Target Corporation
Q1 2021 Earnings Call Transcript

Published: 19 May 2021

[Operator:]

Ladies and gentlemen, thank you for standing by. Welcome to the Target Corporation 2021 First Quarter Earnings Release Conference Call. During the presentation, all participants will be in a listen-only mode. Afterwards, we will invite you participate in a question-and-answer session. At the close of prepared remarks, we will open the queue for the Q&A session. As a reminder, this conference is being recorded, Wednesday, May 19, 2021.

[John Hulbert:]

Good morning, everyone. And thank you for joining us on our first quarter 2021 earnings conference call. On the line with me today, are Brian Cornell, Chairman and Chief Executive Officer, Christina Hennington, Chief Growth Officer, John Mulligan, Chief Operating Officer, and Michael Fiddelke, Chief Financial Officer. In a few moments, Brian, Christina and John and Michael will provide their perspective on the first quarter and their thoughts on our outlook for the second quarter and beyond. Following their remarks, we’ll open the phone lines for a question-and-answer session. This morning we’re joined on this conference call by investors and others who are listening to our comments via webcast. Following the call, Michael and I will be available to answer your follow up questions. And finally, as a reminder, any forward-looking statements that we make this morning are subject risks and uncertainties the most important of which are described in our most recently filed 10-K. Also in these remarks, we refer to non-GAAP financial measures, including adjusted earnings per share. Reconciliations of all non-GAAP numbers to the most directly comparable GAAP number are included in this morning’s press, which is posted on our Investor Relations website. With that, I’ll turn it over to Brian for his thoughts on the first quarter and his perspective on our outlook. Brian?

[Brian Cornell:]

Thanks, John. And good morning, everyone. The first quarter felt like a first step towards a post-pandemic growth and our team and operating model continues to walk alongside our guests and communities, serving them well through another chapter of growth and healing. From our unique mix of categories to our unmatched set of fulfillment options, our business is delivering what consumers want and need each and every day. The results we delivered in Q1 are nothing short of outstanding. Comparable sales grew by nearly 23%, making it our fourth consecutive quarter in which comp sales grew more than 20%. Maintaining that pace this quarter was especially notable, given that we were comping over double-digit growth a year ago. Over the last 2 years, comp sales have grown about 36% and total sales expanded by $6.5 billion in the first quarter alone. This year, sales growth reflected more than $1 billion in market share gains, a clear signal of how relevant guests find our experience, even though they have many more shopping options available compared with this time last year.

[Christina Hennington:]

Thanks, Brian. As we enter 2021, we knew it would be a year like no other, that's because we're coming off of 2020 which was, by far, the most unusual year any of us have ever experienced. As such, we knew there'd be a wide range of potential outcomes for our sales both by category and in total. And so far, with one quarter behind us, results have been extremely positive across every dimension. In the face of this strength, we've seen an incredible response from our teams across the board from our stores to our merchants to the supply chain, who've all worked together in service of our guests. While there are many ways to measure the impact of those efforts, guest loyalty and market share are the two most important measures of success in this volatile time.

[John Mulligan:]

Thanks, Christina. At our Financial Community meeting earlier this year, we detailed how last years $15 billion in sales growth was more than we grew over the prior 11 years. And as you've seen today, trends are not slowing down as we added another $4.5 billion of sales in the first quarter. Given this continued rapid growth and the opportunity still ahead of us, the operations team is focused on building capacity and enhancing processes to create and enable Target's continued growth. That work starts in our supply chain where we've outlined our plans to add four new regional distribution centers by the end of 2022, with the first two buildings slated to open later this year. These new buildings located in Chicago and New Jersey are set to go live in the next several months, creating additional capacity for the network in total, while enhancing service levels in high volume markets that continue to grow. More specifically, once these buildings are operating at scale, they'll meaningfully shorten lead times to nearby stores, improving in stock levels while reducing the need for safety stock in those locations. Beyond the capacity we're adding with these new buildings, we're also investing in updated fixtures to create additional capacity across our current network. These changes are highly capital-efficient, involving a small amount of capital to open up a substantial amount of incremental capacity within the network, equivalent to the addition of about 1.5 new distribution centers. And as we told you at our meeting in March, we're pleased with the initial results from our new sortation center in Minneapolis. As a result, we have plans to build up to five more of these facilities in 2021 with additional openings planned for 2022 and beyond. We're opening these centers which are smaller than an average store in markets with a high concentration of local package delivery. They're designed to receive and sort packages from a large group of surrounding stores multiple times a day, which allows for more optimized, granular sortation. This precision reduces cost for our delivery partners, meaningfully reducing what we pay for delivery. In addition, these facilities eliminate the need for sortation at the stores they serve, while freeing up packing capacity at those same locations. Sort centers have long been on our fulfillment roadmap, which we've built through internal development along with small acquisitions. In these facilities, we optimize the selection of delivery partners by applying technology from Grand Junction, which we acquired in 2017. And we optimize sortation to minimize cost, to increase speed by applying technology we acquired from Deliv in 2020. In addition, beginning in the first quarter, our Minneapolis sort center began testing package deliver using Shipt, another 2017 acquisition to add capacity, reduce cost and enable more flexibility, which will benefit our rapidly growing ship-from-store capability over time. Within our store network, we've begun ramping up our remodel program, following the pause we implemented last year. We have just over 30 full remodels slated for completion in the second quarter and more than 100 planned for the back half of the year. Based on past experience, we expect these remodeled stores will generate an incremental 2% to 4% sales growth in the year following completion with another 2% incremental growth in the second year. Beyond the direct impact on sales, these transformations create an ideal platform for all of the merchandise innovations and service enhancements that we'll launch overtime. In addition to full store remodels, we're planning other store investments this year, including more than 100 Ulta shop-in-shops slated to launch in the back half of the year as well as our enhanced Apple layout and electronics in select stores across the country. Among our store services, we've long known that our same-day fulfillment options would be popular with our guests, but their growth over the last few years has been far above our expectations. This is most evident in our drive-up service where first quarter sales volume was nearly 21 times higher than it was 2 years ago, amounting to nearly $1.3 billion of incremental sales volume over that period. In the face of this incredible growth, there are emerging opportunities in high volume locations to invest in capacity and efficiency in support of our same-day services. Specifically, in more than 100 locations this year, we're investing in small projects to optimize the front ends of these buildings, freeing up additional capacity for continued same-day growth, while making the lay-out more efficient and safer for the team. We also continue to enhance the assortments available for all three same-day services, adding more perishable food to our pick-up and drive-up services and more general merchandise like apparel to the assortment available through Shipt. And we just announced that in the second quarter, we'll have adult beverages available through pick-up and or drive-up in more than 1,200 stores and available for same-day delivery in more than 600 stores across the country. Beyond activity in existing stores, we're expanding our new store opening plans to more than 30 additional locations across the country this year, as we continue to find compelling opportunities in urban and dense suburban markets and on our near college campuses. In recent years, these custom formats have typically been less than 50,000 square feet. However, given the local real estate conditions in dense suburban markets, we're also finding compelling opportunities to open somewhat bigger stores between 50,000 square feet and 100,000 square feet which weren't available in the past. As a group, these new stores are generating higher than average sales productivity, above average gross margin rates and strong financial returns, and we see a very long runway to open more of them over time. And finally, after store comp growth of 18% in the first quarter, driven almost entirely by traffic, we're confident that we're already benefiting from a differentiated service model in our stores. But that's a lead we can't take for granted. So we're continually looking for ways to get even better. So this year, our store teams are rolling out an enhanced service model focused on consistency of every interaction to ensure that our guests will always feel welcomed and appreciated. And if they need help, there will be team members who can find solutions to enhance their experience. This new engagement model is strongly connected to our company purpose, culture and values and we're supporting it with enhanced training and tools across the chain. It's designed not to be a one and done effort, but a sustainable model that's integrated with our operational goals, not something separate that's added onto everyday tasks. So as I turn it over to Michael, I want to, once again, thank the entire team for the incredible things you've already done and your passion to continually raise the bar. This year I'm celebrating my 25th year at Target, so you might be tempted to think I've seen it all. But when I step back and realize what this team has accomplished in the last year under the most challenging of circumstances, it's clear that there is no limit to this team's potential and there is no doubt that we have the best team in retail. Now I'll turn the call over to Michael.

[Michael Fiddelke:]

Thanks, John. When I think about the underlying themes of our recent performance, the most dominant one, by far, has been the unprecedented growth in share gains we've seen over the last five quarters. On the P&L, the leverage resulting from growth has more than offset all of the unique headwinds we faced over this challenging period, resulting in really strong performance. Target's total sales grew 23.3% in the first quarter, reflecting comp growth of 22.9%. Given last year's double-digit growth, first quarter sales have expanded more than 37% over the last 2 years, driven almost entirely by higher comps. Unlike last year when consumers were consolidating trips and shopping less often, this year's comp growth was driven primarily by a traffic increase of more than 17% combined with a 5% increase in average ticket. As Brian mentioned, store-comps were the growth engine this year, while digital was the primary driver in Q1, 2020. As such, over the last two years, both our stores and digital channels have expanded their first quarter sales by more than $3 billion. This balance highlights the relevance and complementary nature of both channels in serving our guest's needs. Our first quarter gross margin rate of 30% was 490 basis points ahead of last year, when we faced a number of temporary headwinds, including markdowns and other costs to right size our apparel inventory. Compared with 2019, this year's first quarter gross margin rate was about 40 basis points higher, which is notable given that digital sales penetration more than doubled in that time from 7.1% in 2019 to more than 18% this year. In terms of the year-over-year gross margin drivers, mix had a positive impact of about 150 basis points, reflecting the dramatic increase in apparel sales and continued strength in our home category. The remaining favorability was driven by core merchandising, as we continued to benefit from low promotional and clearance markdown rates and we annualized last year's cost to right size our apparel inventory. The rate impact of supply chain and digital fulfillment costs was approximately neutral compared to last year, as the cost of outsized digital growth were offset by the benefit of a stronger mix of same-day fulfillment and our ongoing work to control unit costs across our entire suite of digital fulfillment options. Our first quarter SG&A expense rate was 18.6% this year, down more than 2 percentage points from 20.7% a year ago and 20.8% in 2019. In terms of drivers, leverage benefits have more than offset all of the extra cost we've absorbed over the last 2 years, including meaningfully higher pay and benefits for our team and other investments to protect the health and safety of our team and guests. While D&A expenses have grown in each of the last two years, this year's first quarter D&A expense rate was about 40 basis points lower than a year ago and about 80 basis points lower than 2019. Altogether, our first quarter operating margin rate increased an astounding 7.4 percentage points compared with a year ago to an unprecedented 9.8% this year from a temporary low of 2.4% rate a year ago. However, even compared to a very healthy 6.4% operating margin rate in the first quarter of 2019, this year's rate was more than 3 percentage points higher. In terms of dollars, first quarter operating income has more than doubled over the last 2 years. On the bottom line, our business delivered first quarter GAAP EPS of $4.17, up more than 600% from a year ago and well over double our 2019 GAAP EPS. On the adjusted EPS line, which excluded the gain from the sale of our Dermstore business, we earned $3.69 this year, more than 500% higher than a year ago and well over double our 2019 adjusted EPS. As you know, our capital deployment priorities remain the same as they've been for decades. We first look to fully invest in our business and projects that meet our strategic and financial criteria. Second, we return cash through our quarterly dividend which we've maintained every quarter as a public company and grown every year since 1971. And finally, we returned excess cash over time through share repurchases within the limits of our middle-A debt ratings. In the first quarter, we invested just over $0.5 billion in capital expenditures to support our business. We continue to expect our full year CapEx will be approximately $4 billion, but the bulk of those expenditures will be more back-loaded in the year, given the timing of this year's projects. We paid dividends of $340 million in the first quarter, up slightly from a year ago as growth in the per-share dividend was partially offset by a decline in share count. And finally, we resumed share repurchases in the first quarter, following a temporary pause in 2020 and deployed about $1.2 billion to retire 6.1 million shares at an average share price of just under $191. And, in February, we completed the sale of our Dermstore business, which contributed just over $350 million to our first quarter cash flow. Altogether, we ended the quarter with about $7.8 billion of cash and cash equivalents on our balance sheet. This was down about $700 million from the beginning of the quarter, but still well above where we expect to operate over time. With this cash we'll be funding approximately $3.5 billion of additional CapEx in 2021 and we'll be recommending a robust increase in our quarterly dividends to the Board later this year. Beyond these uses, we should have ample capacity for continued share repurchases and will continue to govern the magnitude and pace of repurchases in support of our goal to maintain our middle-A credit ratings. And, given where we are today, it will likely be a multi-year journey before our debt metrics move fully back to where they've been over time. Now, I'd like to turn briefly to our return on invested capital, which reflects both our operating results and the investments we've made to generate them. In the first quarter, our trailing 12-month after tax ROIC moved up to 30.7% which is well over double the 13.4% we reported a year ago. While we've indicated that this measure will likely be volatile near term and could revert to a very healthy number, near 20% over time, the fact that our business has generated such a high after tax return over the last 12 months is a testament both to the strength of our model and outstanding execution by our team. Now, let me turn to our sales outlook. We learned a lot in the first quarter, and notably, got our first look at how our business is successfully comping the comp with impressive growth on top of last year's strong surge in sales. Also, and importantly, we've continued to gain market share on top of last year's dramatic share gains. Based on these results, we're now planning for our business to deliver a mid to high single digit comp increase in the second quarter. This expectation is in line with the 2 year growth rates we saw in the first quarter. And while we only have a couple of weeks in the quarter behind us, the results we've seen so far this month are consistent with this outlook. The range for second quarter operating income remains wide, but should remain strong far ahead of our 2019 rate of 7.2%, but perhaps not fully as high as last year's unprecedented rate of 10%. In terms of the specific puts and takes in the quarter, we'll be comping over last year's reversal of the return reserve estimate, which added about $110 million to last year's operating income. In addition, this year, we're making purposeful investments in store labor hours to ensure we deliver outstanding service and stronger in-stocks than a year ago, when sales grew far beyond our expectations. Of course, we'll continue to benefit from meaningful sales leverage, given that we're planning for healthy growth on top of last year’s record setting increase. Putting that all together, we expect to see continued strong performance on this line. In the back half of the year, the range of possibilities for comp growth is also quite wide and we'll gain more insight as the year progresses. As of today, based on our recent results and confidence going forward, we expect to see positive single digit comps in the back half of the year on top of last year's unprecedented performance. Regarding our full year operating margin rate, following an exceptionally strong first quarter, we have increasing confidence in the consumer and industry backdrop in the back half of the year. As such, the range of outcomes for our 2021 operating margin rate has moved significantly higher. So, despite the anticipated headwinds from higher markdown rates, following last year's historically low rates, we believe that our business is positioned to deliver a full year operating margin rate that's well over last year's rate of 7%. More specifically, we believe this year's operating margin rate could reach 8% or perhaps a little higher. We'll continue to refine our view throughout the year. As the team looks ahead to the rest of the year, they're focused on staying agile in what continues to be a volatile environment. Rather than placing all of their bets on a single forecast number, they're focused on contingency planning, creating flexibility that will allow us to react to unexpected changes, and importantly, take advantage of opportunity when we see it. We're also excited about the investments still ahead of us and the growth that'll create hundreds more remodels, dozens of new stores, new Ulta and Apple shopping environments and supply chain investments to support both replenishment and fulfillment. Given the performance we're seeing today, which is the product of the investments we've made over the last few years, we're eagerly leaning into future opportunities to enable more profitable high return growth over time. Before I turn it back over to Brian, I want to add my voice in thanks to the team. The value our team members are creating for our business, communities, shareholders and each other goes far beyond what we can measure on a P&L. Thanks for making Target an even stronger company, on behalf of all of our stakeholders. Brian?

[Brian Cornell:]

Before we move to your questions, I want to pause and acknowledge, again, the role our team played in the outstanding results we delivered this quarter. I'm thankful for their continued focus on our guests, focus on operational excellence and passion for our brand. I also want to acknowledge the challenges facing our India headquartered team, along with our team members who have family there, given the recent surge in COVID-19 cases. We have been carefully monitoring conditions on the ground and providing extra support to our team during this difficult time, to ensure they can take care of themselves and their families. We've also funded $500,000 donation to UNICEF to increase access to oxygen treatment in hospitals across the country and bring testing resources to the hardest hit communities. We're hopeful that conditions there will continue to improve. So now, as we get ready to move to your questions, I want to underscore the confidence you've heard throughout our remarks today. Coming off an unbelievable year in 2020, we had a lot of confidence as we entered 2021. But our first quarter results came in far ahead of our baseline expectations. With the macro and consumer backdrop that's been surprisingly positive, we've seen remarkable momentum in our performance even as we started the comp over the period of peak increases a year ago. The flexibility of our category mix and fulfillment options combined with an agile, energetic and engaged team continue to resonate with our guests, driving double-digit traffic growth and an increase in average ticket in the first quarter. But as you've often heard me say, we shouldn't confuse performance with potential. So, even after more than a year of unprecedented growth, we're seeing focus and leaning into the opportunities ahead of us, making investments to build on an already strong foundation. With these investments, I'm confident that our business model and outstanding team will continue to raise the bar on our already best in class retail experience, resulting in even stronger loyalty and guest engagement over time. With that, we'll turn to Q&A. Christina, John, Mike and I will be happy to take your questions.

[Operator:]

Thank you. We will now begin the question-and-answer session. Our first question is from Bob Drbul with Guggenheim. You may go ahead.

[Bob Drbul:]

Hi, good morning. Congratulations.

[Brian Cornell:]

Bob, thank you.

[Bob Drbul:]

Great job, Brian. The question that I have is when you look at the mix of - especially on the apparel side, can you talk about, you know, any new brands that you're excited about? You've done a great job with the private brand piece. And I think as you move through the year, any expectations that you have just on that mix in some of the margin implications around that category would be great. Thank you.

[Brian Cornell:]

Bob, good morning. Well, why don't I let Christina spend some time talking about what we're seeing with categories, some of the highlights between our own brands and national brands. Obviously, Christina highlighted the fact that, despite our overall robust performance in the quarter own brands grew by 36%, a record performance for us. So we're clearly seeing great performance in both our own brands and national brands. But Christina, why don't you build on some of what we're seeing in the different categories.

[Christina Hennington:]

Absolutely. And good morning, Bob. Thanks for the question. As Brian was just sharing, we really are excited about the strength across the board. Apparel was certainly a standout in this quarter with growing over 60%. And that came from a range of brands in every segment of the business. But the reality is, the three trends that I talked about in my prepared remarks are benefiting our multi-category approach across the board, joy at home, and the opportunity to celebrate everything that brings the guests to their home, eating, being with their families. And the investments that they've made over time in their home, health and well being the opportunity that our guests are taking to invest in proactive health care, and fitness at home and activewear. And then the newer and more emerging trend is really style and mobility. As guests are going out, they are looking for a fresh look. So our newest collections of our dresses by Christopher John Rogers, Alexis, and RIXO, couldn't have been more perfectly timed to really help guests look their best in what they're wearing, and certainly also across their beauty trends.

[Bob Drbul:]

Thank you.

[Brian Cornell:]

Bob, thank you.

[Operator:]

And the next question is from Paul Trussell with Deutsche Bank. You may go ahead.

[Paul Trussell:]

Good morning. And outstanding results. Congratulations to the team. I guess my question is on first same-day services, which obviously continues to really showcase robust growth. I'm just wondering if you can talk a little bit more about how the business has evolved? What are the additional learnings? And what are the actions that have been taken to really improve the efficiency and profitability of that particular business and service?

[Brian Cornell:]

Paul, thanks again for joining us this morning. Why don't we let John Mulligan talk about some of the progress we've made from a same-day fulfillment standpoint.

[John Mulligan:]

Morning, Paul. It's good to talk to you. You know, as you know, well, we've talked about stores as hubs now for going on four years. And we have always said, we'd like it for a couple reasons. One great guest service and two better economics. Same-day services are that on steroids. They have much better economics than shipping something to someone's home. Because as we've talked about, the shipping expense is the biggest part of delivering something to someone's home. So if we take that out of the equation, then we end up with economics that are much closer to the store transaction. The thing we love about all of the same-day services, pick-up, drive-up and Shipt, all of them continue to go faster than our overall digital growth, and we continue to find ways to improve them, as you said. Part of that is investing in technology for our teams, improving their sort paths and improving how they pick, we've done a great deal of process work to break things apart to make it simpler for our teams to execute. We've done things to help them find items in the store, so that we don't end up with what we call INFs or items not found. And then we continue to invest in helping them physically. And that's a big focus for us this year, and will be over the next couple years. In the case of drive-up, which as we've talked about a couple times, Brian talked about and I talked about, has been our fastest growing same-day service since - basically since we started it. It also has our highest NPS score, so guests love it. We will let you just decide when you want to come, we don't force you into a time slot and then our team brings it out to you in two minutes or less. So our guests absolutely love that and you'll see us invest in making that easier for our team, building capacity on the front end of the store. Over the past year, we've rolled out adding temperature control products to drive-up. And so you'll see us have refrigeration and freezers to the front end of the store, all behind the wall so that our guests don't see that, but making it much easier for our teams to execute. And then much safer, we'll make it much easier for them to walk out to cars, protect them from the environment a little bit. So all of that experience continues to improve as well. So every year our team comes up with multiple ways to continue to improve the service, first and foremost for the guest, and then on the back end, improve things for our team so they can execute it easier as we continue to grow. So we see a lot more opportunity for us. And as I said, that'll be a big part of our capital investment over the next several years.

[Brian Cornell:]

John, the only thing I might add is, as we saw our guests turn to same-day services during the pandemic, using pick-up and drive-up and Shipt. We expect those services to be very sticky over time. And certainly we've matured the awareness, and the use of those same-day services by two, three, if not four years. And certainly as we go into the back half of the year, and during the holiday season, I think we're going to continue to see our guest turn to Shipt and drive-up and pick-up. That's just an easy and convenient way to shop at Target.

[Paul Trussell:]

Thank you for the color. Just quick follow up for Michael, obviously, you really showcasing a lot of confidence in the trajectory of the business, given the outlook provided for the balance of the year. Maybe just a little bit more detail on how we should think about gross margins and SG&A. What's clearly going to be a really healthy operating margin rate in 2Q and the second half?

[Michael Fiddelke:]

Yeah. Sure, Paul. Thanks for the question. And I touched on this a bit in my remarks. But if I had to summarize our profit story, it goes back to the scale benefits we see when we have growth. And our plan for the back part of the year is to see growth on top of some of the strongest quarters in Target's history last year. So we would expect that leave to lead to lead, you know, improving profit rates on a year-over-year basis. And there's still a wide range of where those numbers might ultimately land. And we'll continue to refine our point of view as the year progresses. But scale is a wonderful thing. And we've seen impressive growth over last year, and we expect more to come in the balance of this year.

[Operator:]

And does that conclude your question, sir?

[Paul Trussell:]

Yes. Thank you. Best of luck.

[Operator:]

Thank you.

[Brian Cornell:]

Paul, thank you.

[Operator:]

Thank you. The next question is from Karen Short with Barclays. You may go ahead.

[Karen Short:]

Hi. Thanks very much. And I'll add my congratulations to a great quarter. I wanted to just ask a little bit about share gains, and obviously, we know the categories in your gaining share across all categories. But I wanted to see if you could give a little bit more color on share gains by demographic and which demographics you think you're gaining the most share from? And then I have a follow-up to the last question that was asked.

[Brian Cornell:]

Karen, thanks again for joining us today, and appreciate the question on market share. As you look at our business and I think you know our Target guest and our Target shopper, we're appealing to all demographics and we got over - now, well over 30 million guests who shop us every week, most of America shops to Target. And I think as we look at it, we're picking up share across all these various cohorts. So it's not one consumer, it's all of the guests who are shopping at Target. And as they return to our stores, shopping multiple categories. And I think that's the magic behind our performance is that great combination of in-store experience, the ease, and convenience of digital, but that multi-category portfolio, and that unique combination of our own brands and curated national brands, we appeal to a broad group of consumers in different cohorts and we're picking up share across all of these different areas.

[Karen Short:]

Okay. Thank you. And then just on inventory growth. Obviously, your inventory growth was very strong this quarter, which is impressive, given the freight issues and the port issue. But maybe some color on that growth in general and how you think about the balance of actually wanting more markdowns in 2021 versus 2020? You know, how we should think about that in the context of gross margins?

[Brian Cornell:]

Michael, why don't you start, and then we can provide some additional color as Christina talked about our inventory positions.

[Michael Fiddelke:]

Sure. Well, first off, Karen, I feel really good about our inventory position heading into the second quarter and you can see we're up on a year-over-year basis and we should be, given the growth in sales that we've seen and continue to expect. When it comes to markdowns through the balance of the year, and I've talked about this a little bit previously, we were sold through in a lot of seasons last year and that's not optimal for us. We don't want to look at empty shelves at the end of a seasonal set. And so with our anticipation for growth in the remainder of this year, we'll be buying appropriately to that and hopefully, that means we've got fuller shelves at the end of a season. And with that, we'll come some clearance markdowns that will be a little bit of a drag on markdown rates on a year-over-year basis, if I had to guess, but I would welcome a little bit of that rate drag because it means that we're full and in stock for the guest throughout the season.

[Karen Short:]

Great. Thanks very much.

[Operator:]

Thank you. The next question is from Chris Horvers with JPMorgan. You may go ahead.

[Chris Horvers:]

Thanks. Good morning, everybody. So a couple of questions on guidance. My first question is, in the second quarter, Michael, why couldn't you reach 10% or at least be close to that, you did a 9 8 in 1Q. Sales volumes looked to be similar, is it less rich mix performance or perhaps you’re putting in some caution around potential promotions and clearance?

[Michael Fiddelke:]

Sure, Chris. Thanks for the question. Well, we would expect, like I said in my remarks, the second quarter to be far ahead of the 2 year ago performance, likely not as high as last year, but there is still a broad range around that outcome, and so we'll see as the quarter plays out exactly where we land. Worth noting and I touched on this as well, there is some factors unique to the quarter. We’ve got a $110 million headwind from the way our returns reserve calendarizes between Q1 and Q2. And the second thing is we're investing and we'll continue to invest in the team and in store payroll to make sure we're staffed and in-stock to support the sales we expect to come and our teams have done just an incredible job this year providing such great guest experience. We want to make sure we're investing to continue to support that and to support growth.

[Chris Horvers:]

Understood. And then, as you think about the gross margin, can you talk about the puts and takes of this year versus 2019? Obviously you have a higher e-commerce mix, but you would think that sort of the mix of the business by category could be richer and you also have pretty lean inventories against a strong demand backdrop?

[Michael Fiddelke:]

Yeah. So maybe I'll speak to actuals and unpack the first quarter just a little bit versus 2 years ago. If you look at kind versus our 2019 performance, we saw markdown efficiency and we've talked about that, lower levels of promotional and clearance markdown rates than 2019. On a 2 year basis, mix is actually about 40 basis points of a drag in the first quarter. And also on a 2 year basis, you can see digital and supply chain pressure of a shade over a point, given the growth in the digital business and the impact that has to rates. And so, those are familiar drivers, we've talked about over time. Where those drivers land for the balance of the year will dictate where margin ultimately falls.

[Chris Horvers:]

Great. Thanks very much. Have a great spring.

[Brian Cornell:]

Thanks, Chris.

[Michael Fiddelke:]

Thanks, Chris.

[Operator:]

Thank you. The next question is from Scott Mushkin with R5 Capital. You may go ahead.

[Scott Mushkin:]

Hey, guys. Thanks for taking my questions. I wanted to go into labor. Brian, I heard your comments today on CNBC about that, it’s kind of – you're not really having a struggle getting labor. And I also heard you guys talk about enhanced service model. So I was wondering if you could talk about whether you guys believe you have a labor advantage and kind of what you're doing with your labor force to enhance the store experience. Thanks.

[Brian Cornell:]

Well Scott, thanks for joining us. Why don't I start and then I'll let John build on my comments. But as I said earlier today, we've been investing in our team for many years now. And we took an industry leading position with our starting minimum wage. We've continued to invest over the last year in the health and wellness and safety of our teams and I think that provide us stability, even deeper engagement with our teams in stores and our teams in supply chain. So I do think it gives us a competitive advantage and I think the focus we'd placed on our team, the care of our team, making sure we're investing in their training, their development, their growth, I think that's really provided us with a unique experience and I think it's one of our competitive advantages in the marketplace. John?

[John Mulligan:]

Yeah. Hi, Scott. Just building on what Brian said. Basically, I think our thought has always been the best way to staff our stores and our supply chain frankly is to limit turnover. And so, let's invest in our team, give them a great experience and you've seen us do that for several years now. We've invested in wages. We've invested in benefits. Just as importantly, we've invested in training to help up skill them. And then, over the course of the past year and a half or so, we've invested in safety very overtly. And so, as Brian said, engagement is very high, turnover is down significantly relative to 2019. So we feel really good about where our store is at. And as turnover decreases, you get so many benefits, right. We get team members that know their job. We get team members that know their guests that are in their stores, because they are in their weekly. They can engage with them. And this kind of gets to the service model where the idea is to engage with our guests, make them feel welcomed, and importantly, solve their problem. If they have an issue, solve it in the moment for them. And so, you’ll see us continue to do that. We're very encouraged by what we see. Our NPS scores across all of our services, including the in-store experience, are up over last year and up over 2019. So we're just getting started on this journey. But the early results are very encouraging. And I would just finish where Brian did, we – you've heard us say for a long time, we have the best team in retail and we absolutely believe that’s the truth.

[Scott Mushkin:]

That's great…

[Brian Cornell:]

John and I had a review just yesterday with our store team leaders to look at turnover and retention rates and we just continue to see stronger and stronger numbers. And back to the point that John have made, so the operating model changes we've made over the last few years, putting experts in place in areas like beauty and technology. Those team members are really passionate about the work that they do and they continue to learn and grow every day. And I think that focus on providing training and development opportunities, the expertise that we're providing in those key categories, that's going to continue to provide benefits to us over time.

[Scott Mushkin:]

All right, guys. Thanks very much.

[Brian Cornell:]

Thank you.

[Operator:]

Thank you. The next question is from Kate McShane with Goldman Sachs. You may go ahead.

[Kate McShane:]

Hi, good morning. Thanks for taking our question. I wondered if I could go back to the digital fulfillment questions that were asked earlier. I think you said costs were neutral, and I wondered is it possible for how you're fulfilling to turn into a tailwind as you continue to drive more growth towards the same-day services and away from two day free ship. And then separately, you mentioned the sortation centers and the number you're opening this year. I wondered if you could talk to just the cost optimization from those sortation centers over the long term?

[Michael Fiddelke:]

Sure. Thanks for the question, Kate. I can start and then maybe John can provide more color on the sortation center work that we're doing. Yeah, we didn't see pressure on the supply chain in digital line this quarter. That's due in part to the just incredible strength in our store business with stores up 18% on a year-over-year basis. I get excited by the efficiency improvements I see us continue to make in our digital experience, John talked to some of those just a minute ago. But we can do a lot with the volumes that we've built over the last 2 years in some of those same-day services and all of that volume translates to more efficiency opportunity as we continue to squeeze down the per unit cost to fulfill. But I don't shy away from growth or from a drag on that line from a growing digital business. And the reason why is, when guests lean into digital, when we get more omni-channel guests, more guests using drive-up, more guests using same-day, even if that sale itself comes at a slightly lower rate, it does incredible things for the rest of our P&L, because we see those guests spend more in total, about 30% more for a new drive-up our Shipt guest. And that's way more important than the little bit of rate drag we’ve seen over time from digital growth and that's how we continue to think about it.

[John Mulligan:]

Yeah. And on the sort centers, Kate, we remain pretty excited about this opportunity. But I would caution you that it's early days for us still. We are - we always talk about crawl, walk, run. I'd say we’re still firmly in crawl here in Minneapolis. And so we see a lot of opportunity in front of us. But the play here is a couple of things. And first of all, it's about capacity in the store. So if we can sweep packages out of the stores more routinely than once a day, that frees up space and that frees up space for us to pack additional products in the store and that's an important thing for us. Then as we move downstream, the more granular sort is where we start to see potentially cost reductions as we can sort to provide to our carrier partners further downstream in their operations and like we'd announced about a month ago, using the Deliv technology, creating local routes for local packages, we can get very efficient on delivery using Shipt and Shipt drivers. And so put all that together and our guest gets a great experience, we create more capacity and we have the opportunity to continue to improve what we believe are already advantaged economics because of our stores as hub model. So more to come on all that. It's early days, but we remain pretty optimistic on all three of those fronts.

[Kate McShane:]

Thank you.

[Brian Cornell:]

Operator, we’ve got time for one last question today.

[Operator:]

Thank you. Our last question is from Joe Feldman with Telsey Advisory Group. You may go ahead.

[Joe Feldman:]

Great. Thanks guys for taking the question. So wanted to ask you, you know you just touched on it a little bit, I think, Christina, in the prepared remarks about back to school and being excited and assuming we do have a more normal back to school, and with this child tax credit coming, are you guys planning the back to school period in the second half any differently this year in terms of marketing or inventory levels, maybe that you could share a little bit with us?

[Christina Hennington:]

Yeah. Joe, I'd be happy to talk about that. So, we're very excited about what these life moments afford us in the back half, the opportunity for a little more “normalcy”, it really creates opportunities for us to be relevant to our guests in many different ways. And so you think about back to school as a huge moment where the convenience of our assortment across multi-category portfolio is already a preferred destination. But then, you think about how that leads into opportunities in Halloween and Thanksgiving and the holiday, opportunities for our families to be together and celebrate fun times for the first time in almost 2 years. And so this is where the power of our assortment and the gifting opportunities, the value equation that we offer and the resonance with our brand really shine. And so that means we're very excited about the fall outlook.

[Brian Cornell:]

So Joe, thanks for that final question. It's a great place for us to ramp up and hopefully for all of you, you recognize the confidence we have in our business as we go forward, the execution that we're seeing across all of our different functions and the way we're focused on serving the guests. So appreciate everyone joining us today. And operator, that concludes our first quarter earnings call. So thanks again for joining us.