwards, we will invite you to participate in a question and answer session at that time. If you have a question you will need to press star one on your telephone as a reminder, this conference is being recorded Wednesday August 21st 2019, I would now like to turn the conference over to Mr., John Hulbert, Vice President Investor Relations. Please go ahead Sir.
Good morning, everyone and thank you for joining us on our second quarter 2019 earnings conference call on the line with me today are Brian Cornell Chairman and Chief Executive Officer, John Mulligan, Chief Operating Officer, Mark Tritton, Chief Merchandising Officer, and Cathy Smith, Chief Financial Officer.
In a few moments, Brian John Mark and Cathy will provide their perspective on our second quarter performance, our outlook and progress on our long term strategic initiatives.
Following their remarks, well open the phone lines for a question and answer session.
This morning, we're joined on this conference call by investors and others, who are listening to our comments via webcast.
Following the call Cathy and I will be available to answer your follow up questions.
And finally as a reminder, any forward looking statements that we make this morning are subject to risks and uncertainties. The most important of which are described in our SEC filings.
Also in these remarks, we refer to non-GAAP financial measures, including adjusted earnings per share.
Reconciliations of all non-GAAP numbers to the most directly comparable GAAP numbers are included in this mornings press release, which is posted on our Investor Relations website.
With that I'll turn it over to Brian for his thoughts on our second quarter performance and our outlook for the rest of the year and beyond Brian .
Thanks, John .
We are really pleased with our second quarter financial performance, which reflects the durable model. We built over the last several years in building. This model, we focused on making changes to ensure we maintain long term relevance with our guests while positioning our business to grow profitably over time.
When we began this journey to transform our business in 2017, we said the 2019 would be the year when we'd be positioned to deliver profitable growth.
And our results through the first half of this year, that's certainly fulfilled that expectation.
On the top line, our business delivered second quarter comparable sales growth of 3.4% driven primarily by traffic.
This growth was on top of unusually strong comp growth of 6.5% in the second quarter last year, meaning that our comp sales have increased about 10% since 2017, our best to your snack performance in well over a decade.
On the bottom line, our second quarter profitability was well ahead of our expectations.
Our business delivered double digit growth in operating income, which translated into record high earnings per share numbers and more than 20% EPS growth over the last year, among our sales channels second quarter comp sales grew 1.5% or stores and 34% and our digital channels.
Within our core merchandising categories, we saw more than a 5% comp growth in both apparel and essentials.
This reflects the broad value, we deliver across all of our categories and the balance we achieved between our more discretionary areas like apparel home and beauty.
And our less discretionary food and beverage and essential categories, which deliver consistent traffic throughout the year.
Beyond our frequency categories throughout the year, we focus on important seasonal moments in our guess lives and unique partnerships that create excitement and sustain our brand.
At the beginning of the second quarter, we were really pleased with the guest response to our limited time partnership with vineyard vines.
Which was one of our most successful in our history.
And near the end of the quarter, we saw encouraging early results in our back to school and back to college categories.
In our digital channels, we continue to see the most rapid growth in our same day fulfillment options in store pickup drive up and shipped which together have more than doubled their sales in the last year.
These options offer speed convenience and reliability.
And as a result.
They are quickly becoming the preferred fluent choices for our guest.
And most importantly, because these options leverage our store infrastructure technology and teams.
Same day fulfillment delivered outstanding financial performance as well.
In our stores, which grew both traffic and basket in the second quarter.
We continue to elevate both the environment and the level of service, we completed 84 remodels in the second quarter.
And we're on track to deliver approximately 300 this year.
These projects transformed the shopping environment, featuring and and improvements in our decor lighting and merchandise displays.
In addition, they incorporate changes to optimize digital fulfillment, enabling speed and reliability for our guest and efficiency in support of our financial performance.
Within our product assortment, we continue to focus on providing a unique combination of quality fashion and value across our owned exclusive and national brands.
Just ahead of the back to school season, we launched our new multi category owned brands more than magic.
With our team developed to appeal to guests in their 20 years.
And just this month based on encouraging results in a 20 store pilot, we expanded our test of Levi's Red tabs denim for both men and women to 50 stores in your college campuses and in high traffic urban markets. We're pleased to be partnering with levis to showcase this iconic product line.
Previously reserved for department stores to more and more of our guests.
In recent years, many of our competitors began promoting cyber summer sales in the July period, which drives consumer interest in online shopping and causes the natural spike in our digital traffic.
This seasonal spike creates a natural opportunity for us to thoughtfully investing promotions, allowing us to gain mindshare and convert this traffic into additional orders and sales.
At the same time the acceleration in order volume allows us to test the agility of our operations in advance of the fourth quarter peak.
I'm pleased to report like last year performance of our July deal days event was outstanding both in terms of guest response, where promotions as well as the ability of our operations to handle the surge in demand.
And while I'm on the subject of agility and operations I want to take a moment and address the system outages, which affected our cash registers and payment systems during a busy weekend in June .
These outages disappointed our guest and once again I want to apologize for the inconvenience they cost.
While our business still delivered an outstanding quarter. These outages or a stark reminder of the need for us to continue to focus on execution across every aspect of our business every day.
On the positive side I couldn't be more proud of our store teams across the country, who put our guest first and worked tirelessly to minimize the convenience store guests.
And I just want to thank our headquarter teams, whose scrambled quickly to assess root causes and recover our systems in a very short time.
I've said this before and I see it every day, we have the best team in retail.
As we step back and look at our results throughout the first half of the year.
Our teams have delivered really outstanding performance ahead of our expectations.
Comparable sales have grown more than 4%.
Operating income has grown more than 13%.
And GAAP and adjusted EPS have each grown about 20%.
This performance puts us in a strong position as we enter the back half of the year.
However, as we look ahead to the balance of the year, we're mindful of the volatility and uncertainty in the marketplace, including the timing and extent of additional China tariffs.
As you know the list of products in line for new terrorists includes a broad set of consumer categories, including apparel electronics toys at home.
As a result, we've been following developments carefully and we're encouraged that many items originally slated for tariff increases in September .
I have now been delayed until later in the year.
But as long as the trade situation remains fluid it will present, an additional layer of uncertainty and complexity as we plan our business.
Against that backdrop, we expect to continue to benefit from our diverse multi category assortment.
Deep expertise in global sourcing.
And a sophisticated set of manufacturing partners around the world.
As a result, we are confident in our ability to navigate this period of heightened volatility and move our business forward.
And we're really excited about our plans for the balance of the year in which we'll continue to deliver excitement innovations convenience and value to our guests.
Beyond the back to school and back to college season.
We're excited this quarter to be bringing back hundreds of items from 20 different designers to celebrate the 20th anniversary of targets first designer partnerships.
And just this week, we announced our newest owned brand in food and beverage couldn't gather.
Which our team designed to make it easy for families to discover the joy of food.
Over the next few months will be completing more than 100 additional remodels, so more and more of our guests can enjoy and enhance store shopping experience in time for the holiday season.
And of course, we'll continue expanding our rollout of drive up and shipped across the chain.
Bring enhance speed and convenience to more and more of our guests across the country.
Putting this all together in both the third and the fourth quarter, we are planning to deliver comparable sales growth in line with the 3.4% pace, we established in the second quarter.
As we plan for the profitability those sales our guidance reflects the most recent announcements about the extent and timing of China tariffs.
Altogether based on our performance in the first half of the year.
And our outlook for the back half, we expect to generate full year GAAP and adjusted earnings per share of $5.90 to $6.20 an increase of 15 cents from our prior range.
While we certainly see the potential for us to outperform the midpoint of this range. We believe it strikes the appropriate balance between the outstanding trends, we've been seeing so far this year and the financial flexibility, we'll need to manage through a volatile environment.
And finally for the third quarter, we were planning GAAP and adjusted earnings per share of one dollar four to $1.24.
So before I turn the call over to John I want to recognize our team for their efforts to deliver such outstanding performance in 2019.
But I also want to recognize their hard work over the last few years, which has allowed us to transform nearly every aspect of our business.
Without those efforts we might have found ourselves in the unfortunate position of many of our competitors who are struggling to perform in the face of rapid changes in the consumer and the marketplace.
Through the tough times, our team stuck with us they believed in our plan. They believed in each other and they believed in our brand.
And today I am incredibly honored to be able to share the outstanding results of their work with that.
I will turn the call over to John for an update on our digital fulfillment capabilities and our plans to continue to grow John .
Thanks, Brian .
This quarter provided further evidence of the payback, we're realizing on the investments we've made over the last several years to transform our assets our capabilities and our team.
This work is creating an operational model that can generate growth on both the topline and bottomline as you saw in our second quarter results.
One place, where it's easy to see the impact of our new model is in digital fulfillment.
Where the mix is moving dramatically towards our same day services in store pickup drive up and shipped.
In the second quarter. These three services accounted for more than a third of our digital sales up from about 20% last year.
In other words, our same day options are growing much faster than our digital sales.
Specifically combined sales for in store pickup drive up and shipped have more than doubled over the last year accounting for nearly three quarters of target is 34% digital comp in the second quarter.
That means that nearly one and a half percentage points of the Companys overall comp growth was driven by our same day services.
These are remarkable statistics and they demonstrate how rapidly our guests are learning about and embracing these new convenient options.
For many guests, they're becoming the go to choice for their digital shopping because they offer unique advantages.
Their immediate they allow guests to shop and receive their order on the same day.
They are convenient guest can choose where they receive their order either at the front of the store in the parking lot or at home. They are fast our standards for drive up gas to receive their order in less than two minutes and our average is comfortably better than the standard.
And finally these services provide certainty.
Yes don't have to wonder when a package will arrive at their house and what will happen to the package if they're not at home.
And of course, it eliminates the need to deal with opening and recycling of stack a cardboard boxes every week.
With these advantages it's no wonder that our same day offerings received some of the highest net promoter scores of anything we offer which means that guests want to use the services again and again after they've tried them.
So if you simply apply I guess first mentality you quickly see the value of our investments to develop and roll out our same day options across the country.
But what's even better is that the services also makes sense for our business because they leverage existing store assets and our store teams in new ways. As a result, our same day options are also the most profitable within our digital offerings.
Over the last few years, we have made a concerted effort to increase the efficiency of all of our store fulfillment options, including both our same day and ship from store capabilities.
As a result, since the beginning of 2018 or picking efficiency for pickup and drive up has increased more than 30% and similarly end to end labor efficiency for our ship from store capability has also improved by more than 30% over that same period.
These are massive improvements, which we realized through the natural scale efficiencies, we see on higher volume, which are compounded by incorporating improved processes and technology.
These tactics include creating larger batches for picking orders based on the goal to balance efficiency speed to guest and the guest experience.
Optimizing the path for order picking to minimize steps through the backroom and sales floor. During seasonal peaks batches are further segmented into sub sections of the store like back to school orders this time of year.
Applying new algorithms to prioritize the sequence of order pickup based on a range of criteria rather than simply applying a first in first out system.
Implementing new technology to eliminate ambiguity for our store team members about which work to perform Onest. When work is due and the optimal box size for packing orders.
And of course, enhancing data and reporting for store teams to track the unit efficiency, both pick and pack.
This reporting updates constantly throughout the day and provides leaders the ability to understand the drivers of their teams performance in real time.
These efforts have been focused on store fulfillment, but we've been focused on every step of the guest shopping journey, including returns.
We've always offered free in store returns of digital orders, but guess sometimes refer to ship their returns back to us to make that process seamless we've worked with our shipping partners to expedite the process of our return for digital order.
Under the new process after a guess Prince the return label at home and either drop should offer schedules pickup at their home they receive credit for the return as soon as our third party shipping partner scans to return label.
This means that refunds are receiving I guess credit or debit card account days earlier than before and our guests have notice.
And our guest survey scores, we've seen a meaningful improvement in the level of satisfaction for refund timeliness compared with last year.
So clearly we've done a lot to support our digital growth, but we shouldn't forget about store sales, which continue to account for more than 90% of our total volume.
As we've been saying for years, we believe that in store shopping will continue to be important and account for the vast majority of retail sales for many years to come.
However, in a world where consumers have more choices than ever inferior brick and mortar experiences will go away.
Thats why we are investing heavily both in our store assets and in the experience our team provides.
Regarding the store assets themselves, we're in the middle of a three year period in which we plan to remodel about 300 stores each year.
A more rapid pace than we've ever accomplished as Brian mentioned these remodels transform the entire store experience and optimize them for digital fulfillment.
And as we've covered in past quarters, we continue to see first year traffic in sales lifts inline with our original expectations and second year lifts that we didn't originally anticipate.
As successful as our remodel program has been we continue to look for ways to refine our process.
We continually analyze the results of completed Remodels and apply those learnings into our project plans. So next year's Remodels won't look the same as the ones we completed last year.
We're also finding ways to mitigate the challenges our guest face when construction is in process.
Which is leading to smaller average sales disruption than we experienced last year.
And while guests are enjoying the upgraded look and feel of their new store. They are also experiencing a change in the way our team serves them.
That's because over the last few years, we've been rolling out a completely new operating model for our store team.
This new model, a simpler and focused on our guests rather than accomplishing tasks.
We've also created more specialized roles in which team members, bringing their expertise to categories like food beauty electronics in apparel.
The second quarter was the first time, we had a new model fully implemented across the country and we continue to be happy with the results.
For example, we're seeing improved guest survey scores on questions about their interactions with our team both on the sales floor and at checkout.
Beyond the guest experience. We're also seeing the benefit of the operating model and our financial performance.
Like everyone else, we are currently experiencing meaningful wage inflation in a very tight labor market.
However, because of our ongoing investments in our team and this new operating model, we're seeing strong efficiency improvements in our stores, which is helping to mitigate the impact of higher wages.
Before I turn the call over to Mark I want to talk about our longer term vision for the supply chain.
Specifically I want to address the questions. We continue to hear about the long term prospects for our strategy of using our stores is fulfillment hubs.
One form of the question is to ask if the strategy is only feasible when target's digital sales are still small.
My first reaction is to wonder if it's appropriate to consider digital sales of well over $5 billion to be small.
But I'll stick to what's most important to talk about how we expect to deliver much higher volumes of store fulfill digital sales over time.
And based on the questions we've been getting for many of you I want to cover three distinct questions about our capacity to accommodate growth.
The first question pertains to the ability of our stores to fulfill higher levels of digital sales within their existing square footage.
On that question our experience shows that our stores have a very long runway of capacity.
Think of it this way.
Last year stores fulfilled sales accounted for an average productivity of just over $300 per square foot.
And when you do the math every additional $1 billion of store fulfilled sales would raise that productivity by about $4 a foot.
In other words, if we double last year's $5 billion in digital sales and fulfilled all of that extra volume in our stores, we see our average store sales productivity rise by just over $20 a foot.
So the question is can our stores accommodate that volume and their existing space.
The answer is clearly yes in the easiest way to see that is by looking at the range of productivity of our stores across the chain.
Specifically, our top cortile of stores, a group consisting of more than 450 locations delivered average per foot productivity of more than $430 last year.
That's more than $100 higher than the average for the chain.
So based on our success and operating that large set of stores. We believe we have a lot of room to grow our overall sales productivity through digital fulfillment.
But there is a second capacity question pertaining to the mix of space in our existing stores.
Specifically, we often get asked whether we'll need to expand our store back rooms, as we continue to see rapid growth in store fulfill digital sales on that question. Our internal modeling shows that we are not going to run up against any capacity constraints in the near term because our stores already have ample backroom space.
Specifically, if we continued to simply apply our existing technology and processes and maintained a rapid rate of growth in store fulfilled sales, we wouldn't need additional store and back room capacity until well into the next decade.
And as an aside that constraint would only occur during the two week long seasonal spike in the fourth quarter.
However will only run up against that constraint, if our technology and processes stay the same as they are today and that isn't our plan.
Just as our stores have consistently delivered ever higher productivity in their ability to fulfill conventional sales. We are investing in technology and processes that will allow our stores to continue to grow their backroom productivity as well.
Beyond the capacity of our stores and backrooms. The third capacity question, we hear as weather overtime, we are going to need to invest in additional upstream distribution capacity to accommodate our growth and for this question. Our answer is clearly, yes, but that shouldn't surprise anybody because weve been adding capacity throughout more than 50 years of growth in our stores in other words, when you grow any type of sales either at conventional store sale or a digital sale. Eventually you will need to add network capacity to serve the additional volume.
But that doesn't mean, we're sitting on a surprise addition to the Capex plans, we outlined at this year's financial community meeting.
The capital plan, we outlined that they already accounted for expected future investments in upstream capacity based on our plans to grow both store sales and digital sales in the years ahead.
So in other words, adding network capacity isn't something beyond our plan. It's part of the plan we've already articulated.
Now before I close I want to thank the team for their work to turn theory into reality over the last few years.
When we started many people didnt think we'd be able to grow store traffic and sales ever again.
When we started many people questioned whether store should play a central role in digital fulfillment.
And when we announced our goal to move to a $15 minimum wage across the country by the end of 2020. Many people Didnt think we could accommodate those kinds of wage increases and generate profitable growth.
But because of this team's dedication vision and energy, we've been able to transform our business and deliver outstanding financial results.
Through their efforts our team has delivered the performance that has converted doubters into believers.
Now I'll turn the call over to Mark who will talk about our merchandising performance in the second quarter and our plans for the third quarter and beyond.
Mark.
Thanks, John .
As Brian mentioned earlier, we continue to focus on ways to deepen engagement of I guess across multiple facets of our merchandising assortment in discretionary and frequency categories and brands and national brands and different shopping occasions, including life events holidays and everyday shopping trips.
Of course, the most visible indication of our guest engagement is out traffic growth, which we continue to see across by that stores and digital channels.
Engagement can also be seen in the market share data, which continues to show gains across multiple dimensions of our business.
Between that coal categories second quarter growth was strongest in the central and beauty and apparel, both of which delivered comp increases above 5%.
Results within essential and beauty was strongest in baby beauty and over the counter.
Babies being one of our strongest share stories for the last year and we saw continued gains in the second quarter.
Beauty has also been an amazing run as we've seen accelerating share gains for well over a year.
In apparel in the second quarter, we saw broad strength across a host of categories, including intimate sleepwear jewelry accessories, and shoes baby and performance active wear.
We were particularly pleased to see such strong trends at target despite unfavorable weather trends during the quarter and self sales conditions for the overall industry.
As a result, we saw some unusually strong share gains across multiple parts of the apparel assortment in the second quarter.
Among the remaining coal categories, but that food and beverage and home Assortments. So low single digit increases in comparable sales in food results were led by adult beverages, which delivered another quarter of double digit growth in home results were led by cycle.
In high month this quarter comp sales were approximately flat overall results were led by toys with growth continues at a more moderate pace given that we annualize the closure of toys R us during the quarter.
In addition, we saw healthy growth in our mobile category during the quarter.
These areas of strength were offset by comp declines in our electronics and entertainment categories, reflecting an overall lack of industry newness in their product assortments.
We're expecting this performance to strengthen in the back half of the year.
As both of these categories will benefit from new launches and product introductions by our vendor partners.
To continue to deepen guest engagement, we focus on delivering a constant drumbeat of newness and innovation elevating key life moments for I guess, while making it easier than ever to fulfill their everyday needs.
Oh, great value.
We kicked off the second quarter with a blockbuster limited time partnership with vineyard vines and we're really pleased with the results. This was one of our biggest brand partnerships in recent history and were happy to see that traffic and sales came in ahead of our forecast.
This partnership was also an important moment for our brand as we saw high digital engagement and an amazing amount of buzz in social media.
Also in the quarter were pleased with the results for both mother's day father's day holidays.
Some of the strongest shake out into the quarter occurred during this holiday periods, particularly in men's and women's apparel, but also in toys and kids.
And as Brian mentioned late in the quarter were pleased with the early results in a back to school and back to college programs, which are second only to the fourth quarter holiday season in terms of importance.
Strategically planned right before the back to school season, we launched our newest Arden brand more than magic, which is a complete lifestyle brand spending sportswear dance, where and gymnastics apparel jewelry accessories beauty electronics and even stationary.
Hi team developed this brand to appeal to twin goals, so looking to move beyond cat and Jack but on quite ready to move up to agenus assortment and brands like while feeble.
Central to the more the magic brand is the theme of empowerment through positive messaging on products like apparel and notebooks.
In addition, based on feedback we received from both twins and their parents Ulta beauty products in this new brand in May without Parabens and wet testing on animals. We're really excited to launch this new brand at a time when many mold based alternatives a closing their doors and we've been very pleased with the early results since the launch.
As we look ahead, we are really excited about our plans for the third quarter. When we'll continue to invest in units across both our owned and national brand assortment.
As Brian mentioned earlier this month, we expanded our pilot with Levis in which were offering products with the iconic red tab liable for the first time.
Based on the success of a pilot in which we often means red tech products in 20 stores. We just added another 30 stores to the test and we've expanded the Solomon to phage items for both men and women, including Jane's tops and jackets.
Of course, we're now offering the entire assortment on target to calm and given that Levi's is one of the most such brands on our web site. We were excited to offer our digital guess excess at the clinic level for the first time.
Also this quarter were preparing to celebrate the twentyth anniversary of our design partnerships.
Which began with our friend Michael Graves.
Then as today, our goal was to democratize the marketplace and offer incredible design at an affordable price something we called design for all.
So after 20 years and more than 175 different partnerships. This quarter were getting to celebrate by opening the archives and bring it back nearly 300 items from 20, Pos design partnerships and featured them in our anniversary collection.
Prices will range from $7 up to $160 with most unims price below $50.
And reflecting our commitment to inclusivity all of the women's apparel items will be available in extended sizing.
Will feature the anniversary collection in all of our stores and on target Dot Com beginning on September 14th.
And finally, the food and beverage team is looking forward to the upcoming launch of our new on Brian Good and GABAA, which we just announced earlier this week.
We know the food and beverage is a big reason I guess like shopping at target since nearly three quarters of our baskets have at least one food items in them.
And driven by the improvements we have implemented over the last few years, we've been seeing consistent growth and market share gains in food and beverage for well over a year.
To build on this momentum it's critical that our approach to every aspect of our food offering from selection to presentation brings joy to I guess lives.
So in developing this brand the product design and development team is focused on delivering taste quality and ease.
And importantly, the entire assortments made without artificial flavors synthetic colors artificial sweeteners and high fructose corn syrup, hoping I guess to feel confident they are selling the families affordable great tasting food that doesn't cut corners on quality ingredients.
Good and gather will become targets flagship food brand with extensions focused on kids organic and signature product lines.
It will launch with a 650 items from dairy to produce readymade passed as it meets two granola bars, and sparkling water and by the full set next year. It will be 2000 plus products strong.
It will launch in all target stores and on target Dot Com the same day delivery beginning on September 15th.
Before I turn the call over to Kathy I want to pause and thank our team for the energy and focus on delivering more for our guests. After all our brand promise starts with expect mall.
More newness quality innovation and aspiration more value Joey and everyday surprises more of what I guess need and more of what they want and oil at an amazing value.
That's how we deliver on the pay less side of our brand promise, whether offering organic pastor or fashion item from a low cost designer all delivered at an accessible price.
When you come to work at target. The first thing you notice is the quality of the team that passion for our business and their pride in working for this world Class company, an iconic brand.
Across the company the culture of innovation is infectious and the energy of the team feels limitless.
I'm so proud of what we've already accomplished and I know there was so much more we can do in the months and years ahead.
So now I'll turn it over to Kathy who will provide more detail on our second quarter financial performance.
And outlook for the rest of the year Kathy.
Thanks, Mark as Brian mentioned, we saw outstanding financial performance in the second quarter as our business delivered sales growth that was in line with our expectations and bottom line results that were well above our expectations.
Our comp sales growth of 3.4% on top of 6.5% last year put our two year stacked growth at about 10% our best performance in more than a decade.
Within our sales channels stores comparable sales grew 1.5% and our comparable digital sales grew 34% on top of 41% growth a year ago.
Among the drivers of total comp growth, we saw a 2.4% increase in traffic combined with a 0.9% increase in average ticket.
We have long said that we are focused on driving traffic because it is a key indicator of targets relevance with consumers.
That's why we continue to be encouraged that traffic is growing both in our stores and our digital channels and notably this quarter. We were facing a really strong profit comparison of 6.4% a year ago, meaning that our business jets delivered the strongest two year traffic performance we've ever reported.
On the gross margin line second quarter performance exceeded our expectations as the rate expanded from 30.3% last year up to 30.6% this year.
This was the first time in nearly three years that we have seen a year over year increase in our gross margin rate. This performance reflected the ongoing work of our merchant team to optimize assortment cost pricing and promotions across all of our categories.
In addition, we saw about 20 basis points of benefit from category sales mix, reflecting really strong apparel performance combined with a moderating growth rate in toys and baby.
These tailwinds were partially offset by about 30 basis points of pressure from digital fulfillment and supply chain costs.
Even though we continue to grow digital sales at a very rapid pace, we are seeing less pressure from fulfillment costs given that we're leveraging our store teams and assets to fulfill the vast majority of our digital volume.
And as Brian and John described we're seeing incredibly rapid growth of low cost digital fulfillment options like in store pickup and drive up.
As a result gross margin rate pressure from digital fulfillment and supply chain costs and this year's second quarter was about half of the amount we were seeing a year ago.
Moving down to the EPS DNA expense line, we saw about 50 basis points of improvement in the second quarter. This performance was also better than expected and was driven by multiple factors, including favorability and asset impairment and the timing benefit of marketing and store expenses. They will come back later in the year.
In addition, our expense performance continues to reflect a remarkable discipline across our entire organization, which is key to sustaining outstanding performance overtime.
As John mentioned earlier, an important example is our store teams who are delivering meaningful productivity improvements that are helping us to offset the impact of rapidly rising wages across the country.
Our second quarter, depreciation and amortization expense rate was approximately flat to last year as an increase in DNA expense dollars was offset by the benefit of higher sales.
Given recent changes to our investment plan, we are now planning for higher accelerated depreciation than we originally expected for the year. One example relates to investments that will allow our stores to accommodate high volumes of pickup and drive up orders during the holiday season.
For stores that have particularly high volumes of pick up and drive up orders, we will be deploying flexible fixtures that will allow the stores to temporarily expand our holding capacity at the front of the store during periods of peak demand.
This will allow the stores to maintain their high level of performance in fulfilling pick up and drive a border. A key reason we have seen such rapid adoption of these services.
In total our business saw a meaningful improvement in our second quarter operating margin rate, which expanded about 80 basis points from 6.4% last year to 7.2% this year.
As Brian mentioned this was well ahead of our expectations, putting us in a great position to deliver outstanding financial performance for the full year.
Moving farther down the piano second quarter interest expense was up $5 million from second quarter, 2018, reflecting higher average debt balances compared with a year ago.
And our income tax rate was 23% consistent with the expected range for the year.
As a result net earnings from continuing operations grew $139 million over last year, an increase of 17.4%.
At the end of the quarter, our diluted share count was about 3.8% lower than a year ago, reflecting our continued disciplined approach to capital deployment.
Putting all this together our business generated GAAP earnings per share from continuing operations and adjusted EPS of $1.82, both more than 20% higher than a year ago setting new record highs for the company.
So now I want to turn to cash flow capital deployment and return on invested capital.
But first I want to reiterate our priorities for capital deployment, which have been consistent for decades.
As we look to deploy our cash we first fully investing capital projects that meet our strategic and financial criteria.
Then we look to support our dividend and extend our record of annual dividend increases, which we've maintained every year since 1971.
And finally, we deployed any excess cash beyond those two uses for share repurchase within the limits of our middle a credit ratings.
So how all of these priorities played out in 2019.
Through the first half of the year, our operations have generated about $2.8 billion in cash up from about $2.7 billion in the first half of 2018.
We have deployed that cash to invest about $1.4 billion in capital expenditures pay dividends of $658 million and repurchased $618 million of our stock.
For the full year, we continue to expect to invest about three and a half billion dollars in capex driven by our remodel program other investments in store assets, new store openings and in our supply chain and technology capabilities.
Looking beyond 2019, we anticipate a similar amount of Capex in 2020, as we expect to maintain our current remodel pace of about 300 stores for one additional year.
Beyond 2020, we expect to moderate the pace of our remodels to a longer term range of 150 to 200 a year.
And as a result, beginning in 2021, we expect to see a moderation in the pace of annual Capex into the two and a half to $3 billion range closer to the level of DNA on our cash flow statement.
So now I want to finish my review of our second quarter results by discussing our after tax return on invested capital, which measures the quality of both our operating results and our capital deployment decisions.
For the trailing 12 months through the second quarter, excluding discrete impacts of the 2017 tax reform legislation our business generated an after tax return on invested capital of 15% compared with 14.2% a year ago.
This is outstanding performance and it's even more encouraging to see the year over year improvement, which clearly demonstrates the benefit of our consistent disciplined approach to capital deployment.
Turning to our guidance for the back half of the year I'll start with our expectations for comparable sales growth.
As Brian mentioned, we expect our business to generate comp sales increases in both the third and the fourth quarters in line with a 3.4% comp growth. We just delivered in the second quarter.
This expectation recognizes recent trends now that we fully annualize the closure of toys R us store as well as our bottom up plans for sales driving initiatives in the back half of the year.
On the operating income line, we're expecting our third quarter rate will be flat to up slightly reflecting an expected improvement in our gross margin rate offset by pressure on SGN expense line.
Our gross margin rate expectation reflects last year's supply chain and inventory related pressures that we don't expect to occur again this year.
On the S. DNA expense line, our expectation reflects the plans retiming of spending within marketing and our store teams from the second quarter into the third quarter.
And as Brian mentioned, our outlook for the back half of the year includes expected costs, resulting from the most recent announcements regarding China tariff.
Putting together all of our expectation we are anticipating third quarter GAAP EPS from continuing operations and adjusted EPS of one dollar four to $1.24.
For the full year, our expectations reflect strong trend through the first half of the year.
Three timing of marketing and store cost into the back half of the year.
Updated expectations for accelerated depreciation and expected cost related to tariff, including the increase is currently scheduled for September and December .
Reflecting all of these considerations, we expect to deliver full year GAAP EPS from continuing operations and adjusted EPS of $5.90 to $6.20, which is 15 cents higher than our previous range.
The mid point of this new range is approximately 10% higher than last year's GAAP EPS from continuing operations and 12% higher than last year's adjusted EPS.
This is outstanding performance ahead of our original expectations for the year.
So before I turn it back over to Brian I want to thank the entire target team for everything they are doing to drive this outstanding performance.
It reflects years of work by our team to transform our business and build a durable financial model and it reflects our team's passion for our guests and a relentless focus on strong execution every day.
When we first announced our transformation plan at the beginning of 2017, we talked about the assets, we have at our disposal, including well maintained and well located stores powerful owned brands and iconic target brand a strong balance sheet and a business that generates robust cash flow, but what was most important both in 2017 and today is the team that powers our business.
As Brian said, we are lucky to have the best team in retail and everyday I'm grateful for the opportunity to work with them and learn from them.
Now I'll turn it back over to Brian for some closing remarks, Brian .
Thanks, Cathy before we move to your questions I want to take a moment and acknowledge that my first target earnings call was almost exactly five years ago today.
And I think we all agree that target has changed a lot in those five years.
During that time.
We exited our Canadian segment, allowing our teams to devote all of their energy to our us operations.
We sold our pharmacy business to Cvs, a transaction to generate value for both companies.
We rejuvenating our own brand portfolio launching dozens of new brands across multiple categories.
We went from simply selling on a website to integrating digital within every part of our business positioning our stores at the center of the most comprehensive suite of digital fulfillment options in the U.S.
We opened about a 100 small format stores, reaching new neighborhoods in dense urban areas and around college campuses.
And we made significant changes to our team.
And how we work both at headquarters and our stores.
When I came to target I got an inside look at why this company had such a strong reputation for hiring and developing talent.
Target has a unique and outstanding team.
And I am truly grateful for the opportunity to work with them.
But what's most amazing is the patients and optimism that this team has shown over the last five years as weve handled some significant challenges together.
That's why it's so rewarding to be able to share the amazing results that this team is delivering today.
At the same time, we are focused on the need to stay hungry see around corners.
And continually innovate and reinvent ourselves.
The pace of change in our business doesn't look like it's poison slowdown anytime soon.
But I'm confident this team will continue to lead target and the industry, allowing us to deliver outstanding results.
Both this year and well into the future.
So with that I want to thank you for your time today and now we'll move onto your questions.
Thank you we will now begin the question and answer session to ask a question. Please press star followed by one.
To withdraw your request press star two.
Our first question comes from Chris Horvers with JP Morgan you May go ahead.
Thanks, Good morning, everybody.
This was obviously a big quarter for investors you lap he left toys R. US He had to register Register Glitch on father's day weekend, you know some people packed at the 50 basis point headwind to calm she had the weather. So can you give any color and shed any light on the sort of cadence of the quarter in light of the weather you know how material was the father's day weekend glitch and the impact to comps and then more broadly into the games in apparel and continued good gains in baby and what would you sort of rank order. The the big drivers that are allowing you to gain that share.
Chris I'll start and I think as we look at the quarter, we saw very consistent performance throughout the 13 weeks of the quarter.
And as I've said several times now there's not one element that we can point to we saw a very good response from both sides of our portfolio, both our style side and our essentials.
Mark called out of the strength that we saw in categories like apparel, but also strength in those household essential to drive traffic to our stores and more and more visits to our site. So it was a very balanced quarter.
Strength across our entire portfolio and I think the teams been just very focused on executing our plans both from a store standpoint, and a digital standpoint. So it all added up to a very solid quarter. We think we deliver quality results throughout the quarter that led to traffic gains up 2.4% no very strong comps market share gains in many of our core categories and overall, obviously delivered very strong bottom line performance. So I can't point to one specific element I thought we saw consistent strength and great execution, each and every day and all the investments we've made in store Remodels. The investments, we're making in new small format continues to perform very well as we continue to scale and mature our suite of fulfillment options. The guest is reacting honestly very well to those options.
We continue to see a great reaction to both our own brands in our National brand performance, but I think our team was just focused on executing our plan each and every day and I think it ended up with a very strong quarterly success.
And then as a follow up you know the we're hearing a lot from the apparel said that the inventories in the apparel older are bloated in a given some of the channel shifts that their experience and some of the weather in the second quarter.
Obviously, your inventories flat year over year, but could you perhaps talk about how you look at the health of your inventory, particularly in the more seasonally sensitive areas and frankly, given the momentum in the business do you think that you know you're you're in a good enough in stock position to hit your guidance expectations. Thank you Chris based on the health of our business right now and the momentum we have going into the back half we feel very good about our inventory position, obviously the strength of our performance in categories like apparel speaks for itself, but I think as we prepare for.
These big seasonal moments I think we feel like we're in a great position for back to school and back to college I would actually say, it's the strongest position we've had in years as we get ready for the peak of college and as we get ready for back to school to continue to surge over the next few weeks I think we feel very good about our position and I think it's actually the best inventory position we've had in years in both of those categories.
Thank you best of luck Thanks, Chris.
Thank you. The next question comes from Kate Kate Mcshane with Goldman Sachs. You May go ahead.
Good morning, Thanks for taking my question.
On the first question I had was just about the timing of the expenses that were called out and why they shifted and Cathy I wondered if you could quantify how much favorability on the asset impairment and this the shift of.
<unk> expenses on the quarter into Q3 benefited Q2, yeah happy to good morning, Hey, So first off the the magnitude of the expenses both in marketing in our stores as you've seen already beginning in Q3, you've got some amazing plans in Q3, so we shifted some expenses to support those plans as you know, it's probably in the <unk> and you know 40 basis points range, maybe a little lower.
Oh, sorry, 40 million dollar range, and maybe a little bit lower going from Q2 into Q3.
So thats what you are seeing in the Ltd line reflects on yesterday line and then you asked about I'm sorry. Your second question was.
Oh, the impairment year over year, we did see you know its it reflects the strength of our business actually that we had very low to no or very little impairments. This year versus what we've seen in the previous year and so that was actually pretty significant you'll see that in the queue at low Kate I'm actually glad you called that out actually were talking prior to the call. While there's lots of highlights that we've already covered in the quarter and one of the things that stands out for me is the health of our assets and the performance of our stores and I think that showed up in the change in s. impairment during the quarter.
That's great. Thank you and then just as a follow up I know the cash situation is very fluid, but its list for where to come to fruition on December 15th <unk> <unk> is that something that impacts 2019 or is it is it really a 2020 impact to that again, while we're watching this very carefully and obviously you know there has been a number of shifts over the last few weeks as it sits right. Now this is largely a 2020 issue. So we've got all of the current tariffs built into our guidance and our plan for the balance of the year Mark and his team has done a sensational job up.
Scenario planning as we get ready for the balance of this year and going into 2020, but as its stated today.
The impact of lists for would be something that we'd realize in the first quarter of 2020.
Thank you.
Thank you. The next question comes from Robby Ohmes with Bank of America Merrill Lynch You May go ahead.
Good morning, guys and congrats on a great quarter in a tricky environment out there.
I was hoping to get.
Some of you to talk more about the digital growth outlook. So digital came in I think well above what what a lot of people were looking for.
How should we think about that growth going forward I think you guys had pegged around a 25% for the year can you.
Do a lot better than that and maybe.
An update on you know, how many store pickup locations and drive up location drought or you, maybe accelerating that and are more categories coming in to pick up and drive up like.
Fresh produce et cetera.
Just any help you can give us there would be great. Thanks, Robbie when we let Jonathan to walk through some of the highlights of our digital performance, which again was very strong during the quarter up 34% on top of.
Significant growth last year.
Yeah Ravi good question on the kind of some of the same day fulfillment. We're really excited about what we continue to see there across pickup drive up in shift.
I was about three quarters of the digital growth was represented by same day, it's a third of the business now and growing very very quickly. So we're excited about that pickup is nationwide and has been nationwide for several years Dr. <unk> is very close to being nationwide will be largely done here as we get through third quarter and your question about fresh is a good one not something we're working hard on piloting here in the twin cities and looking to understand the operational needs, they're a little bit more as we get through the back half of this year and then be back to tell you more about how we plan to scale that as we get into early next year, but I think when you put those three together drive a pickup in shift we've got a great offering that our guest is clearly responding to.
They are cheapest fulfillment methods. So most profitable for target they are our fastest and we really see guest adoption taking off so we're excited about the combination there yeah. Robbie as we noted during our prepared remarks same day represents a third of our fulfillment.
And it's grown at a rate of two X versus last year and as we continue to build awareness through our marketing campaign, what we're doing from an in store standpoint, our network standpoint, as well as our digital communication to the guests were building awareness and we're seeing continued growth in that space. So we'd expect those fulfillment channels, which obviously, our most profitable way to fill digital orders to continue to grow over the balance of the year.
And then I apologize if I missed it but what what number roughly year range should we be assuming for digital growth for the year.
Robbie its something that we do not provide guidance around but we've said for a number of years now is we expect to outgrow the overall industry by at least a rate of two X and as you've seen recently, we've been growing at three times the average rate of the digital growth in the industry.
Great. Thanks, so much. Thank you appreciate it.
Thank you. The next question comes from Peter Benedict with Baird. You May go ahead.
Hi, Thanks, guys.
Maybe a question for John can you can you give us a little more color on the on the store operating model that was kind of rolled out here just curious any more detail you can give us on how the operations are are changing either front end or back end just.
Curious, which could add there yeah. This is a journey the store team has been on for several years and really around raising our level of service in the stores are the biggest change around the actual operating model itself. Historically, we kind of had a jack of all trades modeled you'd be a cashier. One day go do price change go do some plan O grams sets whatever we needed to do in general today, we've gotten far more specialized so people in the food area actually can speak about perishables, they're doing the ordering they're responsible for that area. There were responsible for the out of stocks same for beauty. They can talk to our guests about beauty there in that area. All day long, it's the only area. They work and they are responsible for the inventory that sits in the back room related to that area and keeping the four full and interacting with our guests.
In apparel more style right visual merchandising people, who can make up the great products that the merchants are developing look great in the store.
In electronics lots of product information, so a significantly higher level of expertise across the store in the categories, where we need it and then across the rest of the store.
Places like.
You know essentially and some of the dry goods just keep it full all day long that's your job keep the store full and so we're excited about actually implementing that across the chain. This quarter. The teams continue to work through that but but the early results are very positive.
That's great. That's helpful. Thanks, Sean and then maybe for Mark just there's been a number of owned brand introductions over the last year or two.
A very healthy pace.
How do we think about that going forward does that continue or are you guys reached a point here, where youve, you've you've addressed the areas and youre going to just see how a lot of these a lot of these kind of play out.
Yes, Peter I think we addressed this last quarter as well I mean, we expect the rate of change in newness.
Two a pipe, but still sustaining the level of newness to create interest for our guest I think one of the things we must void by adding this quarterly performance is we had a high degree of I've brand launches specifically in our primary as last year, and we had really strong traffic and growth yet we're anniversary ing that yet another quarter and I think just goes to show the building blocks that these are brands build to us in terms of preference to target, but also how they create sustainable growth and long term value. Yeah. So Peter you will expect to see the rate of new brand introductions slow, but mark and his team are very focused on being bringing newness and innovation to the own brands that we've launched over the last couple of years. So we'll continue to make sure. Those brands are on trend, we bring newness and freshness to those brands that have been successfully launched over the next couple of years or the last couple of years and Mark and his team were really excited about some of the innovation will bring to those lines in 2020 and beyond.
Makes sense. Thanks very much good luck. Thank you.
Thank you. The next question comes from Greg Melich with Evercore ISI you May go ahead.
Hi, Thanks, I really two areas I wanted to dig into a little bit one is tariffs just to clarify.
It looks to us that for list for for you guys might be 80% of what you import or as you would have seen some experience from list. One to three is that the right sort of mix 80 20 is to list for versus the first list and then I had a follow up on digital.
Greg why don't we follow up with you offline that number is overstated, we'll circle back, but you know as we've said before we've got a very balanced portfolio. Our sourcing teams have been working to diversify our network for a number of years now.
What will come back and try to address some of that offline. Okay fair enough on the digital I did want to understand a little bit more just given that we had strength to the traffic.
About the nature of the customer see Red card has been sort of flat, but your.
Are you getting a higher spend per trip from people using same day or is it existing customers coming more frequently are you are you finding new customers as a result of this Greg one of the things that we've highlighted now for several quarters is the strength in our traffic growth in Kathee talked about the fact that in this last quarter. It is a record high two year stack for traffic growth. So we're seeing our target guests visit us more frequently shot more categories.
They are enjoying the changes we've made in the store experience, but they are also taking advantage of the convenience of film and options that were offering so as we look at the profile of our guess Theres still shopping our stores on a regular basis, but now we also give them the convenience of ordering online and picking up in their neighborhood store in over now 1500 50 locations. They can place an order and Poland or parking lot. We have shipped shoppers that will deliver within a couple of hours to their home. So we're seeing traffic in interaction and engagement with our brand continue to grow and I think it's that wonderful combination of a great store experience and the suite of fulfillment capabilities that we're now offering that's driving greater engagement and grading greater traffic and visits to our stores into our site.
Great well congrats on that and good luck for the back half. Thank you.
Thank you. The next question comes from Chris Mandeville with Jefferies. You May go ahead.
Hey, good morning.
Just sticking with the digital conversation since you already referenced your performance versus expectations and gave us a little color right. There from Craig's question.
I guess I was just kind of curious about how same day, specifically is contributing to the comp. It was roughly I think 50% last quarter now or a is there any way of breaking down the service modalities between pickup drive up and shifting now they're contributing there and then Kathy how did the.
Service models in aggregate influenced the margin in the quarter.
Well I think we said during the prepared comments that we're seeing obviously exceptional growth in our lower cost digital fulfillment options and one of the things that John pointed out very clearly during our last financial community conference is as we shift our fulfillment from upstream Dcs to our stores.
We see our costs.
Go down by upwards of 40% when it moves to one of our same day options.
Pick up in store drive up or ship, we see a 90% reduction in that cost. So obviously as we're seeing the.
The acceleration of our same day convenient options more guests opting to order online and pick up or use drive up or shift we're seeing the benefits of that flowing through our piano.
Yeah. So I was going to add on as we shared in the prepared remarks, we're seeing because of that shift almost half the pressure that we saw the same time a year ago on our gross margin. So we thought we show that 30 basis points of pressure for fulfillment and supply chain cost. This this quarter and that's almost half of what it was last year. So as we're seeing that movement and the adoption towards the same day services are closer to the store I think it might be helpful. Let John go back and talk about some of the things were doing from a productivity standpoint, and efficiency standpoint at the store level to make sure that as we fulfill those orders will drive even greater productivity and efficiency throughout our system.
I think the store teams have done an outstanding job of initially getting these the service is up and running and providing a great guest experience. That's in place to start always announce they did I think since that time as weve begun to roll. The eye. We have rolled these out to scale them stores have done a great job going back process reengineering, adding tools, adding technology to make all of it easier and faster for our teams and so you know we talked about.
Just to pick for order pickup and drive up is 30% more productive this year than it was.
The across the entirety of ship from store it is 30% more productive and it was in the stores. We you know we continue to work on additional ways to be more productive to add technology potentially add some additional automation in the back of the house to help them become more productive so while we love the shift to the same day experience because that is net better economics. We're also working hard within each one of those services to optimize the unit economics, and so great progress by our stores teams operator, we've got time for one last question.
Thank you our last question comes from Michael Lasser with U B S. You May go ahead.
Good morning, Thanks, a lot for taking my question morning, Michael Good morning, Brian could you unpack that the gross margin commentary about merchandising efforts to optimize cost pricing promotions and assortment in the reason why is because I think there are questions about the sustainability of those factors. It does seem like you're expecting those to continue to drive benefit given your commentary around gross margin in the third.
Yeah, I'll start and.
Mark and can add onto it. So first off you know we had a terrific performance across the board by our team. So our merchant team from assortment to cost to price or promo they manage the business throughout the entire quarter from the beginning of the quarter was vineyard vines through back to school back to college with a cyber event in the middle So amazing performance across the border and across the board and by the way we've got tremendous plans for Q3 and Q4 as well. So I would tell you that they're sustainable type of efforts that we continue to do and then we got a little bit of favorable mix with the strength of the apparel and the apparel categories and a little softening of the growth of toys and baby as we've now anniversaried. The toys are you Uh Huh toys R us and babies or a.
Exit and so the combination of those gave us that really strong performance in gross margin this quarter.
Thank you for that and then Michael I mean, clearly aren't brand strategy is working in the margin contribution as a benefit there, but I think that agility and strength to Joe's endo and team.
Our business in the quarter terms of imaging management markdown management and sales and share gains is definitely one of those strong contributors in our mix, but overall, everyone pulled way than we had a great question, Michael It's probably a good place for me to wrap up and really complement mark and his entire merchandising team for the work that they've done that we've been talking now for multiple years about the benefits of our Multicategory portfolio and I think we're seeing that play out each and every quarter. It was a couple of years ago. We were talking about the investments we made to be priced right daily and our guest is responding to that and that's certainly flowing through in a gross margin. So I think the exceptional work that the team has done to strengthen all facets of our portfolio, both our style and essential categories. The strength, we're seeing across our multicategory portfolio certainly the market share gains we are seeing an important categories like apparel and combining that with the everyday value, we're offering to our guests being price right deal.
Right is contributing to the margin stability and improvement we're seeing in recent quarters. So no complements the mark in the entire merchandising team for the work that they've done but the guest is recognizing it and I think again, it's contributing to the traffic gains were seeing.
In our stores they increased visits to our site and the flow through that we're seeing throughout our PML. So it's a great way for us to wrap up this call I appreciate everyone dialing in this morning, and we look forward to talk to you next quarter. So thank you.
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