Good morning, everyone, and thank you for joining us on our Q2 2016 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer John Mulligan, Chief Operating Officer and Kathy Smith, Chief Financial Officer. This morning, Brian will recap our 2nd quarter performance, including results across our merchandise category. Then John will provide an update on our efforts to improve in stocks and modernize our supply chain. And finally, Cathy will offer more detail on our Q2 financial performance and our outlook for the Q3 and full year.
Following the remarks, we'll open the phone lines for a question and answer session. As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Kathy and I will be available to answer your follow-up questions. Also 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 adjusted earnings per share, which is a non GAAP financial measure and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalize operating leases.
Reconciliation to our GAAP EPS from continuing operations and to our GAAP total rent expense 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 comments on
the Q2 and our priorities going forward. Brian? Thanks, John, and good morning, everyone. Our 2nd quarter comparable sales decline of 1.1 percent was near the middle of our guidance range for the quarter, but well below the results we expect to deliver over time. Against that backdrop, we reported much stronger than expected profitability.
This outperformance was driven by our ongoing cost saving efforts, which benefit both our gross margin and expense rates in the Q2. These benefits help to offset pressure from the current promotional environment, declining comp sales and the investments we're making in our team. I want to pause and thank our team for delivering this outstanding financial performance. At the same time, I want to emphasize that we are committed 1st and foremost to restoring positive comp sales growth in the quarters and years ahead. Based on the conversations with many of you, we know there's a great deal of focus on the broad macro challenges facing retailers, including a consumer focused on experiences, the impact of price deflation and a channel shift into digital.
These are real challenges, but they are not new to our business. With the right strategy and strong execution, we've demonstrated our ability to perform in the face of those challenges. And our expectation is that we will continue to be a top retail performer over time. In the Q2, our number one challenge was traffic, which affected sales in all of our merchandise categories. And consistent with the Q1, we saw higher than normal variability in sales patterns.
Despite these challenges, we're encouraged that we saw the strongest sales performance around key Q2 events, including Memorial Day, the 4th July and the beginning of the back to school season. As we analyze the drivers of our Q2 performance, we've identified some company specific challenges we are actively addressing. This includes meaningful pressure in electronics, where we saw a double digit decline in comp sales this quarter, accounting for approximately 70 basis points of overall comp decline. Notably, about a third of this pressure was driven by Apple products, which were down more than 20% in the quarter. We're focused on reversing these trends and we're collaborating with Apple and other vendor partners to evolve our assortment and accelerate innovation to deliver stronger sales.
In grocery, despite improvements in assortment, quality, freshness, presentation and in stocks, we were disappointed with our sales performance as we saw a small comp sales decline in the Q2. While our grocery business was negatively impacted by food deflation, which accounted for about 20 basis points of pressure, we clearly have more work to do to unlock the growth potential in this important category. Given our recent performance and the increasingly competitive food environment, we're revisiting our second half grocery efforts from presentation to assortment to promotion to improve our competitive position. And as I will discuss in a few minutes, we'll be leveraging the learning from our LA-twenty five remodels to help guide our plans going forward. Beyond food, we are rebalancing our messaging and promotions to ensure we continue to drive strong performance in style categories and reach consumers who are intently focused on value in this environment.
Finally, we experienced soft second quarter traffic trends in the pharmacies in our stores as we completed the rebranding transition from Target to CVS across the country. The execution of transition went very smoothly and we've been very pleased with the level of collaboration between our teams and our partners at CVS. While it's not surprising that the rebranding activity has resulted in some near term disruption, we're focused on restoring growth in this traffic driving area in our stores. As a result, we're working closely with our partners at CVS as they launch media, marketing and member engagement campaigns to increase awareness and utilization of CVS pharmacies in our stores. In addition, CVS is executing an in store engagement campaign and plans to offer special flu shot incentives at the pharmacies in our stores.
As we take steps to increase awareness of the CVS Target partnership, both among our guests and members of the CVS PBM business, we expect to reaccelerate pharmacy traffic in our stores over time. Despite this quarter's challenges, we're pleased that the fundamental elements of our strategy are continuing to shape our results. Comparable sales in Signature categories continue to lead the company, reflecting investments we've made in quality, presentation and marketing. In the 2nd quarter, comp sales growth in these categories outpaced the company by approximately 3 percentage points. Within Signature, we saw a particular strength in both kids and style.
Results in kids reflected the launch of Cat and Jack, which is now positioned to become our biggest owned brand. After the July rollout of this brand, we saw double digit growth in Cat and Jack sales when measured against comparable sales of Serco and Cherokee last year. Within style, we continue to benefit from strength in women's apparel, which saw a mid single digit comp increase in the quarter. This performance was driven by double digit growth in our acceleration brand, which is focused on a younger style savvy guest. In addition, we're really pleased with the performance of Who What Wear, which is one of the most productive brands on our women's floor pad.
As a result, we're expanding the range of this assortment for the fall, inviting more of our guests to enjoy the items from this fashion forward collaboration. Digital sales grew more than 16% in the 2nd quarter, on top of 30% growth last year. We continue to invest in Target's digital assets to enhance the guest experience and drive sales in all channels. And our results demonstrate the impact of the investments we've made over time. For example, several years ago, we told you we had an opportunity to improve our digital conversion.
Since then, we've invested to improve our conversion performance by streamlining online checkout, making the site more appealing and easy to use, enhancing our personalization capabilities and improving search. As a result, for several years in a row, we've seen meaningful improvement in our digital conversion across all platforms, particularly in mobile. In the Q2, we launched a brand new fully adapted site, which means we now provide a seamless experience across all platforms from desktop to tablets to smartphones. This is increasingly important because for many guests, a single purchase journey crosses over 2 or more of these digital devices. We're really pleased with results in our new flexible format stores, which are designed for very dense urban and suburban neighborhoods.
These stores allow us to operate in areas we've never been able to serve with our largest format stores, allowing us to extend our reach to consumers with high affinity for our brand. In July, we opened up new Flex format stores in Washington Square in Philadelphia, Lincoln Park in Chicago, Commonwealth in Boston and Forest Hills in Queens. We're excited to be serving guests in these iconic neighborhoods and the guest response to these new locations has been fantastic. Financially, Flexible formats are very successful. The sales productivity is much higher than our company average and they've been meeting or exceeding our profit targets.
In total this year, we're planning to open 14 Flexformats stores, including a multi level location in Tribeca this October. Based on our experience to date and our investments in capability, we're increasingly confident in our ability to successfully open and operate stores in a variety of neighborhood settings across the country. As a result, we're accelerating our pipeline of locations we can open in future years and we expect Flex format stores to be a key driver of future growth. In our existing stores, we continue to invest in presentation and experience, particularly in signature categories. We completed the remodeling of our LA 25 test stores in the 2nd quarter and we're in the early stages of a robust learning plan to measure guest reaction to the changes we've made.
Overall, we're encouraged by initial results in these stores and we're already rolling out some
of the
innovation from these stores more broadly. Namely, we're pleased with the presentation innovation in home and apparel and results from our work to elevate the order pickup experience. So we're already extending these innovations beyond the LA market. In addition, the changes we've made to the food area in the LA 25 test stores has really resonated with Guess. Grocery sales in these stores are trending 2% to 3% points higher than the comparison stores.
Relative performance in produce is even stronger, driving perishable comps that are more than 5 percentage points higher than the comparison stores. Guests have told us the new food area now feels more intimate and separate from the rest of the store, providing a distinct grocery shopping experience they prefer. We're very encouraged with these initial observations and we'll continue to leverage learning from these stores as we work to improve grocery performance across the chain. We are fortunate to have a strong balance sheet and a business that generates a lot of cash even in challenging times. This cash allows us to make long term investments in our business while returning cash to our shareholders at the same time.
In June, we announced that our Board had approved a 7.1% increase in our quarterly dividend, supporting our 45 year record of annual dividend increases. In addition, our cash position allowed us to return well over $1,000,000,000 through share repurchase in the Q2 in support of our goal to return $3,500,000,000 or more this year. Looking ahead, we're very excited about the back to school and back to college season, which is second only to the Q4 holiday season in terms of importance. In back to school, we continue to work with kids and parents who inform our product design and development process. So it's only natural that this year we engaged with kids to design and execute our back to school marketing campaign.
Kids led all aspects of this campaign, drafting storyboards, illustrating the creative content, directing the spots and performing the music. To make shopping fast and convenient for busy families, this year we partnered with teacherslist.com to make nearly a 1000000 school supply lists available with our School List Assist tool on target.com. This tool allows parents to quickly and seamlessly purchase supplies off their kids' class list, arrange for store pickup or have the item delivered directly to their home. In back to college, our marketing campaign is designed around today's students, which are digital natives. In this campaign, we're partnering with 3 recent graduates to create inspiring do it yourself videos to help college students make their new dorm room or apartment feel like home.
In addition, we provided tools to make college shopping convenient and fun, including college registry, order pickup, subscriptions and special offers on Cartwheel. As we've done for more than 15 years, we're hosting back to college after hours shopping events, which will take place at 85 colleges and universities in the next couple of months. In these events, we provide free bus transportation from campus and provide students the opportunity to stock up and save on everything they'll need for school. I want to pause here and mention how happy we are to have Mark Tritton on the Target team. Mark took on the role of Chief Merchandising Officer in the Q2 he spent the last couple of months getting to know his team and becoming immersed in our business.
Mark is creative and passionate about retail. He's had an amazing career building iconic brands, and I'm confident he'll be able to grow both our own brands and our Target brand. Mark is planning to speak on this conference call next quarter when he'll outline our merchandising and marketing plans for the holiday season. We continue to believe we're focused on the right strategic priorities and we're confident in our ability to grow profitably over time. We believe it's appropriate to update our sales and EPS outlook for the remainder of the year.
Our decision is informed by the retail sales environment and the variability we continue to see in our weekly and regional results. While we are laser focused on accelerating traffic in sales, it's prudent to build near term business and inventory plans that are consistent with recent trends. As always, we'll be prepared to flex those plans upward if results begin to recover in the second half of the year. Before I turn the call over to John, I want to spend a second with a special thank you to our team and our stores. I visit our stores around the country nearly every week and I'm so grateful to have a group of such smart and friendly team members serving our guests.
John's team at headquarters is focused on ways to simplify our processes, modernize our supply chain and help ensure our stores feature the right assortment of items that are in stock every day. When we back up an outstanding team with the right business fundamentals, we offer an unparalleled experience in retail. With that, I'll turn the call over to John, who will provide more details on his team's efforts to modernize our supply chain and improve our operations. Sean? Thanks, Brian.
Good morning, everyone. As Brian just mentioned, our store teams
do an outstanding job serving our guests every day. It's long been a key point of differentiation for our brand. What I didn't fully appreciate until I came into my new role as COO was the workload that our supply chain processes have been driving into our stores. Historically, when we design processes to improve upstream efficiencies in our supply chain, we often achieve those benefits by moving work and complexity into our stores. One of the key priorities of my new team has been to look at the entire supply chain and find ways to optimize it end to end to deliver reliability for our guests, while driving efficiency for the organization as a whole.
A key measure of reliability is our ability to stay in stock, and I'm pleased that we continue to see improvement even as we begin to compare against improvements from a year ago. In stores, as we entered the back to school and back to college seasons, Target's overall out of stock position was better than we have ever measured historically. In addition, out of stocks on frequency and commodity items, the items for which reliability is most important for our guests, are in an even stronger position. And in the digital channel, while we have much work yet to do, we have already reduced out of stocks by more than 50% in the last 6 months. Our work to reduce variability in our distribution centers has been one of the drivers of these improvements.
In the past, an unacceptable number of vendor shipments were received by our DCs either too early or too late. This variability drove a lot of extra workload in the DCs while reducing our reliability downstream. As a result, this year, we have been collaborating with our vendors to increase the percent of shipments that arrive on the correct day and we've already seen meaningful progress. The percent of shipments that arrive on time has more than doubled and we expect to see additional improvement as we roll out new processes to additional vendors over time. As shipments arrive at our distribution centers, we've made changes to the prioritization of inbound processing, which have already cut the time to unload trailers by more than 50%, and we believe we can cut that time even further.
In addition, we've improved process flow between our import warehouses and our regional DCs, reducing the average time it takes for an item in an import warehouse to reach the store shelves by more than half. We're also focused on our outbound processing with the goal of enabling daily deliveries to every store throughout the week regardless of a store sales volume. When implemented, this change will drive additional improvements to store in stocks while reducing backroom inventory and store workload. I want to thank the entire team from merchandise planning to our distribution centers, logistics teams and our stores for these improvements. Without the engagement of the entire end to end supply chain, we couldn't have made such amazing progress.
Before I move on to our work in the stores, I want to comment briefly on our overall inventory position. As we've mentioned over the last several quarters, a portion of our year over year inventory growth reflects intentional investments we're making in non seasonal commodity categories to support in stock improvement on items most important to our guests. In addition, our Q2 inventory reflected an investment to offer additional items in certain categories as we work with merchant teams to reliably offer appropriate assortment both online and in our stores to best serve our guests. Beyond our upstream supply chain work, our investment in self checkout lanes is also reducing store workload, freeing up time for our store teams to focus on guest service, while providing our guests a checkout option that many of them prefer. As of today, we have self checkout in just over 1,000 of our stores.
We're planning to add it to another 200 stores by the end of the year and we will continue the rollout in 2017. In stores with self checkout, nearly a third of transactions go through these lanes, much higher than our initial projections. Our flexible fulfillment initiatives, including store pickup and ship from store, are one way we're reinvesting store labor savings to serve guests in new ways. At the end of 2015, more than 460 stores were shipping items directly to guest homes and we're planning to double our capacity this year by expanding this capability to more than 500 additional stores. These additional locations will further improve our average ship time, while providing deeper access to our store inventories, increasing the likelihood that we can ship a guest's entire order from a single nearby store location.
And importantly, because we are now pre positioning high velocity web only items in the backroom of ship from store locations, we are able to reduce last mile and split shipment expenses dramatically. In store pickup is an increasingly popular option for many of our guests. This year, we've seen 50% growth in pickup orders on top of 60% growth a year ago. Year to date, more than 90% of our pickup orders have been ready in 1 hour and we've implemented process improvements to reduce wait times in stores. As a result, guest satisfaction with the pickup experience is up from a year ago and a higher percent of guests are repeatedly using the service.
To prepare for this holiday season surge, we're investing to ensure our stores can continue to deliver a great pickup experience in the face of rapidly increasing demand. In 75 of our highest volume stores, we're increasing holding capacity to allow our team to retrieve items more quickly even during peak times. We're also investing in additional digital devices to support peak demand. And across all of our stores, we're rolling out new guidance on how our stores can optimize their storage space to enhance speed and efficiency. New this year, we've implemented systems and processes to allow stores to forecast and monitor pickup demand, ensuring we maintain proper staffing levels.
In addition, during the holiday season, about 300 stores will be testing separate branded shirts for the team members in the pickup area and distinctive bags for pickup orders to underscore our commitment to this experience. Finally, as Brian mentioned, back to school, back to college season is our 2nd most important sales driver of the year. As a result, we're planning to carefully measure our pickup reliability and speed during promotional peaks this quarter, so we can apply those learnings in time for the holiday season when peak demand will be even higher. It was just a year ago that I began working with my new team. I'm very proud of what we've accomplished since then.
However, I'm also energized by the opportunity still ahead of us to further increase the speed, flexibility and reliability of our supply chain, to drive unnecessary workload out of our stores and to enable operational excellence across the organization. As we work to accomplish these goals, I'm fortunate to work with an experienced team led by both internal talent and some amazing new hires. And I'm confident that with their leadership, we will continue to improve Target's operations on behalf of our guests. With that, I'll turn it over to Kathy, who will share her insights on our Q2 financial performance and our outlook going forward. Kathy?
Thanks, John, and hello, everyone. Our 2nd quarter adjusted earnings per share of $1.23 dollars was better than the high end of our guidance and just better than last year. 2nd quarter GAAP EPS from continuing operations was $0.16 lower than adjusted EPS driven by $0.17 of debt retirement costs due to settlement timing on a subset of our Q1 debt tender offers. This quarter's profit performance was quite impressive in light of the challenging sales environment. Specifically, comparable sales declined 1.1% this quarter, in line with our guidance and well below our plan at the beginning of the year.
As expected, the total sales in the Q2 were down more than 7% from last year, driven by the sale of our pharmacy and clinic businesses to CVS. Digital sales grew 16% in the 2nd quarter, contributing 0.5 point of our comparable sales growth. Looking at the components of our comparable sales. Comp transactions declined 2.2%, partially offset by a 1.1% increase in average ticket. While ticket growth was broadly consistent with the last couple of years, traffic performance showed a meaningful change from prior trend.
I want to pause and make it clear that we are not satisfied with our 2nd quarter traffic and sales performance. And as Brian described earlier, we are taking steps to grow both our traffic and sales over time. RedCard penetration was 23.9% in the 1st quarter, up about 180 basis points from last year. However, given that last year's pharmacy sales had a much lower than average red card penetration, the removal of those sales from this year's results drove a portion of the penetration improvement. Excluding that benefit, red card penetration was up about 70 basis points from a year ago.
Moving down the P and L. Our 2nd quarter EBITDA margin rate was 11.2%, up about 30 basis points from 10.9% a year ago. This improvement was entirely driven by a year over year increase in our gross margin rate, partially offset by a modest increase in our SG and A expense rate. Among the drivers of our gross margin rate, the pharmacy sales drove about 70 basis points of improvement from last year. This improvement was offset by pressure from shipping expense resulting from online growth along with the impact of 2nd quarter promotional and clearance markdowns, partially offset by the benefit of our cost control efforts.
On the SG and A line, we saw pressure from investments in our team and in marketing, along with the deleveraging impact of the decline in sales. These pressures were offset by the rate impact of the pharmacy sale, combined with the benefit of our cost savings initiatives. Overall, we saw a year over year increase in our SG and A expense rate of about 20 basis points. Given the pressures we were facing, this is really impressive expense performance, and I want to thank the team for their tireless efforts to control costs. Quarter end inventory was up a little more than 4%, consistent with last quarter.
Given the investments we've made in essential categories and assortment enhancements as well as the impact of the sales slowdown that occurred in the Q2, our quarter end inventory position was relatively healthy. And of course, given our cautious sales outlook for the back half of the year, we will continue to monitor our receipts and inventory levels closely. Let's now turn to capital deployment. As we mentioned in our last conference call, this quarter we deployed about $1,000,000,000 to settle a portion of our Q1 debt tenders tender offers, and we funded a $750,000,000 debt maturity in July. In addition, during the quarter, we returned another $1,700,000,000 to our shareholders through dividends of $330,000,000 and share repurchase of more than $1,300,000,000 By the end of the second quarter, we had about $1,500,000,000 of cash and equivalents on our balance sheet, consistent with the guidance we provided in our Q1 conference call.
One other note. Through the end of the second quarter, we had repurchased approximately $8,800,000,000 of shares under company's current $10,000,000,000 repurchase authorization. As a result, we plan to request additional repurchase capacity from our Board in the next several months, given that our outlook anticipates continued cash available for share repurchase going forward. I want to reiterate that our priorities for capital deployment have not changed. 1st, we fully invest in projects that meet our strategic and financial criteria.
2nd, we support the dividend and intend to build on our 45 year record of annual dividend increases. And finally, we return cash by repurchasing shares when we have the capacity within the limits of our single A credit long term credit rating. Looking ahead, we will continue to govern the pace and magnitude of share repurchase in support of our goal to maintain those credit ratings. Despite the challenges we have to generate very strong returns. For the 12 month period through Q2, we reported an after tax return on invested capital of 15.8%, up from 13.3% a year ago.
I'll quickly note, however, that this year's ROIC includes the one time gain from the sale of our pharmacy business to CVS, which occurred last December. Without that one time benefit, our 2nd quarter after tax ROIC was still a very healthy 13.7 percent, up about 40 basis points from last year. Before I turn to our outlook, I want to pause and discuss the factors that are shaping our expectations going forward. Obviously, one consideration is the sales and traffic environment we've faced over the last several months, in which overall trends have been challenging and weekly and regional patterns have been more variable than normal. The second consideration pertains to the relative benefit of planning our business conservatively.
If actual sales turn out to be stronger than our expectations, our teams are prepared to chase inventory and ramp up hours in our stores and distribution centers. In those situations, we generally generate healthy profit rates on incremental sales. However, those same profit dynamics typically work in reverse when we miss our sales outlook, given that it's more difficult to cancel orders and to pull back on labor hours. So despite the fact that we continue to believe in our long term strategy and we're taking steps to address some of the company specific challenges Brian addressed earlier, we believe it's appropriate to temper our near term sales and EPS expectations. So let's turn first to our outlook for the Q3, beginning with sales.
This quarter, we are planning for a comparable sales range of a minus 2% to flat, consistent with our 2nd quarter guidance. If our comp sales are near the midpoint of that range, we expect to generate gross margin and SG and A expense rates similar to last year's level. This expectation reflects the continued benefit from the removal of the pharmacy sales from this year's results, offset by a continuation of the headwinds we faced in the Q2. One note, the pharmacy sale is expected to cause a delta of a little more than 6 percentage points between comp sales and total sales this quarter, similar to what we saw in the Q2. As a result, we expect to deleverage depreciation and amortization line in the Q3 as the depreciation and amortization dollars are expected to be essentially flat to last year, but spread over a smaller sales base.
Altogether, in the Q3, we expect to generate both GAAP EPS from continuing operations and adjusted EPS in the range of $0.75 to $0.95 As we look beyond the Q3, we are planning 4th quarter comp sales in the same range as 3rd quarter. And given our 3rd and 4th quarter profit outlook combined with our year to date performance through the 2nd quarter, we are planning to generate full year adjusted EPS of $4.80 to $5.20 dollars We expect full year GAAP EPS from continuing operations to be about $0.44 lower than adjusted EPS as a result of the debt retirement and pharmacy transaction costs, which we recorded in the first half of the year. While this outlook for full year EPS is somewhat lower than our expectation at the beginning of the year, it reflects healthy profit performance in the face of challenging sales. And consistent with our performance through the first half of the year, it reflects the benefit of our cost savings initiatives and disciplined management by our team. Before I conclude my remarks, I want to thank the team for making cost control a long term habit, not a short term focus.
Last year, we announced a plan to save $2,000,000,000 over 2 years, and I'm pleased to say that we're not only running ahead of that goal, but the team continues to find new opportunities to eliminate unnecessary costs and activities. These savings allow us to reinvest resources in our enterprise priorities, while still generating solid financial performance even in challenging times. With that, we'll conclude today's prepared remarks. Now Brian, John and I will be happy to respond to your questions.
Your first question comes from Matt Fassler with Goldman Sachs. Please go ahead with your question.
Thanks a lot. Good morning. My first and primary question relates to the how much impact do you think the CVS pharmacy transition had on traffic? Did you see that dynamic deteriorate from the Q1? And is there a way to quantify perhaps how much you feel like the spillover effect from that would have impacted the overall comp?
And as I discussed in my prepared comments, our traffic was impacted by a number of factors, including CVS. So we certainly saw a slowdown in our pharmacy operations. We're working closely with CVS to launch some new marketing campaigns to win back our target guests and certainly to begin to unlock the potential of their PBM network. So that certainly played a role. But we also had other factors that we're focused on right now.
We're not pleased with the performance we saw in food despite making some really good progress in presentation, improving our assortment and certainly the freshness of our products. So our number one focus as we sit here today is driving traffic back to our stores and accelerating visits to our site and addressing the pharmacy impact is just one of the variables we're focused on today.
Thank you for that. And by way of quick follow-up, a different topic, you touched on Apple products down over 20%. We're obviously in the middle of a bit of a pause between iPhone releases leading to one most likely later this year. Is the Apple softness at this point really an iPhone story or is it a broader issue across the product suite?
Matt, for us, it's a broader story across the product suite. And one of the first things we've had Mark Trenton do is actually spend time with our Apple partners, really making sure that we're putting the right plans together for the back half of the year, that we're ready to capitalize on their new innovation that they'll be bringing to market. But again, as we think about factors that we have to address to improve our traffic and overall sales performance in the back half of the year, we have to improve electronics performance. It was a significant drag, 70 basis points on our overall comp decline in the quarter and Apple played a significant role there. So we over index with Apple products.
Our guests come to us looking for those products. They're looking for the newness and the innovation and we're putting together plans with Apple and our merchandising teams to make sure we're ready to take advantage of that in the back half of the year.
Brian, thank you very much.
Thanks, Matt.
Your next question is from David Schick from Consumer Edge Research. Please go ahead with your question.
Hi, thanks. Good morning.
Good morning, David.
My question
is on the competitive environment. You talked about all the different things you're working on with traffic, but is there anything out there that you're seeing in anything you could highlight sort of in the major categories that's going on in the marketplace that might be affecting your either traffic or your customers' attention and how you're thinking about addressing that in the back half?
Well, Matt, I think we've seen this environment persist now for well over a year. It's a very conscious consumer. If we look at the overall trends within retail, we've certainly seen on a rolling 12 month basis a slowdown in retail sales growth, but that's not an excuse for us. We've got to make sure we're leveraging our strategic levers. We continue to make sure we improve our in store experience.
As John talked about during the call, we've got to make sure that we offer a sensational in store pickup experience and also make sure that our site is easier to work with and allows us to ship directly to home. So we've got to make sure we're leveraging the key components of our strategy. I feel really good about the progress we've made in store, in preparation for back to school, back to college. I've been out into a number of markets. I don't think our stores have ever looked better.
So it's a competitive environment. It's going to continue to be a competitive environment. And we've got to make sure that we leverage our strategy, make sure that we're bringing the best of our signature categories and bringing the value the guest is looking for in core household essentials to win trips and win back trips in the second half of the year. So it's competitive, but it's always competitive. And we've got to make sure that we're leveraging our assets and our strategy to continue to drive performance in the back half of the year.
I guess the follow-up to that would be, it's competitive as you say, it continues to be competitive. Is there any change in the balance of whether it's new products and merchandising or pathways brought to market or pricing, anything changing in the way the competitive environment sits for you the makeup of it?
David, you've used an important term that I've been using internally and that is balance or rebalancing. And as I look at my experience now over the last couple of years at Target, we're best when we balance both ends of our brand positioning. We've got to deliver on the expect more component and I think we've done a sensational job there. Our progress in apparel and home has been really significant. And we've got to make sure we never lose track of the other side of our brand promise and that's the Payless side.
And that's all about those core household essentials that we have to make sure are presented effectively in store, in our circular, on our end caps to our guests each and every week. So as we think about the back half of the year and the keys to driving our business going forward, we've got to have both of those levers in balance. We've got to continue to make sure our signature categories and particularly those important style categories continue to connect with our guests. And we've got to deliver great value through household essentials, those everyday products that drive that target run. So that balance or rebalance is critically important to the actions we're taking in the back half of the year.
Thanks so much. Thanks, David.
Your next question is from Oliver Chen with Cowen and Company. Please go ahead with your question.
Hi. We had a
question regarding the dynamics you're seeing between fill in and stock up trips. How are you feeling about that in your research? And also as we look towards the back half and model our views on comp store sales, what would you prioritize as the biggest drivers to improve traffic in terms of the different initiatives that you're pursuing in light of what you're seeing? And just another question we had is, why do you think this happened in pharmacy in terms of what was the consumer experiencing in your store that made the transition a little more disruptive than you would have wanted? Thank you.
Yes.
Oliver, let me try to break apart those three questions and have Kathy and John jump in as appropriate. As we think about the rebalancing and the work that we're doing from a merchandising standpoint, an in store presentation standpoint and also a weekly advertising standpoint, we recognize we have to continue to deliver the right presentation for that stock occasion and particularly in the back half of the month have the right assortment, the right presentation, the right availability of the items our guest is looking for in that fill in occasion. So we're activating and ensuring we put those changes in place to find the balance as we speak today. So we're certainly very focused and aware of the fact that we have to win on both fronts. We've got the right assortment for that stock up occasion and we need to make sure we have the right pack price architecture to meet the needs of the guests during that fill in occasion.
So we're very focused on that. From a CVS standpoint, I'll let John jump in here. It's not a surprise to us that there's been some disruption. And I think for all of us on the call, we know what it's like when we change a pharmacy prescription and move from one provider to another. And while they're staying in our location, they've got to sign up for some new programs.
They're entering a new environment. There is some time that that's going to take, but we've been very pleased. John's been working with his CVS counterparts on the transition. We've had great collaboration, great partnership. We're starting to activate the marketing and the personalized messaging.
And we expect over time, we'll see that business accelerate and we expect pharmacy and the partnership to be a future driver of traffic and growth. But John, why don't you talk about some of the things we're doing at store level with CVS?
Yes. I think, I'd start by first echoing what Brian said. We talked going into the deal, we had a great partner. That is certainly what we have observed through the transition here, been a great partner to work with. Our teams have worked together very well to transition.
We've done the best job we can in transitioning guests, but as Brian said, changes change and sometimes you just need to work through that. From a go forward perspective, we're working with CVS certainly on some of their capabilities that they'll bring to bear for Target. And as Brian said, unlock their PBM network into our stores. But more importantly, day to day in the stores, we see great guest service continue to see great guest service from our pharmacists. CVS would note that probably the best scores they've ever seen in a transition like this.
And then starting to work with them to engage the pharmacy more back into the store through things like the opportunity here at back to school, back to college with flu shots, and having the pharmacy play a more prominent role as we go forward. And so the teams continue to develop plans like that. They're very focused on it. We're focused on it. And we're very excited about the opportunity here as we continue to move forward.
Hey, Oliver. This is Kathy. I'll add a little bit more too around priorities for driving traffic in the back half. And we're really excited because we go into this part of the year where we have a lot of events and that's where Target really has some great plans. We always have great plans, back to school, back to college.
We're excited about obviously the launch of Cat and Jack has started out very successfully with a lot of learnings that we took away from Pillow Fort, both online and in stores. And then obviously we go into our prime time. And so standing tall on the events that we typically have always done, but we're really well positioned. And then it's the things that Brian and John have already mentioned, the rebalancing of our messaging that we are relooking at all of our grocery efforts around presentation assortment and promotion, the electronics, the newness that Brian mentioned and then obviously the work that John just said around CVS.
And so Oliver, as we think about the second half, we've got to continue to build on the things that are working today. Even in a challenging Q2, we grew market share in the important apparel space. We saw very strong results in our home categories. We continue to be a destination for toys. So we've got to build on the things that are working and ensure that we're also winning trips for those core household essentials.
So we'll be focusing on rebalancing, on leveraging the improvements we've made both in store with our in store pickup process and also online. And we're not altering our strategic focus. It's making sure we get our strategies in balance and we deliver against both signature categories and those important household essentials that drive traffic to our stores and put cars in the parking lot.
Thank you very much. Best regards.
Thanks, Oliver.
Your next question is from Kate McFadgen with Citi. Please go ahead with your question.
Hi, good morning.
Good morning.
I think when you gave guidance for Q2 originally, it was because of some of the higher inventories that you flagged at other channels, especially with regards to apparel.
So I
was just wondering how much you think you're benefiting from some of the weakness that we have seen at the brick and mortar department stores, especially when considering your women's apparel comp was up mid single digits during the quarter?
Well, we certainly think we are winning in the apparel space. And I think a lot of that's really driven by the changes we've made, the improvement in our assortment, in quality and being more on trend with some of our fashion assortment. I talked about exhilaration performing very well in the quarter. Who What Wear continues to be a real winner for us and connecting well with our guests. And we've also matched that up with an improved in store experience.
We've been talking about mannequins for a while, but the role that our visual merchandisers are playing, the investment that John and I made last year to ensure we had not only mannequins and home vignettes, but the talent in our stores to maintain that experience 52 weeks a year is certainly connecting with the guests. So we think we're benefiting by really executing against the strategy we've been talking about for several years, making sure we have the right quality, innovation, presentation in our stores and we surround our guests with great service and that's paying off with market share gains in a challenging environment where we continue to see improvement in our apparel and home assortments.
Okay. Thank you for taking my question.
Thank you.
Your next question is from Greg Melich from Evercore ISI. Please go ahead with your question.
Good morning, Greg.
Good morning. I want to follow-up a bit on traffic and then get into the guidance a bit. On traffic, if you think about it a different way, I think about a year ago traffic had recovered nicely to say up 1%. And overall retail sales are growing roughly where they were if you just look at the government data and now the traffic is obviously down a couple percent. Do you see any differences in terms of geographies or other things going on, income demographics around your stores where that traffic trend is different, just looking at the last 12 months?
Yes. Greg, we certainly do. And Kathy and I talked about this at the end of the Q1. We've seen quite a bit of variability on a day to day, week to week basis between different markets. We've seen particular strength in many of our West Coast markets, very strong performance in California, driven by great performance in LA and San Francisco, but other parts of the West Coast.
We've seen pockets of softness on the East Coast. And we've really tried to make sure market by market, we're looking at those dynamics, looking at the competitive dynamics, understanding what we can leverage from the markets where we are seeing increases like Los Angeles and bring that into challenged markets. But we've seen over the course of this year in 2016 much more variability than I've seen in many, many years. So we're drilling down on that. And as we think about our plans for the second half of the year, we're building market specific action plans to make sure we address the market specific needs of our stores and our guests.
That's helpful. And then Kathy, I think on the margin, I just want to make sure I got the guidance right. If I take the midpoint, I get to the you mentioned the Q3 flat EBIT margins, although I imagine next to the CVS sale, they would be down like 30 bps. In the 4th quarter, is that right?
Yes. So it's slightly down EBIT margin. We said gross margin SG and A about where they were last year.
4th quarter, does the guidance imply that EBIT margin is going to be flat?
It is slightly up. So yes, so slightly down Q3, slightly up in Q4.
Okay. So I'll make sure I got that right. And then I guess last on that, just to make sure the inventory up 4%, you guys think I mean that you're comfortable with that number, not like part of the 3rd quarter is working that inventory down?
Greg, we're very comfortable right now with our inventory position.
Great. Thanks a lot.
Good luck. Thank you. Thank you.
Your next question is from Dan Binder from Jefferies. Please go ahead with your question.
Thanks. It's Dan Binder. I had a question on the consumer electronics category. You talked a lot about that today and I've noticed in your stores recently you've had some reset activity particularly in TV as you offer more 4 ks. I am curious as you work through these plans to improve that business, do you think that can be a category that returns to positive comps by holiday given all the changes you're making?
Dan, I think it's going to be largely driven by the new innovation that we bring to the guests in the Q4. So we've certainly seen pockets of strength. I mean there's certainly winners and losers within that space. We've seen continued performance with wearable technology, but it's not overcoming the softness we've seen in mobile, in tablets and in some of the core items. So I think the success of that category as always is going to be driven by new news and news that connects with the guests and drives traffic into those categories.
So again, it's why Mark and his team are very focused right now in working with our electronics vendors to make sure we have the right innovation. We're presenting it in a way that's impactful for the guests and we have to see improvements in a category that's been a big drag on our comps over the last couple of quarters.
And then a follow-up on the food category. You mentioned you were reevaluating promotion and I guess food and consumables. I'm just curious, it sounds like you'll increase it. So I'm just curious, are you seeing others out there being more aggressive in the category? Is that what you would attribute the softness to?
And if that is the case, which channels are you seeing it in?
Yes. Dan, I think there's been a lot written recently about the competitive nature of the food channel. And for us, on one hand, we feel I feel really good about the progress we've made with assortment. If you walk our stores today versus even 6 months ago, aisle by aisle, you're seeing more organic, more natural, more gluten free, more local items that are on trend. The freshness and the work that John and his team have done from a supply chain standpoint is clearly connecting with the product we're delivering to the guests.
And we've seen an uptick in categories like produce because we're delivering better product. But at the same time, market by market, this is a very competitive space. There's clearly food deflation right now that we're facing and it's a very competitive environment. And back to the earlier question about traffic and performance trends by market, we're looking very specifically at food by market across the country because we face a number of regional competitors and we've got to make sure our presentation, our promotion, our approach enables us to compete market by market.
Congratulations on the LA-twenty five. It sounds like you're getting good results out of that. I was just wondering if you could share with us the likelihood of being able to roll that out. Is it a cost efficient format? Or are you primarily using it just for learnings?
Well, Dan, we've certainly used it as a learning lab, but our intention is to lift the winners from LA 25 and quickly bring them into other stores across the country. And while it's still very early, we have effectively 1 quarter of learning under our belt. I'm very pleased with some of the results we're seeing in apparel, in home and certainly in food, where as I mentioned during my prepared comments, we're seeing performance in those 25 test stores that are clearly, clearly really encouraging from a food standpoint, particularly in the perishable space. So we'll be looking to leverage that learning. That's part of our strategy that we've articulated for several quarters now that we want to use LA as a test market to lift and shift the winning concepts into more stores across the country.
And we'll continue to lift and leverage the learning from LA 25 to improve the experience and the presentation of product throughout our Target stores.
Thanks.
Thank you.
Your next question comes from Scott Mushkin from Wolfe Research. Please go ahead with your question.
Yes. Hey, I wanted to continue on the path where Dan was going. But before I get started, I'd just say, on our store visits, you can definitely see the improving execution. Kudos to John and get Matt done. But getting back to the food discussion, our research has shown some pretty aggressive moves and I think Dan was getting at this.
I mean, are you guys going to match what's going on in the market? And it looks like we're at the beginning end of a pretty aggressive price war. How do you see it? Where do we we're now seeing deflation reported by the government of 1.5%, 5%, 6% and our pricing surveys are even greater than that. So where do
you see this going?
What do you guys plan to do to combat it tactically in the short term? And then I want to address the longer term food business after that.
Yes. Well, Scott, I'll start with, we're playing to win and we've invested heavily in that very important category. We've had a long term commitment to food. We think it's very important for our guests. And over the last couple of years, while we've done it in a very disciplined fashion, category by category, and I appreciate hearing you say that you've seen an improvement in execution, hopefully in presentation.
And we've added thousands of new items. And we've worked with our vendor partners to make sure we're bringing the right innovation category by category. Our team is absolutely going literally item by item, commodity by commodity to look at how we source and how we flow product to improve freshness and the quality we present to our guests. So we've got to make sure we have the right assortment, the right presentation, the right quality. We have to have the right promotional strategy to compete, but we're playing to win both short and long term.
We think it's very important that we continue to make progress in this space. We're going to make sure we do it in a very focused manner. We really like what we're seeing in LA 25. We're not going to roll it out to 1800 stores tomorrow. We're making sure that we can validate what's working and how can we drive profitable sales in that space.
But we are playing to win in food and we're going to continue to roll up our sleeves and make sure that we're into the details, finding ways to unlock the growth potential in that critically important category.
Sure, Brian. Thanks for that answer. So to kind of dovetail more into the longer term, when you were at Safeway, you guys obviously did a lot of remodels that drove comp. LA 25, it sounds like traffic is positive there. But in the article, I think it was in the journal, they talked about the Board is very reluctant to put more capital behind the food effort.
Talk us through this. I mean, you got a traffic issue, consumables mean traffic. But if you don't invest, it's hard to get the traffic. So you're almost kind of caught in a catch-twenty 2 here.
And
I just want to get your outlook or your thoughts on what I'm saying, given the longer term need for traffic and to drive traffic into the store to make earnings rise continuously as we look out in the out years?
Yes. And Scott, in all due respect to the Journal, let me speak on behalf of our leadership team and the Board. We have no hesitancy at all in investing capital in our business that drives growth and the right returns. And as Kathy has demonstrated throughout the last few calls, even in challenging times, we generate significant cash flows. And we want to make sure the first thing we do with that cash is invest back in our business.
So it's why we're spending time looking at LA 25. It's why we've been testing a number of different features throughout our stores from apparel to home to food. It's why we're so excited about investing in flex formats, where we see a very strong response from the guests. Those are delivering very strong returns, well ahead of our original plans and food plays an important part in those smaller flex formats. So despite what you may be hearing, we have absolutely complete support from the Board to make sure we're investing capital behind the initiatives that's going to drive future growth.
So again, we're not playing for just the short term, we're playing for the long term. Those capital investments have to be done on behalf of the guests and our shareholders, but we're looking right now at a number of different opportunities to continue to invest to drive growth. So there's no hesitancy at all in making those investments. And as you just said, food and perishable and consumable categories will play a very important role in driving traffic to our stores. And in the future, we've got to continue to bundle that with the work John's doing to make sure and we're investing and improving our in store pickup processes and experience.
That's an investment we're making and an investment we're making for the holiday season. We're continuing to invest in our digital assets. So there's no hesitancy at all from this management team nor the Board in making the right investments in our long term success.
All right. Thanks guys and thanks for the answer. I appreciate it.
Thanks Scott. Operator, we've got time for one last call.
Okay. Your last question comes from Joe Feldman from Telsey Advisory Group. Please go ahead with your question.
Hi guys. Thanks for taking the question. One of the questions I had was you guys have made a lot of changes in the stores and we clearly see them. And obviously, we talked all for the past hour about a lot of them. I'm curious about the marketing or communication of that though to just the consumer.
I mean, we see it because we're all following the company pretty aggressively and in the stores. But I wonder if there's more could be done on the advertising side to tell people that you've made so many changes in grocery or that the home department looks better in a lot of stores. Can you talk a little bit about that and where we're at in terms of when we'll see something like that communication wise?
Yes. Joe, it's a great question for us to end on. And I'll take personal responsibility for this. I talked earlier about the fact that we've got to be rebalancing our messaging. And we've done a really terrific job of elevating our messaging and communication around our signature and particularly our style categories.
As we go forward, I've used this term before, we've got to make sure we're rebalancing. And we've got to make sure we continue to elevate our messaging, our communication around style and those core household essential categories, which include food that drive traffic to our store and are important to our guests. So making sure we go back to the brand promise, we've got to make sure that we expect more categories like style, we continue to elevate and we've got to make sure we deliver the Payless component and ensure that we balance the work that we're doing from a style standpoint with the progress we're making on those core household essentials, which include food in that offering. So it's a really important question. It's certainly a big area of focus for us in the balance of the year and into 2017.
And I think it's going to be part of the formula that drives traffic back to our stores and improves comp store growth over the balance of the year and into 2017. So operator, with that, we're going to conclude our call and I thank all of you for joining us for our Q2 earnings call today. Thanks for participating.
Ladies and gentlemen, this does conclude today's conference call. Thank you for participating. At this time, you may now disconnect.