TARGET CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Financial Summary First quarter 2022 included the following notable items: • GAAP diluted earnings per share were $2.16. • Adjusted diluted earnings per share were $2.19. • Total revenue increased 4.0 percent, driven by an increase in comparable sales. • Comparable sales increased 3.3 percent, driven primarily by a 3.9 percent increase in traffic. ◦ Comparable stores originated sales grew 3.4 percent. ◦ Comparable digitally originated sales increased 3.2 percent. • Operating income of $1.3 billion was 43.3 percent lower than for the comparable prior-year period, driven primarily by a decrease in gross margin, reflecting inventory actions taken as a result of lower-than-expected sales in our discretionary categories (Apparel and Accessories, Hardlines, and Home Furnishings and Décor) and supply chain disruptions, as well as increased freight and merchandise costs. Sales were $24.8 billion for the three months ended April 30, 2022, an increase of $1.0 billion , or 4.0 percent, from the comparable prior-year period. Cash flow required for operating activities was $1.4 billion for the three months ended April 30, 2022, a decrease of $2.5 billion, or 222.4 percent, from $1.1 billion cash flow provided by operating activities for the three months ended May 1, 2021. The drivers of the operating cash flow decrease are described on page 20 . Earnings Per Share Three Months Ended April 30, 2022 May 1, 2021 Change GAAP diluted earnings per share $ 2.16 $ 4.17 (48.2) % Adjustments 0.03 (0.47) Adjusted diluted earnings per share $ 2.19 $ 3.69 (40.7) % 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 April 30, 2022, after-tax ROIC was 25.3 percent , compared with 30.7 percent for the trailing twelve months ended May 1, 2021. The calculation of ROIC is provided on page 19 . Supply Chain Disruptions and Demand Shifts We have seen continued supply chain disruptions. In addition to country of origin production delays, trucker and dockworker shortages, volatile consumer demand, and other factors have led to industry-wide U.S. port and ground transportation delays. In response, we have taken various actions, including ordering and receiving merchandise earlier, securing incremental freight and storage capacity, and maintaining elevated levels of staffing. In addition, we have recently seen a significant shift in consumer demand away from longer lead time discretionary categories, resulting in lower-than-expected sales and higher-than-expected inventories in these areas. These factors have resulted in increased costs, as well as increased clearance and promotional markdowns, which contributed to decreased profitability in the first quarter of 2022 compared to the prior-year period. These factors will result in increased costs and decreased profitability in future periods, the impact of which could be material. The Gross Margin Rate analysis on page 16 provides additional information. TARGET CORPORATION Q1 2022 Form 10-Q 13 MANAGEMENT'S DISCUSSION AND ANALYSIS Table of Contents ANALYSIS OF RESULTS OF OPERATIONS Analysis of Results of Operations Summary of Operating Income Three Months Ended (dollars in millions) April 30, 2022 May 1, 2021 Change Sales $ 24,830 $ 23,879 4.0 % Other revenue 340 318 6.7 Total revenue 25,170 24,197 4.0 Cost of sales 18,461 16,716 10.4 Selling, general and administrative expenses 4,762 4,509 5.6 Depreciation and amortization (exclusive of depreciation included in cost of sales) 601 598 0.3 Operating income $ 1,346 $ 2,374 (43.3) % Rate Analysis Three Months Ended April 30, 2022 May 1, 2021 Gross margin rate 25.7 % 30.0 % SG&A expense rate 18.9 18.6 Depreciation and amortization expense rate (exclusive of depreciation included in cost of sales) 2.4 2.5 Operating income margin rate 5.3 9.8 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 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). Comparable Sales Three Months Ended April 30, 2022 May 1, 2021 Comparable sales change 3.3 % 22.9 % Drivers of change in comparable sales Number of transactions (traffic) 3.9 17.1 Average transaction amount (0.6) 5.0 TARGET CORPORATION Q1 2022 Form 10-Q 14 MANAGEMENT'S DISCUSSION AND ANALYSIS Table of Contents ANALYSIS OF RESULTS OF OPERATIONS Comparable Sales by Channel Three Months Ended April 30, 2022 May 1, 2021 Stores originated comparable sales change 3.4 % 18.0 % Digitally originated comparable sales change 3.2 50.2 Sales by Channel Three Months Ended April 30, 2022 May 1, 2021 Stores originated 81.8 % 81.7 % Digitally originated 18.2 18.3 Total 100 % 100 % Sales by Fulfillment Channel Three Months Ended April 30, 2022 May 1, 2021 Stores 96.5 % 96.3 % Other 3.5 3.7 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 April 30, 2022 May 1, 2021 Apparel and accessories 17 % 18 % Beauty and household essentials 29 27 Food and beverage 22 20 Hardlines 15 17 Home furnishings and décor 17 18 Total 100 % 100 % Note 3 to the Financial Statements provides additional product category sales information. 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. 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 April 30, 2022, and May 1, 2021; however, RedCard penetration declined as total Sales increased at a faster pace. RedCard Penetration Three Months Ended April 30, 2022 May 1, 2021 Target Debit Card 11.6 % 12.1 % Target Credit Cards 8.7 8.4 Total RedCard Penetration 20.3 % 20.5 % Note: Amounts may not foot due to rounding. TARGET CORPORATION Q1 2022 Form 10-Q 15 MANAGEMENT'S DISCUSSION AND ANALYSIS Table of Contents ANALYSIS OF RESULTS OF OPERATIONS Gross Margin Rate For the three months ended April 30, 2022, our gross margin rate was 25.7 percent compared with 30.0 percent in the comparable prior-year period. This decrease reflected the net impact of • higher clearance and promotional markdown rates, which were largely the result of inventory impairments and other actions taken in our longer lead time discretionary categories, as well as supply chain disruptions, and higher merchandise and freight costs, partially offset by the benefit of retail price increases; • supply chain pressure related to increased compensation and headcount in our distribution centers; and • unfavorable mix in the relative growth rates of higher and lower margin categories. Supply Chain Disruptions and Demand Shifts on page 13 provides additional information. Selling, General, and Administrative Expense Rate For the three months ended April 30, 2022, our SG&A expense rate was 18.9 percent compared with 18.6 percent for the comparable prior-year period. The increase reflected the net impact of cost increases across our business, including investments in hourly team member wages, partially offset by lower incentive compensation expense. Store Data Change in Number of Stores Three Months Ended April 30, 2022 May 1, 2021 Beginning store count 1,926 1,897 Opened 7 12 Closed — — Ending store count 1,933 1,909 Number of Stores and Retail Square Feet Number of Stores Retail Square Feet (a) April 30, 2022 January 29, 2022 May 1, 2021 April 30, 2022 January 29, 2022 May 1, 2021 170,000 or more sq. ft. 274 274 273 49,071 49,071 48,798 50,000 to 169,999 sq. ft. 1,519 1,516 1,510 190,461 190,205 189,618 49,999 or less sq. ft. 140 136 126 4,147 4,008 3,690 Total 1,933 1,926 1,909 243,679 243,284 242,106 (a) In thousands; reflects total square feet less office, distribution center, and vacant space. TARGET CORPORATION Q1 2022 Form 10-Q 16 MANAGEMENT'S DISCUSSION AND ANALYSIS Table of Contents ANALYSIS OF RESULTS OF OPERATIONS Other Performance Factors Net Interest Expense Net interest expense was $112 million for the three months ended April 30, 2022, compared with $108 million in the comparable prior-year period. Net Other (Income) / Expense Net Other (Income) / Expense was $(15) million for the three months ended April 30, 2022, compared with $(343) million in the comparable prior-year period. The three months ended May 1, 2021, included the $335 million pretax gain on the February 2021 sale of Dermstore. Note 2 to the Financial Statements provides additional information. Provision for Income Taxes Our effective income tax rate for the three months ended April 30, 2022, was 19.2 percent, compared with 19.6 percent in the comparable prior-year period. The decrease reflects lower pretax earnings in the current period resulting in a larger tax rate benefit from fixed and discrete items, partially offset by the impacts of discrete tax benefits in the prior-year quarter, including the resolution of certain income tax matters. TARGET CORPORATION Q1 2022 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 April 30, 2022 May 1, 2021 (millions, except per share data) Pretax Net of Tax Per Share Pretax Net of Tax Per Share GAAP diluted earnings per share $ 2.16 $ 4.17 Adjustments Gain on Dermstore sale $ — $ — $ — $ (335) $ (269) $ (0.53) Other (a) 20 15 0.03 41 30 0.06 Adjusted diluted earnings per share $ 2.19 $ 3.69 Note: Amounts may not foot due to rounding. (a) Other items unrelated to current period operations, none of which were individually significant. 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) April 30, 2022 May 1, 2021 Change Net earnings $ 1,009 $ 2,097 (51.9) % + Provision for income taxes 240 512 (53.1) + Net interest expense 112 108 3.8 EBIT $ 1,361 $ 2,717 (49.9) % + Total depreciation and amortization (a) 679 667 1.8 EBITDA $ 2,040 $ 3,384 (39.7) % (a) Represents total depreciation and amortization, including amounts classified within Depreciation and Amortization and within Cost of Sales. TARGET CORPORATION Q1 2022 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 April 30, 2022 May 1, 2021 Operating income $ 7,918 $ 8,444 + Net other income / (expense) 55 350 EBIT 7,973 8,794 + Operating lease interest (a) 87 85 - Income taxes (b) 1,804 1,864 Net operating profit after taxes $ 6,256 $ 7,015 Denominator April 30, 2022 May 1, 2021 May 2, 2020 Current portion of long-term debt and other borrowings $ 1,089 $ 1,173 $ 168 + Noncurrent portion of long-term debt 13,379 11,509 14,073 + Shareholders' investment 10,774 14,959 11,169 + Operating lease liabilities (c) 2,854 2,563 2,448 - Cash and cash equivalents 1,112 7,816 4,566 Invested capital $ 26,984 $ 22,388 $ 23,292 Average invested capital (d) $ 24,686 $ 22,840 After-tax return on invested capital 25.3 % 30.7 % (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 22.4 percent and 21.0 percent for the trailing twelve months ended April 30, 2022, and May 1, 2021, respectively. For the trailing twelve months ended April 30, 2022, and May 1, 2021, includes tax effect of $1.8 billion related to EBIT, and $19 million and $18 million, respectively, 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 2022 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 $1.1 billion, $5.9 billion, and $7.8 billion as of April 30, 2022, January 29, 2022, and May 1, 2021, respectively. Our cash and cash equivalents balance includes short-term investments of $182 million, $5.0 billion, and $6.9 billion as of April 30, 2022, January 29, 2022, and May 1, 2021, 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 required for operating activities were $1.4 billion for the three months ended April 30, 2022, compared with $1.1 billion of cash flows provided by operating activities for the three months ended May 1, 2021. For the three months ended April 30, 2022, operating cash flows decreased as a result of lower earnings, increased inventory levels and lower accounts payable leverage due to decreased inventory turnover, compared with the three months ended May 1, 2021. Inventory Inventory was $15.1 billion as of April 30, 2022, compared with $13.9 billion and $10.5 billion at January 29, 2022, and May 1, 2021, respectively. The increase over the balance as of May 1, 2021, primarily reflects lower-than-expected sales in our discretionary categories, as well as the impact of supply chain disruptions and demand shifts described on p age 13 . Investing Cash Flows Investing cash flows included capital investments of $952 million and $540 million for the three months ended April 30, 2022, and May 1, 2021, respectively. For the three months ended May 1, 2021 , investing cash flows included $356 million of proceeds from the sale of Dermstore. Dividends We paid dividends totaling $424 million ($0.90 per share) for the three months ended April 30, 2022, and $340 million ($0.68 per share) for the three months ended May 1, 2021, a per share increase of 32.4 percent. We declared dividends totaling $426 million ($0.90 per share) during the first quarter of 2022 and $343 million ($0.68 per share) during the first quarter of 2021, a per share increase of 32.4 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 Excluding the unsettled March 2022 ASR, we returned $10 million to shareholders through share repurchase during the three months ended April 30, 2022. See Part II, Item 2, Unregistered Sales of Equity Securities and Use of Proceeds of this Quarterly Report on Form 10-Q and Note 8 to the Financial Statements for more information. TARGET CORPORATION Q1 2022 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 April 30, 2022, 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 have the ability to obtain short-term financing from time to time under our commercial paper program and credit facility. Our committed $3.0 billion unsecured revolving credit facility expires in October 2026 and backstops our commercial paper program. No balances were outstanding under our credit facility at any time during 2022 or 2021. As of April 30, 2022, we had $0.9 billion outstanding under our commercial paper program. We did not have any balances outstanding under our commercial paper program as of May 1, 2021. Note 6 to the Financial Statements provides additional information. 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 April 30, 2022, 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, namely operating cash flows, credit facility capacity, and access to capital markets, will continue to be adequate to meet our contractual obligations, working capital and planned capital expenditures, finance anticipated expansion and strategic initiatives, fund debt maturities, pay dividends, and execute purchases under our share repurchase program for the foreseeable future. New Accounting Pronouncements We do not expect any recently issued accounting pronouncements to have a material effect on our financial statements. TARGET CORPORATION Q1 2022 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, 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 29, 2022, 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 29, 2022.