TARGET CORP 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations Financial Summary Second quarter 2023 included the following notable items: • GAAP and Adjusted diluted earnings per share were $1.80. • Total revenue was $24.8 billion, a decrease of (4.9) percent, reflecting a total sales decrease of (4.9) percent and a 1.3 percent increase in other revenue. • Comparable sales decreased (5.4) percent, reflecting a (4.8) percent decrease in traffic and a (0.7) percent decrease in average transaction amount. ◦ Comparable stores-originated sales declined (4.3) percent. ◦ Comparable digitally-originated sales declined (10.5) percent. • Operating income of $1.2 billion was 273.0 percent higher than the comparable prior-year period. See Business Environment below for additional information. Cash flow provided by operating activities was $3.4 billion for the six months ended July 29, 2023, compared with $47 million cash flow required for operating activities for the six months ended July 30, 2022. The drivers of the operating cash flow increase are described on page 21 . Earnings Per Share Three Months Ended Six Months Ended July 29, 2023 July 30, 2022 Change July 29, 2023 July 30, 2022 Change GAAP diluted earnings per share $ 1.80 $ 0.39 357.6 % $ 3.86 $ 2.55 51.1 % Adjustments — — — 0.03 Adjusted diluted earnings per share $ 1.80 $ 0.39 357.6 % $ 3.86 $ 2.59 49.2 % 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 19 . 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 July 29, 2023, after-tax ROIC was 13.7 percent , compared with 18.4 percent for the trailing twelve months ended July 30, 2022. The calculation of ROIC is provided on page 20 . Business Environment During the first two quarters of 2023, sales growth in our Frequency categories (Beauty & Household Essentials and Food & Beverage) was more than offset by accelerating decreases in our Discretionary categories (Apparel & Accessories, Hardlines, and Home Furnishings & Décor). This trend of decreased Discretionary category sales began in 2022. In response to this trend, during 2022 we took actions and employed strategies to align inventories with sales trends. These actions, as well as improvements in the supply chain, have resulted in decreased inventory as of July 29, 2023 compared with January 28, 2023 and July 30, 2022. These actions and improvements have also resulted in a reduction in costs related to managing elevated inventory levels and reduced our working capital investment. Along with supply chain improvements, we have experienced a significant decrease in freight costs due to a decline in freight rates compared to 2022. We have also experienced lower digital fulfillment costs due to a decrease in digital sales and a continued shift by our guests to lower-cost same-day fulfillment options. We continue to experience higher inventory shrink, as a percentage of sales, relative to historical levels — including significantly higher shrink rates at certain stores. We believe that this trend is pervasive across the retail industry. Increased shrink has had, and if current trends persist will continue to have, an adverse impact on our results of operations, including potential impairment of our long-lived assets. The Gross Margin Rate analysis on page 17 and the Inventory section on page 21 provide additional information. TARGET CORPORATION Q2 2023 Form 10-Q 14 MANAGEMENT'S DISCUSSION AND ANALYSIS Table of Contents FINANCIAL SUMMARY Index to Notes Analysis of Results of Operations Summary of Operating Income Three Months Ended Six Months Ended (dollars in millions) July 29, 2023 July 30, 2022 Change July 29, 2023 July 30, 2022 Change Sales $ 24,384 $ 25,653 (4.9) % $ 49,332 $ 50,483 (2.3) % Other revenue 389 384 1.3 763 724 5.5 Total revenue 24,773 26,037 (4.9) 50,095 51,207 (2.2) Cost of sales 17,798 20,142 (11.6) 36,184 38,603 (6.3) Selling, general and administrative expenses 5,184 5,002 3.6 10,209 9,764 4.6 Depreciation and amortization (exclusive of depreciation included in cost of sales) 594 572 3.9 1,177 1,173 0.4 Operating income $ 1,197 $ 321 273.0 % $ 2,525 $ 1,667 51.5 % Rate Analysis Three Months Ended Six Months Ended July 29, 2023 July 30, 2022 July 29, 2023 July 30, 2022 Gross margin rate 27.0 % 21.5 % 26.7 % 23.5 % SG&A expense rate 20.9 19.2 20.4 19.1 Depreciation and amortization expense rate (exclusive of depreciation included in cost of sales) 2.4 2.2 2.3 2.3 Operating income margin rate 4.8 1.2 5.0 3.3 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 (number of transactions, or "traffic") and the amount spent each visit (average transaction amount). TARGET CORPORATION Q2 2023 Form 10-Q 15 MANAGEMENT'S DISCUSSION AND ANALYSIS Table of Contents ANALYSIS OF RESULTS OF OPERATIONS Comparable Sales Three Months Ended Six Months Ended July 29, 2023 July 30, 2022 July 29, 2023 July 30, 2022 Comparable sales change (5.4) % 2.6 % (2.8) % 3.0 % Drivers of change in comparable sales Number of transactions (traffic) (4.8) 2.7 (2.0) 3.3 Average transaction amount (0.7) 0.0 (0.8) (0.3) Comparable Sales by Channel Three Months Ended Six Months Ended July 29, 2023 July 30, 2022 July 29, 2023 July 30, 2022 Stores originated comparable sales change (4.3) % 1.3 % (1.8) % 2.3 % Digitally originated comparable sales change (10.5) 9.0 (7.0) 6.1 Sales by Channel Three Months Ended Six Months Ended July 29, 2023 July 30, 2022 July 29, 2023 July 30, 2022 Stores originated 83.1 % 82.1 % 82.8 % 81.9 % Digitally originated 16.9 17.9 17.2 18.1 Total 100 % 100 % 100 % 100 % Sales by Fulfillment Channel Three Months Ended Six Months Ended July 29, 2023 July 30, 2022 July 29, 2023 July 30, 2022 Stores 97.6 % 96.6 % 97.4 % 96.6 % Other 2.4 3.4 2.6 3.4 Total 100 % 100 % 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 Six Months Ended July 29, 2023 July 30, 2022 July 29, 2023 July 30, 2022 Apparel & accessories 17 % 18 % 16 % 18 % Beauty & household essentials 31 28 31 28 Food & beverage 22 21 23 21 Hardlines 14 15 14 15 Home furnishings & décor 16 18 16 18 Total 100 % 100 % 100 % 100 % Note 2 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. For the three months ended July 29, 2023 and July 30, 2022, total RedCard Penetration was 18.6 percent and 20.1 percent, respectively. For the six months ended July 29, 2023 and July 30, 2022, total RedCard Penetration was 18.8 percent and 20.2 percent, respectively. TARGET CORPORATION Q2 2023 Form 10-Q 16 MANAGEMENT'S DISCUSSION AND ANALYSIS Table of Contents ANALYSIS OF RESULTS OF OPERATIONS Gross Margin Rate Quarter-to-Date Year-to-Date For the three months ended July 29, 2023, our gross margin rate was 27.0 percent compared with 21.5 percent in the comparable prior-year period. For the six months ended July 29, 2023, our gross margin rate was 26.7 percent compared with 23.5 percent in the comparable prior-year period. For both the three and six months ended July 29, 2023, the increase reflected the net impact of • merchandising benefit, including ◦ lower clearance and promotional markdown rates and other costs compared with the prior-year, which included the impact of inventory impairments and other actions; ◦ lower freight costs; and ◦ retail price increases; • lower digital fulfillment costs due to a decrease in digital volume and a shift by our guests to lower-cost same-day fulfillment options; and • higher inventory shrink. Business Environment on page 14 provides additional information. TARGET CORPORATION Q2 2023 Form 10-Q 17 MANAGEMENT'S DISCUSSION AND ANALYSIS Table of Contents ANALYSIS OF RESULTS OF OPERATIONS Selling, General, and Administrative Expense Rate For the three months ended July 29, 2023, our SG&A expense rate was 20.9 percent compared with 19.2 percent for the comparable prior-year period. For the six months ended July 29, 2023, our SG&A expense rate was 20.4 percent compared with 19.1 percent for the comparable prior-year period. The increase reflected the deleveraging impact of lower sales and the net impact of cost increases across our business, including investments in team member pay and benefits. Store Data Change in Number of Stores Three Months Ended Six Months Ended July 29, 2023 July 30, 2022 July 29, 2023 July 30, 2022 Beginning store count 1,954 1,933 1,948 1,926 Opened 5 5 11 12 Closed (4) (1) (4) (1) Ending store count 1,955 1,937 1,955 1,937 Number of Stores and Number of Stores Retail Square Feet (a) Retail Square Feet July 29, 2023 January 28, 2023 July 30, 2022 July 29, 2023 January 28, 2023 July 30, 2022 170,000 or more sq. ft. 274 274 273 48,995 48,985 48,798 50,000 to 169,999 sq. ft. 1,534 1,527 1,521 191,947 191,241 190,734 49,999 or less sq. ft. 147 147 143 4,404 4,358 4,256 Total 1,955 1,948 1,937 245,346 244,584 243,788 (a) In thousands; reflects total square feet less office, supply chain facilities, and vacant space. Other Performance Factors Net Interest Expense N et interest expense was $141 million and $288 million for the three and six months ended July 29, 2023, respectively, compared with $112 million and $224 million in the respective comparable prior-year periods. The increase in net interest expense was primarily due to higher average debt levels in addition to higher floating interest rates for the three and six months ended July 29, 2023 compared with the prior-year periods. Provision for Income Taxes Our effective income tax rate for the three and six months ended July 29, 2023 was 22.2 percent and 21.6 percent, respectively, compared with 15.8 percent and 18.7 percent in the respective comparable prior-year periods.The increase reflects higher pretax earnings in the current year, resulting in a smaller tax rate benefit from ongoing and discrete tax items. TARGET CORPORATION Q2 2023 Form 10-Q 18 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 July 29, 2023 July 30, 2022 (millions, except per share data) Pretax Net of Tax Per Share Pretax Net of Tax Per Share GAAP and adjusted diluted earnings per share $ 1.80 $ 0.39 Reconciliation of Non-GAAP Adjusted EPS Six Months Ended July 29, 2023 July 30, 2022 (millions, except per share data) Pretax Net of Tax Per Share Pretax Net of Tax Per Share GAAP diluted earnings per share $ 3.86 $ 2.55 Adjustments Other (a) $ — $ — $ — $ 20 $ 15 $ 0.03 Adjusted diluted earnings per share $ 3.86 $ 2.59 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 Six Months Ended (dollars in millions) July 29, 2023 July 30, 2022 Change July 29, 2023 July 30, 2022 Change Net earnings $ 835 $ 183 356.5 % $ 1,785 $ 1,192 49.8 % + Provision for income taxes 237 34 591.2 491 274 79.4 + Net interest expense 141 112 26.3 288 224 28.7 EBIT $ 1,213 $ 329 268.8 % $ 2,564 $ 1,690 51.8 % + Total depreciation and amortization (a) 683 650 5.0 1,350 1,329 1.5 EBITDA $ 1,896 $ 979 93.6 % $ 3,914 $ 3,019 29.6 % (a) Represents total depreciation and amortization, including amounts classified within Depreciation and Amortization and within Cost of Sales. TARGET CORPORATION Q2 2023 Form 10-Q 19 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 July 29, 2023 July 30, 2022 Operating income $ 4,706 $ 5,773 + Net other income 65 54 EBIT 4,771 5,827 + Operating lease interest (a) 102 88 - Income taxes (b) 986 1,282 Net operating profit after taxes $ 3,887 $ 4,633 Denominator July 29, 2023 July 30, 2022 July 31, 2021 Current portion of long-term debt and other borrowings $ 1,106 $ 1,649 $ 1,190 + Noncurrent portion of long-term debt 14,926 13,453 11,589 + Shareholders' investment 11,990 10,592 14,860 + Operating lease liabilities (c) 3,104 2,823 2,695 - Cash and cash equivalents 1,617 1,117 7,368 Invested capital $ 29,509 $ 27,400 $ 22,966 Average invested capital (d) $ 28,454 $ 25,183 After-tax return on invested capital 13.7 % 18.4 % (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 20.2 percent and 21.7 percent for the trailing twelve months ended July 29, 2023 and July 30, 2022, respectively. For the trailing twelve months ended July 29, 2023 and July 30, 2022, includes tax effect of $1.0 billion and $1.3 billion, respectively, related to EBIT and $20 million and $19 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 Q2 2023 Form 10-Q 20 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 $1.6 billion, $2.2 billion, and $1.1 billion as of July 29, 2023, January 28, 2023, and July 30, 2022, respectively. Our cash and cash equivalents balance included short-term investments of $739 million, $1.3 billion, and $189 million as of July 29, 2023, January 28, 2023, and July 30, 2022, 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 $3.4 billion for the six months ended July 29, 2023, compared with $47 million of cash flows required for operating activities for the six months ended July 30, 2022. For the six months ended July 29, 2023, operating cash flows increased as a result of higher net earnings and an improvement in working capital, including lower inventory levels, compared with the six months ended July 30, 2022. Inventory Inventory was $12.7 billion as of July 29, 2023, compared with $13.5 billion and $15.3 billion at January 28, 2023 and July 30, 2022, respectively. The decrease from the balance as of July 30, 2022 primarily reflects actions taken to align inventory levels with sales trends and improvements in the supply chain, including reduced in-transit inventory. The Business Environment section on page 14 provides additional information. Investing Cash Flows Cash required for investing activities increased to $2.8 billion for the six months ended July 29, 2023, compared to $2.5 billion for the six months ended July 30, 2022, due to capital investments. Dividends We paid dividends totaling $499 million ($1.08 per share) and $996 million ($2.16 per share) for the three and six months ended July 29, 2023, respectively, and $417 million ($0.90 per share) and $841 million ($1.80 per share) for the three and six months ended July 30, 2022, respectively, a per share increase of 20.0 percent. We declared dividends totaling $516 million ($1.10 per share) during the second quarter of 2023 and $502 million ($1.08 per share) during the second quarter of 2022, a per share increase of 1.9 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 did not repurchase any shares during the six months ended July 29, 2023. 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 Q2 2023 Form 10-Q 21 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 July 29, 2023, 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 facilities. Our committed $1.0 billion 364-day and $3.0 billion unsecured revolving credit facilities that will expire in October 2023 and October 2027, respectively, backstop our commercial paper program. No balances were outstanding under either credit facility at any time during 2023 or 2022. We did not have any balances outstanding under our commercial paper program as of July 29, 2023, and we had $1.5 billion outstanding as of July 30, 2022. 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 facilities also contain a debt leverage covenant. We are, and expect to remain, in compliance with these covenants. Additionally, as of July 29, 2023, 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 Q2 2023 Form 10-Q 22 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 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 28, 2023, 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 28, 2023.