Good morning, everyone, and thank you for joining us on our Q1 2015 earnings conference call. On the line with me today are Brian Cornell, Chairman and Chief Executive Officer John Mulligan, Chief Financial Officer and Kathy Teshia, Chief Merchandising and Supply Chain Officer. This morning, Brian will discuss our Q1 performance and priorities going forward. Then Kathy will provide insights into our Q1 results across our merchandise categories and plans for the Q2 and beyond. And finally, John will provide more detail on our Q1 financial performance and expectations for the Q2 and the remainder of the year.
Following their remarks, we'll open the phone lines for
a question and answer session.
As a reminder, we're joined on this conference call by investors and others who are listening to our comments via webcast. Following this conference call, John and I will be available throughout the day to answer any follow-up questions you may have. Also, as a reminder, any forward looking statements that we make this morning are subject to risks and uncertainties, the most important of which are described in our SEC filings. Also in these remarks, we refer to adjusted earnings per share, which is a non GAAP financial measure and return on invested capital, which is a ratio based on GAAP information with the exception of adjustments made to capitalize operating leases. Reconciliations to our GAAP EPS and to
our GAAP total rent expense are included in this morning's press release posted on our Investor Relations website. With that, I'll turn it over to Brian for his perspective on our Q1 performance. Brian? Thanks, John, and good morning to all of you. We're very pleased with our Q1 financial results, which we announced earlier this morning.
Our Q1 adjusted EPS of $1.10 is 19.6% higher than last year and $0.05 better than the high end of the range we provided at the beginning of the quarter. Comp sales increased 2.3% in the quarter, a bit ahead of our expectations. This increase was driven by a healthy balance of growth in both traffic and average ticket. 1st quarter digital sales increased 38% over last year, driven by higher traffic and a substantial increase in conversion. Digital growth contributed 80 basis points to our comp sales increase in the Q1.
While we enjoyed a healthy pace of sales throughout the Q1, we saw particularly strong results in March as weather warmed across many parts of the country and Easter timing moved seasonal sales into the month. In April, we were thrilled with the overwhelming demand for items from our collaboration with Lilly Pulitzer, with most of the collection selling out in the 1st few days. We were disappointed, however, that our digital channels were not able to properly accommodate the surge in traffic at the time of the launch and the team is working to address root causes and learn from the experience as we prepare for holiday season peak later this year. The Q1 saw a meaningful increase in our gross margin rate as we cycled over a promotional Q1 of 2014 and we benefited from very strong mix of sales in our Signature categories this year, both in stores and online. 1st quarter comp sales in signature categories grew more than twice as fast as our comparable sales overall and mix in our digital channels was even stronger.
Specifically, about 2 thirds of our Q1 digital sales increase was driven by growth in home and apparel. Kathy will provide more detail on category performance in a few minutes. Once again, our stores did a great job controlling costs this quarter. While outside of the stores, we continue to move to a leaner, more agile way of working. During the Q1, we recorded restructuring charges related to headcount reductions at our headquarters.
While these reductions were very difficult for all of us, I strongly believe they were a necessary step to remove roadblocks, which were preventing us from moving more quickly and responsibly to the guests' needs. I want to thank the team for their perseverance during this time of significant transition. I continue to admire the energy they bring to work every single day. As you know, we are committed to returning cash to our shareholders through both dividends and share repurchase over time. And I'm very pleased that this quarter we began returning cash through share repurchase for the first time in nearly 2 years.
This change reflects the improving health of our U. S. Business along with the cash flow benefit of our 4th quarter decision to discontinue operations in Canada. For several quarters now, I've been talking about the 5 priorities we are focused on as a leadership team: becoming a leader in delivering shopping on demand for our guests establishing clear roles in our merchandising categories with particular focus on growing our signature categories style, baby, kids and wellness developing capabilities to become more localized in our store experience and more personalized in our digital interaction with guests continuing to develop and test urban formats like Citi Target and Target Express And finally, transforming the way we work to create capacity to invest appropriately in the growth initiatives I've just described. I strongly believe if we make progress on these five priorities over the next few years, Target will deliver outstanding financial results and become an even stronger retailer.
While we're at the early stages, I'm encouraged with signs of progress on these efforts. Specifically, our strong mix of 1st quarter sales in signature categories demonstrates the value of the work to define category roles. We continue to roll out upgraded fixtures in apparel, beauty, baby and home, while investing in wellness with programs like Made to Matter. Our buying teams are focused on delivering enhanced newness, quality and value to our guests. And we're communicating this renewed focus in both traditional and digital channels.
Our digital sales growth of nearly 40% on top of 30% growth a year ago shows that we have a meaningful opportunity to generate comp sales growth investments in digital channels. And following our March headcount reductions at headquarters, our teams are taking a fresh look at everything we do and taking steps to remove approval layers and increase the speed of decision making. While there will certainly be a meaningful adjustment process, I believe we will emerge with an agile and engaged team that is equipped and empowered that quickly on behalf of the guest. These signs of progress are meaningful to the team and they demonstrate the value of our efforts and validate our strategic priorities. Yet as we look ahead, we realize we're on a much longer journey and need to accomplish many more things.
Specifically, we're in the very early stages of our work on localization and personalization. In the future, these efforts should benefit both sales and gross margin rate. And while we're still in the testing phase, we're very encouraged by the progress in evaluating and rolling out urban formats like Citi Target and Target Express. We opened 2 new Express locations in the San Francisco market this quarter, both of which are quite different from our first location in the Minneapolis market. We expect to open 6 more locations this year in a variety of markets and demographic areas to continue to learn how to operate this new format in a diverse array of sizes and settings.
Finally, we are just beginning to reinvent our food assortment and presentation. We have an opportunity to drive more traffic and sales in this critical area of the store by becoming more specialized in our assortment, more focused on healthy options in support of wellness. We're testing potential assortment and presentation options. And this year, we plan to study the guest response, the potential changes before determining what will roll out more extensively next year. While this quarter's results are encouraging, we're focused on the work ahead of us as we transform ourselves to become a truly modern retailer and more relevant to our guests.
We're taking the necessary steps both on investment decisions and the way we work to position Target for continued profitable growth in the years ahead. The momentum we've seen so far makes us more confident than ever that we're moving in the right direction and encourages us to move even faster. Yet we know that long term success depends on achieving the right balance between speed and the time it takes to convert we're making the right changes that we can execute at scale. Once we have that confirmation, we're committed to moving forward, both quickly and confidently, in becoming the retailer our guests want Target to be. Now, I'll turn it over to Kathy to recap our Q1 results and plans going forward.
Thanks, Brian. In the Q1, we saw encouraging trends across many dimensions of our business, including traffic, sales, merchandise mix, markdown rates, digital channel growth and overall profitability. Within our sales, our results reflect our continued focus on growing Signature categories. Beauty had another outstanding quarter and delivered more than a 5% comp, but apparel and home were right behind with a mid-four percent comp. Given weather trends and Easter timing, apparel comps peaked in March, but were strong throughout the quarter.
Among the drivers was swim, where we saw better than expected results across the board in women's, men's and kids. In ready to wear, we saw particular strength in Marona and our new plus size brand Ava and Viv. And while it's small relative to the quarter, the response to the Lilly Pulitzer partnership was the icing on the cake as more than 90% of the apparel items sold out the 1st day. Across the rest of our assortment, food comps were just below the company average and Hardlines experienced a mid single digit comp decline, reflecting a very tough comparison to last year when we saw particularly strong sales from Disney's Frozen and elevated promotions drove sales in Electronics. As Brian mentioned, 1st quarter comparable sales were driven by a healthy combination of growth in both traffic and average ticket.
Within average ticket, an increase in average retail was partially offset by a decline in units per transaction. This decline in average units was driven by category mix, particularly apparel, along with channel mix, as digital transactions typically have fewer units at higher average retail. Besides channel mix, growth in average retail was driven by a lower level of promotional activity this year and a trend in which our guests are trading up to higher quality and premium branded items. We were really pleased with the pace of digital channel sales growth this quarter and even happier that it was driven by home and apparel. But our digital goals are ambitious and we have a lot more work to do.
So we're continuing to invest in and roll out new initiatives to maintain our momentum. The February launch of a lower $25 free shipping threshold drove a meaningful increase in conversion this quarter and guests continue to embrace store pickup, which was up more than 100% from a year ago. Subscriptions are also growing rapidly. Sales on subscription grew 32% between the Q4 and the Q1 and the active subscriber base grew 20% within the Q1. And we continue to see great results from our ship from store capability, which delivers shipping savings for us and reduced delivery times for our guests.
And we expect to roll out this capability to more than 200 additional stores this fall. As I mentioned in the last call, we were very happy to see the West Coast port situation resolved, yet we knew it would take a few months for the shipping backlog to be completely relieved. As of today, I'm pleased to say that those delays are fully behind us. Consistent with our Q4 experience, the team did a great job in the Q1 working around port related issues by pre ordering inventory and rerouting shipments. However, despite these efforts, some categories including shoes saw spotty in stocks in the quarter and saw sales accelerate as receipts began to flow and in stocks recovered.
As we look ahead, we are working to build on our current momentum in the Q2 and beyond. In apparel, beyond swim, we've been seeing encouraging trends in shorts, dresses, tanks and sandals and expect these businesses to be a key driver of 2nd quarter sales. In jewelry and accessories, this morning we announced a new limited time partnership Eddie Borgo for Target, which launches July 12. Eddie has crafted a first of its kind limited edition collection of customizable jewelry, accessories and wall art, featuring the designer's signature aesthetic and on trend colors and finishes. In Home, we're seeing great momentum in our tabletop business and we'll expand the offering this quarter with a broader selection of both indoor and outdoor options for summer entertaining.
We're also excited about our new product development programs, which will launch in July, featuring more exclusive content from licensed and exclusive brands and do it yourself programs, which will allow students to decorate their own journals, notebooks and lockers. In wellness, we continue to see amazing results from the Made to Matter collection. Since the announcement of this collection, featured brands are running up 25% to last year and the collection is on track to record $1,000,000,000 in sales this year. In kids, we have a blockbuster set of license programs planned for the Q2 and beyond. In stores now, we're offering about 150 items from the new Avengers movie, including many that are exclusive to Target.
To support the release, we've created an omnichannel marketing campaign that includes social media engagement and a uniquely creative stop motion broadcast spot that brings the actual 12 inches action figures to life. Also this summer looks for exclusive items across multiple categories in celebration of the June release of Jurassic World and the July release of Minions. On target.com, we've expanded our license offering by creating experiences for our top 29 licenses. Each of these experiences includes favorite items that we carry in both channels, plus extended assortments that include collectibles, more apparel choices and hard to find toys. We will continue to roll out experiences to more of our favorite characters throughout the year.
To celebrate the 65th anniversary of the iconic comic strip Peanuts, we're rolling out a summer collection of more than 100 exclusive products. These items are the work of our own product design and development team who partnered with current Peanuts cartoonists and the Charles M. Schulz Museum to design fresh fun items that are true to the Comic Strip's roots. We'll roll out more exclusive items across multiple categories throughout the year, leading up to the release of the new Peanuts feature film in November. And finally, like moviegoers, we're already excited about the December movie release from the most famous license of them all, Star Wars.
Earlier this month, as part of the worldwide May 4th Be With You event, we allowed Darth Vader and Yoda to take over the target.com homepage offering special online only deals on Star Wars licensed product. We'll provide more details on our next earnings call, but for now I can assure you that Star Wars fans will find plenty of reasons to visit our stores and target.com this year. As we've said many times, we're encouraged by our progress, but recognize that we are only at the beginning of a multiyear journey to transform our business. We continue to roll out new store fixtures to enhance the shopping experience in apparel, baby, electronics and home. And we're working quickly to develop and test ideas to reinvent our food area to become more specialized and more clearly embrace wellness with local products, naturals, organics and clean labels.
And we continue to invest in our technology and supply chain capabilities to allow our guests to shop on demand and receive products where and when they want. The good news is that even though we have much more to do, the positive guest response to what we've already accomplished makes us confident we are moving in the right direction. Now I'll turn it over to John, who will share his insights on our Q1 financial performance and our outlook for the Q2 and beyond.
Thanks, Kathy. Our first quarter financial results were stronger than expected, driven by better than expected sales performance, particularly in our signature categories. Adjusted EPS of $1.10 was $0.05 above the high end of the guidance range provided at the beginning of the quarter. First quarter diluted EPS from continuing operations of $1.01 about $0.09 lower than adjusted EPS, driven primarily by pre tax restructuring costs of $103,000,000 combined with small adjustments for breach related expenses and a favorable resolution of income tax matters. 1st quarter GAAP EPS of $0.98 included a $0.03 loss on discontinued Canadian operations compared with a $0.24 loss on Canadian operations in the Q1 2014.
Our first quarter comparable sales increase of 2.3% was just ahead of the guidance of 2% we provided at the beginning of the quarter. We are pleased with the sales results throughout the quarter, but they were particularly strong in March as weather warmed and Easter timing moved seasonal sales into the month. Comparable sales growth for March April combined, which eliminates the effect of Easter timing, was stronger than we experienced in February. Digital channel sales increased 38% in the Q1, on top of more than 30% growth in the Q1 last year. Digital channels drove about 80 basis points of our Q1 comparable sales increase, in line with our Q4 experience.
Comparable transactions were up, both in the store and digital channels, accounting for approximately 90 basis points of our comp increase. RedCard penetration of 21.5 percent was about 110 basis points ahead of last year, in line with our expectations. This growth is faster than our 4th quarter pace and consistent with new account growth in the latter half of twenty fourteen. Risk levels on the portfolio continue to run at historically low levels. And this quarter, we saw an increase in payment rates.
This increase is consistent with commentary from others and potentially explains what consumers are choosing to do with some of their savings from lower gas prices. One other note, we've now begun piloting acceptance of chip transactions our stores as the entire U. S. Payment industry prepares to move to chip technology later in the year. Our first quarter segment EBITDA margin rate of 10.5% was stronger than expected, driven by an unexpectedly strong gross margin rate.
Specifically, our Q1 gross margin rate of 30.4% was nearly a percentage point higher than a year ago. This rate this year's rate benefited from lower markdowns as we analyzed last annualized the last year's promotional activity following the data breach and we saw a very favorable mix of sales in our signature category. In fact, the last 2 in recent history in which sales mix has been a positive contributor to our overall gross margin rate. This shows the value of our focus on driving growth in our Signature category. This quarter, we grew sales and traffic while replacing promotionally driven sales on lower margin items with higher margin sales in signature categories and the benefit to our P and L was compelling.
On the SG and A expense line, this quarter we benefited from productivity improvements in the stores and overall leverage of paying benefits, partially offset by higher technology expense compared with a year ago. Altogether, our Q1 segment SG and A expense rate improved about 20 basis points compared with last year. Before I leave our segment discussion, I want to discussion, I want to comment on our inventory position at the end of the quarter, which was about 9% higher than a year ago. This increase was intentional and reflects some decisions we've discussed in the past calls. First, beginning last summer, we increased our inventory commitment in commodity categories to support in stocks in these frequency driving businesses.
And second, our receipts this quarter reflected some pre buying of imported product that the team had undertaken to mitigate risk before the West Coast port slowdown had been resolved. Looking ahead, we continue to feel very good about our overall inventory level and we expect year over year growth to moderate in the second quarter and beyond. Moving to consolidated metrics. 1st quarter interest expense was essentially flat to last year and we returned $333,000,000 to shareholders in the form of dividends in the Q1, an increase of 22% over last year. As we mentioned during the last call, the improvements in our business results and cash balance have positioned us to once again return cash through share repurchase within the limits of capital structure goals.
As a result, this quarter we bought back shares for the first time since the Q2 of 2013, investing $297,000,000 in open market repurchases and another $265,000,000 to an accelerated share repurchase agreement late in the quarter. This means that in the quarter, we returned over 140% of our net income through dividends and share repurchase. Given our current cash position and continued strong cash generation by our business, we expect to continue to repurchase shares in the Q2 and beyond and believe we will have the capacity to retire $2,000,000,000 or more of our shares in this fiscal year, within the limits of our current authorization later this year. As a result, we exhaust the current authorization later this year. As a result, we will be reviewing with our Board the need to increase our share repurchase authorization at an upcoming meeting.
Before I turn to our outlook, I want to pause and discuss our decision to begin reporting after tax return on invested capital from continuing operations or ROIC in this quarter's earnings press release. As you know from our previous discussions and the long term performance incentives described in our proxy statement, we believe ROIC is an important metric to measure the quality of our capital allocation decisions over time. Also, as you know, we presented our long term aspirations for this metric during our Financial Community Meeting in March. Specifically, we intend to reach the mid teens or higher on this metric over the next 5 years. Beginning this quarter, we will report how we have performed on this metric for the most recent trailing 12 months, providing clarity on how we are measuring our own performance, while allowing everyone to track our progress.
To provide additional context, we're posting the last 2 years of quarterly calculations of this metric on our Investor Relations website in the summary financials section. With that backdrop, this morning we reported that for the trailing 12 months through Q1 2015, our after tax return on invested capital was 12.5%, up about 60 basis points from a year before, reflecting improved profitability on a relatively stable base of invested capital in our continuing operations. Now let's move to our outlook for the Q2 and the remainder of the year. In the Q2, we expect our comparable sales to increase between 2% and 2.5%, reflecting expected growth in digital channel sales in the high 30% range. Both of these expectations are similar to our Q1 performance.
And while it is still early, our results through the 1st few weeks of Q2 are consistent with that forecast. We expect our Q2 gross margin rate to improve about 50 basis points from last year, as we benefit from the comparison to last year's promotional activity, while we continue to make price investments and add quality back into our owned and exclusive brand products. On the SG and A expense line, we expect our 2nd quarter rate will be 20 basis points to 30 basis points higher than a year ago, as the rate benefit from productivity improvement is expected to be offset by a planned year over year increase in compensation expense. You'll recall that compensation expense was unusually low in the Q2 last year, as we significantly reduced our accrual for full year incentive compensation in light of softening financial performance. Combining our gross margin and expense rate expectations, we're looking for improvement in our 2nd quarter EBITDA and EBIT margin rates of 20 to 30 basis points compared with last year.
2nd quarter interest expense is expected to be about $150,000,000 well below last year, which is unusually which was unusually high due to the retirement of some high coupon debt. Our effective tax rate is expected to be just over 35%, higher than last year's 33.7% rate driven by improved profitability. Altogether, these expectations would lead to 2nd quarter adjusted EPS, representing results of continuing operations in our single segment business of $1.04 to $1.14 compared with $1.01 a year ago. While we've seen a strong start to the year so far, it is early and we have a lot more to accomplish as the year progresses. However, our Q1 performance validates that we are focused on the right strategic priorities to propel our business forward.
And it certainly adds to our confidence that we can deliver on our guidance for the year. As a result, we've taken the lower end of our prior full year guidance up by $0.05 and now expect full year adjusted EPS from continuing operations of 4.50 dollars to $4.65 With that, we'll conclude today's prepared remarks. Now Brian, Kathy and I will be happy to respond to your questions.
Your first question will come from the line of Oliver Chen with Cowen and Company.
Hi. Congratulations on really solid results. We're very pleased hear about all the progress. Regarding the comp in the back half, should we think about traffic as the main opportunity? Or do you feel like ticket will also be an opportunity?
And as we think about gross margin and your product assortment, how are you balancing the idea of investing in price versus the innovation that you're conducting in your Signature categories?
Oliver, good morning and thanks for joining us today. As we think about the balance of the year, I would ask you to think about 3 important variables and you saw those come to life in the Q1. We're clearly focused on driving traffic to our stores and we expect that to be a very important driver of our growth over the balance of the year. But you're also seeing the benefit of our focus on signature categories and the higher ticket that that generates. But importantly, the third element is the increasingly important contribution we're seeing from our digital and online businesses.
So as we go forward, we're going to continue to make sure we're seeing growth in traffic, growth in our signature categories that leads to that gross margin rate improvement we saw in the Q1 and the higher ticket, but importantly, the ongoing contribution of our online channel.
Brian, you've been very agile with strategic decisions around the online and digital business. As we look forward to back to school and holiday, are there any key pointers in terms of the strategies you're undertaking, particularly as mobile and shipping continue to be hot topics? Yes. Well, Oliver, you heard Kathy talk about
some of the key initiatives that came to life in the Oliver, you heard Kathy talk
about some of the key initiatives that came
to life in the Q1 and you're going to
continue to see us build off of that over the balance of the year. We've completely rebuilt our app. We're focused on improving our subscription and registry. We're leveraging our stores to ship to our guests. So we're going to continue to build on those initiatives as we go forward and continue to make sure that we're making the investments both in technology, but importantly in the supply chain that brings that online business to life for our guests.
And Oliver, if we can go back for a minute to your question on thinking about price versus innovation and how do we balance those. I would just say that we start from the guest looking at what it is that they expect from any given product category and then how do we build the very best product, which is depending on what it is, could be a combination of both price and innovation or more heavily leaning on 1 or the other, depending on what we're talking about. But very much guest focused to make sure that we're offering them the content that's going to inspire them and resonate. So there's not one size fits all. It's really guest focused driven by each category.
Thank you. Congrats. And that was very clear and Lily Pulitzer, congrats on that as well. Best regards.
Thank you. Oliver, thank you. Appreciate it.
Your next question will come from the line of Matt Niemeyer with Wells Fargo Securities.
Good morning. And I'll add my congrats as well. My first question is on gross margin. Does the gross margin guidance assume a continued mix shift to the Signature categories that you enjoyed this quarter? And is the formula for Q2 in terms of price and quality investments kind of what we should be thinking going forward I.
E. You were down about $100,000,000 last year and you recapture about half according to your guidance. Does that seem like a reasonable formula for Q3 as well?
Let me start with the gross margin and the focus for not only the quarter, but for many years to come. And we've been very clear about the importance of focusing in on our signature categories. We believe that's our path to differentiating the brand. So you should continue to expect us to focus on building our style categories. And Kathy and her team are making great progress in apparel and home and beauty.
And you saw the comps that those categories produced in the Q1. We'll continue to focus on baby and kids and accelerate our focus on wellness. So we believe those categories both in store, but importantly as we demonstrated in Q1 online where a significant portion of our growth in the digital channel was driven by apparel and home. So that is a very favorable impact to mix both in store and importantly as we improve and accelerate our online performance.
Yes. The other thing I'd add Matt more tactically between Q2 and Q3 that's really last year where you saw us transition from focusing on significant promotions that were primarily hard lines or some of our lower margin categories focused to the business back to back to school and then into the holiday season. So as we think about the way Q2 work looks versus Q3, where that promotional impact was real in Q2, but it was also we had a significant mix impact because of where we focus those promotions. A little bit less of that as we go into Q3 and Q4. So the delta between last year's margin and this year's margin will change meaningfully.
And as Kathy said, we continue to invest in price and quality across all of our brands.
That's very helpful. If I could just ask one follow-up on the e commerce business. I'd love to get your insights perhaps using RedCard data in terms of how much digital growth do you think at this point is incremental I. E. Are these new customers or infrequent customers?
Thanks.
I think Matt, I would answer it broadly and say that what we see across all guests is when they become engaged in the digital channel, we see incremental growth in that channel and importantly incremental growth in the stores. So their total engagement with us is very incremental. We pick up incremental sales and importantly incremental profitability in both channels.
Okay. Thanks, John.
Your next question will come from the line of Scott Mushkin with Wolfe Research.
Hey, guys. Thanks for taking my questions. Just wanted to get into a topic of traffic. I mean, I think traffic was up 2nd quarter in a row that it's been up. But I was wondering if you could maybe dig a little deeper into that.
Someone in the grocery space talks about loyal households. And it seems to me when you think about Target, you guys want to build frequency and want to build these loyal households.
How are you thinking about that?
Do you measure that? Is that measure improving? Some of our research suggests some of the early things you guys are doing should be building this number, but I want to get your take on it.
Yes. I would say that, Scott, it's pretty early in our transformation to say that we see momentum in that measurement as it pertains to food. I will tell you a lot of our growth in transactions is driven by new guests and that's driven more in the signature categories that we have been talking about. Now we believe that we have an opportunity to drive traffic in food and that's why we're in the midst of putting a lot of tests out in front of our guests, both product and presentation, to get that business on track and to make sure that we've got a really compelling point of view for our guests. And then we will measure that over time to make sure that we're making progress.
But today, I would say it's more driven by the signature categories that we've highlighted.
Yes. I mean that's actually where I was going not just food just on the idea that I think your heavy users were up 25, 30 visits a year. Are you seeing increase in those types of loyal households? It seems to me that might be a key driver here as we go forward to get that frequency up.
Scott, it's certainly something that we're going to continue to monitor and measure over time. It's still very early for us. But that is a measure that we're clearly looking at.
We absolutely want to make sure
we're building loyalty. We want to build engagement and traffic. We believe our focus on signature categories brings guests back to Target looking for what's new, what's exciting. And we also want to make sure we complement that with an improved food assortment because we know food is critically important to building engagement and driving overall traffic.
All right. Perfect. And I had one other one. We obviously are in the stores quite a bit. And I want to get your take.
I mean some of the pushback that we hear from investors is on the store level execution staffing levels in stock position. I think people should maybe just be a little bit better. And I was wondering what you think of that? And are there initiatives to improve some of those measures? And where do you think you are?
What entity you are in on these areas?
Yes. I think as we would measure that and as we look at the guest feedback that we get, Scott, I would say store execution is very high. Guests are very satisfied with the number of people that we have, their ability to help them. I would say that we have an opportunity on the in stock side and we've been working on that collectively, stores and merchandising as we work through the port situation and getting those back in stock, but also just our everyday basics. And it's one of the reasons why our inventory is elevated as we've talked about is that we have been making investments, particularly in essentials category to make sure that we can raise our inventory levels appropriate to be in stock in those categories.
So I think that's where we have the most opportunity right now. And Scott
that's reflected in the key initiatives we've been talking about. As we think about changes we're making in experience to elevate apparel with mannequins to restructure our home layouts to begin to make changes in electronics. We want to make sure we provide the guests with a great in store experience particularly in those signature categories. But as Kathy just noted, we also need to make sure we're focused on the basics every day. And we need to make sure we've got very high in stock conditions, particularly in those key consumable categories.
So for us, execution at store level is critically important. We believe we have the best team in retail and our focus now is on elevating the experience in those key signature areas of our store and ensuring that we're improving the in stock conditions for basic essentials.
Perfect. Our focus group of women was really pleased. So keep up the great work. Thanks.
Thanks, Scott. Appreciate the support.
Your next question will come from the line of Robbie Ohmes with Bank of America Merrill Lynch.
Hey, thanks for taking my question. I think maybe for Kathy, the comments you just made to Scott Mushkin about a lot of the growth in transactions being driven by new guests. Can you give us a little more insight to that? Is that a shift in traffic away from frequency and towards new guests? And how significant is that?
And is there how are you doing it? Is it are there some new marketing approaches you're taking to get people into the stores to alert them about the signature categories, etcetera? Just some color on that would be great.
Yes. So this is something that we aim to do all the time. And of course, right now, we're comping against some pretty weak numbers post breach last year. So certainly that's part of it. As we focus on signature categories, I do think that's getting more new guests back into the brands and in a variety of different areas because signature categories cover so much from beauty to home, etcetera, to the different style categories.
And I think the way that we're doing it is really what Brian was just talking about, presentations that are really compelling with product that's very inspirational and inviting them into the store through our marketing, which resonates with them, and then when they get to the store or online being able to convert them, to a purchase. So it's all of those things that I think are moving the needle.
And Kathy, can you just comment more on the sort of propensity to trade up for the guest? Is there something changing there? Or is that just easy comparisons?
No. We've seen this coming for a little bit now. 3rd quarter was the start of it, continued into 4th quarter and now again in our Q1. But I think as we're improving quality, as we're stepping up our assortments to be more aspirational, we're seeing the guests really resonate with that product and move. And that's broad across virtually all of our categories.
So not just in one segment of our business, but really all of them. So I think it's driven by the guests perhaps having a bit more money in their pocket. I think it's the quality that we've put in. They're recognizing those benefits and they're wanting to be able to trade up. Robbie, the
one point I'd emphasize so that we're really clear, this isn't an eitheror, it's an and. So we want to make sure we're delivering exceptional value every day on those core essentials and continuing to bring great quality, newness, innovation and value to our guests as they look for these more aspirational items. So it's not a shift in strategy and it's not a either or, it's an and. And we've got to make sure that both elements of our strategy include a focus on core essentials and more experiential offerings. And when we bring those together, that is the Target brand promise and experience.
That's where we bring expect more pay less to life. So both of those elements are starting to work together and I think you're seeing the guests respond very positively to it.
Sounds great. Thanks very much.
Thank you.
Your next question will come from the line of Sean Naughton with Piper Jaffray.
Hi, good morning and thanks for taking the question. Just I guess a regional question. In terms of the comp on a regional basis in the Q1, did you see any differences in your sales trends in states that are potentially a little more dependent on oil and gas? And then I guess the follow-up there is, can you also address any negative or potentially positive impact on the organization you see in areas that are increasing the minimum wage?
Yes. Let me start with the regional performance trends. And we didn't see any correlation between what you just referred to changes in the oil and gas industry and an influence on our comps. Obviously, like everyone else and this happens every single year, weather did impact regional performance. We had some challenging days in the Northeast.
We faced the same ice storms that others did in the Southeast and in the Texas market. But overall, we saw very consistent comp performance across signature categories. The growth Kathy talked about was strong across the country in apparel and beauty and home. And we've seen very consistent performance trends and responses from our guests across the country. And
to the minimum wage question, no, we haven't seen those types of impacts either.
Okay. And then just secondly, it looks like RedCard, nice pickup, looks like on a sequential basis and year over year. Can you just talk about where management expectation is now on this particular product and where we think this could potentially go over the next 2 or 3 years here? Thanks.
It's a great question, Ravi. And I think we're sorting through that. We want to get through annualizing past all of last year with the breach and the impact there. We're really pleased that we saw 110 basis points of penetration growth. We're seeing new accounts grow again, roughly equally between credit and debit.
I think as we learn a little bit more here as we go through this year, we'll figure out where we want to go. We still are very energized by RedCard as a product offering. I think the opportunity for us is to tie that into a more holistic loyalty offering for our guests. We're testing some of that now out East and you'll see us as the year goes on continue to test that, take those learnings and apply it more broadly to loyalty for our guests.
Yes. That's helpful. Best of luck in Q2. Thanks.
Thank you.
Your next question will come from the line of Greg Melich with Evercore ISI.
Hi, thanks. I had a couple of questions. I wanted to make sure I understood the SG and A progression a little bit better. I think John in the guidance you said we would delever 20 to 30 bps in the Q2, which if I take your comp guide suggests it will be up around 5% in dollar terms. Is that are we thinking about that right?
And what's the real run rate once you get through some of these other timing issues and the breaches on SG and A dollars?
Yes. I think, yes, you're right. And all of that increase is really incentive expense offset by again some productivity improvements. I think as the year progresses, we'll continue to see improvements in SG and A. As we said throughout the year, as the year progresses, we'll continue to start to see the savings that we committed to the $2,000,000,000 $500,000,000 of savings this year, about half in COGS, half in SG and A.
In SG and A, that will be offset somewhat by investments in technology. So we should continue getting past the noise. As the year progresses. We'll continue to see leverage probably similar to what you saw in Q1 as we get through into Q3 and Q4.
Okay. Got that. And then Brian, I think in your prepared discussion, you've mentioned some disappointment on digital execution, particularly around the Lilly launch. Could you give us a little more detail on what's being done to address those issues in terms of how the website actually works or supply chain? Will you ultimately invest more in fulfillment center capacity or just some actual actions to try and address that?
Thanks.
Greg, in some ways you've answered the question for me. And we've been very clear in the fact that we're going to make a $1,000,000,000 investment in technology and supply chain to enhance those capabilities, to improve our capabilities, to make sure we're partnering up technology with the ability to provide the product effectively through our supply chain. So the Lilly event while a sensational event for the brand and we're really proud that we were able to create a Black Friday type event in the month of April with 100 and 1000 of our guests lining up waiting for that product. But online, we know we had some missteps. And we're doing a deep dive.
We're looking at root causes. And it's going to provide important learning for us as we get ready for the traffic we expect to generate during the holiday season. But we are very committed to putting our capital behind improving technology capabilities and the supply chain requirements necessary to continue to grow that business at the accelerated rates we're delivering right now.
When do you think you'll know the things you need to get done for holidays? Is that something you'll know now? Or was it something we'll learn in the fall? Yes.
Well, this afternoon would be nice. But we are actively tearing apart the learning and clearly want to make sure that we have the diagnostics in place as soon as possible. And we're making the necessary adjustments and investments to enhance our overall digital experience. So this afternoon would not be soon enough and the team has an incredible sense of urgency to ensure that we have the right capabilities so that we're constantly meeting the needs of the guests.
And Greg, I would just add that we're never done with that. So certainly, we're learning from the Lilly event and we will put that into play as soon as possible. But as we're growing at the rate that we are and we're introducing new code all the time, we are never done. So this is an ongoing effort probably till the end of time.
Good luck. Thanks.
Your next question will come from the line of Peter Benedict with Robert W. Baird.
Hey, guys. A couple of questions. First, just on Made to Matter. Just can you give us a sense of how many brands have been designated with that? What categories you're seeing being most impactful so far?
And what you're doing from a marketing standpoint to support them?
Yes. So Made to Matter has been a fantastic program for us, Peter. As you know, it's we went from about 15 vendors last year and we increased that to about 30, 31 vendors this year. And we're seeing about 25% lift in sales. So the guest is really loving the products that we're offering.
It's in a variety of categories. There's certainly food products, but there's beauty products, there's OTC, there's baby. All of them though are really driven by simpler, better for you products, whether that's in food with cleaner labels and organic or whether that's in baby where it's cotton and more natural materials, but really great results. And we marketed it most recently in the past month in what we call the rear seasonal area of our store where we brought all the products together for the first time and had really fantastic results. There was a marketing campaign that went along with that that really resonated with the guest And then the in store presence helped make it easy for them to find when they came to the stores.
Peter, I think the great part of the program is it's just another point of validation that when we understand what the guest is looking for and we deliver the right curated assortment, they respond really well. And you know that we have over 25,000,000 guests visit our stores every week. We know that 98% of our guests purchase natural or organic products. Thus, we need to make sure we offer them the products and the selection they're looking for. It doesn't mean that conventional products don't play a very important role going forward, but our guest has voted.
We understand the guest better than ever before. And Kathy and her team are just doing a sensational job of curating the right assortment and bringing the guest what they're looking for when they shop at Target.
That's helpful. Do you think is 30 to 31 a good number that you guys think you'll stick with? Do you think you'll add additional vendors to that program over the next 12 months or just maybe rotate out some and keep the number at 30, 31?
I think that's a pretty good number. We're still evaluating the program. It's just we launched the new vendors this spring, so we're still analyzing those results. But to Brian's point, the guests will guide that work. The important part about Made to to buy them, but they come looking for those new exclusive really innovative products.
So I think keeping the number at a reasonable amount so that we're sure that we can drive that right innovation. It's very much a partnership with us and these suppliers. So I think we're in the hunt with the right number.
Okay. That's how we've definitely seen it
in the stores as well. Quick one just on the food repositioning. What should we in terms of the cadence this year in terms of testing things, what should we be looking at? Is it going to be space allocation changes? Is it going to be just new brands?
And once you do decide what you're going to do, is it going to be an early 2016 kind of rollout something that could impact a lot of that year? Or is it something that would happen later in 2016? Thank you.
Peter, Kathy and I have been talking about this for several months now. We're using 2015 to test and learn. Kathy has talked about key categories within food that we really think Target should stand for and we're looking very closely at how we evolve assortment and how we merchandise those categories going forward. But this is not about how fast we make the changes. We want to make sure we really have a chance to test, learn, get the feedback from the guests, iterate.
So then as we move into 2016 and beyond, we move forward with confidence and with the confidence that the guest has guided us through the changes we're going to make. So we're clearly focused on it. The team is making very good progress. But we're in that test and learn and validate environment right now. And you should expect to see much more unfold as we get into 2016.
The thing that I would add is, as we're going through the testing, as Brian mentioned, we're testing many different things, whether that's, assortment changes that we're making, presentation changes that we're making, supply chain changes. Part of our testing is to try to isolate those tests so that we can get a good read. So there's not going to be one place that you can go and look at what does the new food innovation look like. We've got it all over the place. And the other thing that I would add is that we just hired Anne Dement to run the Senior Vice President of Grocery and we're very excited about that.
She's been on board now for about a month. Anne brings us 19 years of experience in grocery and CPG. So she's certainly learning and onboarding into Target and bringing a wealth of knowledge from grocery, which will also impact what we put forth in terms of tests for the rest of the year. But I think you can look to 2016 as we learn and prove out what's working with the guests, what's resonating, we will start rolling those in 2016. But don't expect a big bang on January 1.
To Brian's point, this is really about getting it right and delighting the guests, not moving fast.
Understood. Thanks, Kathy. Thanks, Brian.
Your next question will come from the line of Bob Drbul with Nomura.
Hi, good morning. I just had a couple of questions. On the gross margin line, did shipping expense at all impact you with the move to $25 And how many RedCard holders are utilizing their cards for free shipping? And so how do we think about that as e commerce continues to grow?
So certainly shipping expense went up when we moved to $25 but I would tell you not a material impact on the quarter. And net net as we've said as that brings more guests online they shop our store and so a net positive as far as we're concerned across the lifetime value of those guests. I don't have the actual number of RedCard holders that use free shipping on the site, but I can tell you the penetration of free shipping due to RedCard on the site is very, very high. We in general, we have a very high percentage of our shipping that goes out free from the site. We talked about this last year when we shipped to free switched to free shipping during the holiday season.
And I think that is why going back to what Brian said, the supply chain investments we make are incredibly important for our guests because they provide speed to market from their perspective, but they're incredibly important for us, because they improve the economics of our online business meaningfully.
Got it. And then thanks. And the second question I have is, there's a lot of license initiatives that are coming over the next several quarters. When you think about the year over year impact on the business overall, are those gross margin accretive in terms of what they're trying to do? Or they'd be lower margin?
And just how do we think about that as it relates to the mix and the gross margin overall?
A lot of that depends on the categories. I think the good part about licenses at Target is that our guests respond to them very broadly. So it isn't just a toy or a video game. For us, there's apparel involved. There's back to school products like backpacks and notebooks.
So it's a pretty they have a pretty healthy margin mix just given the breadth of category and most of them fall into our signature categories. So we're very excited about the lineup of licenses and the fact that they start this summer and really go all fall.
Great. Thank you very much.
Okay. We have time for one more question.
Your final question will come from the line of Christopher Horvers with JPMorgan.
Thanks. Good morning, guys. So two quick ones. You originally guided the Q1 gross margin of 40 to 50. So I was curious what came in better versus your expectations?
Was it mix or was it the level of promotions lapping the level of promotions year over year? And then I have a follow-up.
It was mix is what came in better. And I think we see that in 2 ways. First of all, there's just the mix of selling those products. And then when we see strength in home and apparel, of course, our sell throughs go up and so we have less markdowns. And so the positive benefits of mix go on and on.
I'd only add, Christopher, that again, we saw that mix benefit both in store and online. So the combination of those two channels working together clearly impacts and improves gross margin rate.
Understood. And so the outlook and you mentioned this going forward. So the outlook in the second quarter is predicated on recapturing both of those and then going on further in the year. It's really expectation that the Signature categories outcomp more than the Essential side.
That is certainly core to our strategy as we go forward. And I think what you saw, what we saw in Q1, very solid performance. Kathy and her team did a terrific job of curating the right products, particularly in those signature categories for our guests. Despite some of the poor challenges, our supply chain teams did outstanding job of making sure we had inventory in place for the guests. I was very pleased with our marketing program.
And if you haven't seen the Target style campaign or some of the things we just did for Avengers, it's spectacular advertising and the guest is responding to it. And our store teams just did a phenomenal job throughout the quarter despite port challenges and weather challenges of providing the guests with a good experience and it added up to really solid results in Q1. So we hope that continues. We're confident it's going to continue throughout the year. But we feel good about the progress.
We know we've got a lot of work in front of us. But that combination of strong in store and online growth in the Q1 gives us a lot of confidence that we're heading in the right direction. So operator, that concludes our call today. I thank everybody for their participation and we look forward to talking to you next quarter. Thanks.
This does conclude today's conference call. You may now disconnect.