BJ's Wholesale Club Holdings, Inc.

Good morning. My name is Chris, and I will be your conference operator today. At this time, I would like to welcome everyone to the BJA's Wholesale Club First Quarter Fiscal 2019 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you. I would now like to turn the call over to Fatma Prihat, Vice President, Investor Relations. You may begin your conference.

Thank you. Good morning, everyone. We appreciate you joining BJ's Wholesale Club's first quarter fiscal 2019 earnings conference call. Chris Baldwin, Chairman and CEO, Bob Eddy, Chief Financial Administrative Officer, and Bill Werner, Senior Vice President, Strategic Planning and Investor Relations are on the call. Chris and Bob will provide you with an overview of our results, followed by a Q&A session. Before we begin, please remember that during this call, we may make forward-looking statements within the meaning of the federal securities laws. These statements are based on our current expectations and involve risks and uncertainties that could cause actual results to differ materially from our expectations described on this call and in today's press release. Please see the risk factors section of our Form 10-K filed with the FCC on March 25, 2009, for a description of those risks and uncertainties. Finally, please note that on today's call, we will refer to certain non-GAAP financial measures that we believe will provide useful information for investors. The presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Please refer to today's press release and supplemental document posted on the Investors section of our website for a reconciliation of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP. With that, I'll turn the call over to Chris.

Good morning. Thank you for joining us. Ahead of discussing our results for the quarter, I'd like to share that Robert Steele, who has served on our board since 2016, has been appointed to serve as our lead independent director. His extensive experience and knowledge of our industry and our business will be invaluable. This appointment enhances our corporate governance, and we all look forward to working with Rob in his expanded role. Let's turn to our results. Our first quarter results reflect a solid start to the year as we continued our transformation of our company. We're pleased with our performance in sales, earnings, and cash flows. For the quarter, we saw merchandise comp sales of 1.9%, representing a 3.9% two-year stacked comp. Sales were affected by the timing shift of government assistance benefits, which we discussed last quarter. Without this shift, our comp sales would have been above the high end of our full-year guidance range, which is 1.5% to 2.5%. Adjusted EBITDA was $124 million, up 2% over last year, which exceeded our internal expectations. We continue to drive strong cash flows and expect to reach our goal of leverage below three times EBITDA in Q2, well ahead of our accelerated schedule. My comments today will be focused on the work we are doing to transform our company for the long term. Our investments are focused on building capabilities across our strategic priorities, which are acquiring and retaining members, delivering value to get them shopping, making it more convenient to shop at BJ's, and, of course, expanding our strategic footprint. First, I'll give you an update on acquiring and retaining members. Our membership level remains as historic highs, and we delivered record membership fee income in the quarter. We continue to see increases in both new members and renewals. In addition, we experienced double-digit growth in members enrolling in our higher-tier memberships. Our co-bearing credit card is a powerful tool for delivering value and engaging our members. As a group, our credit card holders are among our most loyal members with the highest lifetime value. Since we launched the program in 2014, enrollment in our credit card plan has quintupled, and we continue to find new and innovative ways to improve this program. As I mentioned on previous calls, last year we invested in technology that enables credit card sign-ups through our in-lane POS system. Early results of this investment are encouraging, with new credit card enrollment up more than 20% over the same period last year, and we expect strong growth to continue during 2019. Our second priority is to deliver value to get our members shopping. We started our assortment transformation in our general merchandise business several years ago. Our GM performance shows that members respond well to new categories, products, and brands, obviously at unbeatable prices. For the first quarter, our GM comp sales were up 9%, a continuation of our strong third and fourth quarter performance. We saw growth during the quarter in a number of general merchandise categories, including consumer electronics, toys, and home, which includes products such as gift cards, books, and kitchen items. Our investment in assortment capabilities is driving continued growth in our apparel business. we're able to change our inventory more often, ensuring that we can deliver relevant styles and seasonal items at the right time at great prices. Since we started our apparel transformation, we've seen growth in categories like children's licensed apparel and women's athleisure. In the first quarter, we've continued to see these trends while also seeing strong performance in men's active wear from brands such as Reebok and Champion. Given our consumer target, men's workwear has also been a growth driver for us. TV sales were also very strong in the quarter, driven by our assortment and the investments we made to improve the quality of signals in our clubs to better showcase high-definition TVs. Growth has been particularly strong in premium TVs, which we define as those larger than 60 inches. Our grocery and perishables business are key to delivering value to our members. In Q1, our perishables business, which includes frozen foods, was impacted by the government assistant benefits shift I mentioned earlier. At the same time, our focus on value and in-club execution deliver growth in key areas of our fresh business during the quarter, including olive produce, rotisserie chicken, bakery, and full-service deli. We're also quite pleased with our performance during the Easter season. As we've mentioned before, our simplified baby assortment is delivering increased productivity with significantly less space. We are taking a deliberate approach to applying our assortment learnings. We see opportunity throughout our clubs to simplify our assortment with an emphasis on the most productive items and to enhance the member experience through improved displays and graphics. In terms of member experience, we've worked with Starbucks to improve presentation in our coffee category. We plan to expand a current test of in-club signage and displays that pair coffee with complementary items. We'll start to apply our assortment learnings across a range of grocery categories beginning in Q2. As in other areas of the club, we expect a simplified assortment and great value to resonate with our members over time. Our members continue to appreciate the value provided by our own brands, and our penetration remains strong, driven by Wellesley Farms produce, meat, and seafood. In Q2, we're offering a selection of summer seasonal items, and we're expanding our housewares collection, which will strengthen our own brand's presence within general merchandise. As I have foreshadowed, We see a significant opportunity to improve our services business at BJ's as we deliver new products and value to our members. Our optical business, which we started to relaunch late in the fourth quarter, is gaining momentum with our members and we're able to deliver improved value in a stronger selection. Importantly, in Q1, we launched an improved contact lens offering, which offers very competitive value compared to online and club store competitors, and we are pleased with early performance. We're just beginning to transform our services offering and look forward to strengthening our portfolio in ways that deliver additional value to members over time. Our next strategic priority is making it more convenient to shop at BJ's. We continue to invest in our digital properties, adding new capabilities and improving features rolled out over the last year. In Q1, we launched a new feature on BJs.com, making it more convenient for members to reorder items they have previously purchased. In addition, we are now showcasing our fresh items on BJs.com, making it easier for members to see the breadth of our offering. Sales driven by convenience features like buy online pickup and club and same day delivery, while small relative to the rest of our business, continue to grow rapidly. Items that account for more than three quarters of our sales are now available for same day delivery at club store prices. We've also started to streamline the buy online, pick up in club feature by enabling members to check in for pick up in our app, eliminating the need to wait in line. Importantly, a significant number of Bopix shoppers buy additional items once they're in the club. We also started to update an improved convenience feature that allows people to scan and pay for in club purchases within our app. This new test builds on our earlier pilot program and plays on the unique advantage of the club store environment, where every item is directly scannable with a UPC code. In club stores, shoppers do not need to weigh articles and print and scan their own labels for items such as fresh produce. While our current test is still quite small, this is a potentially transformational change for us. We'll continue to learn from the ongoing tests as we work to provide a more convenient, seamless shopping experience for our members. Finally, we plan to expand our strategic footprint. Our club in Clearwater, Florida is off to a strong start. We're pleased with membership acquisition, which has exceeded our goals. In the first quarter, we also broke ground on two clubs in eastern Michigan and are on track to open both clubs in Q4. We're actively looking at additional locations in this market. I want to make a comment on our gas business. BJ's gas stations are key to delivering value to our members. In Q1, our comp gas gallons showed significant growth as we continue to take share from our competitors. Our credit card and gas business are excellent examples of how various elements of our value proposition work together to drive growth. Our credit card offers members additional savings on gas, driving both credit card sign-ups and gas sales. We've also found that off-site gas stations are important tools for driving member acquisition and keeping BJ's top of mind for our members. We're on track to open 8 to 10 gas stations in fiscal year 2019 and expect to have gas stations in about two-thirds of our clubs by the end of this year. Overall, we're pleased with our performance in Q1, and most importantly, we're optimistic about the opportunities ahead of us. The investments we've made are resonating with members and driving growth. Going forward, we'll continue to drive growth by focusing on our strategic priorities and investing in the company for the long term. With that, I'll turn the call over to Bob, who will review our results and outlook for the year in more detail. Bob?

Thanks, Chris. Good morning, everyone. As Chris noted, Q1 merchandise comp was 1.9%, reflecting a 3.9% two-year stacked comp. In addition, we drove growth in our gross margins, earnings, and cash flows during the quarter. We are on track to deliver our full-year outlook and remain focused on continuing the company's transformation in order to deliver our long-term financial goals. Let's turn to our results for the first quarter in more detail. Net sales increased by 2.5% to $3.1 billion. Comp sales increased by 2%, including a 1 tenth of a percent favorable impact from the sale of gasoline. Merchandise comp sales, which exclude gasoline, increased by 1.9%, primarily driven by increased traffic. Let me walk you through a few external factors that impacted our merchandise comp performance. First, as we mentioned in our last earnings call, there was a shift in the timing of government EBT funds from February into January. This shift between Q1 and Q4 reduced EBT transactions for this quarter. On the net, the headwind was a bit more than we had originally anticipated when we entered the year. Second, we had a slight benefit from a competitor's labor disruption in April. This small benefit was offset by unfavorable weather during the month. Excluding those factors, we believe our first quarter merchandise comp performance would have been slightly above the high end of our full year guidance range. Let's turn to our comparable club sales by division. The shift in government assistance timing had the largest impact on our perishables division, where comps were negative 1%. About half of a typical EBT basket is made up of perishables. The headwind was particularly pronounced in stock-up categories, such as frozen food, which is included in our perishables division. Excluding this shift, we believe our perishables comp would have been closer to our recent full-year performance trend. As Chris noted, we continue to work on our perishables business, and we saw solid growth in certain categories this quarter, such as fresh produce and bakery. In our edible and non-edible grocery divisions, comps were 1% for the quarter. Excluding the EBT shift, edible grocery comps would have been closer to our recent full-year performance. We continue to transform these two businesses by simplifying our assortment, adding new offerings, and enhancing our presentation to highlight the value we provide to our members. The work that started in our baby assortment has continued into our health and beauty categories with more to come. Lastly, in our general merchandise division, where we've made significant investments, Comp sales grew by 9% for the quarter. We continue to see strong growth across various categories, including home, TVs, apparel, and toys. Membership fee income grew by 8% during the first quarter. Approximately half of the growth was driven by growth in members and half by our membership fee increase. Recall that the benefit from the fee increase launched in January 2018 peaked in last year's fourth quarter and will wane throughout this year. The growth in MFI underscores our continued focus on adding new members, maintaining our high renewal rate, and growing our higher-tier membership program. Excluding the gasoline business, our merchandise gross margin rate increased by approximately 30 basis points over last year, driven by continued benefits from our procurement initiatives. This represents a return to solid margin rate growth provided by our CPI program and reflects a two-year stacked merchandise margin improvement. of approximately 130 basis points. As expected, gasoline margins returned to historical levels following the market dislocation in the fourth quarter of last year. SG&A expenses were $500 million in the first quarter compared to $481 million in the prior year after excluding $5 million of non-recurring expenses in the prior year period. This year-over-year increase in SG&A is primarily driven by investments in our capabilities and talent in areas such as our optical business to continue our transformation over the long term. Interest expense decreased to $28 million from $45 million a year ago due primarily to deleverage and the benefit of repricing our first lean term loan and ABL facilities in last year's third quarter. For the quarter, we recorded income tax expense of $7 million compared to $5 million in the prior year period. The variance between our normalized tax rate of 28% and the reported rate of 16% for this quarter was driven primarily by windfall tax benefits from stock options exercised. Adjusted net income in the first quarter exceeded our internal expectations at $37 million, or 26 cents a share. compared to $28 million or 20 cents per share in the prior year period. Our press release includes a table that reconciles GAAP net income to adjusted net income, including on a per share basis. Adjusted EBITDA of $124 million also came in ahead of our internal expectations. Moving now to the balance sheet, our AP to inventory ratio, which measures how much our inventory is sold before we pay for it, remains solid at 76%. and free cash flow for the quarter came in at $8 million, ahead of our expectations for the first quarter of the year. As a result, our funded net debt to adjusted EBITDA ratio was three times at the end of the quarter. As we've previously said, as we get further into this year and this ratio falls below three times, we'll begin to think about alternative uses for our excess cash. Before turning to our guidance, I would like to note that we adopted the new lease accounting standard during this quarter. As a result, we recorded assets and liabilities of approximately $2 billion on our balance sheet. Importantly, the change did not have any material impact on our adjusted EBITDA or net income. It did yield some small P&L geography changes, resulting in a slight net increase to rent expense of approximately $1 million, which was offset by a decrease in amortization expense. Therefore, it did have a slight impact on our operating income growth for the quarter. We expect these geography changes to continue throughout the year. Let's now turn to our guidance for fiscal 2019. At a high level, our outlook reflects confidence in the underlying strength of our business and the benefits from continued investments in our strategic priorities. As such, our guidance remains consistent with that provided on our last call. A couple of things to note. Because there is still uncertainty around the impact of tariffs, We don't believe that this issue warrants a change to our full-year guidance at this point. As we've noted in the past, our exposure to Chinese goods, including directly and indirectly sourced products, is approximately 5%. Therefore, we believe that we will be affected less than many of our competitors. Our plan is to mitigate any exposure as best we can while maintaining the value that our members expect. In terms of margin growth, our CPI program remains strong, and we see a lot of opportunity ahead to continue to drive merchandise gross margins through CPI and private-label penetration. We expect adjusted EBITDA growth in the second and third quarters to be above the year-over-year growth rate we saw in the first quarter, and we would anticipate Q4 adjusted EBITDA growth to be impacted by the significant benefit from disruption in the gasoline market in last year's Q4. In closing, we remain optimistic about the long-term health of our business. We continue to invest in our transformation to drive future growth in sales and profitability. We look forward to delivering on our goals for fiscal 2019. And now I'll turn the call back over to the operator to begin the Q&A question.

Chris? Thank you. At this time, I would like to remind everyone in order to ask a question, press star, then the number one on your telephone keypad. Your first question comes from Robbie Owens of Bank of America Merrill Lynch. Your line is open.

Hey, good morning, guys. Actually, I'll just ask two quick follow-up questions. The first on the SG&A, can you give a little more detail on the investments that you called out in the press release? Was there some unusual things in SG&A that maybe don't recur? Did you accelerate any investments into this quarter um you know to to offset some of the benefit you might have gotten from the lower tax rate and then the other question is and i know you get this all the time but the um the merchandise gross margin x gas up 130 on a two years pretty incredible and so i know i always get asked i think a lot of us get asked how you know can you keep that going how do we think about you anniversarying that next year thanks

Hi, Robbie. Thanks for the questions. Let me take them one at a time. The SG&A increase year over year reflects our continuing investments into the building against the strategic priorities that we've talked about and Chris highlighted in his prepared remarks today. You know, they sort of cover the waterfront, right? It starts with operations. We are no different than our competitors out there where we are investing in in our buildings through labor, through training, through getting better folks behind our membership desks, for instance, and giving them all the tools to do their jobs in a more effective fashion. We've talked to you all about investing behind membership and marketing in terms of driving the higher tier renewal rates and higher tier membership program and driving our renewal rates. And then certainly digital is a big part of that as well as we look to grow our digitally enabled sales and make it more convenient to shop at BJ's. I would say those are the primary drivers of the SG&A growth and that will continue as we see results from those efforts. As to the margin rate growth, I think you're absolutely right that it's pretty astounding. Over a long period of time, we've been able to grow margin rates over 100 basis points stacked in this quarter, a little over a couple hundred basis points on a three-year stack. And remember back to the story, we still think we're sort of in the middle innings of this effort. Every category that we look at multiple times has continued to yield benefits. The second and now even third times we've looked at certain categories. And even the categories that aren't undergoing CPI reviews are getting margin rate growth as well. So the merchandising team is doing a great job applying the discipline learned and applied in the CPI process to the rest of the business as well. Chris talked about in his prepared remarks own brands as well. Certainly the increasing penetration of Owen Brents helps margin rate too, and we see continued runway to do that. And as we've talked about on prior calls, the next game here for us is changing the assortment. We've talked about that a little bit in things like baby and health and wellness. You'll see that go around our club in an orderly fashion We want to make sure we do it as fast as we can, but as slow as it takes us to do it right, not make any mistakes. Certainly, reducing our assortment will allow us to drive volume into the remaining SKUs and use the space that's opened up to add additional categories that can be both sales and margin accretive for us. Long story short, we're tremendously proud of the effort we've put forward from a merchandise margin rate perspective, and we see a whole lot more to come from that perspective.

That's great. Thanks so much, Bob.

Thanks, Robbie.

Your next question comes from Chuck Grom of Gordon Haskett. Your line is open.

Hey, good morning, guys. Nice quarter. I'm just curious how the store saw benefit from the SAMS closing did. in the first quarter. Based on some of the data we have, we think there was about 16 or so that are within 20 miles of a SAMS club. So just curious how they did this quarter.

Good morning, Chuck. It's Chris. The direct answer to your question is those clubs performed in line with the overall comp expectations. And we've gotten that question over time quite a few times. And We've tried to be really consistent. While there's going to be, you know, the short-term impact, the bigger idea for us is the long-term impact of our ability to serve the members in those communities well, and we're really encouraged by the reception we've gotten and expect those clubs to continue to grow given the changing competitive landscape.

Okay, good to hear. And then just to follow up on Rob's question just regards to the assortment changes and baby and When you think about the box, where do you think the big opportunity lies within the ability to skew ladder a little bit more? Any opportunities there? You could just flush that out for us. It would be great.

Sure. Chuck, I think the evidence on assortment transformation is really resident in general merchandise. Lee Delaney and his team have done a really terrific job over a long period of time grounding our assortment decisions in more deep understanding of consumers and our members, and it has yielded the results. We've been doing pretty consistently mid-single digit or higher comps in GM that we feel really good about. The principles we applied there are really important. It's grounded in our members. And we've been very disciplined and arguably deliberate in executing those transformations and it's yielded really good results. The next place we're going is grocery. We've foreshadowed and then communicated very directly about what we've done in baby, which is almost at full implementation stage. We've done changes to health and beauty. And the next place to go is grocery. So we feel really good. And while it's not necessarily assortment-related, we feel really proud of the progress we've made in perishables with produce units growing. And Jeff Derocious and his team have done a really nice job of upping our game in the clubs, which I think you've noted in some of your reporting.

That's great. Good luck, and thank you. Thanks, Chuck.

Your next question comes from Edward Kelly of Wells Fargo. Your line is open.

Hi, guys. Good morning. I wanted to ask about membership. I was hoping that you could provide maybe a bit more color on what you're seeing from a renewal rate perspective, new member acquisition perspective, and then you talk about half of the 8% gain in member revenue coming from new members, which it's hard to tell, but I think that's an acceleration from You know, what you've had, the spite lapping, the Sam's closures. Could you talk a bit about that? And I'm not sure what that would look like, you know, at existing clubs if you were to back out.

Thanks, Ed. I think overall the 8% split 4-4 is – we characterize it as generally in line with previous quarters and – This is one place where if you step way back, as we have tried to transform this company, the investments we've made in membership are encouraging and we have more to do. And the progress that we've made and what we've talked about is we will speak to specific results when we hit major milestones and basically on an annual basis. We reported at the end of last year that we had all-time membership level highs, which we've maintained, and a high level of renewal rate, which is kind of a 300 basis point improvement over the past three years. I think the news in this quarter is about premium memberships, which were up. And frankly, the credit card acceleration was materially higher than we expected. And it just speaks to the visceral reaction we get to the value proposition when we communicate the value associated with our credit card as clearly as we have. The credit card sign-ups with the POS investment we made a year ago are, you know, above 20%. We expect some very strong performance through the course of the year. So we feel good about where we are. And, you know, as we think about the SAM, per my comments to Chuck, Ed – We don't think about the SAMS change as a short-term thing. We think about how can we invest into the business for the long term, and our communication to investors has been consistent. We try to be consistent in that regard, and we feel good about where we are.

Great. And just shifting from membership to getting members to spend more, can you maybe just give a little bit more color on sort of what's brewing in the pipeline from the perspective of driving comp. So, you know, I think you're testing prepared food offerings, so maybe help there. Where is apparel going from here? So many other initiatives that are kind of building in general merchandise. And optical, right, how's that doing so far?

Sure. Look, I think what you're seeing is the reality is those retailers out there who have worked hard to deliver products what consumers want, when they want it, and the method in which they want it are starting to win at an accelerated rate. And we're no different. So grounded in the learnings we've gotten from our general merchandise business, we feel good about our ability to continue to involve the assortment. I mean, a year ago we were in a situation where, you know, we did – Our TV business wasn't that great, and we've made some investments over the course of the last year, and we've consistently talked to investors about very strong comps. So the learnings there are about new assortment, new capabilities. So let me go one by one. In produce, our operations capability is materially better than where we have been. We are using that capability to continue to operate the clubs more effectively, and we're in the very early stages of testing and prepared foods. In our grocery segment, we're using the – under Lee Delaney's leadership, who's done a wonderful job transforming our general merchandise business. Those capabilities are starting to be applied to our grocery business, and we expect more progress there. Optical is one that, candidly, given our old model, we weren't serving our members well. And I don't mean to be that blunt, but I'm going to be that blunt. And as you think about the value proposition, the selection – And the service we deliver to our members, it's materially better today than where it was a year ago. So we'll continue down that path. I have foreshadowed that we'll continue to invest in services because in the membership world we're living in today, making the membership worth it is foundational to our ability to continue to grow, and we expect to do just that.

Great. Thank you.

Thanks, Ed. Thanks, Ed.

Your next question comes from Peter Benedict of Baird. Your line is open.

Hey, guys. Thanks for taking the question. Just circling back quickly just on MFI, can you give us a sense for how much the fee increase added to the growth last year, and then just what your view is kind of for the full year this year as that starts to wane? I think it's probably fully cycled by the end of the year, but just curious that perspective.

Hey, Peter. You know, it works in a a curve over the two-year period, right? So we launch it in January of 2018, and it starts to build. So Q1 was relatively little growth last year. It builds throughout last year and peaks right around the end of Q4 last year, and then sort of retraces that throughout the course of this year. So that's kind of how I would think about it. It's pretty ratable on that curve. on that basis, it's not really spiky at all. So by the time we get to the end of this year, you're sort of back to the core trends within the membership. How many members are we getting? Who's renewing? What's the average dollar price of people signing up or renewing? You've got to sort of get back to that level after the two-year period. And we should throw premium tiers in there as well. Our success in getting folks into our rewards tier and into the co-brand credit card program will influence that as well.

Got it. So that underlying rate, if you look at this quarter, was roughly calling 4%. Not that that necessarily is the way it's going to grow going forward, but that's the way to think about that. Is that right?

That's right. That's correct. Yep.

Okay, thanks. And then I recognize it's hard to forecast here the tax benefit that you guys get from the stock option exercise, but can you remind us what's assumed for the year? I think your full year tax rate's assumed around 25%, and it was lower this quarter, but just trying to understand what we should be expecting from that over the balance of the year.

Yep. You're absolutely right. We forecasted 25% when we issued our annual guidance. We did think that Q1 would be a little bit heavier based on how people were trading and when stock options vested and things. So we are expecting that to moderate as we go out through this year. You're completely correct that it's very, very hard to forecast this stuff because you're trying to figure out individual team members' desires relative to their equity compensation as well as what the market's doing to the stock price as well. So we took our best guess at it. We still think that's an okay guess at this point. And should that change, we'll change that assumption as we go forward.

Okay. That's fair. Last one. Maybe, Chris, I don't know how far you want to go into this, but just on in-housing, the services portfolio, you've talked about the optical. Can you give us a sense of maybe what might be on tap beyond that, either later this year or anything for 2020? I know that's a big initiative for you guys.

Sure. Look, I think that... Peter, that's a great question. I think that foundational to how we've spoken to both this community of people and investors overall, we're pretty blunt in our assessment that our services portfolio needed improvement. And Lee and team have started with Optical because we saw it as the biggest opportunities to serve our members better. And during the course of the you'll see us continue to get better, adding doctors' offices, adding people, improving the assortment we have. So that's a multi-quarter journey for us that we're on a path of. That's point number one. Point number two is the other place where we've tried to do is think about our services through the lens of our digital assets. The digital assets we've used that provide the most compelling service Growth is our tire business where you can now sign up online for tire changes. Why is that important? You know, if you think about a big capital expense that could cost several hundred dollars like the changing of the tires for the families we have the good fortune to serve, the loyalty we get out of saving money for multiple hundreds of dollars for a member when they change tires at our clubs is significant. So think of the renewal rate of a tire changer being higher than an average member. So we'll continue to use digital to make the experience of changing tires more convenient. Third is, as you think about overall the service we provide, I foreshadowed on the convenience initiatives and will continue to do so in our digital portfolio. This is really early, but express pay has the potential to be a really compelling way to make the trip to the club more convenient, and we're very, very early in that regard. Lastly, I'll tell you that as we look at travel, we're trying to make travel better, and we'll continue to work on that portfolio, but overall... our overarching strategy is to try to make money by providing great value to members. And when we do that well, a lot of things take care of themselves.

Okay, great. Thanks so much, guys.

Sure.

Your next question comes from Christopher Manderville of Jefferies. Your line is open.

Hey, good morning. Chris, can we start off just talking about the comp cadence throughout the quarter and if you're able to or willing to offer any color with respect to quarter-to-day trends?

Yeah, we're not going to get into any of the specifics other than reiterating full-year guidance overall. But overall, the foundation of the comp cadence in the quarter was pretty good. The first month of the quarter was weaker given the EBT shift that we had discussed, and as that waned, we turned into pretty good shape. So as most of the people on the call, not most, but a good portion of the people on the call live in the Northeast, so they know how I'd characterize the weather as both cold and rainy. It has been, and You know, we feel really good about our seasonal portfolio and, frankly, could have done even better with a little bit better weather. But, frankly, the weather wasn't great a year ago either. So we consider that about a wash. So we feel pretty good about our business going into the second quarter, and we'll see where we end up.

Okay. And then just maybe specifically on the perishables front, if you adjust for the snap impact and use a similar comp relative to 2018's results, it would still seem to suggest a modest deceleration on the two-year stack. So maybe you could just talk a little bit about what you're seeing there, give us a little sense of what inflation is looking like, the ability to pass that on, and if you're able to break it out, just what competition is looking like between the likes of club and traditional grocery.

Yeah, Chris, I think the thing that we haven't talked about with respect to perishables is We're still seeing a little bit of deflation in certain categories out there, primarily in eggs and dairy. It wasn't a huge amount of perishables deflation on that division as a whole, and it was flat on the company as a whole. But certainly within perishables, there's still some deflation in this particular category. So when we look at the stacks... sort of equalize for all that stuff. We feel like that business is getting better over time. You know, we've made great progress in produce, as Chris has talked about, with our ops transformation there. Units are up pretty significantly there. And we'll continue to invest in that. Those categories are incredibly important to maintaining the frequency and the value proposition that we show to our members every day.

Just any color on the competitive front?

On the competitive front, we feel the competitive environment is pretty balanced. I would characterize it as rational and consistent, both of which I think are important for us to all consider as we think about our business both today and going forward.

Great. Thanks, guys.

Thank you.

Thanks, Chris.

Our next question comes from Christopher Horvers of J.P. Morgan. Your line is open.

Thanks. Good morning, guys. A couple follow-up questions on customer acquisition and retention. You became much more aggressive around customer acquisition in late 17, and obviously with the waterfall, that's something that one would think that that's the key to the acceleration and comp as you look forward to the back half of the year. Can you talk about how I don't know if you phrase it in terms of advertising efficiency or something like that. What does that look like? Has that improved since those efforts have started and you got smarter about the process? As you think about renewal rates, in the past you've talked about 50% renewal rate in year one, obviously accruing to a very, very strong level over time. Is that 50% Have you seen any change around that 50%? And can you provide any comment on, you know, sort of what the year two renewal rate looks like relative to year one versus the longer term?

Sure. You want to go back? Yeah, I mean, Chris, I would say the whole thing starts with membership, right? We've got to get that right to get the rest of the business to run right. And so... Brian Pouliot and his team here have done a great job over the past couple of years driving the key initiatives within that area of our business. And we've talked about a number of those already with driving the all-time highs in membership count and renewal rates, the all-time highs in our credit card program that Chris talked about in his prepared remarks. A lot of things going our way. That is really the result of a couple of underlying efforts. One is just to do more of what we were doing. So we've invested significantly behind the thought that our average member lifetime value to customer acquisition cost ratio is about 10 times. And so we should be investing behind that significantly. And that started a year or so ago. Not only are we doing more things, but we're trying to do them in a smarter fashion. We're trying to optimize them. So you take the story all the way back and sort of everybody got the same promotional materials. And we've talked to you all over time over getting more towards a segmented view than now a personalized view of promotions as we do that. Brian's team is taking that to the next level in terms of acquisitions. So how can we better predict who is going to be a good member, who is going to renew, who is going to spend well, and trying to target acquisition spending towards that level. That is in the extremely early days, but it's kind of the next leg of the journey from that perspective. And so we feel good about what we've done so far in this arena and good about what's on the horizon to come.

And so I guess following up to that, have you seen any shift in the first-year renewal rates and then, again, any commentary on sort of how that first-year renewal rate accretes higher to the overall company renewal rate?

Yeah, I don't know that we've ever disclosed a first-year renewal rate specifically. It's higher than the numbers that you cited. And I think that the news in this quarter, Chris, Bob gave you the foundation strategically of how we approach lifetime value to CAC and investing in this part of our business significantly as we see it as the foundation of the company. But The one thing we've tried to speak to investors about is our focus on the more premium memberships and the efficiency with which we've been able to yield benefit from our investments in that area have improved materially. Let me give you a couple of really specific examples. We've talked about improving the quality of the talent we have in the clubs engaging with our members when they come in. That's helped us improve conversions when we have people coming in for memberships. We have improved premium-tier sign-ups pretty much across the board. Last year, I foreshadowed an investment we were making where we had pre-qualified the member base and then made an investment in some software to allow them to sign up for credit cards in Lane in quite literally a couple of seconds. This quarter, we've given you some texture on that by saying credit card signups were up over 20%, and we expect that number to be very strong during the course of the year. Finally, as the company has attempted to transform itself, we're starting to talk to more effectively lapsed members who can come back into the portfolio, which we think is a good thing for our company over time. Those are the levers we're pulling. We've tried to be consistent in that regard, and we feel good about where we are, and we have a lot more work to do.

Helpful. Thanks very much. Good luck.

Thanks, Chris.

Your next question comes from Simeon Gutman of Morgan Stanley. Your line is open.

Hey, good morning. Hi, Chris. Hi, Bob. My question is on if you just take the merchandise compass core, I think 1.9, Do we know? Have you shared with us? Or how should we think about the percentage of the contribution that's coming from existing members versus new members? Is it like a 90-10? And just how does that compare sequentially? Are you seeing any changes in that?

We haven't talked specifically about that kind of a split. And we feel good about where we are because there's really no major change in the flow. I think you think about some of the answers to the questions we had earlier about the 4% new member growth, 4% pricing, and the 8% MFI growth. The way to think about it, Simeon, is that a new member matures over basically a three-year period. And what we have gotten better at is communicating to them more efficiently, more frequently, and more effectively And we're starting to make some progress in more personally. So this maturing, one of the reasons that we talk about membership and credit card is we're trying to communicate to investors how much we're investing in the long term of the company. And certainly there's going to be stuff that goes on quarter to quarter. But as you think about foundationally, higher levels of membership, higher renewal rates, and material acceleration and premium memberships and and credit card sign-ups, you start to see a future that we're making a little bit of progress, but we're humbled by the fact that we have a lot more to do.

I guess maybe I'll ask it a different way. Spend per member, like on the same store member basis, is improving, I presume, and you're seeing that waterfall of benefit from new members as those initiatives that you just mentioned are playing out.

Yes.

Okay, and then I think you also said that traffic was a bigger or the big driver of the 1.9 merch prompt, if I'm not mistaken. Is that correct?

That is correct.

And is that, if you look at the number of trips per member, is that going up or is this the new members also? Just, I guess, another way to think about the split through traffic or is it the newer members now entering into that company through the traffic? It's a little bit of both.

We feel good about our traffic. Our traffic tends to be really solid over time, which is really encouraging.

Great. Okay. Thanks, guys.

Thank you.

Your next question comes from Michael Montani of Evercore ISI. Your line is open.

Hey, guys. Good morning. Thanks for taking the question. Just wanted to ask about renewal rates. You know, obviously, there's about a 300-bip plus deficit versus Costco, and yet you all have been doing a lot of great work there. Obviously, it's up 300 bips the last few years. Can you just talk about, is there any structural impediments that would prevent you from reaching that level? And then if that's not the case, you know, how should we conceptualize things like auto renewal? Where is that? And then some of the other initiatives you have to try to close that gap.

Yeah, there's no structural reason why we can't continue to make progress. What we've talked about is, you know, you'll continue to see the impact of the higher price memberships flow through the back half of this year as we report renewal rate on a lag basis. But we expect to hold renewal rate overall to the levels that we communicated at the end of last year, which is an all-time high for the company and up 300 basis points over the last three or so years. Point number one. And over time, as we continue to deliver value to members, we expect to continue to improve renewal rates. Easy renewal is a little more than half of the member base. We launched that program in 2014. In 2017, we changed it to an opt-out versus an opt-in program. And that's, as I said, a little more than half of our member base. And the reason I continue to point to the credit card proposition, as we've communicated to investors on more than one occasion that Our credit card members tend to be our highest spending, most loyal, and they tend to renew at kind of think about it as high 90s on a percentage basis. So we have talked about that number multiple times. So we feel good about our ability to make progress. But, look, we have competitors that are really good at what they do, and it's humbling. Having said all that, you know, you're talking about a company that, over the last three years in a pretty challenging external environment, has grown earnings by 60%, flipped a negative comp to a positive and quadrupled cash flow as it continues to invest in what is the long-term proposition that can create value for both our employees and members and shareholders. So we're going to continue down that path, and membership is the primary place we're focused.

Great. And then if I could just follow up, you know, obviously you've mentioned the benefit of having the credit card members and the premium tier members. Is there any update you can share with us in terms of penetration rates there and or a way to quantify, you know, just how important it is in terms of their regular spend per year versus an average member, let's say?

So at the end of last year, we talked about we had premium members Premium memberships represented about 23.8% of our membership base. I think everybody will probably recall that number. We've talked about that. That number is now above 25, and we feel good about that. Those members are certainly more loyal and spend more, and we feel pretty good about that. One of the things I've tried to point to is the relative importance of gas value. and linking back this whole idea of frequency and top of mind awareness to our fuel proposition. The reality, I've got a lot of experience in the fuel business. People are generally irrational in terms of what they'll do to get better value on fuel because the price is so transparent. Our value proposition is very, very strong in fuel. It gets even better when you own a credit card. And as a result, you've heard us talk about as fuel prices have risen, We're starting to make significant progress in market share and fuel, and we feel good about that in terms of how it drives loyalty over time.

Great. Thanks, and good luck.

Thank you. Thanks, Mike.

Your next question comes from Simeon Siegel of Nomura Instanet. Your line is open.

Hey, good morning, guys. It's Steve McManus on for Simeon. Thanks for taking our questions. On the topic of tariffs, I think last quarter you guys called out a $2 million to $3 million headwind to merge profit. Was there a similar impact this quarter, and maybe how should we think about that for the balance of the year?

Let me take that one at a high level, and I'll ask Bob to comment on the specifics. At a high level, I think this, from an investor perspective – The reality is that our exposure will be generally lower than many of our competitors. We've talked about 5% of our businesses exposed to Chinese imports and or component parts. So given our multi-category portfolio of businesses, We're probably a little bit less exposed. Ultimately, what we're most concerned about is the impact that these may have on the members we serve, as ultimately, given the magnitude of the tariffs, consumers will likely pay for the tariffs over time. We think we've got a balanced approach, and there's no need to change any guidance as a result of what we've heard so far. And I'll ask Bob to comment on the financial impact to the degree he wants to add something to that.

Yeah, hey Steve, I think I would echo everything Chris just said. Certainly you're correct that we told you in Q4 it was a couple million dollar headwind. It wasn't a particularly big headwind here in Q4, sorry, Q1. And we will continue to watch the issue and if we feel like it warrants an update to our guidance, we'll issue that when we feel like that. Right now it's sort of too many uncertainties to really Think about that, and if passed this prologue, it won't be that big of a deal for us, and we'll pull every level possible to make this work for our members.

We think that's our job.

And then maybe just to squeeze in a follow-up, can you guys give us an update on what you've been seeing with respect to wages, any wage pressure, and maybe comment on freight a little bit?

Sure. Like many of our competitors, we continue to see wage pressure. We look at it store by store and market by market basis to make sure that we have the right team members to serve our members every day. And so certainly that's been a cost pressure, has not been any more of a cost pressure in Q1 than we had planned for. I think you probably remember that we talked about our last call that we had pulled forward some investments from a wage perspective into Q4. We had some good visibility to what that was going to cost us in Q1. Not a big difference there. The freight market, I would say a similar thing. It was not a big headwind for us. Maybe getting a touch easier out there, but Certainly, we continue to watch that market as well. We've talked to you in the past about the fact that we have a captive freight carrier for us. They've been a great partner over time, and we can manage our freight cost exposure a little bit differently. And the fact that we carry what's thought of in the industry as good freight, it's palletized, it's easy to load and unload. We use techniques like drop and hook that allow the carriers to do it in a much more efficient fashion than some others out there. And so it hasn't been a big headwind in the past, and we don't anticipate it being a big headwind going forward.

All right, great. Thanks, guys. Best of luck.

Thank you. Thank you, Steve.

Your next question comes from Rupesh Parikh of Oppenheimer. Your line is open.

Good morning. Thanks for fitting me in. I had two quick questions. So on the gas margins, were they favorable or unfavorable versus last year?

Yeah, they were about flat to last year, Rupesh. So certainly we ended the last year in a little bit of a flourish given the market dislocation. The market more or less got back to normal. During Q1, it was flattish. It was maybe slightly down, but nothing to really think about from that perspective. We see it staying that way for a little bit. You never quite know with the gas market.

Okay, great. On the interest expense, clearly you guys have been able to lower your borrowing costs in recent quarters. Now we've seen the rates go down in the markets. We're just curious if you see another opportunity to potentially lower your interest expense going forward.

Yeah, I think that's a great question. We're certainly watching the market and watching how our loans are trading within the market. I do think as we continue to delever, we'll certainly have that opportunity again. and the market may provide us an opportunity to do so regardless of any future deleverage. So we'll keep a close eye on it, and hopefully we can take advantage of some favorable conditions and get that done.

Okay, great. Thank you.

Thank you.

Your next question comes from Mike Baker of Deutsche Bank. Your line is open.

Thanks. I'll be quick here. A couple of falls. One, so you're not changing the guidance on tariffs. Just to be clear, is that because some tasks have gone from 10% to 25%. You're not changing the guidance. Is that because it's too small to matter or you're just not sure what the impact will be?

I would never characterize a 25% tariff as too small to matter, Mike, but I think we can manage it at this point based on what we know today. This is such a dynamic situation. We're relatively less exposed given our multi-category business and the large fresh business we have. So we feel pretty good about our ability to deal with it. I also think that American consumers are going to ultimately pay at these levels of tariffs. So let's see where it all plays out. I think we're in good shape at this point. I would never say those tariffs would be too small to matter, but I think we can manage it.

Okay. Thanks for that, Collar. And then sorry to play weatherman. As I look out my window here in Boston, it is getting nicer, but it has been pretty bad, the weather in April and the first part of May. Should we expect a sort of pickup in demand from seasonal product as we go through May and through the second quarter? In other words, is there pent-up demand? And then one clarifying question. At one point you said weather was a negative and it was offset by the stop-and-shop strike, but then at another point you said weather was a wash, so I just wanted to square those two comments. Thanks.

Mike, think about whether versus an average year, this spring stunk. It just so happens that last spring stunk, too, and so on a year-over-year basis, it wasn't a huge difference, and that difference was offset by what happened at one of our local competitors here. Versus a normal year, it stunk, so I would say that there is some hope that we can do a little bit better from our seasonal category. Certainly, we have A lot of great product out there, and as we look out our window here, we see the same thing you do. It's nice to finally see the sun, and I do think people are ready to get outside and take advantage of what we have to offer.

Makes perfect sense. Thanks for the call.

Thanks, Mike. Take one more.

Today's final question comes from Chuck Sarankoski of North Coast Research. Your line is open.

Good morning, everyone. I just wanted to talk about a couple of the categories you wanted to work on over the next year or so, the more hard goods categories oriented towards tools, hardware, sporting goods. What's happening there over the past quarter, and how do you see it proceeding over the rest of fiscal 2019?

Overall, we feel very good about our general merchandise business, and it's a little bit to Mike Baker's question just a minute ago. With GM comps at a stack seven, we feel pretty good about our seasonal business despite some of the crummy weather, but we had crummy weather a year ago too. But as you think about the consumer work that Lee and his team have done to enter new categories, it's grounded in the right work and You know, we feel good about each one of those. Probably the upcoming news will be a little bit more on sporting goods as we work our way through the summer. And we feel good about the continued evolution in TVs and the foundational work we've done over the last year, as well as apparel, where we're continuing to add space. And we feel good about that as well. So we feel good about new categories overall.

All right. Thank you.

Thank you.

That concludes our Q&A session for today. I will now return the call to our presenters.

Thank you all very much, and we'll see you on the road over the next couple of weeks. Thanks, Eric. Appreciate your time.

This concludes today's conference call. You may now disconnect.