Faten Freiha - VP, Investor Relations Christopher Baldwin - Chairman, President & Chief Executive Officer Robert Eddy - Executive Vice President, Chief Financial and Administrative Officer Bill Werner - Senior Vice President, Strategic Planning and Investor Relations.

Robert Ohmes - Bank of America Merrill Lynch Christopher Horvers - J.P. Morgan Mike Baker - Deutsche Bank Simeon Gutman - Morgan Stanley Kate McShane - Citi Peter Benedict - Baird Simeon Siegel - Nomura/Instinet Chuck Grom - Gordon Haskett Laura Champine - Loop Capital Scott Mushkin - Wolfe Research Chuck Cerankosky - Northcoast Research.

Good day ladies and gentlemen and welcome to BJ's Wholesale Club, Third Quarter Fiscal 2018 Earnings Conference Call. My name is Christine and I will be your lead operator today. After the presentation we will conduct a question-and-answer session.

[Operator Instructions] I would now like to hand the conference over to Faten Freiha, Vice President of Investor Relations. Please go ahead..

Thank you. Good afternoon everyone. We appreciate you joining BJ's Wholesale Club's third quarter 2018 earnings conference call. Chris Baldwin, Chairman and CEO; Bob Eddy, Chief Financial and 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 prospectus filed with the SEC on September 27, 2018, 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 the information 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 afternoon. Thank you for joining us and Happy Thanksgiving. First of all, I want to welcome Faten Freiha, who joined BJ's as a Vice President of Investor Relations earlier this month. Many of you know Faten who was previously at UNFI, we are thrilled to have her on our team and look forward to working with her.

In the third quarter we successfully executed a secondary offering of approximately 32 million shares. This reduces the combined ownership of CVC and Leonard Green & Partners to approximately 40%. As a result, we have started to add more independent directors to our Board.

To that end, I also want to welcome Judy Werthauser, Executive Vice President and Chief People Officer at Dominoes Pizza to our Board. Based on her experience at Dominoes and at Target, Judy will be a valuable addition to our Board. We are pleased with our third quarter performance.

While we're in the early stages of our transformation, we continue to make progress and we exceeded our expectations for sales, earnings, and gross margin. In the third quarter we saw sales growth of 4.3% and merchandise comp sales of 1.9%, our fifth straight quarter of positive merchandise comps and an acceleration of our two-year stack.

Adjusted EBITDA was at $149 million which is up 5.3% over last year is an all-time high for our company in the third quarter. Our performance was particularly strong in our core Northeastern markets. Our progress continues to be driven by disciplined investments in the capabilities necessary to unlock our true potential over time.

We believe these investments are driving growth across our strategic priorities. First, I'd like to update you on acquiring and retaining our member base. Membership is the foundation of our company. In Q3 our membership and renewal rate trends continue to exceed our high expectations despite the fee increase instituted earlier in the year.

We expect to report that year end membership and renewal rates will be at historic highs. We're particularly pleased with the success we're having in re-engaging lapsed members as we focused on reaching out to previous members and showcasing our transformation.

We continue to focus on acquiring new members through digital channels which are key to attracting younger members. Through Q3 we have more than doubled the number of members acquired digitally versus the same period a year ago.

In addition, we are successfully moving members to our higher membership levels with nearly a quarter of our members now in premium tiers. In Q3 we also held an open house to showcase our transformation to nonmembers prior to the holiday season.

The open house was an extension of our membership acquisition program and gave us the opportunity to talk to prospective and most importantly lapsed users.

We used the event to showcase the value, merchandise and services we offer, previewed some of our Holiday and Black Friday deals and highlight the convenient new features we have launched and improved over the past several months. Services like our app, buy-online-pick-up-in-club, digital coupons and of course same day delivery.

Our second strategic priority is to deliver value to get members shopping. Our progress is based on delivering outstanding value to our members. We strive to give members a 10x return on their membership fee and continue to invest in pricing to deliver unbeatable value every single day.

As you may recall, we have more than a million members who shop us more than 50 times a year. Our fresh business is key to delivering member value and driving frequency and we are committed to maintaining extremely sharp pricing in this area.

While Q3 saw a deflationary environment in many perishable categories, unit sales were up as we continued to focus on value and much improved execution by our field operations team. Our private-label brands are crucial to delivering great products at outstanding value to members.

We have a very strong pipeline of owned brand products and in Q3 launched Wellsley Farms' seafood items and fresh packet soups in the marketplace. For the quarter owned brand's penetration was 20%. We also deliver outstanding value to members by offering great assortment. We started our assortment transformation by focusing on general merchandise.

This category is key to creating the treasure hunt that drives trips and engages members in our clubs. Our recent results show the effect of this work as GM comps were up 5% in the quarter. Our apparel business continues to benefit from our investment in assortment of capabilities.

We're now able to offer the latest trends in seasonal apparel at unbeatable prices. In Q3 apparel grew by double digits as we delivered great value with brands like Levi's, Champion, IZOD [ph], and Jones New York. Earlier this year we invested in improved TV signals to our clubs allowing us to better display HD 4K TVs.

As a result we saw strong TV growth in the quarter and clubs with the improved signals are double-digit comp increases. This bodes well for our Black Friday performance in TVs as well as other electronics categories. We're accelerating our assortment work in categories outside of general merchandise for the first time.

Earlier this year we relaunched our Health & Beauty category with a more focused assortment and much enhanced marketing. The results have been strong driving business increases in members, shopping and in sales with 6% fewer items. Lee and his team have also updated our baby section moving from two national brands to one in diapers.

Overall we reduced diapers, wipes, and training pants assortment by approximately 30%. We used the freed up space to create a convenient one-stop location of items including toys, baby food, car seats and formula.

We are in the early stages of this change, but this is a key category for many of our newest members who are just starting families and we'll be rolling out our improved assortment chain wide in 2019. Our third strategic priority is our attempt to make it more convenient to shop at BJ's Wholesale Club.

A key element of our transformation is building a true omnichannel offering that let's our members shop how and when they want, whether it is in-club, online or via a mobile app. We've taken an agile approach that allows us to quickly develop and launch new features.

Over the past year we launched an app, Digital Coupons, Buy Online Pick Up In Club, Same Day Grocery Delivery, and most recently Next Day Tire Installation. Let me make a few comments on each. A little over a year ago we launched our mobile app. We continue to enhance the app and downloads grew by 20% in the quarter.

Members have already clipped 10s of millions of digital coupons and we continue to add features that will help unlock the value of the BJ's membership by making shopping even more convenient. In Q3 we launched a reorder feature which lets members place orders from the app based on their purchase history we also added same-day delivery from the app.

Our tire business shows how our investments in this area deliver both value and convenience to our members. We know that members can save $100-$150 when they purchase tires from us and we work to make this process even more convenient for our members.

This quarter we launched next day tire installation which allows members to order tires and can scheduled next day installation online. Following this launch digitally enabled tire sales more than doubled for the quarter.

This is an excellent example of how we can use our online platform to deliver value to our members, improve convenience and drive sales and traffic to our physical locations. Our investments are also allowing us to deliver personalized offers that help drive trips and get members to shop new categories.

These offers delivered through both digital and traditional means have a high response rate than non-personalized offers. This effort is still just beginning but we see significant opportunity in personalization and plan to further scale it moving forward. Finally we plan to expand our strategic footprint.

We reinvented the BJ's Club opening model using a data-driven approach that has yielded much better new club performance. As a reminder, the clubs opened using this approach in Kearny New Jersey and Somerville South Carolina outperformed the clubs opened before we used this approach.

In Q3 we opened in Roanoke Virginia which is our 216th club and 136th gas station. We exceeded our initial membership goals for this club and we're on track to open at least four clubs in 2019 with our next new club in Clearwater, Florida set to open in the spring.

I'm also pleased to announce our plans to add two new clubs and gas stations in Eastern Michigan. This represents a new market for us and we're thrilled to be part of Michigan's future. At BJ's we proudly serve hard-working middle class families and see Eastern Michigan as a great fit for our company.

We expect the clubs and gas stations in Madison Heights and Taylor Michigan to open late in 2019 and are actively looking for additional growth opportunities in the region. Overall, we're pleased with our Q3 results. We continue to make progress on our transformation and have significant opportunities ahead of us.

We have strong plans in place for the holiday look forward to building on our momentum. 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 afternoon everyone. As Chris noted, during the third quarter we continued to drives gains in sales and see encouraging membership trends. In addition, we improved our gross margin enabling us to invest to further our capabilities and fuel topline growth. Finally our profitability and cash flow results were very strong.

Our performance demonstrates our continued execution against our strategic priorities, attracting and retaining members, delivering value to get them shopping, making it more convenient to shop at BJ's, and expanding our strategic footprint. Let's turn to our results. For the quarter net sales increased by 4.3% to $3.2 billion.

Comp sales increased by 3.6% including a 1.7% favorable impact from the sale of gasoline. Merchandise comp sales which exclude gasoline sales, increased by 1.9%, primarily driven by increased traffic. Let me give you some color on two factors that impacting our sales performance for the quarter.

First, as Chris mentioned earlier, the membership open house event that we ran in the back half of the quarter performed in line with similar historical events and represented a contribution of approximately 0.2% to our merchandise comp sales results. We expect to see additional membership and sales benefits over time from this event.

Second, after experiencing very little net inflation or deflation in the first half of the year, deflation accelerated in the third quarter, primarily in our Perishables division. The impact of this net deflation was approximately 1.5% on our Perishables division comp or 0.4% on the total company merchandise comp for the third quarter.

We have improved comps across all of our four divisions since the beginning of the fiscal year. Our General Merchandise business led our merchandise comp sales gains with 5% comp during the quarter. This represents a stack comp for our GM business of 8% and continues the strong momentum we saw in the second quarter.

Chris mentioned earlier that some of the key drivers of our success here are our TV and apparel categories. Comp sales at our edible grocery division increased by 1% during the quarter driven primarily by our water and specialty beverage categories.

Comp sales of our non-edible grocery division increased by 3% during the quarter driven primarily by our laundry and HBA categories due to the impacts of assortment changes that Chris mentioned earlier. Our perishable comp sales were flat for the quarter. Unit growth during the quarter was offset by the impact deflation.

The fresh category such as fresh beef and pork and fresh fruits and vegetables all saw deflationary pressure during the quarter. While we are pleased with the unit growth in these categories, we expect these deflationary pressures to continue into the fourth quarter. Membership fee income grew by approximately 10% during the third quarter.

Approximately two thirds of the growth was driven by our membership fee increase and one third by member growth. Gross margin dollars increased by $31 million and gross margin rate increased by 20 basis points to 18.4% over the third quarter last year. As you know, gasoline is sold at lower gross margins than much of our other merchandise.

Excluding the impact of gas sales our merchandise gross margin rate increased by approximately 60 basis points over last year driven by our procurement initiatives. Our reinvention of procurement which began nearly three years ago has been considerable.

We have surpassed $300 million in procurement cost savings due to these efforts and we continue to innovate to drive an optimized assortment and achieve the next waves of savings. SG&A expenses were $500 million in the third quarter compared to $480 million in the prior year.

Excluding expenses associated with our secondary offering and other one-time expenses, SG&A for the third quarter was $496 million compared to $474 million in Q3 last year. This increase reflects continued investments in membership marketing and talent to continue to drive the company's strategic priorities.

Operating income adjusted for the expenses mentioned earlier was $94 million compared to $87 million in the prior year as a percentage of total revenue increased by 10 basis points year-over-year. We continue to remain balanced in our approach to investing while also improving our profitability.

Interest expense decreased to $33 million from $42 million in last year's third quarter. As you know we completed repricing transactions for our first lien term loan and ABL facilities during the quarter.

Please note that this quarter's interest expense included a $6 million write off of deferred financing costs and transaction fees related to those repricing transactions. For the quarter we had an income tax expense of $3 million compared to $15 million in the prior year.

The variance between our normalized tax rate of approximately 27% and the reported rate of 5% was driven primarily by an approximately $8 million windfall tax benefit from stock options exercised in connection with our secondary offering and two additional benefit items totaling approximately $5 million related to reduction in our reserves and deferred tax liabilities.

Going forward we expect to realize windfall tax benefits as stock options are exercised. These benefits are treated as discrete items in the period in which they occur. Timing and amounts of windfall tax benefits are difficult to estimate. Again we estimate our normalized effective tax rate to be approximately 27%.

Adjusted net income was $54 million in the third quarter or $0.39 per share compared to $35 million or $0.25 per share in the comparable period last year.

Adjusted net income for this year's third quarter primarily excludes transaction fees and the write-off of deferred financing costs related to the repricing of our first lien term loan and ABL facility, along with the windfall tax benefit related to the secondary offering.

For the purposes of calculating adjusted net income, we have used a normalized tax rate of approximately 27%. Our press release includes a table that reconciles GAAP net income to adjusted net income including on a per-share basis. Adjusted EBITDA increased to $149 million in the third quarter from $141 million in the comparable period last year.

This is a record level for us and we're proud the continued significant increase in profitability over the past 11 consecutive quarters. For clarity on the adjustments used to arrive at these figures, please see the non-GAAP tables included in our press release.

Moving now to the balance sheet, total inventory was up 5% over the last year's third quarter driven by changes and timing of inventory receipts. Our AP to inventory ratio, which measures how much of our inventory is sold before we pay for it improved to 78% versus 75% last year. In prior quarters we have been disciplined in our inventory investments.

That discipline continued in Q3 and our inventories are well-positioned going into the holiday season. Year-to-date free cash flow which we define as operating cash flow less CapEx, came in very strong at $148 million versus $14 million in the same prior year period.

Recall that the prior year included a one-time cash outflow of approximately $73 million related to our February 2017 recapitalization. Therefore a more appropriate comparative prior-year amount is $87 million. The strength in this year's cash flow is driven by our improved profitability and strong working capital management.

As a result we have continued to pay down debt and our net leverage to LTM adjusted EBITDA ratio at the end of the quarter was 3.3 times. We expect to further reduce our leverage supported by our strong cash generation in the fourth quarter.

We're pleased with the results we have delivered on all of our key metrics thus far and in our earnings release we have updated the guidance for the fiscal year. There are a few items I'd like to note as it pertains to that guidance.

Before I get into the details, let me take a moment to remind you that fiscal year 2017 was a 53-week year and as a result the fourth quarter was a 14 week quarter compared to a normal 13 week quarter this year. We estimate the 53rd week to represent approximately $240 million in net sales and $15 million in EBITDA.

Our full-year comparable sales projection is 1.9% to 2.1%. On our second quarter call we discussed our view that the fourth quarter we discussed our view that the fourth quarter looks slightly more favorable than Q3 from a comp sales perspective.

Those underlying fundamentals remain in place, and we expect Q4 comps to be affected by the deflation that we have seen of late in our perishables business.

We've updated our full-year EBITDA and adjusted net income guidance to reflect our third quarter to be and now expect to report adjusted EBITDA in the range of $558 million to $565 million and adjusted net income in the range of $170 million to $175 million for the fiscal year.

We expect our fully diluted share count to be 140 million shares at year end. Our full year interest expense guidance remains in line with our prior guidance. As you know, our first lien term loan and ABL are both floating rate facilities.

Last week we entered into a series of interest rate swaps that fix $1.2 billion or approximately 60% of our debt at a LIBOR rate of 3% beginning in February 2019. As we continue to repay debt, that percentage of fixed-rate debt will increase significantly. As a result we believe we are now well-positioned to manage future interest rate risks.

I would refer you to the table in our press release for more details on our updated full year guidance. We remain committed to delivering on the long-term financial goals we highlighted last quarter and look forward to providing guidance for 2019 on our Q4 earnings call.

In closing, we have a business that is earning its right to grow with five consecutive quarters of comp sales growth. We've seen encouraging membership trends and substantial increases in profitability and cash flows enabling us to continue to invest for future growth.

I am proud that our continuing transformation has yielded Q2 performance that exceeded our expectations. I am also happy to have reported to you an outlook for the remainder of the year that reflects our great year-to-date performance along with a meaningful impact our debt repricing transactions.

Finally, we have solidified our long-term interest expense outlook as a result of the rate hedging transactions consummated in the opening days of Q4. I look forward to delivering on our goals for the remainder of the year and now I'll turn the call back over to Chris for closing comments before we begin the Q&A session.

Chris?.

I want to close by saying that we're pleased with our Q3 results. Our performance shows that we're making progress on our transformation as we exceeded expectations for sales, earnings, margin, and reduced our debt. We remain on track to reach historic highs for membership and renewal rates.

We feel very good about our holiday plans and our ability to deliver on our long term targets. I most importantly want to thank every one of our team members who've worked so hard to help us transform our company. We're very proud of their efforts and think we have many, many miles to continue to go in our transformation.

And I'd like to wish everybody on the call a Happy Thanksgiving. With that operator, we'll go to Q&A..

[Operator Instructions] Your first question comes from the line of Robby Ohmes from Bank of America Merrill Lynch. Your line is open..

Hey, guys congrats on a good quarter.

Actually two quick questions, the first was just you know now that you're beyond the member open house, what do the trends look like on how well you are converting some of those people to members, do you have any data on that, any thoughts on how that might help membership growth going forward?.

Look Robby, I think overall we feel very good about the membership growth overall.

We're not going to get into the specifics of every tactic we pull, but as we think about our transformation Robby, over time we started with changing dramatically the company's ability to earn and we've started over the last year and a half or so reinvesting that money in earning the right to grow as Bob indicated in his comments.

Membership is the most important investment we'll make and we'll continue to use different approaches to appeal to both new members and frankly lapsed members. The big news for us is how important lapsed members and digitally acquired members have been to improving.

In total they're probably a little bit over 20% of our acquired members in the year and we feel really good about our ability to continue to do that..

That sounds great. And then, I guess this might be for Bob.

Can you give us any guidance on - for gasoline it was year-over-year is gas a tailwind or headwind to your profitability in the quarter you just reported and then maybe thoughts on how we should think about it in the fourth quarter?.

Yes. Hey Robby, gas has certainly been a little bit of a tailwind at the end of Q3 here and the beginning of Q4, not an incredible tailwind, but certainly the market has provided some benefit there. As you think about Q4, Q4 tends to be the most volatile of the quarters from a gasoline pricing perspective.

So the favorability that we've seen so far in Q4 could easily go away. So we're not putting it in the bank yet, but it's certainly had been a little bit of a tailwind so far..

Got it. That's really helpful. Thanks guys..

No problem. Thanks Robby..

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

You sound very fancy, it's Horvers..

I'm glad you said that Chris, because I was going to be really tempted..

So, first question is on the comp guide. Bob you sort of said we continue to expect 4Q to be better than the third quarter, but then you've got deflation, if you drafted it in the model it's pretty wide. It's sort of like one 1.5 to 2.5 implied complex guess.

So just could you sharpen the pencil on the 4Q comp guide?.

Yes, Chris, you're absolutely right, that's the implied Q4 range and when we think about, we think about how to rationalize that - come off the trend that we've had all year long of somewhere around 2 and we told you in the prior quarterly call that Q4 was shaping up a little bit better, we still believe that ex the impact of deflation.

So if we hadn't seen that deflation we probably would have taken the applied range for Q4 up a little bit more than what we took it up from this standpoint. So that range is a midpoint of 2 which is more or less the trend that we've seen, but reflects that headwind from a deflation perspective.

So we're feeling pretty good about the business at this point and even in the deflationary categories we feel great about the unit growth that we've seen in those categories that tells us it’s a temporary pricing issue not a business issue and our traffic is growing nicely. So we're not so worried about any of that..

Understood. And then as a follow-up question, the CPI benefit, the merchandise margin expansion has been strong all year, I think up 60 in the in the third quarter which is pretty similar to the second quarter.

Can you talk about what your outlook is implied in the fourth quarter and how much legs do you think there is on CPI as we look to 2019? And then just as a tangential question, this fresh deflation does that end up being a benefit or a headwind from a merchandise rate perspective? Thanks..

So certainly, we beat our expectations from a CPI perspective in Q3 and we had forecasted, we are little lower than 60 and came out on the high side of that. I would say, we hope for the same thing to happen in Q4, we're forecasting lower than 60 and expect to roughly do a little bit better when everything is said and done.

We have future savings coming of things that we've already sourced and we expect to continue this program going forward in its current iteration as well as new iterations. In my comments, I talked about how we are evolving the process a little bit and Chris talked about some of the assortment changes that we've made in categories like Baby and HBA.

Those started as ideas that fell out of the CPI process and so now we're merging those two thoughts to have one coherent process to get the right assortment on the shelves at the right cost.

So to us that's really the next leg of growth from a CPI perspective is taking a holistic look at categories understanding what should be on the shelves, understanding our relevant brands versus our strength in owned brands in each particular category and making some bolder bets from an assortment perspective as we go.

We've proven that it works in apparel and HBA so far and in Baby, we will see how that continues to work as we roll it out throughout the chain in Q1, but we are happy with where we are from a CPI perspective. We are very pleased with the results in Q3.

We have chosen to hopefully be conservative in our guidance in Q4 and we see a lot of growth coming from that perspective as we enter next year. From a fresh perspective, I guess what I would tell you is, we saw significant margin growth in Q3 in our fresh categories.

The vast, vast majority of that was due to CPI efforts rather than any of the pricing or cost changes associated with deflationary categories.

And I'd ask you to remember back to some of our earlier discussions when we were first telling you about our CPI process, we put a chart up in front of everybody that talked about the different categories that we had done on that chart.

We hadn't done a whole lot of perishables categories at that point and this is our first year that we have really touched perishables with any vigor. That has yielded great results. It was our highest margin growth in basis points of our four divisions by a long margin and no pun intended and that that should continue, so that's what I'd tell you..

Thanks very much..

No problem..

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

Hi, thanks.

A couple more merchandising questions, you didn’t talked about toys at all, at least I didn’t hear it, and I know that was one of the reasons why are you expecting a 4Q comp acceleration, so if you could touch on what you're seeing in that category?.

Yes, hi Mike, thanks your question. Toys is an important category for us. We feel very good about our toy assortment if you’re in our clubs at all in the last few weeks. We feel really good about the assortment we have. We expect it to grow substantially.

We expect to grow share in toys and in particular we're doing a much better job online with toys as well. So the combination makes us feel really good as we go into the fourth quarter given the market disruption in that category..

Okay.

And I guess as a followup because this is on the same topic of same-store sales, can you discuss the monthly trends and you said Northeast was strong than any other regional calls or impacts from weather, hurricanes, rain in Mid-Atlantic, et cetera?.

Yes, overall the business was strong in the last month of the quarter and it was a little, it was not as good as we wanted to be right in the middle because of all the rain you refer to.

So we had the hurricane from a year ago in the basin we talked to you in our last call about the issue associated with in the year ago period in Florida where there was quite a bit of government spending after the hurricane which provided some comp strength which we were up against this year.

And in our Northeast markets, we performed really, really well despite the fact that the rainfall, our intent is never to give you a weather report, but rainfall was up between 50% and 100% in these markets, you folks mostly live in them, so you felt that just like we have.

So it's been a very another wet cold quarter and despite that we feel we got through it, but we consider weather to be about a half a point of comp headwind in the quarter.

To give you some texture on that Mike, on the hurricane impact just batteries year-on-year was down $3 million in the quarter, that's about a 10th of a point to comp on the company and that was all because of what happened a year ago in the hurricane period last year in the southeast..

Okay. I appreciate the color. Thank you..

Thank you..

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

Hi, everyone. Good evening.

My first question is, if you look at spend per existing number and you strip away fuel, I don't think you'll tell us what that’s trending on a number basis, but can you tell us directionally how that looks and I guess it sounds like now we probably should think about weather and some of the perishable deflation to try to normalize those numbers?.

Yes Simeon, I guess what I would tell you on that one is spend per member is going up a little bit, and you look at the – just look at the core of the business you've got traffic gains, you've got a little bit more members in there as well, but we feel good about the member shopping, the member spend trends that we see on average.

Chris mentioned some of the things that are also affecting the business in his comments right, we're bringing back more lapses members. That's been an important thing for us too as we go. So as we look across the member portfolio, we're pretty pleased with a lot of what we see..

Okay.

And my followup is on the topline and the initiatives that you're working on surrounding memberships, surrounding assortments, is it reasonable to expect that the run rate of the business in terms of topline growth should accelerate as these initiatives take hold or is it that look the business should continue at this steady rate as a result of these efforts?.

I think the way that I would answer that is through the lens of our general merchandise business which is a business that was declining for most of my tenure with the company and now we've turned that around. We're doing a nice job comping the comp this year and stacking comps.

It's the business that together as a team we've been working the longest on together that was the first business we started playing with from a growth perspective and so you're seeing that bear fruit faster than the rest.

But look it's a competitive world out there, so we're trying to move as fast as possible in the rest of the categories and no one is less satisfied with our pace than ourselves. We are very critical of ourselves on how fast we're moving to change the assortment and deliver value in every category that we have.

And so you're seeing us make some good early wins here and we look forward to putting more runs up on the board, but we also understand our responsibility to all of our investors to put numbers out there that we know we can hit. And so you're never going to hear us, at least I don't think put out grandiose comp expectations.

You're going to hear us have reasonably balanced views of our business. We will be bullish in the categories that we're bullish and will be reasonable in the other ones.

So as you think about longer term guidance, I wouldn't stray too far from what we told you from a long-term guidance perspective last year until we’re ready to really move that around..

Yes, thanks Bob..

Thanks Simeon..

Your next question comes from line of Kate McShane from Citi. Your line is open..

Hi, good afternoon. Thanks for taking my question.

I just wondered if you could comment at all about anything you saw during the quarter with regards to market share gains in general and how it contributed to the comp or any perspective on contribution from Sam’s Club in the third quarter and the Sam’s Club closures?.

Thanks Kate. Overall market share was in our fresh in grocery business was about flat and we believe we grew share in general merchandise as we put up a five comp 8 stack. So overall we probably grew by a little bit overall.

And this is a story to Bob's earlier comments where we're trying to be really balanced in how we make investments based on our ability to make progress on our cost structure and reinvest the business in the long term health for the benefit of the company and shareholders over time.

In terms of Sam's we continue to work on making sure we're giving those members the services they want in the markets in which Sam's is exited and we don't get into specifics, but we feel good about our ability to continue to meet the needs of those members..

Okay great.

And if I could just ask a followup question on the general merchandise categories in Q4 just from a margin standpoint with investment in categories like toys and some of the hard lines from a mix perspective will this be offset by the higher margin in apparel?.

Yes, Bob gave you some guidance, why don’t you give some sense of what that looks like Bob?.

I think that's fair. I mean general merchandise is a really general statement performs around the company average from a merchandise margin perspective. So I wouldn't tell you it's very high margin, I wouldn't tell you it's very low margin. Certainly some of the moves we've made in the past couple of years have helped from a mix perspective.

As you think about Q4 specifically, Q4 is a little lower margin from a GM perspective as it's a more promotional time as you might expect. So we've modeled that into our guidance for the quarter and we're looking forward to beating it..

Hey Kate, let me just add one thing. I usually don't add on, but I want to on this. When Lee Delaney and his team have done quite frankly an outstanding job in helping the company think about mix and how it manages everything from assortment to how we market to how we promote.

And on that basis we feel good about where we are as we head into the fourth quarter that we'll been able to deliver on the guidance Bob provided..

Thank you..

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

Hey guys thanks. First question auto renew.

Can you give us a sense of maybe how that's tracking relative to your expectations? I assume it's up versus last year but just what's happening with auto renew?.

Auto renewal is, we now have just a little bit over 50% of our members on auto renewal, 51 is the number..

All right terrific.

On the deflation, is that purely commodities based or are you guys doing anything or is anyone in the market doing something to try to maybe push on price to drive units?.

I would tell you it's mostly the cost coming through. There are some places that it's a little bit disconnected where the cost might be down a little bit more or less than the prices gone through, but as a general statement it's all commodity based. So you're seeing it play through that way.

And we've seen as I said in my comments great unit growth in most of those categories. So take a category like fresh fruit, we were down five from a cost perspective but up 8% in units, so we're not we're not dropping units as we go as well.

So we'll manage our way through it and in the CPI process can be helpful as we do that and we know we'll come out the other side and be just fine..

Okay, great. And then just the last question and maybe a little more color as to why Michigan and when we should maybe expect other new markets to come up on your store opening plan? Thank you..

Bill and his team have done a really good job of working on the markets that we think that our offering would be a value add to the consumers we have the good fortune to serve and as we looked at Eastern Michigan, the combination of the consumer base the competitive environment was one that was pretty compelling to us and we're excited about going there late next year.

So will - and we'll keep you posted on any further expansion as we go forward..

Okay great. Thanks so much, guys..

Thanks Peter..

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

Hi guys. Good afternoon. Can I ask about the, I do want to start asking about the fresh business. Can you just talk about what you're seeing there, especially from like an underlying momentum standpoint? I mean I know we had deflation this quarter, but units seem a little sluggish, share is flat.

This category is an opportunity for you, so how are you feeling about the progress maybe an update on in club execution and just how focused are you on driving you know better units going forward here?.

Yes, sure. Thanks for the question. I wouldn't say that our units have been sluggish. The category as a whole was flat, but that was point and a half of deflation offset by unit. So it's not like we're bleeding units or even really flat in units. We've seen nice growth in many, many categories and in particular the key categories.

So if you think about fruit and vegetables as I said a second ago fruit was up 8 during the quarter, vegetables are up 6 during the quarter. So we're in really key categories like that seeing great unit growth and that directly links back to the improved execution from our club operations team.

We've put a tremendous amount of pressure and resources behind fixing the execution out there, getting it more consistent, making sure that we have the right team members in the right place at the right time, training those team members. We've talked about putting the right team members behind the membership desk.

All of those things, it's not just a fresh thing for us, it's making sure that we feel great about the entire business. And so, we're pretty pleased with the fresh business. It remains an opportunity for us.

As you know it's a long term rebuild of that business, but as we sit here today from the place we started two years ago we are very happy with the progress that we've made and we've we see a whole lot more coming..

And then just as a followup one, when CPI and the upside that you're seeing from the process, when thinking about as that relates to the level of comps and where top line of the business is today, any thoughts around taking some of the upside from the process and looking at that value bucket that's important for you and pushing a little bit harder on that value bucket with the upside to get some complex out of that, just thoughts on how you think about that whole balance?.

Ed, let me give you my perspective on that. Overall Lee and his team have done a really good job in managing CPI.

And overall the approach we've talked to investors about is a pretty balanced approach between sales and earnings growth, but pricing and our ability to deliver on the pricing model that we've talked to you about at some length is sacrosanct where we are, we will never come off of that in my tenure here.

And so our ability to continue to drive value that leads the market across the board is something we feel great about.

The place where we think we are able to do - to continue to improve the track record and what has delivered, what several quarters of improved stacks over time is our ability to do the right value proposition as well as the right assortment.

But we've talked about trading jewelry for apparel, we've talked about trading, doing some better work in baby. We've talked about doing some better work in a variety of house wares categories and Lee and his team have done a really, really good job in that.

And so we're going to continue to offer market leading value and we are going to continue to invest in price every single day..

Okay. Thank you..

The other thing I'd ask you to think about Ed is how we're investing in technology to drive value like the tire business in club stores is terrific, but it's not that convenient. So we're investing in technology.

I made a couple of comments in my comments about you can save 100 bucks but it's not that convenient, and the investments we're making in technology to make the trip more convenient, I think also can help us..

Got it, thanks..

Thank you, thanks Ed..

Your next question comes from the line of Simeon Siegel from Nomura/Instinet. Your line is open..

Thanks, good afternoon guys. Nice quarter.

Chris, what do you say the private label penetration was this year versus same period last year, maybe an update on where you think that can go? And then Bob, just as we round out this year, any color on things to keep in mind for expenses next year and if there is anything wage related or freight or just any things to keep in mind? Thanks..

Yes, I’ll take a shot at both and then Bob can add. Simeon, the number in private label was 20%.

Seasonally it's a low quarter for us in private label because we don't have things like big seasonal patio sets and frankly we expect some of the private label things we're doing in the fourth quarter to flow through an even better number as we look at that quarter.

So 20% is the answer to that question and we feel good about our private label business. Over time, we expect that number to grow to at least 25%. This year we’re up about 60 basis points so far this year and we think we're going to get about a point a year.

On the expenses in the macro, I know there's a lot of questions about wage inflation and there's no question that in certain markets we're dealing with some wage inflation but we'll continue to deal with that locally.

I'd ask you to consider that relative to other retailers in general, this is a lower labor model, so as you think about wage cost inflation it's less of an impact for us than others. On freight, we also have a dedicated fleet that we work with one of our suppliers on that.

We have been able to manage through some freight pressure, there is some freight pressure for sure, but it's nowhere near what others are dealing with.

Bob, do you have anything to add to that?.

No, I think those are the two big ones we talk the most to investors about and we'll give you detailed guidance on our next call for next fiscal year..

Thanks guys. Best of luck for holidays..

Thank you Siegel, Simeon..

Thank you..

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

Hey thanks, guys good afternoon.

Just to circle back on the general merchandize side of the equation, where it's going to settle out as a percentage of the mix in 2018 and then just to give some perspective where was it maybe five to 10 years ago and I guess how quickly do you think you can narrow that gap looking ahead?.

Probably the high watermark for the company was in the low to mid-20s. We’re up in the higher teens now, Chuck.

I think you've written about this and take the numbers pretty accurately from back in the 25% days, there's no question that company had done think about it as 25 probably to a lower 15, we’re back in the 18 range and we expect to get back to 25.

I've said it a couple of times now, Lee and his team have done a really, really good job in managing assortment. Our team there is, we've made material investments in things like TV signals and there's a lot of room to continue to figure that out and we feel good about that..

Okay, then Bob, just any sense of how much that implies as a percentage of the mix from 3Q to 4Q as you have a pretty easy comparable in that general merchandise category from last year?.

We do, we're certainly expecting some good results from our team here in Q4. I wouldn't say it's a tremendous benefit to the mix, but it's certainly baked into the comp guidance that we've got and the margin guidance that we’ve got out there..

Okay, great and then just Chris, bigger picture you talked about it in your opening remarks about the opportunity from lapsed members, just wondering if you've done any more work on the catalog that's out there, how you can go about attracting them back, just sort of frame out the opportunity because it seems to be pretty big?.

Yes, we think it is and I think that the - Chuck probably the most interesting thing that really brought this to my mind was two years ago we opened in Kearny, New Jersey which is eight or nine miles north of Newark Airport and frankly it's an infill club in a market where we're pretty saturated, and about 15% of the members we got in that club which has been very successful were lapsed members which had us think a little more strategically about how we approach that opportunity.

So as we think about the fact that we've made some progress with the company and I keep on saying it but we have miles to go but as we've made more progress, our membership team led by Brian Poulliot has done a good job in reaching back into the member roles to make sure they understand the value prop we offer with a particular emphasis on the capabilities we have today BOPIC, same day delivery, a much better general merchandise assortment and using those as marketing tools to get them back in.

And I said in my comments that the most compelling thing about our membership proposition is the combination of what we've been able to do digitally and getting at lapsed members..

Okay, great. Thanks a lot, Happy Thanksgiving to both of you guys..

Thank you, Chuck..

Thanks Chuck..

Your next question comes from the line of Laura Champine from Loop Capital. Your line is open..

Thank you.

I think my question is for Bob and can you give us a look into where you think interest expense is likely to fall out next fiscal year and maybe comment on your balance sheet goals more generally?.

Yes, hi Laura. Certainly, we've got a lot more visibility and I tried to give you color on that during my prepared remarks, given we've fixed a big chunk of the LIBOR exposure at this point. Going forward, first and foremost what we're trying to do is get leverage below three times.

We've made considerable progress against that goal this year and should be there before the end of the year, next year. We'll do that obviously by paying down debt somewhere in the neighborhood of a couple of $100 million per year is how you should think about it.

So if you're running your model, now you've got a fixed LIBOR rate at 3% and our first lien is at 3% spread and our ABLs at 125 spread, I believe. So you can kind of run the model that way. There might be it’s a market get a little bit better, there might be a repricing opportunity next year.

As we look forward to that, there was probably one earlier in Q3 for us before the equity market went sideways, but we've got the soft call in place that expires, I believe in early February.

So look, we will look to do the best job we can getting up free cash flow and use that to de-lever and get down to that three times mark as soon as possible and that will obviously hit interest expense lower and lower as we go..

Great, thank you..

Thanks Laura..

[Operator Instructions] Your next question comes from the line of Scott Mushkin from Wolfe Research. Your line is open..

Hey guys, thanks for taking my question. So I guess I'm trying to kind of understand a little bit of the promotion that you ran, I think you called it open house three months free.

I guess my first question around that is, when is the last time you did that three months free and then half of your off the next year?.

The company ran an event like this in 2012. So that's the answer..

Okay, great.

And then my followup question obviously most a lot of us on this call fallow Costco and one of the ways the investors look at it is membership is an annuity and then not looking at it as a gross margin story, you guys are almost a little different in kind of memberships being given away for free, but we're going to do gross margin improvement.

I guess I'm just trying to understand as investors how we're supposed to look at that from in comparing to your closest competitor?.

Scott, I would challenge the notion that we're giving membership away for free. We got almost over 5 million paid members, they pay us on average of 55 bucks a year to come in and experience the value and the offering that we have.

So that simple answer is we're not giving it away for free, it's almost $300 million of profit roughly half of our adjusted EBITDA. So start from that perspective. We have great renewal rates, they've been improving every single year this team has been together.

We are now going to, at the end of this year hopefully report our fourth all time high of renewal rates in a row and we are getting in the neighborhood of Costco's renewal rates.

We've still got a whole lot of work to do to get there, but the trend is impressive and so that annuity of the membership is certainly in play in our business just as it is in theirs.

We absolutely look at it that way and that's why we spend a whole lot of time talking and thinking about how to provide our members the best experience and the best value that we can every single day because the annuity is the backbone of the business and if we don't give them a good experience and a good price when they come in to buy then it threatens the existence of that annuity.

So we feel great about our membership business. It's been dramatically improving over the last couple of years and I’d encourage every investor out there to look at it through that annuity lens as they think about the value of our company and the value of our stock..

The other thing Scott I think that's important is this, our ability to improve margin is in driven entirely by our ability to buy better not taking pricing period.

So as we came in here as a team a couple of years ago, it was obvious that - it was obvious that the company’s ability to procure was weak and we have reset that capability and feel really good about the progress. But the first thing we do when we think about our procurement capability is how do we make sure we're price right in the marketplace.

Thanks for your question..

Your next question comes from the line of Chuck Cerankosky from Northcoast Research. Your line is open..

Hi, Chuck..

Hi, Chuck..

Hi there. Good afternoon everybody. Thanks. Congratulations on a good quarter. And looking at the 5% comps in general merch and then the lower numbers in grocery and food and I know you've got some deflation in there, should those be closer together and what gets them both at higher levels and I'd say the general merch is at a pretty good leve?..

Yes, I think over time Chuck we are, I've been really consistent and probably a little bit boring is we're investing in some core capabilities that we think will benefit the company over time. And I'll accept, I clearly accept that and I feel good about what we're doing and we're all incented to move it more quickly.

I do not think the grocery business particularly is the center store grocery business, I'm not sure that one is going to ever grow at the mid to high single digits.

But our ability to continue to make progress to run our fresh business well which we're starting to make progress on the GM business is all about, how do we price, how do we have assort and how do we market.

And the combination of those capabilities, how we think about our investment pools and what are we going to invest in to create a great experience for the member and over time we expect to continue to make progress..

Do you include and see opportunity for fresh prepared foods as part of that?.

We certainly do. You'll see more from us in that regard in the future for sure. We think fresh prepared food is a terrific category.

Frankly, we don't do much more than rotisserie chicken today and some of the encouraging progress that has been made in private label is in things like seafood and soup that we talked about this quarter, it makes us even more encouraged about fresh, prepared fresh over time..

All right, thank you very much. Good luck in the final quarter..

Thanks Chuck..

Thank you..

Thank you. That concludes our question-and-answer session for today. I would now like to turn the conference back to Chris Baldwin for any closing comments..

Thank you very much for your time. We wish all of you a happy and healthy and most importantly a safe Thanksgiving. Have a great day..

This concludes our conference call. You may now disconnect..