BJ's Wholesale Club Holdings, Inc. (BJ) Q3 2019 Earnings Report, Transcript and Summary

Good morning. My name is Sharon and I will be your conference operator today. At this time, I would like to welcome everyone to the BJ's Wholesale Club third quarter fiscal 2019 earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions].I would now like to turn the call over to Faten Freiha, Vice President, Investor Relations. You may begin your conference.

Thank you. Good morning everyone. We appreciate you joining BJ's Wholesale Club's third quarter fiscal 2019 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 Form 10-K filed with the SEC on March 25, 2019, 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 Chris.

Good morning and thank you for joining us. In Q3, we continued our progress in expanding margins, enabling us to deliver another quarter of record earnings with adjusted EBITDA of $154 million, an increase of 4% over the prior year. We posted merchandise comp sales of 1.1%, our ninth consecutive quarter of positive comps. The quarter got off to a strong start as we built on the momentum from Q2 but we faced some unique challenges in October, particularly in general merchandise that we don't expect to repeat. These headwinds included a shift in the timing and scope of our promotions and warmer than normal weather in October which affected our seasonal apparel and cold weather related general merchandise products.In the press release, we updated our guidance to reflect our year-to-date performance and current expectations. Bob will provide more details on the update in his remarks. Overall, we believe we are well-positioned for the fourth quarter from an assortment and promotional standpoint. We expect our two-year stack comps to improve compared to the first half of the year and continue to drive solid margins, adjusted EBITDA and earnings growth for the full year.Our transformation has been and will continue to be built on investing and making strategic decisions that will benefit our business over the long term. We have made so much progress, but we all know we have more work to do. Let me give you an update on our strategic priorities.First, acquiring and retaining members. Membership is the foundation of our company and as we have discussed in prior calls, we are investing in the overall quality of our membership base. It's important to note that we finished the quarter with record MFI driven by increases in paid members and higher tier memberships. But it's more important to note that the dividends that this higher-quality membership base will yield will pay over the long term.First, let's talk about new members. As you may know, we have changed our approach to first year membership offers moving away from trial members with a goal of increasing the number of paid members. As a result, we finished the quarter with the highest percentage of paid members in our company's history. We continue to make strides in shifting our membership acquisition to digital channels. As a result, the percentage of members acquired through digital channels doubled in the quarter year-over-year.Members acquired through these channels tend to be younger than those acquired through traditional methods. We are very pleased with the progress in this area as we continue to invest in innovative ways to acquire members. Higher tier memberships represented 23% of our member base at the end of last year and is now at a 28% number, again the highest in our company's history. The progress has been anchored by our ability to offer BJ's MasterCard at the register, a new capability we invested in this year.As a reminder, higher tier members include all members that hold a credit card as well as our rewards members. We will continue to invest in this area which will benefit the company for a long time. Finally, from a renewal perspective, we continue to make progress in our easy renewal offering with more than 60% of the member base enrolled in the program. We are pleased with our progress in this area.Our second strategic priority is to deliver values to get our members shopping. Providing outstanding value to the families we serve is the fundamental commitment of our company and we have continued to make investments that will ensure we can offer unbeatable prices on quality products. Let me address our three growth platforms in this area, assortment, promotions and services.First, we are making a sustained effort to transform and simplify our assortment including continuing investments in private label. Our simplification efforts began in general merchandise which is up 5% on a two-year stack basis as well as for 2019 year-to-date. The work we have done in this area leaves us in a strong position for Q4 and beyond. We are moving forward with the transformation in our edible and non-edible grocery business with the goal of driving sales growth with a simpler assortment. In Q4, we will continue to roll out a simpler edible grocery assortment.We are also seeing good results from the clubs where we have this is assortment in place. We are also testing simplified assortments in our non-edible grocery business and our plan is to continue to reduce SKUs over the next year. We are taking a very deliberate approach in this area taking time to make sure we get the simplified assortment right. Our own brands are central to providing great value to our members, to assortment simplification and to our category profit improvement efforts. We continue to increase own brand penetration during the quarter. It's currently above 20% and we remain on track to get to 21% for the full year.We are particularly pleased with our performance in prepared foods, which we introduced this year. Our new clubs in Michigan were launched with an expanded assortment of prepared foods showing very strong early results. I will provide more details on our performance in Michigan shortly. The assortment transformation will go on throughout 2020. We strongly believe in limiting our assortment will offer better clarity of offering, provide opportunities for sourcing savings and free up space to drive growth through entry into new categories.Next, we continue to invest to take advantage of our new promotional capabilities. This work enables us to deliver highly personalized offers and targeted promotions. Personalized offers are based on member's purchase history giving us a powerful vehicle to engage members and drive trips and baskets. While this is still in the very early innings, we are confident that our investment in this system will deliver outstanding value to our members drive trips and enable us to use our promotional dollars more effectively. In addition, we will leverage this capability to improve our promotional cadence.Finally, we are making rapid progress in transforming our services business. We are pleased with the performance of our new optical offering as members have responded to our improved assortments that feature strong brands at outstanding value. We are excited to launch the next phase of our services transformation. We recently began offering our members outstanding value on cellular services through AT&T. We believe that this new arrangement will offer our members significantly better value than the best deals in the market on the latest smartphones every day of the year. This offer will be live in the vast majority of our clubs before Black Friday. Our progress in optical and cellular services is just the beginning of our services transformation. We are on the right track to delivering outstanding value to our members and driving growth through services.Our next strategic priority is to make it more convenient to shop at BJ's. Omnichannel is another area where we have invested for the long term and our progress in this area continued in Q3. Late in the quarter, we launched same-day delivery for beer, wine and liquor in 74 clubs in seven states. We also expanded our mobile ordering for deli items to 64 clubs in New York, New Jersey and Boston which lets members place their orders in advance and save time once they are in the club.Our convenient services, while still small compared to the rest of the business, continue to grow and resonate with our members. Buy online, pick up in club and same-day delivery continued to accelerate in the third quarter. About half of our BOPIC users make additional purchases once they are in the club. We are expecting biggest holiday season ever in digital driven by a fully integrated marketing campaign, a strong assortment, free shipping for our premium tier members and of course outstanding value.Finally, we plan to expand our strategic footprint. We opened two clubs and gas stations in Eastern Michigan this month. As we have said before, we took a very new approach to marketing to raise awareness in these clubs. We opened these clubs with about 1,000 fewer items than our typical clubs along with new items such as an expanded prepared food assortment, localized apparel, local craft beers and a snack shop. Though still in the early days, we are very pleased with the initial membership response and our near term sales trends. Our performance in Michigan along with our performance in other recently added clubs is very encouraging for the future of our company.We have opened six gas stations in 2019 and remain on track to open eight to 10 across the portfolio. We are also on track to open our club in Pensacola, Florida around the end of the year, followed by our third Michigan club in Chesterfield during the first half of next year. Our new club pipeline remains strong and we look forward to providing an update on next year's plans in our next call.Looking forward to Q4, we have strong plans in place for the holiday season. We feel confident in our promotional cadence and our ability to deliver unbeatable value to our members. Our combination of fresh items and general merchandise is crucial to delivering value to our members during the Thanksgiving period and beyond. We are focused on executing the marketing, merchandising and operations programs that will get our members shopping and to drive sales. We remain committed to driving topline results while also delivering on our bottomline goals.With that, I will turn the call over to Bob who will review our results in more detail. Bob?

Thanks Chris. Good morning everyone. Let's turn to our results in detail for the third quarter. Net sales were $3.2 billion. Merchandise comp sales, which exclude gasoline, increased by 1.1% and were driven primarily by ticket. Comps in our general merchandise business were flat, reflecting a 5% two-year stacked comp. Our general merchandise business was impacted in the third quarter by changes we made in our TV assortment ahead of the holidays as well a shift in the timing of promotions. In addition, as Chris mentioned, sales of seasonal apparel and other related items such as heaters slowed due to warmer than expected weather late in Q3.In our perishables division, comps were flat for the quarter as we worked through assortment changes, particularly in our dairy and frozen categories. Although we experienced a small level of inflation in this division compared to the prior year period, this was more than offset by assortment changes and the timing and scope of promotions.Comps in our edible and non-edible grocery divisions were up by 1% for the quarter. We continue to simplify the assortment and increase our own brands offering in these two businesses as we work to deliver outstanding value to our members.Membership fee income grew by 7% during the third quarter. Approximately three quarters of this growth was driven by increases in members with the remainder driven by our membership fee increases. Higher tier penetration is now at 28% of our membership base, up from 23% at the end of last year and more than 60% of our membership base is enrolled in our easy renewal program.The continued growth in MFI underscores our focus on continuing to improve the quality of our membership base. MFI is the cornerstone of our business model and paid members now represent about 97% of our total membership base. We continue to acquire members with innovative vehicles and have doubled the number of members acquired digitally.Excluding the gasoline business, our merchandise gross margin rate increased by approximately 50 basis points over last year driven primarily by continued benefits from our procurement initiatives. This reflects a two-year stack improvement of approximately 110 basis points. Our CPI program remains strong and we see continued opportunities to drive merchandise gross margins through CPI and private label penetration.SG&A expenses were $510 million in the third quarter compared to $496 million in the prior year after excluding prior-year expenses associated with the secondary offering and other one-time expenses. This year-over-year increase in SG&A primarily reflects the continuing run rate of investments we made earlier this year.Interest expense decreased to $28 million from $33 million a year ago, primarily due to deleverage and the fact that the rate on our first lien debt is down by 25 basis points at the end of this year's first quarter.For the quarter, we recorded income tax expense of $18 million compared to $3 million in the prior year period. The variance between our normalized statutory tax rate of approximately 28% and the reported rate of approximately 25% for this quarter was driven primarily by $2 million of windfall tax benefit from stock options exercise.Adjusted net income for the third quarter was $57 million or $0.41 per share, compared $54 million or $0.39 per share in the prior year period reflecting 5% growth on a per share basis. Our press release includes a table that reconciles GAAP net income to adjusted net income including on a per share basis. Adjusted EBITDA was $154 million reflecting 4% growth over the prior year period.Moving now to the balance sheet. Our AP to inventory ratio remains solid at 77%. Free cash flow for the year-to-date period came in at $77 million and we remain on track to deliver more than $200 million of free cash flow for the year. As we expected, our free cash flow in the third quarter was impacted by the timing of our capital expenditures which increased as we purchased land for new clubs in Michigan. As we previously noted, we plan to enter into sale-leaseback transactions on these new clubs and would expect that net of related proceeds, our capital spend would be approximately $160 million for the year.Let's now turn to capital allocation. During the third quarter, we completed a body of work, together with our Board of Directors, to determine the capital allocation plan that reflects our priorities. Our first priority is and will always be to invest in our business for the long term. We will first direct our capital towards our growth avenues adding new clubs and gas stations, attracting and retaining and engaging our members as well as expanding our omnichannel business.Next, we expect to continue to delever. While we achieved our near term leverage target of three times six months ahead of our plan, we currently believe an appropriate medium term target is two to 2.5 times funded debt to adjusted EBITDA. We anticipate achieving this level within the next two years.Finally, we have added an element of return to shareholders through a stock repurchase program. Yesterday, our Board of Directors authorized a repurchase of up $250 million and our intent would be to opportunistically execute this program over the next couple of years allowing us to more than offset dilution from equity compensation.All of these priorities, investing in our business, continuing to delever and providing returns to shareholders reflect our growth plans as well as the strength of our cash flows. We look forward to executing against these priorities and as we achieve our new leverage target, we will look for other opportunities to increase shareholder returns.Let's now turn to the guidance for the remainder of fiscal 2019. With three quarters of the year behind us, we are updating our guidance to reflect year-to-date performance and our current expectations. Our press release tables provide the full details. While many components of the guidance changed, they resulted in an EPS range with the same midpoint of our previous guidance. Let me we walk you through some of the highlights.Our updated full year merchandise comp range implies a merchandise comp range for the fourth quarter of 1% to 1.5%. This reflects a two-year stack comp north of 4%, an improvement from the third quarter and the first half of the year. We believe we are well-positioned for the holidays in the fourth quarter from an assortment and promotional perspective.Our updated adjusted EBITDA guidance range of year is now $585 million to $592 million and reflects the impact of the change we made to our topline along with an updated view of tariff exposure, partially offset by continued improvement in our gross margins delivered by our CPI program. From a tariff perspective, we do not currently expect further risk to our adjusted EBITDA guidance for the remainder of the year.We are continuing to monitor the situation and are hopeful that a long term agreement can be reached and we continue to execute against our mitigation strategies while maintaining the value that our members have come to expect. As I said before, the changes to our guidance resulted in an adjusted EPS range of $1.44 to $1.48 for the year, midpoint of which is the same as our previous guidance range.Before turning to Q&A, I would like to reflect on our results for the first three quarters of the year. Looking at the topline, we have generated 1.5% comp for the first nine months of the year. Our priority remains to focus on growth and continue to drive strong traffic and sales trends. Looking at the bottomline, you will see that we have grown adjusted earnings per share by more than 18% in the first nine months of the year due to strategic decisions and investments we made to transform and enhance our business for the long term. We believe in our ability to provide strong EPS growth in future years.Further, the strength and predictability of our cash flow has enabled us to launch a capital allocation plan that will further drive total shareholder return. Our bottomline and cash flow performance is a testament to the strength of our underlying business model and our strategy. We remain optimistic about the long term health of our business and we continue to invest in our transformation to drive growth in sales and profitability and we look forward to delivering on our goals for the remainder of the year.Now I will turn the call back over to the operator to begin the Q&A session. Sharon?

[Operator Instructions]. Your first question comes from Robby Ohmes with Bank of America Merrill Lynch.

Hi. Good morning guys. My question, Chris, is I was hoping you could talk more about the SKU reduction program and maybe give us a little more color on the edible and non-edible reduction that you mentioned? And I think you mentioned it had a negative impact on 3Q. Can you remind us or give us some numbers may be on the number of SKUs or percent reduction in assortment? And also kind of walk us through, as you are making these SKU reduction changes, is the expectation it has a short term negative impact and then re-bounce down the line? Or should we be a little concerned that as you keep reducing SKUs, there could be some pressure on your comps over the next several quarters? Thanks.

Thanks for your question, Robby. Good morning. And so as I think about one of the things we have talked to investors about over the course of the last year-and-a-half is, how do we simplify our assortment in order to grow? So let me be clear. Our simplification work overall that Lee and his team are leading, is about driving growth. I have, also in the last couple of quarters, spoken to you about edible and non-edible grocery where we are disrupting just about everything we do in order to create a better long term algorithm for our company on the topline and we feel good about being able to deliver on just that.The range of reduction across categories varies category by category. We have talked specifically, let me give you some real texture on diapers as an example. So we talked in very great detail about diapers. We have reduced diapers from two brands to one, added private label and use the space to expand our assortment for young families, largely in general merchandise. So that's a shift out of grocery to general merchandise in that example. Other categories are like that. As we reduce trashbags assortment, we are adding that space to mops and brooms as an example.So think about it as double digit percentage SKU changes that we think there is some short term disruption but it's very short term and we feel like this is all about driving growth. We think we can do much better job of being more efficient. I will also point you to the encouraging progress we are making in new markets where we have a simplified assortment at hello when we open. We are really encouraged by what we are seeing in Michigan where we have opened with more than 1,000 fewer SKUs and this week we have actually had parking lot capacity issues where we had members not being able to park.So we are very encouraged by the progress we are seeing where we are delivering a reduced assortment. The number is, to your specific question, in the double digit percentage of SKUs kind of number and it's all about growth and while we have taken a couple of short term hits as we make the transition, we think it's the right long term move to make.

Great. Thanks so much. Very helpful.

Thank you Bobby.

Next question comes from Kate McShane with Goldman Sachs.

Thank you for taking my question. The margin improvement has been a great part of your story and again in the third quarter. I am wondering if there has been any thought behind, using some of that margin flow-through to be a little bit more competitive on price. Is there any issue, do you think, in terms of how competitive you are in your value offering and to why maybe the comp isn't a little bit stronger as a result of that?

Sure. Kate, first of all thank you for your question and good morning. So overall, it is our contention that we were continuing to find the right balance of sales and profitability. We are priced every day to all of our club store competitors and we feel very good about our balance, our value proposition. In this quarter, there is no doubt, late in October, we had some disruption we didn't expect and we are where we are. So as we think about going into next year, we are going to be once again balanced in terms of our ability to continue to deliver margins and improve the topline performance and we were encouraged by our ability to do that.But what you are talking about is what we debate all the time inside of our company. If you looked at our quarter, Kate, at the end of August, it's a very different picture than it was at the -- excuse me, at the end of September versus where we ended up at the end of October. So this is a short term disruption that we frankly didn't expect and we think we are going to be back on track as we move forward and we feel good about that. But we are constantly driving on the value proposition because it's foundational to the way we run our company.I hope that's helpful.

Thank you.

Next question comes from Chuck Grom with Gordon Haskett.

Hi. Good morning. This is actually John Parke on for Chuck. I guess how do you think the weather impacted the general merchandise category in the quarter? And then you guys talked a little bit about a shift in the promotion. Anyway to quantify what that impact was?

Sure. As you look it through two months of the year, our business was in great shape. We felt really good about that both the topline and bottomline performance and we did see some disruption in October. You have a couple of things going on. One is, we have made a pretty material shift into the more premium TVs as we start the fourth quarter and that had some lapping impact on the end of the third quarter where a year ago we had some very high value on lower-priced TVs.But the more important thing is, on a year-on-year basis, we had a very significant cold snap at the end of the quarter in the last year period that just didn't come this year until the beginning of this quarter. So everything from our core apparel business was terrific, but some of the cold weather apparel didn't perform the way we expected it to.And you also have a very big business for our company in both shoulder seasons. In this quarter, it is when you get the cold snap, you get a big heater business and frankly in the spring when you get the first heat snap, we get a very big air conditioner business, particularly in our metro locations. And those had a material impact on our quarter as we wrapped it up. We think it's transitory in nature and we feel good about where we are going moving forward.I hope that's helpful.

Next question comes from Edward Kelly with Wells Fargo.

Yes. Hi guys. Just a follow-up actually. Chris, could you just give a little bit more color on how tough October was and the cadence? I don't know if you can give some numbers around this. And then what Q4 is looking like so far now that the weather has improved? And then as we think about your guidance, the 1.3% to 1.5% for the full year, it looks like at the midpoint would be one even in Q4, which seems lighter than what I thought. So I am just kind of curious if you can provide color there? And then how much was tariffs in terms of the impact on EBITDA? And what exactly that relate to?

Yes. Hi. Good morning Ed. First of all, there is a lot there. I am going to take some of it and then let me ask Bob to take a couple as it relates to guidance and the flow-through. October was a little bit negative. It was think about a minus 1 and it was really the last two-and-a-half weeks and as you look at particularly the last week was rough as we worked into Halloween. In your note this morning, you noted as we look at going into next quarter, we are up against the 2.9 of a year ago, which was artificially inflated by the snap benefits from the government in the month of January.So we recognize completely that we trade on our credibility and it's really important that we provide you numbers we think we can deliver and we intend to do just that. So as we think about it, we have been operating before this quarter in a hanging around a 4% stack and we expect that the number we are providing for the fourth quarter gets us to the low-4% in terms of the stack and we feel good about that. And when we deliver it, we will be exiting the year with some strength. Just as a reminder, the gas benefit at EBITDA in the fourth quarter is about $15 million and we talked very, I think very openly about that last year as we approached it.In terms of our guide, I will let Bob make the comments but in the last quarter, Ed, we talked to you about a $5 million tariff risk and in our revised guidance as we go forward, that's gone. So it's in there.But I will let Bob make a couple of comments on the guidance

Yes. Hi Ed. Let me start very high think. I think when we think about the Q4 guide, we most presently think about the compare. We are up against the 2.9 from last year, the highest comp of last year therefore our toughest compare. And so when we set out our plan for the year, we always thought that Q4 would be the lowest comp from that perspective. And the street, I don't think really forecasted that in all of your models. But we always did. And having seen now the performance in the first nine months of the year and most particularly in this last quarter, that informs the revised annual guide more than anything else, right. We expect it to be a little bit better in Q3 and therefore a little bit ahead going into the fourth quarter and expecting Q4 to be a little bit of a tougher compare.So that's what I would say on the revenue side. Chris said exactly what I would say from a bottomline perspective. Again, I don't think perhaps we didn't do the best job explaining it or people didn't read it through very well. But I do think everyone should take into account that $15 million of the gas benefit in last year that resulted from the disruption in the gasoline market, I don't see anything as we sit here today that would tell us we are going to have that happen again in Q4. And so when we normalize our EBITDA for our EBITDA plan for the fourth quarter, we see nice growth from that perspective and nothing to worry about there.And then finally Chris mentioned as well, we have baked in that $5 million of tariff risk we talked about last quarter where we said last quarter effectively at $5 million. We hadn't figured out yet and we just left it out there for people to qualitatively consider in their guide. We are still trying to figure it out. Quite frankly, we didn't figure it out without changing the value. We always want to provide the best value to our members and that's what we are doing. So we are effectively lowering our margin growth assumption and therefore our EBITDA assumption related to tariffs and as I said in my prepared remarks, offset by some better than anticipated CPI performance in the quarter. So all told, we are not happy with where we were for Q3 but we stand ready to execute very well in Q4 against the tougher compare.

And Ed, just to link in my comments to Kate's question, because I think there is some linkage here. We probably spend $1 million or $2 million in EBITDA in the third quarter, making sure our prices were right despite tariffs and I think everybody who does what I do you who you folks cover talks about, we are going to protect pricing for our consumers because that's what we are paid to do. So it probably cost us $2 million in the quarter.

Next question comes from Simeon Gutman with Morgan Stanley.

Thanks for the question. Good morning. So I want to clarify again on the third quarter and the fourth quarter. So the third quarter was impacted by timing of promo as well as late-breaking or non-breaking cold weather in the quarter. And if you think the fourth quarter does recoup a little, which it sounds like it does, why isn't there some pent up demand, especially on the cold side for you to recapture that? The TVs, I guess, that maybe lost demand. And then the second question, if you back out the $15 million and thanks for that color, I think it's implying a 2% to 7% EBITDA growth. Can you get to that midpoint at the lower end of our sales guidance? Or is that perfectly reflective of the range of comp outcomes that you get?

Yes. Thanks Simeon. What we think about Q4 is we did lose some demand, to your point. I do think there is some element of shifting in the demand as some of the cold weather stuff just moves with cold weather, right. If you don't get it in the end of October, you may pick up it up in November. But think about the incredibly rainy Northeast whether on Halloween, that's just lost demand. It just vaporizes for the year. And so there is a little bit of both.The TV is again just a total shift. And the promo shift is a little of both, right. We are striving to be much more efficient in our promotions and that was a little bit of hurt in Q3 and we will try and reinvest some of that in Q4. Overall, Chris said that we are trying to balance all those competing demands. Recognize that Q4 has the toughest compare and put a number out there that we all think we can hit. And so it's really just the amalgam of all that together.I think your question on sales guidance versus EBITDA guidance is a good one in recognition of the $15 million in gas benefit in last quarter. And so I do think the way that we set the range out there, if we hit the sales target, we will hit the EBITDA target. And if we don't, we may not. We certainly will pull every lever we can pull to hit the bottomline as we go despite any sales variability. But when you back all the way out, this is retail. If you don't, you don't make the money that you think you are going to make. And so we are working very, very hard on both of those angles.

Can I ask one follow-up.

Yes. Sure.

Okay. Great. Chris, you mentioned in some of the test stores had edible arrangements. Can you give us a sense of the number of items per basket growing with fewer SKUs? I don't think maybe even want to quantify yet, but can you give us a sense of the numbers of items that are growing in that versus your existing average?

Yes. I think it's too early to tell at this point. So the message I wanted to send is that, the assortment moves we are taking, if you step back, Simeon, I think it's a great question and I will answer it in our strategic view. We are taking a long view like other retailers have in different points of their transformation and are willing to take a couple of hits to get the right long term answer. We have started to get much more aggressive on getting assortment in line and I made a comment in response to Robby's question.Think about it that double digit percentage of SKUs that we are working on. But it varies widely by categories and we are generally moving grocery space to GM. I talked about that in baby and I talked about that in trashbags versus mops. Taking out grocery things and moving to more GM because we think this company will be GM-led for a long time.The point I wanted to make on Michigan is how encouraged we are by the consumer response to our brand. The membership numbers and the sales numbers, while early, exceeded our expectations. And a big part of our story is about our continued ability to make progress in that kind of area. And we are seeing encouraging results and we will continue to report on it. But it's a bit too early to make a macro point on that area at this point.

Okay. Thanks and good luck.

Thank you.

Next question comes from Peter Benedict with Baird.

Hi guys. Thanks. Just a quick follow-up on that one. Just the simplification journey that you are on, Chris, how long do you think it will take to get the broader chain to get their assortment to near what you have got out in Michigan, I guess maybe the 1,000 SKU count reduction? That's kind of a follow-up to that last question. And then, my main question is just on the MFI. The membership fee income grew 7% in the quarter. That was obviously very impressive, better than we thought, 5% plus if you ex out the fee increase. Is that 5% pace something you guys think you can continue or sustain here into the fourth quarter and into next year? Just curious how you are thinking about that? Thank you.

Sure. Thank you peter and thank you for your question. I think overall the way we have talked about MFI, you have a lot of mix within that number and we have talked about low single digit membership growth over time as the impact of the pricing action, to your point, staves by the end of this year. So think about it as low single digits. To the point I am trying to manage the company for the long term, we have made material investments in shifting the mix of the member base.To give you some perspective, when our team started working together, the percentage of the member base that was paid and I have been here for five years now, it was below 90%. And Bob told you that today it's at 97%. Just that fact alone is probably the single biggest transformation in our company.And on the SKU part, we are not going to necessarily set a timeline on SKUs. We did say we would continue to change assortments through 2020. And as a practical matter, it's a lot easier to set a new club in a place like Michigan to our new assortment and what's really encouraging about it is how, to give you some sense, that club is opening up with a dramatically higher percentage on general merchandise. Prepared food is doing very well.Some of the systems that many of you have written about have helped us localize assortment in things like beer and spirits and soft drinks. So we feel really good about that. We are not going to necessarily set a timeline, but we do feel like the assortment work will continue through 2020. And it's all about growing.

Okay. Great. Thanks so much.

Thanks Peter.

Next question comes from Chris Horvers with JPMorgan.

Thanks. Good morning guys. A couple of margin questions. First, can you talk about was gas a net benefit this quarter? And then as you look ahead obviously very strong CPI benefits on a stack basis and an absolute basis this quarter. You have a bit of an easy compare on that front as you go into the fourth quarter given the strength of, I think, TVs last year. So can you talk about those and how you are thinking about merchandise margin opportunity in the fourth quarter?

Yes. I will take the first part and I will ask Bob to take the second part. Gas was basically a flat. There is no net benefit really in the third quarter. It was exactly what we expected it to be. Our stack margins, we don't expect them to be as high as they were in the fourth quarter as they were this quarter, though 110 is a big number.So I will ask Bob to make a couple of comments about that.

Yes. Hi Chris. I think in various answers to various questions, we have talked about the pluses and minuses for margin. And the way I think about it is, I think the CPI program is healthy and continuing to provide tons of benefits to us. We really think that continues going forward into next year and certainly in Q4. One of the benefits of that program is it provides us pretty good visibility from a margin growth perspective. And I will tell you, given that visibility, we know that Q4 will be a little less than Q3 and then that's exacerbated by including the tariff exposure into the fourth quarter as well. So I don't think we will grow at 50 bips again in Q4, but we will see some growth in Q4. And we do anticipate continuing to grow into next year as well.

Got it. That's helpful. And then on a follow-up. Can you talk about, as you look ahead to 4Q, the snap that accrued to January and it's sort of I would say 40, 50 basis point headwind to the quarter. So it seems like you are expecting very strong mid-2 kind of comp in November and December. So I was curious if that math was correct and how you are thinking about gen merch growth versus the grocery side of the business in the fourth quarter?

Yes. Chris, I feel really confident on our gen merch business. We had a disruption in the end of October and I get it. And with a 5% stack on the year and the year-to-date, we are growing share in GM and we expect it to continue. Your snap number is probably a little light versus what we experienced a year ago in the month of January. But the big thing is that we feel much better about promotional cadence as we go into the fourth quarter and we are trying to be thoughtful. We recognize we trade on our credibility. We are trying to give you a balanced view of where we think the company is as when we deliver what we said, we expect the stacks to be equal to a little bit equal to a little bit better than where we were in the first half of the year and we expect to end the year strong and move into next year. So that's my perspective on that. But we feel really good about promotional cadence and really good about our GM business despite the disruption we dealt with in October.

Got it guys. Have a great holiday.

Thank you Chris. You too.

Next question comes from Karen Short with Barclays.

Hi. Thanks for taking my question. Just in terms of the assortment, I guess what I want to ask is, well, a couple of questions. One is, what do you think the timeline then is to feel that all the clubs are reset optimally? And I guess the second question is, it just seems to me like it's so club specific in terms of what you need to put in like in each category, especially in grocery, but it is really pretty heavy lifting to do that. And then I guess the question top of that is, once you have got the reset and you feel like you have the optimal assortment, is it literally like a club by club decision on how to comp?

Yes. A couple of things, Karen. First of all, as you think about assortment and promo, the work you put out, I don't know, a month or six weeks ago did exactly what we are doing like spot on. And at the end of the day, we expect assortment work to continue through 2020 and I wouldn't characterize it as local, in as localized away as you have in that context.So the work that Lee and his team are leading is, if you think about our business, we have a big suburban business, we have a big metro business. And we sell the bestsellers in every category. So on the margin, we do some localization but we feel very good about our ability to do this in what we would consider big chunks or segments of our markets.To be fair, our metro New York business is very different than our suburban Boston business. We think it's going to take a while. We think it's the right decision to do this in a thoughtful and methodical way and we expect it to go on through 2020. But more important, while we are going to take a little bit of disruption, this is about growth and our ability to where we have done this particularly in grocery, we have been encouraged by what we are seeing in terms of growth.It's a simplified consumer experience and frankly operational it's a lot better. But we couldn't do it until we have got the systems and processes in place that you wrote about that give us the tools to be more effective in this effort which versus what would have been available to us prior to the investments in those systems.

Okay. That's helpful. And then I guess just in terms of the quarter specifically and I know you don't necessarily like to give this detail but it would be helpful to get some context on traffic specifically, I mean excluding October, in the quarter. So August and September?

Yes. The traffic was up in August, September, no doubt. And as we dealt with the weather and some of the stuff that we talked about extensively at this point, October wasn't as good. It was actually down in October. But we feel really good about where we are at this point.

Okay. And then just last question. Can you just give a little context or color on the fuel stacking promotions? Like how you see that driving the business? And maybe anything you can talk to in terms of conversion into the store? Or just any color on that given that that's fairly new?

Yes. It is fairly new. And we are pretty encouraged by it. We are clearly growing share in fuel. We are clearly growing share in general merchandise. We are holding to losing a little bit as we do with a whole bunch of transformation work in other parts of our business. But the high octane program, we feel is a very efficient spend of our partners' dollars.And the education process to our members is encouraging, but also frankly some of our credit card progress also helps us grow share because we deliver great value on fuel as a starting point and credit card holders get even better value. So we feel really good about our fuel business. And that's why we are opening gas stations as aggressively as we are because we ultimately we think it's a good opportunity for us to drive traffic and drive the value proposition.One of things that's worth noting is selling price in fuel was down pretty significantly in the quarter. So that flows through and Bob can make a comment on that if he wants to.Bob?

No, I think that's absolutely right. I think the thing that I was thinking about as Chris was just making his comments was, this is certainly an effort to better tie in the gasoline business to our in club business. Further to your question of, are we seeing better conversion? We see about 30% of our members on the same-day go into the store are the days that they get gasoline. We have tons of headroom against our competitors to get that number up and that's what this effort is driving at. And certainly we are seeing good results as we educate members about this program. But I will tell you, even the members that really don't understand they are getting this benefit and I would count myself on that in score, at least on my most recent trip to get gas at one of our clubs, I didn't realize I had purchased an item that was in this promotion. There are a couple of hundred items still in the promotion at any one point in time. I went to the pump and I got my $0.10 off for being a BJ's MasterCard member and I got another $0.20 off that I didn't expect. So it really becomes a fun way to surprise and delight members on one side of the equation when they don't expect it. And when they do, it's a great way to provide them value and link the in club and the gasoline business together.

Thanks. It's helpful. Thank you.

Thanks Karen.

Next question comes from Michael Baker with Nomura.

Thank you. Two really, one, I wanted to follow-up on Peter's question earlier. The MFI increased ex the fee hike, about 5%. That does seem to be an acceleration from what we can back into over the previous two quarters which were probably in the 3% to maybe 4% range. So what drove that acceleration? Is that more, the higher tiers? Or just generally more paid memberships?

Hi Mike, it's Bob. It's a good question. I think what's driven it is the series of continued investments we have made in membership. It's certainly the number of members. It's certainly number of upgrades into the higher tiers. It is certainly the push towards acquiring more through digital means. Certainly the push away from trial into paid. It's all the things that we have been doing over a number of years here that are sort of investments in the long term nature of the business.The whole business starts with members, right. So I think about through the lens of new clubs and the transformation that we have made there, the clubs that we have opened that haven't been as successful as others didn't have enough members. And the ones that are opening today have vastly more members than the breakeven proposition would put forward. And that's all on the back of the same stuff, focusing on the basics, illustrating our value, telling the story right, executing right at the desk every day, making the investments in data capabilities to the target members the right way, spending more on acquisition year-over-year, all the things that we talked to everybody about in prior calls and prior meetings.With that said, 5% new member, well this is a pretty stinking good number for us. And so I am a little leery to tell you that we are going to keep going at that clip. I would certainly love it. But I am not sure I would factor it into your model. Certainly not in our long term models. As Chris mentioned, it's sort of low single digits is what we have in our long term models. So I think Brian and the membership team at large here have done a great job in this past quarter getting that number to where it was.

Yes. And thanks for that. If I could follow-up, because you talked about what you see in the new clubs. I am curious, it sounds like results for the Michigan is at least on plan, if not better than plan, by virtue of the fact that in the parking lot you can't even fit all the cars. From the membership there, are you seeing anything surprising in terms of the complexion, in terms of demographics or who the memberships are and how might that inform your long term growth prospects?

So Michael, look, I want to be clear that we are really early on in Michigan. We are very encouraged that the reception we have got into the brand and frankly we spent some money to get it. And we have been willing to make investments that are necessary to inflect the performance here. And in this case, we feel pretty good about what we are getting for it.There is no real change to the families we are serving there. Think about it as middle class families and very similar to what we talked about before. That's how we marketed. That's how we targeted. And there are a lot of markets that feel like Michigan in the Midsouth and through the Midwest that are encouraging for us. But Michigan is really important for our company. And so we put some chips on the table in order to make that bet and early on we are encouraged.But let's be really clear. I always try and be really balanced in how I talk about stuff. This is early. But you can rarely recover in this business from a bad start and we feel good about the start. And therefore, we feel like we are on the right track and a little bit ahead of where we expected to be.

Great. I appreciate that. Thank you.

Thanks Mike.

Thanks Mike.

Next question comes from Michael Montani with Evercore ISI.

Hi guys. Thanks for taking the question. First, I had a housekeeping one and then a little bit more high level. So first off, just on preopen expense. We had about $12 million for the year. Is that still the right figure? It just seems to be running a little bit ahead of that.

Yes. It's certainly running a little bit ahead of that, Mike. Some of it, certainly in the third quarter, was timing of spend versus what we had in our models and likely what you had in your model. But as Chris just mentioned, we are going to spend a little bit more this year. So we had modeled $12 million early in the year. We are modeling closer to $15 million right now. Some of that it timing as we get into the next year, but some of it is just spending a little bit more as we get into markets like Michigan, taking a wholly new approach to doing it, spending a ton more on media and getting our name out there in a new market that's important to the company long term and frankly allowing us to test whether that type of marketing would work across the whole company too. So I think you are right. I think we have spend a little bit more. Some of its timing but some of it is, we will spend more for the full year.

Okay. Thanks for clarifying that. And then just the follow-up I had was two parts. One was around the new member signups seem to be coming through strong. So I just wanted to ask about what kind of spending performance you are seeing from them? Do they seem to be spending in the club at the rate you would anticipate? And then the second one which is related to that would just be, we had the 1.5% to 2.5% comp algo for this year. It looks like it might come in at the bottom end of that. But into next year now, assuming kind of similar market conditions, is 1.5% to 2.5% still the right way to think about it? Or do we need to adjust that maybe to 1% to 2%, just given some of the disruption as you guys re-assort for long term traffic and topline growth?

Sure. First of all, Mike, the second part of your question is easiest. We will comment on 2020 when we have our Q4 call. I know you expected that answer.We are encouraged by what we are seeing in the member base. We also recognize that we have the responsibility to you to give you numbers we are going to make and also get our topline moving a little more quickly than it did in the third quarter. And that's why we are talking about the stacks the way we are in the fourth quarter. We feel like, absent the third quarter, the stacks for the first half of the year and the fourth quarter will be equivalent to what we thought they would be as we started the year.We feel really good about the proposition. But these transformations are rarely a straight line and we feel like we are doing the right things to get this business going in the right direction in the long term. We feel like we delivered on what we said we would do and we expect to continue to do that.Thanks. And just the membership seasoning component?

I am sorry. Pardon me. Yes. The membership, the way we talk about that is, it generally takes a new member about three years to season. So there is a short term drag but we use our promotional cadence to try and accelerate that as best we can. We have seen those members do about what we expected them to do. And the seasoning is about where we expect it. But it takes about three years to get a new member up to what we would consider to be normalized.

Thank you.

That's a little bit of the drag you are seeing from us. Thank you Mike

Next question comes from Rupesh Parikh with Oppenheimer.

Good morning. Thanks for taking my questions. So first a clarification question. I know there was a question on the quarter-to-date comp performance. I was curios, if you look at November if you are back into a plus 4% stock range? And if you have seen a recovery in some of the cold weather items? So I will start there.

Yes. Rupesh, we are not going to make any inter-quarter comments but as you think about what we have said, as we go into the fourth quarter, we thought it was important to make sure we told you guys numbers that we can make and we think the stacks will give us good performance exiting the year based on what we have continued.

Okay. Great. And then on the share buyback program and debt paydown. So clearly, you guys are targeting to get to that two to two-and-a-half range. So is it fair to say that it is more of an aggressive focus on paying down debt versus buying back shares? I just wanted to get a sense of how you guys are thinking about the interplay between the two?

Yes. Rupesh, it's a good question and that's kind of why I tailored my prepared comments the way that I did, right. As we think about our cash flow allocation, the first stop is growth. We are always going to throw money at things where we think in the long term the company benefits. Second will be paying down debt. We look around the market at our peers and everybody is lower than we are. I don't think there is any pressing need to get there in a hurry because the market is stable the debt's relatively cheap, especially compared to equity financing. But in a long term focus, we want to get to two to two-and-a-half times leverage. And then we at least recognize that we don't want to dilute the shareholders through equity compensation. And so we will execute the buy back with some minimum execution to offset that and opportunistically execute above and beyond that threshold if the stock gives us opportunities to do that, if we think it's a value to do so. So again, we will execute according to those priorities and hopefully exceed our expectations and we can do a little bit better.

Okay. Great. Thank you.

At this time, I will turn the call over to the presenters.

Thank you for your time. I hope everybody has a happy and healthy holiday season and we appreciate your participation in the call. We look forward to follow-up conversations during the course of the day. Thank you.

Thanks everybody.

This concludes today's conference call. Thank you for participating. You may now disconnect your lines.