BJ's Wholesale Club Holdings, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the BJ's Wholesale Club Q2 FY20 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Satyen Sriha, Vice President of Investor Relations. Thank you. Please go ahead. Good morning, everyone. Thank you for joining BJA's Wholesale Club's second quarter fiscal 2020 earnings conference call. Lee Delaney, President, CEO, Bob Eddy, Chief Financial and Administrative Officer, and Bill Werner, Senior Vice President, Strategic Planning and Investor Relations are on the call. 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. Please see the risk factors section of our Form 10-K filed with the SEC on March 19, 2020, 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 posted on the investor 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 Lee.

Good morning, everyone. I hope you are all safe and healthy. Let me touch on a couple of things briefly before discussing our performance and go forward expectations. First, I'd like to thank our team members for their dedication as we continue to navigate these unprecedented times. This past quarter, we faced challenges that impacted every aspect of our business. I am extremely proud of how our team responded with resilience and creativity to the ever-changing environment and sustained demand for our products and services. Across every function in our company, from the field to supply chain teams to the merchants and marketing team to all our support teams in the home office, people stepped up to deliver exceptional performance across the board. Their dedication and effort enabled us to safely serve our communities and deliver outstanding results. Thank you to all of them. We recognize them through temporary wage increases through July, as well as multiple rounds of bonuses, including a bonus that will be paid in September. Year to date, we have invested $83 million in team member wages and bonuses. In addition, we continue to support an enhanced benefits package and financial assistance through our employee relief fund. Our top and most important priority remains the health and safety of our team members, as well as the members and communities we have the privilege to serve. We continue to practice the extensive safety measures we introduced in March. We will remain vigilant and continue to work with federal and local authorities to ensure we remain ahead of evolving safety and health standards. Year to date, we have spent approximately $24 million in increased safety and sanitation costs. Second, I'd like to take a moment and address the social injustice that garnered worldwide attention this quarter. We stand in solidarity against racism, discrimination, and violence. We are proud to serve an incredibly diverse membership base and work alongside a diverse population of team members. These events reinforce the importance of our ongoing efforts to build a culture of inclusion and diversity. To support and lead our efforts, we created an Inclusion and Diversity Council to implement training, education, recruiting, and development initiatives that drive inclusion and foster diversity. The leadership team and I are passionately committed to this work, which we deem inherent to our values and our success as a company. Now, let's turn to our performance. Q2 was another remarkable quarter with strong top-line growth, profitability, and free cash flow. As I reflect on our results to date and the implications for the future, I believe that we have turned the corner from merely reacting to the pandemic to proactively transforming our business to enable a much brighter future for the company. We have a radically different company than we had just six short months ago. In many areas of the company, we are now years ahead of how we thought our transformation would evolve, and we are actively looking for ways to increase the pace of progress. For the balance of my remarks, let's dive a bit deeper on five key topics, membership, assortment, digital transformation, strategic footprint, and capital structure. From a membership standpoint, we continue to see a strong increase in new members joining BJ's. We now have over 6 million paid members. To put this in perspective, in the past six months, we acquired and retained approximately 18 months' worth of members. This pace, should it continue, would have us experience three years of membership growth in this one transformative year. Not only are new members joining at elevated levels, they skew younger and are more digitally engaged. We believe our membership will be stickier, and we are adding incremental efforts to ensure higher levels of engagement. We have added incremental marketing to support member outreach and have been encouraged by the results in new and existing clubs. We are also focused on ensuring our members remain engaged, especially new members. We are closely monitoring their behavior and utilizing a targeted, personalized approach to keep them engaged in shopping. We will lean aggressively into membership investments throughout the balance of 2020. With assortment, strong underlying demand driven by increased food at home trends and consumer investments in their homes allowed us to considerably accelerate plans to change our product and services offerings. We essentially revamped our assortment in real time, selling through old inventory at a rapid pace, simplifying and expanding into high growth and high demand categories where we did not previously compete. Let me share a few examples from this past quarter. First, our merchants did a terrific job engaging with existing and new suppliers to keep us in stock and to expand into highly relevant new categories. We added 32 new vendors to bolster our supply chain in food, paper, and cleaning supplies and to participate in new personal protective equipment categories. Second, we dramatically accelerated the reset of our food business with a new set in nearly 200 clubs that incorporates more healthy and organic options months ahead of our initial schedules. We knew changes here would be important to engage younger members and accomplishing it so quickly should aid our retention efforts with our new first-year members. Third, we continue to expand our general merchandise assortment, delivering great prices on well-known and new brands, including Sony, Puma, Lucky, and Champion. We also reinvented the way we buy apparel to be more opportunistic and capitalize on market disruptions. And finally, from a services standpoint, the team continues to build our capabilities. Our AT&T mobile offering is resonating well with members, and we have further enhanced it by adding buy online capabilities. Our optical business is open again, and we continue to offer great value and convenience, including new digitally-enabled optical services like telemedicine appointments. And we relaunched our home improvement and appliance platforms, offering unbeatable value and enhanced member experiences. Our digital business is crucial to our existing and new members and is stronger than ever. We grew digitally-enabled sales by more than 300% and made dramatic progress rolling out new digital services. After a brief test, we launched curbside pickup in all clubs earlier this month, and we expect buy-online pick-up and club for perishables to be available by the end of the third quarter. The initial response from members has been encouraging. We will move aggressively to add infrastructure in our clubs to handle these rapidly-growing offerings, knowing that our economics are advantaged versus our competitive set. I am also thrilled to announce that earlier this month, Monica Schwartz joined the team as Chief Digital Officer. With great retailers like Home Depot and eBay in our background, Monica's extensive knowledge, experience, and diverse background will be instrumental as we scale our digital business. We remain focused on expanding our footprint in a much more aggressive fashion. Our third club in Michigan opened late in July, and while it's still very early days, we are pleased with the initial membership response and sales trends. We expect to open two new clubs in New York around the end of the fiscal year and can currently see opening as many as six new clubs next year. We are moving aggressively to make those numbers or even larger ones a reality. Our balance sheet is a radically different quality today. We have used the massive amounts of free cash flow to reduce leverage to 1.4 times funded debt to EBITDA versus 2.9 times just a year ago. And we began to selectively buy back shares to offset the dilutive EPS impacts of equity compensation. Stepping back, we expect that consumer trends will likely continue for the foreseeable future. We expect this landscape combined with our considerable transformative investments will increase our relevance to members and prospective members alike. Almost regardless of the level of economic uncertainty, we should be well positioned versus competitors given our low price positioning and the fact that we have grown our membership revamped our analog and digital offerings, increased our rate of new club openings, and transformed our capital structure. In this environment, we will look for additional opportunity to accelerate our transformation, remake our balance sheet, and drive step-change levels of profitable growth. We hope to look back on this turbulent period as our moment in time to radically improve our business. With that, I'll turn the call over to Bob. Bob?

Thanks, Lee, and good morning, everyone. Before I begin, I would also like to thank our team members. Our industry-leading results reflect their performance and the investments we've made over the past few years. As Lee noted, 2020 has been an incredibly transformative year for our business that will catapult us forward into the future. Net sales for the quarter were $3.9 billion. Merchandise comp sales, which exclude gasoline sales, increased by 24% and were driven by both traffic and tickets. We had significantly more members shopping our clubs, consolidating their trips, and growing their baskets. These trends were relatively consistent across all of our geographies. We saw consistently strong comp performance during the quarter, with comps exceeding 20% for each month. We exited the quarter with July merchandise comp growth of 24%, and trends remained strong in August, which is running at a 20% comp so far. Our digitally-enabled sales grew by more than 300% and drove about six full points of our 24% merchandise comp. About three-quarters of the Q2 growth in digitally-enabled sales was driven by same-day delivery and by online pickup and club, or BOPIC. The complexion of this growth is important as it is centered in those fulfillment methods where we have advantaged economics. As you know, we operate a limited SKU warehouse environment with significantly higher average tickets, which allows us to be much more efficient. OPEX sales tend to skew towards higher ticket items, and same-day delivery sales have the same margins as traditional sales in our clubs. Comps in our grocery division grew by 25%. We saw very strong growth rates in expected categories. Paper products, cleaning essentials, fresh meat and produce, frozen, dairy, and beverages. Our team improved our in-stock levels during the quarter, including in certain very high-demand categories. by innovatively working with both existing and new suppliers. Our general merchandise and services division saw a comp growth of 22%, driven by strong apparel sales, TV sales, and other home-related categories. Membership fee income, or MFI, grew by 10.4% during the second quarter to $82 million. MFI growth was driven by new members, renewals, and membership mix. We now have 6 million paid members, which is an exciting milestone for this company. To get here, paid members grew by 10.6% year over year. Cash MFI for the quarter was up 15% due to growth in new members and membership renewals. Despite these gains in the number of members, our higher tier penetration increased to 29%, and easy renewal enrollment is nearly 70%. Let's move now to gross margins. Excluding the gasoline business, our merchandise gross margin rate was flat as CPI initiatives and improved performance in our general merchandise business was offset by COVID costs and cost inflation of certain commodities, most notably beef. We invested meaningfully in price during the quarter in order to sustain our outstanding value to members in these tough times. SG&A expenses for the quarter were $591 million and included approximately $42 million of total costs associated with the pandemic. These costs came in above our expectations as we extended our temporary wage increase longer than anticipated, and we implemented a bonus program to reward and recognize our team members. In spite of these additional costs, we leveraged SG&A by approximately 40 basis points, enabling great flow-through to earnings. Please note that these costs have not been adjusted out in the calculation of our adjusted EBITDA metric. Our adjusted EBITDA grew by 42% to $217 million, reflecting the robust sales beat offset by discipline investments in our team members and their safety and in our business. Adjusted net income in the second quarter was $108 million, or 77 cents per share, and reflected an incredible 97% year-over-year growth. Our earnings growth highlights the strength of our revenues, our disciplined capital expense management, and reduced interest expense. As a result of our outsized performance and working capital benefits, we generated free cash flow of $220 million in Q2 and a record $655 million year-to-date. We bought back $34 million worth of shares and paid down $150 million of our first lien debt. We ended the quarter with $169 million in cash balances and a funded net debt to adjusted EBITDA ratio of 1.4 times. Our balance sheet has been dramatically transformed in the past year. Let's now touch on our outlook. The current environment remains challenging and unpredictable. There are several uncertainties and factors that would impact the overall economy and our business, including the evolution of a pandemic, government stimulus, consumer behavior, the elections, and unemployment levels. As a result, it remains extremely difficult for us to forecast how the second half of the year will play out in specificity. What we do know is that our business has strengthened significantly. We are not the company we were six months ago, six quarters ago, or six years ago. We've added more members and are accelerating investments to improve all facets of our business. Although we benefited from increased EBT and stimulus benefits in the last six months, we have built an underlying strength in the business that will be sustained in the future even after EBT and stimulus benefits are behind us. Change is accelerating, and we believe we will emerge from this situation transformed with a long-term algorithm that significantly outpaces the plan we laid out at our IPO. Let me touch on some high-level expectations for the remainder of the year. First, we expect strong comps for the remainder of the year and to continue to attract and retain new members as we invest and transform our business. Given the uncertainty around stimulus and other matters, it's difficult to predict sales in the second half of the year in detail. Based on our new member growth we've seen in the first half of this year and our current member mix, we would expect MFI on our P&L to grow by approximately 12% in Q3. From a gross margin standpoint, our view remains the same as Q1. We expect to benefit from strong sales, CPI, and private label expansion. There are also manageable headwinds to consider, including the higher cost of freight and near-term inflationary pressures on certain categories. We aren't planning for a margin benefit from our gasoline business for the rest of the year, and in fact, margins could potentially contract a bit. On SG&A, we expect to incur approximately $20 to $25 million of incremental expense associated with COVID-19 in Q3. These costs are related to team member bonuses and ensuring we keep members and team members healthy and safe. Despite these costs and uncertainties, we expect to achieve very strong adjusted EBITDA and earnings growth. Let me touch on capital allocation. This year has been incredible so far. Over $600 million in free cash flow has enabled us to repay nearly $500 million in debt, repurchase nearly $40 million in shares, and accumulate nearly $170 million in cash on our balance sheet. This has been truly transformational. As we look forward, our first priority is the growth of our company. We will fully fund all growth initiatives that meet our strategic and financial hurdles. Next, we will look to continue to optimize our balance sheet. Finally, we may consider returns of capital to shareholders. Our goal is to ensure that we have the appropriate capital structure that would enable the company to succeed over the long term and maximize shareholder returns. To wrap up, we're extremely pleased with our results for the first half of the year, and we feel tremendously well positioned for the future. Our business is more relevant than ever before, and our investments are enabling us to succeed and drive continued profitable growth. Importantly, we have a team that is executing at the highest level and building a truly transformed BJ's Wholesale Club. Now I'll turn the call back over to the operator to begin the Q&A session.

Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound or hash key. Please stand by while we compile a Q&A roster. And our first question comes from the line of Edward Kelly from Wells Fargo. Your line is open.

Hi, guys. Good morning, and congratulations on a good quarter. First thing, Lee, I wanted to ask you about the accelerated club growth. Maybe could you provide a bit more color here, including the decision to accelerate growth a bit and You know, it certainly seems like you're more optimistic now about this opportunity. Where do you think you can get to in terms of a run rate over time? And then how would this impact CapEx?

Sure. Let me start, Ed, and then I'll turn it over to Bob to round out the perspective. You know, as we've talked about in the past, accelerating our rate of new club openings has long been a strategic priority. And we spent a lot of time over the course of the last several years making sure that we had the model right because we were unhappy with the success of the openings going back three to four years. And so with our clubs in Kearney and Somerville and Michigan, we really looked to revamp that model and make sure that when we opened the clubs, we had a sufficient membership base to make them successful. And then that we were investing enough in the infrastructure, in the marketing, in the acquisition activities, And we've been really happy with our efforts in clubs, particularly the most recent set of clubs that we've opened in Michigan and Pensacola and Clearwater. And I think we have the ability to step on the gas a bit. We're also hopeful that there will be some disruption in the broader real estate market that may create opportunities for us. And so Bob and I, together with the real estate team, decided that we would more aggressively look for opportunities to fill the pipeline. And we've been working on it for a while. And, you know, our hope is that next year we'll be able to open significantly more than we have in the past. So in the script we talked about as many as six. I'm not sure what the right long-term algorithm is, but we've, you know, been in the range of three to five, and we'd clearly like to take that a bit higher going forward. Bob, if you'd round that up.

I think that's right, Lee. Ed, good morning. The question on CapEx. Certainly, as we open more clubs, we will incur more capital expenditures and potentially meaningfully more. One of the things that we've done is look through our own process to see what we can do to speed up our own process. The real estate process in general is fraught with uncertainty and long timelines. Some of that is just the real estate thing and some of it is our own process. We've looked to streamline our own process. and do things like start buying buildings and land as opposed to just leasing them. And so you may have heard us talk about a $10 million per club cost. That is particularly associated with a leased club. If we start buying clubs in any material nature, it will go up from there. And I think we will do that as we look to accelerate our growth because it's it's a little bit faster to go buy the club, go buy the land, and it's a little bit more economical as well. And now that our balance sheet is so much different than it was a year ago, we have the flexibility to go do that. So as those plans crystallize for next year, later in this year, we'll start talking about the direct impact on CapEx. But I think you heard in the script, our first priority when we think about what to do with our cash is growth. And we will look to fund every avenue of growth we have, and this will be a great opportunity to, you know, take advantage of the situation we find ourselves in today and make our company great for the long term.

Great. Just a follow-up on the merchandising side. Could you maybe just provide a little bit more color on the opportunities that you're seeing out there? I mean, you did mention, you know, a reset on the grocery side, you know, some color on on what you did there and what the response has been. And then I'm even more curious on the GM side and just what you're seeing from vendors at this point, you know, what's happening on the branded side. Has that actually started to work into the business yet, or is that too common? Just taking a step back, you know, you've been underpenetrated in general merchandise, arguably. Where do you think that can get to over time or do you have a goal around that? Sure.

Let me break that apart a little bit. As we've talked about in the past, we offer our consumers a large degree of choice in a relatively narrow set of categories. And some of that really works well for us in our fresh food offering because we have more people choosing to use us as their regular shopping destination. I think that clearly has helped us during the pandemic. But the reality is in a number of categories, we offer more choice than our members really need for a curated club environment. And so the core of what we're trying to do is simplify choice in the right places and then extend it to new categories. That will be particularly true in general merchandise, where we've had a fair degree of success entering new categories while more closely curating our assortment in food. And so that allows us to get into things in bigger ways like fishing and sporting goods, new consumer electronics, connected home devices, and also to engage new branded players. And I think the jury is still out a bit in terms of the degree of new branded players we'll be able to add, but we are having more and better conversations with a set of companies than we've had before, and our merchants are actively looking to engage new suppliers. And just given the velocity and the traffic benefit we're seeing, we're a unique player in this environment. We have the buying capacity, we have the shelf space, and we have the traffic. And so we'll continue to invest in new categories. In terms of the ultimate level of general merchandise penetration, I would expect that in a normalized environment, we would see general merchandise continue to grow at an accelerated pace. And the other piece of that that's important is our services business. We know this is a place where our competitors, most notably Costco, have enormous businesses. And we, by and large, haven't participated much in the past. And so we have new offerings in optical and cellular phones, in home improvement, in major appliances that are scaling quite nicely. despite kind of the backdrop of the pandemic. And I think those will be multi-year growth vehicles for us.

Great. Thanks, guys.

Our next question comes from the line of Chris Horvath from J.P. Morgan. Your line is open.

Thanks. Good morning, guys. So a couple of follow-up questions there. Is there any sort of capacity constraint around opens? You know, given the timing of opens at the end of this year, you're effectively growing almost – you know, 4% unit growth. So, you know, could you, like, could you sustain growth sort of like a high single-digit type unit, a number of clubs opening in any particular year? And as you think about, you know, buying the land to speed the process, would you say at least back those ultimately or look to build the real estate value?

Good morning, Chris. It's Bob. There are plenty of capacity constraints on the openings that I talked about. The real estate process is sort of fraught with them. We've seen quite a bit of them so far this year just from a COVID perspective. The two clubs that will open around the end of the fiscal year should have opened much earlier in this year. But getting town officials and permits and all those things has been a challenge. So The challenge in a normal year this year is a little bit more of a challenge, and we are pulling every lever that we can think of to offset those challenges and go faster, and buying is one of the ways that we'll do it. Another one might be we would typically want to open a new club with a gas station and typically open the gas station a few weeks beforehand as a means of driving membership interest. You can imagine the permitting complexities with a gas station versus just the retail store. And so now we've sort of de-prioritized that requirement. We will open the store before the gas station as a means of getting vendor unit open earlier. You know, as I spoke earlier about our transformed balance sheet, I think we will look at the individual economics of salesy spec transactions, but I would expect a lesser desire to do that given where our balance sheet stands today versus where it stood a year ago. You know, we were doing that, you know, primarily to get cash to pay back the bank debt. And now that our bank debt is much lower than it was before, we will sort of opportunistically look at, say, at least backs. But given where rates are in the bank market, it's probably a little bit better for us to keep our bank debt a little higher and not incur the sale-lease back debt at this point.

Understood. And then you talked about a better long-term financial algorithm than when you went out on the IPO. You addressed the potential unit growth acceleration, but originally it came out as a 1% to 2% type core comp, and you had margin expansion, how are you thinking about the dynamics there? Clearly with the momentum in the business, momentum on membership, that 1% and 2% would seem pretty low, but also are we transforming more towards a flow-through model where the operating margin caps out?

Well, I think it's a little bit early to get into specifics, but certainly I think you hit a couple of the key points. We have gained so many new members this year that, you know, that alone should drive the comps higher than what we would have planned pre-COVID and pre this avalanche of members that have come in. Certainly our margin opportunity is not done, but it is, you know, and I'm speaking gross margin related. Not done, but it is a little bit slower growth than what it was a couple of years ago. And the other things are really the differences in interest expense and potential returns of capital as well as we think forward. So again, as we get through the rest of this year and start thinking about next year's plan and new long-term plan, we'll give you some detailed thoughts on the long-term algo But I think in large degree you're thinking about it the right way, that membership will power greater sales growth combined with more unit growth. And, you know, the balance sheet side of it will help as well. That's great. Best of luck. Thank you.

Our next question comes from the line of Chuck Rome from Gordon Haskett. Your line is open.

Good morning. Great results. Just a lot of momentum on the membership front. Curious what the new member growth look like in the second quarter. I think last quarter you said 40% for 1Q. And I'm curious how weekly rates have looked once you're on board with these shoppers.

Good morning, Chuck. It's Bob. I'll take that, and we can chime in. Certainly Q2 has had great membership statistics, as we talked about on the call, now over 6 million paid members. To get there, we grew quite nicely. On that same basis as that 40% growth last quarter, we were about 28%, so year-to-date 36%. and a touch slower, but certainly a whole lot faster than we would grow in a normal year, and we're very happy with that. As we look forward, those members are shopping very nicely. Their behavior is similar to other members that are already in the portfolio, and that leads us to think good things about their long-term potential as members. Certainly, you've heard us talk about before, the more members spend, the more likely they are to renew. And nearly all of our members are spending more than they have before. So that bodes well for renewal rates and for sales going forward in the future.

Yeah, and Chuck, I'd just add to that commentary that we're really pleased with how broad-based the momentum is. Across all geographies and all business lines, we're seeing great engagement. And as Bob said, we know that the more categories of member shops, the more frequently they come, the more likely they are to renew. And seeing bigger baskets that are broadly based gives us hope that the existing members and the new members that have joined will be stickier than they have been in the past. The underlying shopping behavior is quite robust. The big wild card clearly is the impact of the pandemic and how that plays out into next year, whether there is a vaccine, whether there's a treatment. So there's a large amount of unknowns. But what's really encouraging is the underlying member shopping behavior relative to a normal baseline would suggest that we should see good retention rates of both the existing and the new members we've added.

That's great. And then this, Bob, would be on the components of the card. You said traffic and ticket both contributed, I believe, last quarter. They're about 50-50. Just wondering if you could give us that detail. And then I guess I'm also curious how the mix of traffic and ticket moved throughout the quarter. If you look at Costco's traffic, it's obviously improved a lot, but their basket has actually stayed relatively intact, which is encouraging. So a little bit of color on that front would be helpful. Thanks.

Sure. The comp position, Chuck, is roughly a thirds traffic, two-thirds ticket in the overall comp base. That's held relatively consistent throughout the period, as have our overall comp trends. So we saw a good comp momentum through each of the three months of the quarter, which is encouraging. We also know that we're gaining share. We're seeing some degree of trip consolidation. We're seeing larger baskets when people come, and that is leading to outsized growth, again, across all geographies and nearly all categories, which is very encouraging. Awesome. Thank you.

Our next question comes from the line of Chris Mandeville from Jefferies. Your line is open.

Yeah, good morning. So maybe I just wanted to start off with the holiday period. I heard that you have brought in some newer, higher quality brands on the apparel side. But can you speak to any other efforts that you're putting forward to ensure you see some continued success in Gen Merch as we go through the back half of the year? And how are you approaching the season any differently versus prior years in terms of purchasing and promotions?

Chris, I lost part of your question, but I think I understood it. It was how are we thinking about the back half, the assortment, particularly as it relates to general merchandise, and the holiday season. I think the holiday season overall is going to be particularly tricky to plan. As you think through Halloween, we're assuming there are fewer parties and probably less trick-or-treating. And as you get to Thanksgiving, we suspect there may be more Thanksgiving gatherings of smaller size. So that would mean buying more turkeys, albeit smaller turkeys. And then as you roll through, you know, to the Christmas, Hanukkah season, again, we would expect there would be less large gatherings, which is a pretty meaningful part of our business is supporting those parties and social events. And so we've been thinking through how to pivot and transform our assortment to meet that demand. And it is on both the food and the general merchandise side where a fair amount of work has gone into really thinking through the implications and how we should plan the stores and the online offerings. But the biggest thing that we're doing that is new is trying to buy into new categories in a bigger way. So more or less any investment in the home has been resonating. And so we're looking at exercise equipment and textiles and consumer electronics and connected home devices because our baseline assumption is you'll still have a large amount of people either working from home or spending more time in their homes, and the investment in people's homes will continue. And so we're shifting the development pretty meaningfully in that direction.

Okay, that's helpful. And then I haven't heard much on Project Momentum for quite some time. Where do we stand on realizing what savings you expect for this year, and where have you found said savings, and where are the opportunities that lie ahead still?

Chris, we are on target for Project Momentum for this year, but it's been a bit of a different route to get there than we had projected. So at the beginning of the year we would have thought of our savings that were planned would come out of our operations team. And that's still the truth, but it's slightly less today as you can imagine those folks are out there trying to figure out how to order and less about how to save money. But that's been more than offset by increased savings by our home office teams in figuring out how to allocate labor more efficiently, how to automate and potentially offshore certain things that are currently done here. So, for instance, my finance team has a big project on robotic process automation that is taking some of the lower value add work and having that done by software robots. And our human resources team has done a wonderful job saving money on our benefits program without it's available to our team members. So it's a wide cross-section of things that we're doing, a little bit more home office focused this year than in the field. versus what we planned, but we are on target overall for this year and expect to be on target for next year.

Great. If I could just fit one last one in very quickly. If you have it on hand, what was the gallon comp decline in the quarter, and how did that look in August?

Our gas business has been incredibly strong. Gallons are actually up 4% in the quarter, and so when Lee talked about gaining share in few moments ago. Gas is a wonderful example of how we're doing that. Your question sort of assumed we were with the rest of the market, which is certainly down from a gallons perspective, but we've seen our members consolidating trips in all manners, and we've been gaining tremendous share from a gasoline perspective as well as inside the club.

Got it. Appreciate it, guys. Take care. Thanks, Chris. Thank you.

Our next question comes from the line of Karen Short from Barclays. Your line is open.

Hi, thanks very much. I wanted to just talk about membership. So of the new members that you've gained since year end, I'm wondering if you could just provide a little color on the composition of the members in terms of tiers. And then on the actual MFI, like reported MFI, one Q and then it was 15% in two Q with a 28% increase in new member acquisition. So can you just walk through how reported MFI dollars should grow in three Q and four Q based on what you know today?

Sure. Thanks for the question, Karen. Let me answer the first part and I'll turn the second part over to Bob. You know, from a Overall quality of the new members, we're quite excited about it. You think about it quantitatively on engagement of higher-tier memberships and then on participation and easy renewal. Both of those metrics held strong and actually grew a little bit in the quarter. And so the only way you get there is to have the new members contribute at roughly the same rate, which is very encouraging. given typically new members need time to tenure and to the higher tier credit card offerings. And so, you know, we're happy with our credit card program and how that's developing. And then if you look at the demographics and the behavioral characteristics of the new members, they are skewing younger. They are more digitally engaged. And they're clearly shopping more than we would typically see from new members. Some of that is undoubtedly pandemic related. But if you step back and, you know, think about the type of member that we're trying to acquire, it's young families, young new homeowners, and the crop of members we're adding does skew more in that direction than what we would typically see. And so that's very encouraging to us. Bob, do you want to talk about the math side of it?

Karen, maybe we take the math side of it to our callback later. But I think... What I would say is a lot of what Lee just said. We've experienced pretty tremendous new member growth. That's driving the 16% cash on FI growth in Q1 and 15% here in Q2. And that is a combination of new member growth and member mix and increasing renewals as well. So all three things are going well. So we've talked a lot about the number of new members that we grew already, so I'll skip that. I'm not going to give a heck of a lot on renewal rates other than to say that we have more renewal bodies so far this year, and we believe based on people's shopping habits that the overall membership and these new members will be stickier over time. And from a tiers perspective, you asked where we were there. In the script, we talked about 29% into the higher tiers and almost 70% into easy renewal. To make those numbers happen, just strictly from a mathematics standpoint, you have to be doing a great job converting at the front line and at the membership desk. Given the sheer number of members we signed up, to go higher on those numbers has been pretty impressive, and thank you to our field teams out there for making that happen.

Okay, that's helpful. And I just had a question on new units. So I understand that if you own the land and building, it obviously gives you a lot more flexibility, and you said that the cost would be greater than $10 million a club. Can you maybe just get a little more granular on that? Would it be double cost? kind of a new unit if it's owned, and then if we're thinking about the six for next year, what is the kind of rate mix to think of, of owned versus leased?

Yeah, we're a little early on your last question in terms of owned versus leased, but at least one of them will be owned for sure. It's difficult to to really answer your first question because there's such a wide variance depending on the market. So, you know, I don't want to give you a number that is crazy, but they could be $25 or $30 million versus the $10. If we bought a club in Metro New York, it would be even higher than that, for instance. So it's very difficult to answer that with any specificity. But what I would... you know, have you think about is the additional flexibility that we have with the transformation of the balance sheet and the fact that it's overall more economical to buy usually than lease because you're taking out the lease premium that would go to the developer. So when you sort of think about how it runs through the P&L, the rent expense on a leased club would be higher than the depreciation expense on an owned building. So while it's a little bit of a drain on cash to buy things, it allows us to go faster and we save P&L dollars on the whole.

Yeah, no, no, I definitely think it makes more sense. I was just curious on the actual cost. Thank you.

You bet. Thank you.

Our next question comes from the line of Robbie Ohms from Bank of America Securities. Your line is open.

Well, good morning, guys. Actually, two questions. You know, Lee, I was wondering if you could talk about maybe new things you might be doing on the marketing side to keep that really strong new membership momentum going into the back half. And then the other question is, you know, Bob, on gross margin, I think you mentioned price investment impact in 2Q. Can you kind of tell us what that was? And do you think price investment will be sort of larger than normal, you know, going forward? And I think you also mentioned distribution cost pressures, maybe some more color on what that was like in the quarter and what that could look like going forward. Thanks.

Sure. Thanks, Robbie. You know, from a membership marketing standpoint, you know, We are investing more and doing it in different ways than we have in the past. So over the course of the last few months, we turned on an advertising campaign using traditional channels, broadcast TV, radio, as well as a whole suite of digital channels and saw good results with that program. We saw a lift in shopping in our clubs and higher new member sign-ups. We've also been experimenting and scaling investments in very targeted membership acquisition. So we built a database that allows us to market more specifically to individual members across our footprint with a whole set of demographic behavioral characteristics so that we can get very specific in our outreach across both analog and digital channels. And then we're looking to invest more in onboarding people into the credit card program from the start. And so a pretty meaningful investment in different programs and tactics to have someone enroll in the credit card because we know that if we have people participate in the credit card program, they save more money, they spend more, and they're much stickier in a membership standpoint. And so As we've tried new things, scaled new programs, and looked to invest more, we found some things that are pretty exciting to us, and we're going to ramp the investment in those behaviors in the back half. Now, again, we're clearly benefiting from a desire to consolidate trips, to buy in bulk, to save value, kind of the core of our offering. But against that backdrop, accentuating it with marketing is something that is – it's very attractive to do in very high return. So we'll be more aggressively into the marketing throughout the balance of this year and into next.

That sounds great. And then Bob on gross margin.

Yeah. Good morning. It's a tangled story on gross margin. There are a lot of puts and takes that we tried to line out in the prepared remarks, but it's, you generally know the story, right? Certainly the good guys include continued wins from a CPI perspective, private label penetration, improving performance in our general merchandise business when you think about the markdowns we took in Q1 versus where we are today in that business. And we certainly had some cost inflation, most notably in beef. And that is where In instances like that, we tend to invest in price and lag the inflationary increases to help our members out, and many of our competitors do that as well. But you know that our pricing architecture is to match Costco and Sam's every day and maintain great pricing gaps against mass and groceries. that's really sank or sank in the way that we think about it. And this year is no different from that perspective, but it's just been a little bit crazier with some of the moves and some of the commodities. In this quarter, it was beef. We'll continue to invest in price. We won't really change that methodology. It's incredibly important in our membership model to offer our members a value, and we believe that that's what we're here for, and so we will continue to do that both in sort of normal course events and when we have events of significant inflation like we have this quarter for beef. The distribution expenses were more or less in line with what we were expecting, maybe slightly higher, and that is just the cost of running our distribution centers is higher given the given the incremental expenses that we are incurring to keep our team members safe and keep the goods flowing. And then overall, freight has been a little bit more expensive than we had planned, but not materially. So certainly we will do everything we can to keep our team members and our members safe until those increased distribution costs, I think, will continue for the foreseeable future. And we will, you know, we'll see how it goes from here.

Got it. That's really helpful. Thanks.

Our next question comes from the line of Mike Baker from DA Davidson. Your line is open.

Hi. Thanks. My first question, you've talked a lot about trip consolidation. I'm wondering if from the complexion of the basket, any way for you to be able to discern if you're becoming more of your customers weekly shopping trip and using you exclusively instead of filling trips at grocery or the like, and are you seeing that more with the new younger customers?

I think the short answer to that question is yes, but with a little bit of complexity layered on. So one is I think – Trip frequency across the market is declining. So people are making fewer trips, and when they go, they're making bigger trips. We, however, with the growth in the membership and with the growth in trips we're seeing, know that we're winning from a trip perspective, and then we're winning from a basket perspective as well. So we're seeing growth in trips, and we're seeing growth in baskets. which means we're gaining pretty considerable share. And, again, that holds true across all markets and across essentially every category in our business. And it holds true across almost all sectors of the membership, both tenured members and new members. And so we do think we are a net beneficiary from people being more choiceful about when and how they make shopping trips We haven't talked a lot about our omnichannel offerings, but these become pretty important in this realm as well, where our investments in same-day delivery, buy online, pick up in club, have really helped us grow. And we know that we have an economic advantage given our larger rings, larger baskets. And so we made the decision in this quarter to launch curbside across the chain. We will soon add fresh items to that as well. And we think that will only help drive more traffic to our buildings where we make the shopping experience more convenient, recognize that people, at least some people, don't want to come into the stores. And so, you know, all of this behavior is quite encouraging to us.

Yeah, that makes perfect sense, I think, that curve side. in both will be very important. One more follow-up. I'm intrigued by the comments on apparel closed out, getting back to your TJX roots, I guess, way back in the 80s. But can you talk about is that sort of a temporary phenomenon just because there's a lot of inventory on the market, or is that something that's going to be more of a permanent change in how you guys buy apparel? Thanks.

No, we hope for it to be a permanent change. Typically, when we buy apparel, we would be buying the whole season in advance of the season, which is different from how a lot of discount apparel companies, particularly the TJXs and the Ross stores of the world, buy apparel where they're buying relatively little in advance of the season and then being much more opportunistic in the season. I think the whole world of apparel is a bit flipped on its head from what is the norm But we're looking to make bigger opportunistic buys. And we believe that will help us in a few regards. One, it will help our goods be more current and timely and fashionable. It should afford us opportunities to buy more efficiently. And then it will allow us to manage our inventory more tightly so that we don't have end-of-season markdowns to the same degree. And so this is a pretty meaningful shift for our buying teams, and they're working through how to do this well. But we're hopeful this is an unlock for us for the long term.

Yeah, it makes sense. Clearly the off-price model works in apparel. So it makes sense. Thanks. Appreciate the time. Thank you.

Our final question today will come from the line of Peter Benedict from Baird. Your line is open.

Oh, hey, guys. Thanks for sneaking me in here. I guess first question, just any color on the mix of new members that are coming in full pay versus discounted, kind of how that compares to what you typically see and maybe what you saw in the first quarter?

Yes, Peter, thanks for the question. It's an important one. We have seen more full-freight membership growth across the board, particularly with new members, than we might normally see. While we are marketing our membership, we're seeing more walk-in behavior, both online and in-store, and so that translates into even better behavior. We do know there's kind of an element of the behavior where, But the more someone pays for the membership, the more committed they are to it, and so they tend to shop more. And so that should have a halo benefit as those members continue to visit the buildings and our online offerings.

Okay, great. And then for Bob, just kind of circling back on the margin comments, so the view on merch margins going forward, I guess, in the back half of the year, at this point, you're kind of thinking more of a push, I guess, on merch margins, understanding gas can throw the gross around a bunch. Just wanted to make sure. Is that what you're trying to say?

Yeah, ignoring gas, I think we should be up a little bit based on what we see here today, but... But, you know, we'll see how it plays out. We've got a lot of puts and takes that I walked through. I don't see anything today that would make me terribly nervous that it would go down tremendously. So I would say flat to up is probably the way I would think about it.

All right, perfect. And then just last, maybe – Lee, on the whole category and SKU adjustments that you guys have been going on and now accelerated here, maybe just to give us a sense for where you are on that journey in terms of the category shifts. And, I mean, do you think you're going to be where you want to be by the end of this year, or is this something that's going to go on, you know, into 21, maybe even longer? And maybe to call our general merch versus grocery within that discussion. Thanks.

I think this is a multi-year journey where we'll continue to work closely, curate our assortment in the categories we currently compete to look for opportunities to grow into new categories. We're excited by what we're seeing from the early results. We are expanding our assortment of healthy foods, organic foods, which we know will be really important with younger members. We're doing that at the expense of traditional center store grocery items. and we think that is important for long term. We're expanding the mix of general merchandise categories into a whole set of areas that we haven't traditionally played and seeing really good results. An example of that that we think will be really relevant in the back half is fitness equipment, where we normally wouldn't play in a meaningful way, but that clearly is on trend and we have the space to do it. And then, you know, the last area that I hinted about a bit before is services, where we have a kind of a reputation and an image with our members of offering the best value in market, yet we haven't by and large competed in some pretty meaningful categories. So, you know, an example of that is cellular phones, where our offering now in cellular phones is a terrific value. We have been marketing that in clubs. We've now added the capability this quarter to do that online, and we expect that to be a multi-year growth vehicle for us. And so we'll continue to lead into the services offerings. And, you know, our competitive side clearly points the way here where we know that our competitors have much more developed offerings here than we have in the past, and it should provide a robust avenue for growth for us.

Okay, great. Thanks so much, and best of luck, guys.

Thank you. Thanks, Peter.

I would now like to turn the call back over to Lee Delaney for closing remarks.

Well, let me just say, you know, thank you to everyone for your participation on this call, your ongoing support and engagement with us as a team. We're, you know, very excited about our results in Q2, as you can no doubt tell. But more importantly for Q3, what it means for our future and our ability to invest into the strength and really transform our business. So we'll look to keep up the dialogue with you over the coming months, and I wish you all the best of safety and health going forward. Please be well.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.