TARGET CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Financial Summary First quarter 2021 included the following notable items: • GAAP diluted earnings per share was $4.17. • Adjusted diluted earnings per share was $3.69. • Total revenue increased 23.4 percent, driven by an increase in comparable sales. • Comparable sales increased 22.9 percent, driven by a 17.1 percent increase in traffic. ◦ Comparable stores originated sales grew 18.0 percent. ◦ Comparable digitally originated sales increased 50.2 percent. • Operating income of $2.4 billion was 407 percent higher than the comparable prior-year period. • We recognized a $335 million pretax gain on the sale of Dermstore. Sales were $23.9 billion for the three months ended May 1, 2021, an increase of $4.5 billion, or 23.3 percent, from the comparable prior-year period. Cash flow provided by operating activities was $1.1 billion for the three months ended May 1, 2021, a decrease of $0.1 billion, or (11.3) percent, from $1.3 billion for the three months ended May 2, 2020. Earnings Per Share Three Months Ended May 1, 2021 May 2, 2020 Change GAAP diluted earnings per share $ 4.17 $ 0.56 643.2 % Adjustments (0.47) 0.03 Adjusted diluted earnings per share $ 3.69 $ 0.59 525.0 % Note: Amounts may not foot due to rounding. Adjusted diluted earnings per share (Adjusted EPS), a non-GAAP metric, excludes the impact of certain items. Management believes that Adjusted EPS is useful in providing period-to-period comparisons of the results of our operations. A reconciliation of non-GAAP financial measures to GAAP measures is provid ed on page 18 . We report after-tax return on invested capital (ROIC) because we believe ROIC provides a meaningful measure of our capital allocation effectiveness over time. For the trailing twelve months ended May 1, 2021, after-tax ROIC was 30.7 percent, compared with 13.4 percent for the trailing twelve months ended May 2, 2020. The calculation of ROIC is provided o n page 19 . COVID-19 As the COVID-19 pandemic has evolved, we have experienced unusually strong sales, as guests rely on Target for essential items like food, medicine, cleaning products, and household stock-up items, as well as merchandise associated with guests spending more time at home. Underlying this trend, we have seen significant volatility in our sales category and channel mix, including same-day fulfillment options. During the first quarter of 2021, strength in comparable sales growth continued across our multi-category portfolio, with significantly higher growth in our higher-margin Apparel & Accessories and Home Furnishings & Décor core merchandise categories. Comparable sales growth was strongest in Apparel & Accessories, which experienced a significant decline during the first quarter of 2020, Additionally, strength above the chain average continued in Hardlines. During the first quarter of 2020, comparable sales growth was strongest in our lower-margin Hardlines, Food & Beverage and Beauty & Household Essentials categories. Note 4 to the Financial Statements presents sales by category. TARGET CORPORATION Q1 2021 Form 10-Q 13 MANAGEMENT'S DISCUSSION AND ANALYSIS Table of Contents ANALYSIS OF OPERATIONS Index to Notes Analysis of Results of Operations Summary of Operating Income Three Months Ended (dollars in millions) May 1, 2021 May 2, 2020 Change Sales $ 23,879 $ 19,371 23.3 % Other revenue 318 244 30.4 Total revenue 24,197 19,615 23.4 Cost of sales 16,716 14,510 15.2 Selling, general and administrative expenses 4,509 4,060 11.0 Depreciation and amortization (exclusive of depreciation included in cost of sales) 598 577 3.9 Operating income $ 2,374 $ 468 407.0 % Rate Analysis Three Months Ended May 1, 2021 May 2, 2020 Gross margin rate 30.0 % 25.1 % SG&A expense rate 18.6 20.7 Depreciation and amortization expense rate (exclusive of depreciation included in cost of sales) 2.5 2.9 Operating income margin rate 9.8 2.4 Note: Gross margin rate is calculated as gross margin (sales less cost of sales) divided by sales. All other rates are calculated by dividing the applicable amount by total revenue. Sales Sales include all merchandise sales, net of expected returns, and our estimate of gift card breakage. We use comparable sales to evaluate the performance of our stores and digital channel sales by measuring the change in sales for a period over the comparable prior-year period of equivalent length. Comparable sales include all sales —except sales from stores open less than 13 months, digital acquisitions we have owned less than 13 months, stores that have been closed, and digital acquisitions that we no longer operate. Comparable sales measures vary across the retail industry. As a result, our comparable sales calculation is not necessarily comparable to similarly titled measures reported by other companies. Digitally originated sales include all sales initiated through mobile applications and our websites. Our stores fulfill the majority of digitally originated sales, including shipment from stores to guests, store Order Pickup or Drive Up, and delivery via our wholly owned subsidiary, Shipt. Digitally originated sales may also be fulfilled through our distribution centers, our vendors, or other third parties. Sales growth — from both comparable sales and new stores — represents an important driver of our long-term profitability. We expect that comparable sales growth will drive the majority of our total sales growth. We believe that our ability to successfully differentiate our guests’ shopping experience through a careful combination of merchandise assortment, price, convenience, guest experience, and other factors will, over the long-term, drive both increasing shopping frequency (traffic) and the amount spent each visit (average transaction amount). TARGET CORPORATION Q1 2021 Form 10-Q 14 MANAGEMENT'S DISCUSSION AND ANALYSIS Table of Contents ANALYSIS OF OPERATIONS Index to Notes The increase in sales during the three months ended May 1, 2021, is due to a comparable sales increase of 22.9 percent and the contribution from new stores. The COVID-19 pandemic has affected the amount and mix of sales across channels and categories. Comparable Sales Three Months Ended May 1, 2021 May 2, 2020 Comparable sales change 22.9 % 10.8 % Drivers of change in comparable sales Number of transactions 17.1 (1.5) Average transaction amount 5.0 12.5 Comparable Sales by Channel Three Months Ended May 1, 2021 May 2, 2020 Stores originated comparable sales change 18.0 % 0.9 % Digitally originated comparable sales change 50.2 140.6 Sales by Channel Three Months Ended May 1, 2021 May 2, 2020 Stores originated 81.7 % 84.7 % Digitally originated 18.3 15.3 Total 100 % 100 % Sales by Fulfillment Channel Three Months Ended May 1, 2021 May 2, 2020 Stores 96.3 % 96.7 % Other 3.7 3.3 Total 100 % 100 % Note: Sales fulfilled by stores include in-store purchases and digitally originated sales fulfilled by shipping merchandise from stores to guests, Order Pickup, Drive Up, and Shipt. Sales by Product Category Three Months Ended May 1, 2021 May 2, 2020 Apparel and accessories 18 % 14 % Beauty and household essentials 27 30 Food and beverage 20 24 Hardlines 17 15 Home furnishings and décor 18 17 Total 100 % 100 % The collective interaction of a broad array of macroeconomic, competitive, and consumer behavioral factors, as well as sales mix and the transfer of sales to new stores, makes further analysis of sales metrics infeasible. TARGET CORPORATION Q1 2021 Form 10-Q 15 MANAGEMENT'S DISCUSSION AND ANALYSIS Table of Contents ANALYSIS OF OPERATIONS Index to Notes We monitor the percentage of purchases that are paid for using RedCards (RedCard Penetration) because our internal analysis has indicated that a meaningful portion of the incremental purchases on RedCards are also incremental sales for Target. Guests receive a 5 percent discount on virtually all purchases when they use a RedCard at Target. RedCard sales increased for the three months ended May 1, 2021 and May 2, 2020; however, RedCard penetration declined as total Sales increased at a faster pace. RedCard Penetration Three Months Ended May 1, 2021 May 2, 2020 Target Debit Card 12.1 % 12.7 % Target Credit Cards 8.4 9.7 Total RedCard Penetration 20.5 % 22.4 % Gross Margin Rate For the three months ended May 1, 2021, our gross margin rate was 30.0 percent compared with 25.1 percent in the comparable prior-year pe riod. This increase reflected: • The benefit of merchandising actions, including exceptionally low promotional and clearance markdown rates, in this year’s results and purchase order cancellation fees and inventory impairments in last year’s results; • Favorable category mix driven by strength in higher margin categories including Apparel & Accessories and Home Furnishings & Décor; and • The net impact of other factors, most notably the margin impact of our returns estimate for sales during the temporary returns suspension period in the first quarter of 2020. Selling, General, and Administrative Expense Rate For the three months ended May 1, 2021, our SG&A expense rate was 18.6 percent compared with 20.7 percent in the comparable prior-year period. Incremental team member pay and benefits, including higher wages and bonus expense, represented the vast majority of the $449 million increase in SG&A expenses compared with the prior-year period. From a rate perspective, these increased costs were more than offset by leverage resulting from strong revenue growth. TARGET CORPORATION Q1 2021 Form 10-Q 16 MANAGEMENT'S DISCUSSION AND ANALYSIS Table of Contents ANALYSIS OF OPERATIONS Index to Notes Store Data Change in Number of Stores Three Months Ended May 1, 2021 May 2, 2020 Beginning store count 1,897 1,868 Opened 12 3 Closed — — Ending store count 1,909 1,871 Number of Stores and Retail Square Feet Number of Stores Retail Square Feet (a) May 1, 2021 January 30, 2021 May 2, 2020 May 1, 2021 January 30, 2021 May 2, 2020 170,000 or more sq. ft. 273 273 272 48,798 48,798 48,613 50,000 to 169,999 sq. ft. 1,510 1,509 1,505 189,618 189,508 189,226 49,999 or less sq. ft. 126 115 94 3,690 3,342 2,745 Total 1,909 1,897 1,871 242,106 241,648 240,584 (a) In thousands, reflects total square feet less office, distribution center, and vacant space. Other Performance Factors Net Interest Expense Net interest expense was $108 million for the three months ended May 1, 2021, and $117 million for the three months ended May 2, 2020. The decrease in net interest expense was primarily due to a lower weighted-average interest rate on our long-term debt for the three months ended May 1, 2021, compared with the three months ended May 2, 2020. Net Other (Income) / Expense Net Other (Income) / Expense was $(343) million for the three months ended May 1, 2021, and $22 million for the three months ended May 2, 2020. The increase was due to the $335 million gain on the February 2021 sale of Dermstore. Note 3 to the Financial Statements provides additional information. Provision for Income Taxes Our effective income tax rate for the three months ended May 1, 2021, was 19.6 percent, compared w ith 13.9 percent in the comparable prior-year period. The increase reflects significantly higher earnings, partially offset by the impact of discrete tax benefits in the quarter, including a $44 million benefit resulting from the resolution of certain income tax matters. TARGET CORPORATION Q1 2021 Form 10-Q 17 MANAGEMENT'S DISCUSSION AND ANALYSIS Table of Contents RECONCILIATION OF NON-GAAP FINANCIAL MEASURES Index to Notes Reconciliation of Non-GAAP Financial Measures to GAAP Measures To provide additional transparency, we have disclosed non-GAAP adjusted diluted earnings per share (Adjusted EPS). This metric excludes certain items presented below. We believe this information is useful in providing period-to-period comparisons of the results of our operations. This measure is not in accordance with, or an alternative to, U.S. GAAP. The most comparable GAAP measure is diluted earnings per share. Adjusted EPS should not be considered in isolation or as a substitution for analysis of our results as reported in accordance with GAAP. Other companies may calculate Adjusted EPS differently, limiting the usefulness of the measure for comparisons with other companies. Reconciliation of Non-GAAP Adjusted EPS Three Months Ended May 1, 2021 May 2, 2020 (millions, except per share data) Pretax Net of Tax Per Share Amounts Pretax Net of Tax Per Share Amounts GAAP diluted earnings per share $ 4.17 $ 0.56 Adjustments Gain on Dermstore sale $ (335) $ (269) $ (0.53) $ — $ — $ — Loss on investment (a) — — — 21 15 0.03 Other (b) 41 30 0.06 — — — Adjusted diluted earnings per share $ 3.69 $ 0.59 Note: Amounts may not foot due to rounding. (a) Represented an unrealized loss on our investment in Casper Sleep Inc., which was not core to our operations. We sold this investment during the fourth quarter of 2020. (b) Represents asset impairment charges resulting from the consolidation of our headquarters office space. Earnings before interest expense and income taxes (EBIT) and earnings before interest expense, income taxes, depreciation, and amortization (EBITDA) are non-GAAP financial measures. We believe these measures provide meaningful information about our operational efficiency compared with our competitors by excluding the impact of differences in tax jurisdictions and structures, debt levels, and for EBITDA, capital investment. These measures are not in accordance with, or an alternative to, GAAP. The most comparable GAAP measure is net earnings. EBIT and EBITDA should not be considered in isolation or as a substitution for analysis of our results as reported in accordance with GAAP. Other companies may calculate EBIT and EBITDA differently, limiting the usefulness of the measures for comparisons with other companies. EBIT and EBITDA Three Months Ended (dollars in millions) May 1, 2021 May 2, 2020 Change Net earnings $ 2,097 $ 284 639.8 % + Provision for income taxes 512 45 1,017.1 + Net interest expense 108 117 (7.6) EBIT $ 2,717 $ 446 508.7 % + Total depreciation and amortization (a) 667 641 4.1 EBITDA $ 3,384 $ 1,087 211.3 % (a) Represents total depreciation and amortization, including amounts classified within Depreciation and Amortization and within Cost of Sales. TARGET CORPORATION Q1 2021 Form 10-Q 18 MANAGEMENT'S DISCUSSION AND ANALYSIS Table of Contents RECONCILIATION OF NON-GAAP FINANCIAL MEASURES Index to Notes We have also disclosed after-tax ROIC, which is a ratio based on GAAP information, with the exception of the add-back of operating lease interest to operating income. We believe this metric is useful in assessing the effectiveness of our capital allocation over time. Other companies may calculate ROIC differently, limiting the usefulness of the measure for comparisons with other companies. After-Tax Return on Invested Capital (dollars in millions) Trailing Twelve Months Numerator May 1, 2021 May 2, 2020 Operating income $ 8,444 $ 3,992 + Net other income / (expense) 350 (26) EBIT 8,794 3,966 + Operating lease interest (a) 85 87 - Income taxes (b) 1,864 855 Net operating profit after taxes $ 7,015 $ 3,198 Denominator May 1, 2021 May 2, 2020 May 4, 2019 Current portion of long-term debt and other borrowings $ 1,173 $ 168 $ 1,056 + Noncurrent portion of long-term debt 11,509 14,073 11,357 + Shareholders' investment 14,959 11,169 11,117 + Operating lease liabilities (c) 2,563 2,448 2,231 - Cash and cash equivalents 7,816 4,566 1,173 Invested capital $ 22,388 $ 23,292 $ 24,588 Average invested capital (d) $ 22,840 $ 23,940 After-tax return on invested capital 30.7 % 13.4 % (a) Represents the add-back to operating income driven by the hypothetical interest expense we would incur if the property under our operating leases were owned or accounted for as finance leases. Calculated using the discount rate for each lease and recorded as a component of rent expense within SG&A. Operating lease interest is added back to operating income in the ROIC calculation to control for differences in capital structure between us and our competitors. (b) Calculated using the effective tax rates, which were 21.0 percent and 21.1 percent for the trailing twelve months ended May 1, 2021, and May 2, 2020, respectively. For the trailing twelve months ended May 1, 2021, and May 2, 2020, includes tax effect of $1.8 billion and $837 million, respectively, related to EBIT, and $18 million related to operating lease interest. (c) Total short-term and long-term operating lease liabilities included within Accrued and Other Current Liabilities and Noncurrent Operating Lease Liabilities, respectively. (d) Average based on the invested capital at the end of the current period and the invested capital at the end of the comparable prior period. TARGET CORPORATION Q1 2021 Form 10-Q 19 MANAGEMENT'S DISCUSSION AND ANALYSIS Table of Contents ANALYSIS OF FINANCIAL CONDITION Index to Notes Analysis of Financial Condition Liquidity and Capital Resources Capital Allocation We follow a disciplined and balanced approach to capital allocation based on the following priorities, ranked in order of importance: first, we fully invest in opportunities to profitably grow our business, create sustainable long-term value, and maintain our current operations and assets; second, we maintain a competitive quarterly dividend and seek to grow it annually; and finally, we return any excess cash to shareholders by repurchasing shares within the limits of our credit rating goals. Our cash and cash equivalents balance was $7.8 billion, $8.5 billion, and $4.6 billion as of May 1, 2021, January 30, 2021, and May 2, 2020, respectively. Our cash and cash equivalents balance includes short-term investments of $6.9 billion, $7.6 billion, and $3.6 billion as of May 1, 2021, January 30, 2021, and May 2, 2020, respectively. Our investment policy is designed to preserve principal and liquidity of our short-term investments. This policy allows investments in large money market funds or in highly rated direct short-term instruments that mature in 60 days or less. We also place dollar limits on our investments in individual funds or instruments. Operating Cash Flows Cash flows provided by operating activities were $1.1 billion for the three months ended May 1, 2021, compared with $1.3 billion for the three months ended May 2, 2020. For the three months ended May 1, 2021, operating cash flows reflect stronger operating results, offset by higher net settlement of accounts payable and incentive compensation payments, compared with the three months ended May 2, 2020. Inventory Inventory was $10.5 billion as of May 1, 2021, compared with $10.7 billion and $8.6 billion at January 30, 2021, and May 2, 2020, respectively. The increase over the balance as of May 2, 2020, reflects efforts to align inventory with sales trends. Additionally, the lower inventory balance as of May 2, 2020, reflected the impact of elevated sell-through rates in high-demand merchandise categories and efforts to reduce inventory levels in certain discretionary categories to align with evolving sales trends early in the pandemic. Investing Cash Flows Investing cash flows included capital investments of $540 million and $751 million for the three months ended May 1, 2021, and May 2, 2020, respectively. We continue to expect full-year capital investments of approximately $4 billion, with the majority of those investments occurring in the second half of this year. For the three months ended May 1, 2021, investing cash flows includes $356 million of proceeds from the sale of Dermstore. Dividends We paid dividends totaling $340 million ($0.68 per share) for the three months ended May 1, 2021, and $332 million ($0.66 per share) for the three months ended May 2, 2020, a per share increase of 3.0 percent. We declared dividends totaling $343 million ($0.68 per share) during the first quarter of 2021 and $333 million ($0.66 per share) during the first quarter of 2020, a per share increase of 3.0 percent. We have paid dividends every quarter since our 1967 initial public offering, and it is our intent to continue to do so in the future. Share Repurchase We returned $1.2 billion to shareholders through share repurchase during the three months ended May 1, 2021. See Part II , Item 2 , Unregistered Sales of Equity Securities and Use of Proceeds of this Quarterly Report on Form 10-Q and Note 9 to the Financial Statements for more information. TARGET CORPORATION Q1 2021 Form 10-Q 20 MANAGEMENT'S DISCUSSION AND ANALYSIS Table of Contents ANALYSIS OF FINANCIAL CONDITION Index to Notes Financing Our financing strategy is to ensure liquidity and access to capital markets, to maintain a balanced spectrum of debt maturities, and to manage our net exposure to floating interest rate volatility. Within these parameters, we seek to minimize our borrowing costs. Our ability to access the long-term debt and commercial paper markets has provided us with ample sources of liquidity. Our continued access to these markets depends on multiple factors, including the condition of debt capital markets, our operating performance, and maintaining strong credit ratings. As of May 1, 2021, our credit ratings were as follows: Credit Ratings Moody’s Standard and Poor’s Fitch Long-term debt A2 A A- Commercial paper P-1 A-1 F1 If our credit ratings were lowered, our ability to access the debt markets, our cost of funds, and other terms for new debt issuances could be adversely impacted. Each of the credit rating agencies reviews its rating periodically and there is no guarantee our current credit ratings will remain the same as described above. We obtain short-term financing from time to time under our commercial paper program. No balances were outstanding at any time during the three months ended May 1, 2021, and May 2, 2020. We have additional liquidity through a committed $2.5 billion revolving credit facility that expires in October 2023. No balances were outstanding at any time during 2021 or 2020. Most of our long-term debt obligations contain covenants related to secured debt levels. In addition to a secured debt level covenant, our credit facility also contains a debt leverage covenant. We are, and expect to remain, in compliance with these covenants. Additionally, as of May 1, 2021, no notes or debentures contained provisions requiring acceleration of payment upon a credit rating downgrade, except that certain outstanding notes allow the note holders to put the notes to us if within a matter of months of each other we experience both (i) a change in control and (ii) our long-term credit ratings are either reduced and the resulting rating is non-investment grade, or our long-term credit ratings are placed on watch for possible reduction and those ratings are subsequently reduced and the resulting rating is non-investment grade. We believe our sources of liquidity will continue to be adequate to maintain operations, finance anticipated expansion and strategic initiatives, fund debt maturities, pay dividends, and execute purchases under our share repurchase program for the foreseeable future. We continue to anticipate ample access to commercial paper and long-term financing. New Accounting Pronouncements We do not expect any recently issued accounting pronouncements to have a material effect on our financial statements. TARGET CORPORATION Q1 2021 Form 10-Q 21 MANAGEMENT'S DISCUSSION AND ANALYSIS & SUPPLEMENTAL INFORMATION Table of Contents FORWARD LOOKING STATEMENTS & CONTROLS AND PROCEDURES Index to Notes Forward-Looking Statements This report contains forward-looking statements, which are based on our current assumptions and expectations. These statements are typically accompanied by the words “expect,” “may,” “could,” “believe,” “would,” “might,” “anticipates,” or similar words. The principal forward-looking statements in this report include: our financial performance, statements regarding the adequacy of and costs associated with our sources of liquidity, the funding of debt maturities, the continued execution of our share repurchase program, our expected capital expenditures and new lease commitments, the expected compliance with debt covenants, the expected impact of new accounting pronouncements, our intentions regarding future dividends, the expected return on plan assets, the expected outcome of, and adequacy of our reserves for, claims, litigation and the resolution of tax matters, the expected impact of changes in information technology systems, future responses to and effects of the COVID-19 pandemic, and changes in our assumptions and expectations. All such forward-looking statements are intended to enjoy the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995, as amended. Although we believe there is a reasonable basis for the forward-looking statements, our actual results could be materially different. The most important factors which could cause our actual results to differ from our forward-looking statements are set forth in our description of risk factors included in Part I , Item 1A , Risk Factors of our Form 10-K for the fiscal year ended January 30, 2021, which should be read in conjunction with the forward-looking statements in this report. Forward-looking statements speak only as of the date they are made, and we do not undertake any obligation to update any forward-looking statement. Item 3. Quantitative and Qualitative Disclosures About Market Risk There have been no material changes in our primary risk exposures or management of market risks from those disclosed in Part II , Item 7A , Quantitative and Qualitative Disclosures About Market Risk of our Form 10-K for the fiscal year ended January 30, 2021.