Ladies and gentlemen, thank you for standing by and welcome to BJ’s Wholesale Club Q2 FY ‘20 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session.

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

Good morning, everyone. Thank you for joining BJ’s Wholesale Club’s second quarter fiscal 2020 earnings conference call. Lee Delaney, President and 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 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 will turn the call over to Lee..

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 6 months, we acquired and retained approximately 18 months worth of members.

This pace, should it continue, would have us experience 3 years of membership growth in this one transformative year. Not only our 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 number 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 re-launched 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, pickup in 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 in sales trends. We expect to open 2 new clubs in New York around the end of the fiscal year and concurrently see opening as many as 6 new clubs next year. We are moving aggressively to make those numbers or even larger ones a reality.

Our balance sheet is of radically different quality today. We have used the massive amounts of free cash flow to reduce leverage to 1.4x funded debt to EBITDA versus 2.9x just a year ago. And we began to selectively buyback 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 will 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 have 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 ticket. 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 6 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 buy online, pickup in 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 skew warehouse environment with significantly higher average tickets, which allows us to be much more efficient.

BOPIC 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 cost 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 through our 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 to be offset by disciplined investments in our team members and their safety and in our business. Adjusted net income in the second quarter was $108 million or $0.77 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 lient debt. We ended the quarter with $169 million in cash balances and a funded net debt to adjusted EBITDA ratio of 1.4x. 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 the 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 6 months ago, 6 quarters ago or 6 years ago.

We have 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 6 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 the 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 have 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 of 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 million 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 cost 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, repurchased 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 are 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 will turn the call back over to the operator to begin the Q&A session..

Thank you. [Operator Instructions] 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 the good quarter. First thing, Lee, I wanted to ask you about the accelerated club growth, maybe could you just provide a bit more color here, including the decision to accelerate growth a bit and it certainly seems like you are 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 will turn it over to Bob to round out the perspective.

As we have talked about in the past, accelerating our rate of new club openings has long been a strategic priority and we spent lot of time over the course of the last several years making sure we have the model, right, because we were unhappy with the success of the openings kind of going back 3 to 4 years.

And so with our clubs in Carney and Somerville and Michigan, we really look to revamp that model and make sure that when we open the clubs, we had a sufficient membership base to make them successful and then we were investing enough in the infrastructure, in the marketing, in the acquisition activities.

And we have been really happy with our efforts in clubs, particularly the most recent set of clubs that we have opened in Michigan and Pensacola and Clearwater and I think we have the ability to step on the gas a bit. We are 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 have been working on it for a while. And our hope is that the next year will be open – we will be able to open significantly more than we have in the past. So in the script we talked about as many as 6.

I am not sure what the right long-term algorithm is, but we have been in the range of 3 to 5. And we clearly like to take that a bit higher going forward.

Bob, if you round that out at all?.

I think that – I think that’s rightly right. 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 have done is look through our own process to see what we can do to speed up our own – our own process.

The real estate process in general is fraught with uncertainty and long timelines and some of that is just the real estate thing and some of it is our own process. And we have 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 a little bit faster to go by the club or go by 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 crystallized for next year, later in this year, we will start talking about the direct impact on CapEx, but I think you heard of 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 would be a great opportunity to take advantage of the situation we find ourselves in today and make our company great for the long-term..

Great.

Just a – so a follow-up on the merchandising side, could you maybe just provide a little bit more color on the opportunities that you are seeing out there? I mean, you did mention a reset on the grocery side, some color on what you did there and what the response has been? And then I am even more curious on the GM side and just what you are seeing from vendors at this point, 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 have been under-penetrated 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 have talked about in the past, we offer our consumer 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 are trying to do is simplify choice in the right places and then extend into new categories.

That will be particularly true in general merchandise, where we have 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 will be able to add, but we are having more and better conversations with a set of companies than we have had before. And our merchants are actively looking to engage new suppliers.

And just given the velocity and the traffic benefit we are seeing, we are a unique player in this environment. We have the buying capacity. We have the shelf space. And we have the traffic. And so we will 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 have been 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 the 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 Horvers from JPMorgan. Your line is open..

Thanks. Good morning, guys. So a couple follow-up questions there. Is there any sort of capacity constraint around opens, given the timing of opens at the end of this year, you are effectively growing almost 4% unit growth.

So, could you – like could you sustain growth sort of like a high single-digit type units, number of clubs opening in any particular year and as you think about buying the land to speed the process, would you sale leaseback those ultimately or look to build the real estate value?.

Yes, 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 and we have seen quite a bit of them so far this year, just from a COVID perspective, the two clubs that will open around at 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 or 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 will 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 permanent complexities with a gas station versus just the retail store and so now we have sort of de-prioritized that requirement.

We will open the store before the gas station as a means of getting vendor unit opened earlier.

As I spoke earlier about our transformed balance sheet, I think we will look at the individual economics of sale leaseback transactions, but I would expect lesser desire to do that given where our balance sheet stands today versus where it stood a year ago. We were doing that primarily to get cash to payback the bank debt.

And now that our bank debt is much lower than it was before, we will sort of opportunistically look at sale leasebacks, 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 leaseback debt at this point..

Understood. And then you talked about a better long-term financial algorithm then when you went out on the IPO, you addressed the potential unit growth acceleration, but you originally came out as 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% to 2% would seem pretty low, but also are we transforming more towards a flow through model where the margin – 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 alone should drive the comps higher than what we would have planned pre COVID.

And previous this avalanche of numbers that have come in, certainly our margin opportunity is not done, but it’s. And are seeking 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 will we’ll give you some detailed thoughts on the long-term algo, but I think in large degree you are thinking about the right way that membership will power greater sales growth combined with more unit growth the balance sheet side of it will help as well..

That’s great. Best of luck..

Thank you, Chris..

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

Good morning. Great results. Just a lot of momentum on the membership front curious of what the new member growth look like in the second quarter last quarter you said 40% for 1Q.

And I am curious how weekly rates have looked once you have on-boarded new shoppers?.

Good morning, Chuck, it’s Bob. I will take that and we can chime in. Certainly our Q2 had great numbers of statistics as we talked about on the call now over 6 million paid members. Together we grew quite nicely on that same basis.

That 40% growth last quarter, we are 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 are very happy with that. As we, look forward, those members are shopping very nicely their behaviors is similar to other members that are already in the portfolio.

And that leads us to think that things about their long term potential as members. Certainly, you have 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 more than they have before.

So that that bodes well for renewal rates and for sales going forward in the future..

Yes, Chuck, I would just add to that on that commentary that we are really pleased with how broad based momentum is across all geographies and all business lines, we are 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 they are broadly based, gives us hope that the existing numbers 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 wildcard clearly is the impact of the pandemic and how that plays out into next year, whether there is a vaccine that sort of is a treatment. And so there is a large amount of unknowns.

But what’s really encouraging is the underlying member shopping behavior relative to a normal baseline that suggests that we should see good retention rates of both the existing and the new members we have added..

That’s great. And then just a follow-up would be on the components of the comp you said traffic that is both contributed, I believe, last quarter there we are about 50-50 just wondering if you could give us that detail and then I guess I am also curious how that mix of traffic ticket moves throughout the quarter.

If you look at look at cost goes 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. It’s the composition, Chuck, is roughly one-thirds traffic, two-thirds ticket in the overall comp base and that’s held relatively consistent throughout the period as 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 are gaining share.

We are seeing some degree of trip consolidation. We are seeing larger baskets when people come and that is leading to outside – 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..

Yes, good morning. I think 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 are 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 promotion?.

Chris, I lost probably just in the – 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.

And as you think through on Halloween we are assuming there are fewer parties and probably less trick or treating. And as you get to Thanksgiving, we suspect there maybe more Thanksgiving gatherings of smaller size, so that would mean buying more Turkeys albeit smaller Turkeys.

And then as you roll through to the Christmas Hanukkah season, again, we would expect there would be less large gatherings, which is a pretty meaningful part of our business. It’s supporting those parties and social events. And so we have 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 are doing that is newest 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 are looking at exercise equipment and textiles and consumer electronics and connected home devices, because our baseline assumption is you will still have a large amount of people either working from home or spending more times in their homes and the investment in people’s homes will continue.

And so we are shifting the equipment 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 do you found that 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 have had projected.

So 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 or unless 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 are 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..

Great.

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

Our gas business has been incredibly strong. The gallons are actually up 4% in the quarter. And so when Lee talked about gaining share a few moments ago, gas is a wonderful example of how we are doing that.

Your question sort of assumes we were with the rest of the market, which is certainly down from a gallons perspective, but we have seen our members consolidating trips in all manners and we have 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 memberships so of the new members that you gained since year end, I am wondering if you could just provide a little color on the composition of the members in terms of tears.

And then on the actual MFI, like reported MFI, you gave that number of 16% cash MFI on 40% increase in new member acquisition in 1Q and then it was 15% in 2Qwith a 28% increase in new member acquisition.

So can you just walk through how reported MFI dollars should grow in 3Q and 4Q based on what you know today?.

Sure. Thanks for the question, Karen. Let me answer the first part. And I will turn the second part over to Bob, from a overall quality of the new members, we are quite excited about it, you think about it quantitatively on engagement of higher tier memberships and then on participation in 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 contributed roughly the same rate, which is, which is very encouraging, given, typically, new members need time to tenure into the higher tier credit card offerings.

And so, we are 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 are clearly shopping more than we would typically see from, new members.

Some of that is undoubtedly pandemic related. But if you step back and think about the type of member that we are trying to acquire, it’s young families, young, new homeowners, and the proper members we are adding does skew more in that direction than what we would typically see. And so that’s very encouraging to us.

Bob, you want to talk about the math side of it..

Karen, if we take the math side of it, where I will call back later, but I think what I would say is a lot of what we just said, right, we have experienced pretty tremendous new member growth that’s driving the 16% cash MFI growth in Q1 and 15% here in Q2.

And that is a combination – excuse me a combination of new member growth and member mix and increasing renewals as well. So, all three things are going well. So, we have talked a lot about the number of new members that we grew already. So I will skip that. I am not going to give a heck of a lot on the renewal rate.

We went 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 and 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 mathematical point, you have to be doing a great job converting at the at the front line.

And at the membership desk, given the number of just the sheer number of members we signed up to go higher on those numbers has been, 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 on so I understand that you as if you own the land and building obviously, gives you a lot more flexibility.

But then 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 kind of a new unit if it’s owned? And then if we are thinking about the six for next year? What is the kind of right mix to think of own versus lease?.

Yes, a little early on, your last question in terms of loan versus lease, but at least one of them will be will be owned for sure, it’s difficult to really answer your first question because there’s such a wide variance depending on the market.

So, I don’t want to give you a number that is crazy, but that they could be $25 million or $30 million versus but the 10 if we bought a club in Metro in 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 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 are 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, dollars on the whole..

Yes, no, I definitely think it makes more sense. I was just curious on that full cost. Thank you..

You bet..

Thank you..

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

Well, good morning, guys. Actually, two questions. 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, 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, 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. From a membership marketing standpoint, 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 hired new member signups.

We have also been experimenting and scaling, investments in very targeted membership acquisitions.

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 and our outreach across both analog and digital channels.

And then we are looking to invest more in on-boarding people into the credit card program from the start and so a pretty meaningful investment in different programs and in tactics to have someone enroll in the credit card. Because we know that if we have people participate in a credit card program, they save more money.

They spend more, and they are much stickier in a membership cost standpoint. And so, as we have tried new things, scaled new programs and look to invest more, we found some things that are pretty exciting to us, and we are going to ramp the investment in those behaviors in the back half.

Now again, we are fully 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 very attractive to do and very high return.

So we will be more aggressively into the marketing throughout the balance of this year and into next..

That sounds great.

And then Bob on gross margin?.

Yes, good morning..

Good morning..

It’s the tangled story on gross margin, there are a lot of puts and takes that we try to line out in the prepared remarks but 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 everyday and maintain great pricing gaps against mass and grocery. That’s really sacrosanct.

And the way that we think about it this year is no different from that perspective, but it’s just been a little bit crazier with some of the moves in some of the commodities in this quarter it was beef we will 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’s what we are 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 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. And so those increased distribution costs I think will continue for the foreseeable future. And we will see how it goes from here..

Got it. That’s really helpful. Thanks..

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

Hi, thanks. My first question, you have talked a lot about trip consolidation. I am wondering from the complexion of the basket anyway for you to be able to discern if you are becoming more of your customers weekly shopping trip and using you exclusively instead of filling trips or grocery or the like.

And are you seeing that more with new, 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 are making bigger trips.

We however with the growth in the membership and with the growth in trips we are seeing know that we are winning from a trip perspective and then we are winning from a basket perspective as well. So, we are seeing growth in trips. And we are seeing growth in baskets, which means we are 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 omni-channel offerings, but these become pretty important in this realm as well where our investments in same day delivery, buy online, pickup 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 and recognize that people at least some people don’t want to come into the stores and so all of this behavior is quite encouraging to us..

Yes, that makes perfect sense. I think that curbside and BOPIC will be very important.

One more follow-up, I am intrigued by the apparel – the commerce and apparel close out getting back to your TJX routes I guess way back in the 80s, but can you talk about is that sort of a temporary phenomena just because there is a lot of inventories in the market or is that something that’s going to be more of a permanent change and how you guys buy apparel? Thanks..

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, whether 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 are 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 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 pretty meaningful shift for our buying teams and they are looking to how to do this well, but we are hopeful this is an unlock for us for the long-term..

Yes, that 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..

Hi, 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. That’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 are seeing more walk-in behavior both online and in-store. And so that translates into even better behavior.

We do know there is an kind of element of the behavior where 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 that are 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 are 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 are trying to say?.

Yes. Ignoring gas I think we should be up a little bit based on what we see here today. But we will see how it plays out. We have 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 about it..

Alright, 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 both of the category shifts and I mean, do you think you are going to be where you want to be by the end of this year or is this something that’s going to go on, into ‘21, maybe even longer and maybe any color on general merch versus grocery within that discussion? Thanks..

Sure. Yes, I think this is a multiyear journey where we will continue to more closely curate our assortment in the categories we commonly compete to look for opportunities to grow into new categories. We are excited by what we are 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 are doing that at the expense of traditional center store grocery items and we think that is important for long-term.

We are expanding the mix of general merchandise categories into a whole set of areas that we haven’t traditionally played and seeing really good results.

And 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 the last area that I have hinted about a bit before is services where we have a kind of a reputation and image with our members of offering the best value in market yet we haven’t by and large compete it in some pretty meaningful categories.

So, an example of that is cellular phones, where our offering now in cellular phones is of terrific value. We have been marketing that in clubs. We have now added the capability this quarter to do that online and we expect that to be a multiyear growth vehicle for us. And so we will continue to lead into the services offerings.

And our competitive set 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..

Thank you, Peter..

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

Well, let me just say, thank you to everyone for your participation on this call, your ongoing support and engagement with us as a team. We are very excited about our results in Q2 as you can no doubt tell. But more importantly for what it means for our future and our ability to invest into the strength and really transform our business.

So, we will 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 do..

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