BJ's Wholesale Club Holdings Inc (BJ) 2020 Q3 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to the BJ's Wholesale Club's Third Quarter Fiscal 2020 Earnings Conference Call. (Operator Instructions) I would now like to hand the conference over to your speaker today, Faten Freiha, Vice President, Investor Relations. Thank you. Please go ahead, madam.

Good morning, everyone. Thank you for joining BJ's Wholesale Club's Third Quarter Fiscal 2020 Earnings Conference Call. Lee Delaney, President, CEO; Bob Eddy, Chief Financial and Administrative Officer; and Bill Werner, Senior Vice President, Strategic Planning and Investor Relations, are on the call.

Please remember that during this call, we may make forward-looking statements within the meaning of the federal securities laws. These statements are based on our current expectations and involve risks and uncertainties that could cause actual results to differ materially from our expectations described on this call. Please see the Risk Factors section of our Form 10-K filed with the SEC on March 19, 2020, for a description of those risks and uncertainties.

Finally, please note that on today's call, we will refer to certain non-GAAP financial measures that we believe will provide useful information for investors. The presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Please refer to today's press release posted on the Investors section of our website for a reconciliation of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP.

With that, I'll turn the call over to Lee.

Good morning, and thank you for joining us. I hope you are healthy and safe. Q3 was another outstanding quarter with considerable, strategic, operational and financial success. We are clearly benefiting from a unique combination of factors, allowing us to dramatically accelerate our transformation and strengthen our business for the future.

For the balance of my remarks, I will describe the major factors contributing to our success and discuss their implications for our future. First, our team has been amazing, and I could not be prouder of them. They have stepped up to meet incredible challenges all year. Across our distribution centers, clubs and home office, our team's creativity, resilience and dedication has been so impressive. They have kept safety as our highest priority with extensive protocols to ensure a safe and healthy environment for our entire community.

In partnership with our vendors, who, too, have been incredible, our team has continued to provide for members when they needed us most. Let me offer my sincere thanks to everyone who has and will continue to power our success. I deeply appreciate your contributions and partnership.

We continue to support our team with investments in bonuses, enhanced benefits and safety measures. Year-to-date, we have invested $128 million in these practices, and we'll continue to prioritize our team's well-being. Importantly, we have also upgraded our team's capability over the last 6 months with key senior hires in membership, marketing, merchandising, digital, analytics, operations and IT. We know these recent additions will further speed our transformation, and we expect to continue to invest in great talent as we become an even more attractive employer.

Second, and perhaps most obviously, we remain on trend. Members are consolidating their trips, buying bigger baskets in response to the pandemic and searching for savings given broad economic anxiety. Our industry leading value, bulk sizes and broad category participation, worked exceptionally well in these times.

As a result, we have gained considerable share. More than half our growth was driven by share gains based on IRI data. Furthermore, our growth outpaced the market by more than twofold, and we gained share in more than 90% of the categories we track. For example, our perishables business outpaced the market by more than 2x, and our nonedible grocery business grew at 8x the rate of the market.

Our strongest share gains occurred outside our core Northeast geography as more people discovered our relevance. These share gains outside of our core markets further support our confidence that we can successfully expand our reach and assert our relevance far beyond the Northeast, and we are gaining share digitally. We anticipate elevated shopping trends will continue well into 2021 given the current state of the pandemic, likely time line for vaccine distribution and ongoing unemployment trends.

Third, I believe our business model is competitively advantaged for current and future times. We run large clubs and distribution facilities with capacity for growth as others are closing stores. We operate efficiently with focused labor and lower marginal expenses, positioning us favorably, should wages rise.

We saw a limited selection of larger-sized items, offering advantaged economics in a more digital world. We offer industry leading value, critical as prices become more transparent and consumers seek out savings. All these factors will allow us to meet elevated levels of demand with favorable economics under nearly all potential future environments. Our Q3 share gain and profit is evidence of these structural business model advantages.

Finally, we've accelerated our transformation in 6 key areas: growing our membership, delivering value, improving convenience with digital, expanding our footprint, lowering our cost position and improving our capital structure. Let me say a bit more about each.

From a membership standpoint, we are ahead of our expectations on all metrics. We continue to attract new members at high rates, and retention remains robust. Our tenured members and new members continue to shop at elevated levels, driving increased trips to our clubs. In addition, new members continue to skew younger and engage more with our digital platforms.

We are leaning into membership investments to drive acquisition and engagement. Through our data-driven approach, we are focused on attracting members with the highest lifetime value. Similarly, we are also concentrating on retaining members by helping them discover all the ways in which BJ's can deliver value. These efforts have powered 12% growth in our total member base year-over-year.

These investments also drove a meaningful improvement in the quality of membership. This quarter, our highest tier penetration increased by 200 basis points to 30% of total members compared to the prior year period. Higher-tier members renew at much higher rates and have greater lifetime value. We expect gains in membership, size and quality will yield benefits well beyond the current environment.

Assortment optimization remains a key initiative to deliver value to our members. We continue to work hard to remain in stock on high-demand essential products and have quickly pivoted to add new suppliers and categories. In-stock levels improved this quarter, and we continue to mitigate supply chain challenges. Our strategy remains consistent, simplified to expand into high-growth and high-demand areas, and remain agile with our space to meet member demand.

This quarter, we expanded our assortment in categories where we were historically underpenetrated, including fitness equipment, household goods, indoor furniture and select consumer electronics categories. We accelerated the reset of our food business with more healthy and organic options in the first half of this year. These changes drove market share gains in several categories, including alternative snacking, where we grew our sales 8x the market rate.

We also saw significant share gains in many perishables categories with growth 2 to 3x the market. Our new prepared foods business also gained share. We know these improvements will serve us well with the younger new members we have recently added.

Let me touch on our holiday planning. First, we pulled our Black Friday deals to start earlier in November with a seamless experience across all channels and an enhanced focus on relevant categories like furniture, fitness and recreation, small appliances, housewares and consumer electronics. We have adapted our grocery offering to account for fewer large gatherings, for example, by downsizing our party platters and buying more small turkeys. While we anticipate some headwinds from fewer holiday gatherings, we feel great about our holiday assortment.

From a services standpoint, the team continues to enhance our capabilities. Services, including optical, cellular and home improvement, all returned to growth. We recently relaunched our major appliances business with a new assortment and improved digital experience, and it is growing at a significantly faster rate. We believe services will be a significant growth driver for many years to come.

Our digitally enabled sales grew by approximately 200% this quarter. Our biggest gains came in channels where our economics are most attractive, with buy-online-pickup-in-club or BOPIC and same-day delivery, representing 3/4 of the growth.

The growth in our digital platforms continues to surpass our expectations. In the last 9 months, we have grown by more than 4x all of last year's growth. This quarter, we expanded BOPIC to include curbside service, including fresh and frozen grocery items chain-wide. Although still early, results from this expanded offering have been very promising. For example, roughly 40% of our BOPIC orders post-launch were delivered curbside.

We will continue to aggressively invest into digital platforms given their increased relevance in our competitively advantaged economics. We believe shifts to digital will bode well for us on the top and bottom line.

Our efforts to expand our footprint are progressing well. We remain on track to open 2 new clubs in New York at the end of this fiscal year, for a total of 4 this year, and as many as 6 clubs next year. To further expand our reach, we are pursuing additional locations in new and existing markets with a focus on attractive demographics.

We are pleased with the performance of our clubs so far especially from a membership standpoint, where in Michigan, our members per club average is 20% better than the chain-wide average. We plan to invest aggressively to support our new clubs given our ability to gain share in new markets and the performance of recent openings, the latter of which continues to run ahead of expectations. All told, we expect greater unit growth to be a multiyear growth factor.

Our cost reduction efforts and enhanced balance sheet afford us increased flexibility to invest in our business and return capital to shareholders. We remain on track with our Project Momentum cost reduction goals and have used this year's considerable free cash flow to transform our balance sheet. Our leverage now stands at 1.3x EBITDA compared to 2.9x a year ago, and we return capital to shareholders by opportunistically buying back shares.

Before I turn the call over to Bob, let me leave you with a few takeaways. Our business has been transformed, and we expect to continue to gain share over the near and long-term. We are well-positioned structurally and strategically with an extremely relevant and extendable value proposition, a growing and upgraded member base, advantaged digital capabilities, faster unit growth and geographic expansion and a better cost position and transformed balance sheet. As we look past the current environment, we see a stronger business with robust sales, higher profitability and strong cash flows.

With that, I'll turn the call over to Bob. Bob?

Thanks, Lee, and good morning, everyone. Before I begin, I would also like to take this opportunity to thank our team members for their hard work and dedication during this truly remarkable year. We continue to execute at the highest standards and drive industry-leading results.

Net sales for the quarter were $3.6 billion. Merchandise comp sales, which exclude sales of gasoline, increased by 18.5% and were driven by both traffic and ticket. We continue to see more members, tenured and new, shopping in our clubs, expanding their baskets and penetrating all categories. These trends were consistent across our geographies.

We saw consistently strong merchandise comp sales during the quarter. Each month's comp was within 100 basis points of our quarterly comp. October's merchandise comp was slightly over 18% and strengthened towards the end of the month. The consistency of our monthly performance, coupled with the expanded market share, gives us confidence that the underlying strength we have gained will outlast the transient benefits of the pandemic.

Merchandise comps have continued to strengthen since the end of the quarter. In the first 3 weeks of November, we are running north of 20%, with strength across almost all categories as we continue to see increased food-at-home trends and consumer home investments, in addition to earlier holiday shopping.

While we are pleased with our early fourth quarter comp, it's difficult for us to predict how the rest of the quarter will play out given the number of significant uncertainties such as inventory availability and member behavior during the holidays, namely as it relates to entertaining.

Our digitally enabled sales grew by approximately 200% and drove about 4 full percentage points of our 18.5% merchandise comp. As Lee noted, we are aggressively investing behind our digital platforms, particularly in BOPIC and same-day delivery, which together drove 3/4 of our digital growth.

As you know, our economics are advantaged versus our peers. We operate a limited SKU warehouse environment with significantly higher average tickets, allowing us to be much more efficient. BOPIC and curbside sales tend to skew towards bigger baskets, and same-day delivery sales have the same margins as traditional sales in our clubs. Additionally, digitally engaged members appear to shop much more than those that only interact with us through traditional means.

Comps in our grocery division grew by 19%. We saw robust comps across all categories, most notably in perishables, where we saw strong growth in fresh meat, frozen meals and fresh produce. As Lee noted, our perishables division grew more than twice as fast as the rest of the market.

In edible grocery, we saw robust growth in beverages and salty snacks and grew twice as fast as the rest of the market in those categories as well. In our nonedible grocery division, we continue to see strong growth in paper products, cleaning supplies and health and beauty items. Our growth outpaced the market by 20x in health and beauty and by a little bit more than twofold in household goods and cleaning. Our in-stock levels improved throughout the quarter as our team worked tirelessly with both existing and new suppliers.

Our general merchandise and services division saw a comp growth of 13% driven by strong sales of TVs, computer equipment and other home-related categories such as indoor furniture and small appliances. Although we made great progress, our services business is still ramping back to its full run rate potential and represents a great opportunity for growth in the new year.

In our gasoline business, although sales were impacted by lower prices, our gallons sold at comp clubs increased year-over-year by about 2%. This performance outpaced the significant decline in the overall market. This is yet another great example of our continued gains in market share.

Membership fee income or MFI grew by 11% during the third quarter to $85 million. MFI growth was driven by new members, renewals and membership mix. We continue to grow total paid members compared to last year, adding a little bit more than 630,000 members on a net basis. To put this in perspective, historically, we would have added between 200,000 and 250,000 net new members year-over-year.

Along with terrific increases in our membership count, we also improved the quality of our memberships significantly. For example, our penetration of higher-tier memberships increased to 30%, and easy renewal enrollment is at 70%.

Also, we recently passed another important milestone by acquiring our 1 millionth co-brand credit card holder. These are our best members, and they renew at significantly higher rates. We remain very excited about the membership growth we've seen year-to-date and our focus on retaining these members, we expect, will be sticky given their shopping behavior.

Let's move now to our gross margins. Excluding the gasoline business, our merchandise gross margin rate increased by 10 basis points driven by CPI initiatives, which were partially offset by increased COVID-related distribution costs and investments in price, particularly in areas experiencing some inflation. Investing in price is a bedrock principle of our business in order that we sustain our outstanding value to members, especially in these tough times.

SG&A expenses for the quarter were $552 million and included approximately $17 million of total costs associated with the pandemic. The costs were primarily driven by increased labor, safety and sanitation costs and our bonus incentive program. During the third quarter, we were able to better leverage our SG&A by a little more than 100 basis points. Given the current trajectory of the pandemic, we expect to incur more incremental expenses associated with COVID-19 in Q4. Costs related to team member bonuses and ensuring we keep members and team members healthy and safe are expected to be $30 million to $35 million.

Our adjusted EBITDA grew by 57% to $242 million, reflecting the robust sales beat, growing margins and disciplined expense management, slightly offset by investments in our business and the safety of our team members. Adjusted net income in the third quarter was $128 million or $0.92 per share and reflected an incredible 124% year-over-year growth on a per share basis.

Our earnings growth highlights the strength of our revenues, our disciplined expense management and reduced interest expense. We generated a record $675 million of free cash flow so far this year. We don't typically generate much cash in Q3 as we position our inventory for the holiday season. Coming out of Q3 ahead of the game, we feel great about our ability to build on our year-to-date performance in Q4.

From a capital allocation standpoint, our strategy remains consistent. Our overwhelming priority is investing in our business and expanding our footprint. Our next priority is the continuing improvement of our balance sheet.

The current year's tremendous free cash flow has allowed us to repay nearly $575 million in debt. Ultimately, we ended the quarter with a funded net debt to adjusted EBITDA ratio of 1.3x. As we go forward, we will look to target a funded debt level of approximately 1x adjusted EBITDA. Finally, we will look towards returns of capital to shareholders.

From a capital return standpoint, we bought back $50 million worth of shares in the quarter. And year-to-date, we have returned approximately $88 million to our shareholders by repurchasing 2.3 million shares.

We will also opportunistically look to optimize our balance sheet. During the third quarter, we used $100 million of excess cash and borrowed $260 million from our revolver to reduce our first lien debt by a total of $360 million. In connection with this transaction and shortly after the conclusion of the quarter, we terminated one of our interest rate swaps with $360 million of notional value. The combination of these changes will result in interest expense savings of approximately $10 million on an annualized basis.

Let's now touch on our outlook. The current environment remains challenging and unpredictable. There are several uncertainties and factors that would impact our business, including the evolution of the pandemic, government stimulus, consumer behavior and unemployment levels. As a result, it remains extremely difficult for us to forecast how the fourth quarter or next year will play out in great specificity. Given these uncertainties, we will again refrain from offering guidance.

With that said, we have a larger and more meaningful business with industry-leading comps and incredible membership trends, and we are accelerating investments to improve all aspects of our business. Given the current trends in the public health crisis, we believe that the push towards food at home will remain robust for Q4 and well into the next year. We also believe that with the election behind us, a new stimulus package may have the potential to gain more momentum in Washington. Both of those factors should drive our business even more.

Like others, we continue to work through inventory availability challenges and await how holiday entertaining plays out in the coming months. The net of all these items should be bullish for us.

While we've had some good news in the race for a vaccine, it will most likely take many months to get enough people inoculated to improve the public health crisis. Further, consumer behavior in our geographies has certainly changed to our advantage, and we expect this change to be sustained for the foreseeable future. As a result, we continue to believe that our long-term growth algorithm significantly outpaces the plan we laid out at our IPO.

To wrap up, we are extremely pleased with our financial performance. Investments made in prior years have set the stage for our great performance so far this year. We continue to invest behind our strategic priorities as we leverage this extraordinary and challenging set of circumstances.

As we look beyond today's environment, we believe we are well-positioned given the nature of our business model, our sizable share gains and our transformed balance sheet. And finally, we have a team that continues to execute at the highest level against elevated and bolder expectations, enabling us to truly transform BJ's Wholesale Club.

And now I'll turn the call back over to the operator to begin the Q&A session.

(Operator Instructions) Your first question comes from Robby Ohmes of BofA Securities.

Terrific quarter, just a great execution. Actually, 2 questions. One, I just wanted to ask about the membership growth rate. I think it was 11% for the quarter. So it sequentially accelerated a little bit it, looks like from the second quarter. But can you just remind us how to think about how that could look going forward? And also, is there a slowdown in new member growth happening the further that you're moving into this year? And how -- can you give us any thoughts on how we should think about what that could look like for next year?

And then my second question is just on accelerating store growth. Maybe some more color on how much you might start looking to really accelerate outside the Northeast given what you're seeing in new stores? And maybe what regions you might be doing more stores in as you look out over the next few years?

Robby, this is Bob. I'll take, I think, both of those questions. Thank you for both of them and for the good wishes on a great quarter.

Membership is the bedrock of the business. I think as we sit here and stare at the numbers, we see a membership of record size with strong momentum and great and improving quality. In terms of the size, we built on our 6 million member record from the second quarter. And total members on a net basis are up 12% year-over-year. So we're very impressed with that continued growth.

From a momentum perspective, MFI growth accelerated from Q1 and Q2 on the P&L. That's an important feature. More importantly, members are responding to the investments we're making and did so throughout the quarter.

As to the quality point, despite growing the overall membership, we were also able to improve our premium tier penetration to 30%, improve our easy renewal penetration to 70% to get to the 1 millionth co-brand cardholder, which is an important milestone. And we continue to see robust shopping behaviors across the portfolio, which make us believe that these gains will be sticky going forward.

You're correct to point out there was a touch of a slowdown, and we did miss our guide by a couple hundred thousand dollars. I guess what I'd say to that is many things impact MFI, including the absolute member count, TYLY acquisition campaign timing and performance, the calendar month end versus quarter end versus the fiscal quarter end as it relates to easy renewals, footsteps in the club and on and on and on.

And so one way is to -- look at it is to think about the slight miss or a slight slowdown. The better view, I think, in our estimation is to really consider the record size and momentum and quality. We don't see those things slowing down in our view. And hopefully, as we get through the rest of this fiscal year and into next year, we continue to build on the gains on all 3 of those phases, right, record size and strong momentum and great quality.

As you think about store growth, certainly, we've talked about that being our biggest priority in terms of investment in the company. We've made great strides in building a portfolio of clubs we can bring to bear. We are on track this year to get to 4 clubs. As you know, we opened one in Michigan and one in Pensacola, Florida already this year. We have two set to open in January, one in Newberg, New York and one in Long Island City, New York. Those are right on track to open in January as we said on our last earnings call, and our team is working with great haste to get that done. We're excited for those clubs.

As we get to next year, we've talked about 6 or more, and we are still on track to do that. I think you will see us pursue new markets and existing markets. So we will, hopefully, get into the Pittsburgh market next year and then sprinkle some other clubs throughout our chain. As we look forward to the following year, we see a path towards 10 clubs, but we are a long way away from that. As you know, real estate is a game full of surprises. So as we get through next year, we'll certainly give a more robust update into that. But I think the same function will hold where we will look to open, at least one new market in that year and then add into our existing markets as we go.

Your next question comes from Chuck Grom of Gordon Haskett.

Great quarter. Just wondering if we could just dive into the components of the gross margin strength, up 10 basis points, which is better than the front half of the year? And then looking ahead, if you had any thoughts with regards to the -- how the fourth quarter to play out?

Chuck, it's Bob again. So maybe I'll touch on the gross margin one, and Lee can pile on as we go. So certainly, we saw great performance from a gross margin perspective.

In terms of total gross margin, gasoline had a great quarter. And inside-the-box had a great quarter, 10 basis points of merchandise margin inside the box. There were puts and takes against that as we talked about in the prepared remarks. The biggest gain was our continuing success with our CPI program. That effort continues to move forward as we've talked about, moving more towards assortment changes and getting into growthier and margin-heavier categories versus just classic negotiation tactics as we've talked about in the past. So great success from a CPI perspective.

We did see some increased distribution costs that were primarily COVID-related. We are doing the same things in our distribution centers that we are doing in our clubs and frankly, in our home office just to try and keep everyone safe and healthy as we go. And that weighed on gross profit a bit.

Versus the front half of the year, we had a much better inventory position, particularly in apparel. And so where we talked about in the first quarter, pretty significant markdowns in apparel. We did not experience those in the third quarter.

And finally, with the investments in price, we typically do that as just part of the every day. As you know, it's a big part of the club industry, maintaining the value that we offer to our members, which is tremendous and why they pay their membership fees. We did see some inflation during the quarter, although not terribly material, particularly in beef. And so we did invest in price in those categories and a few others as we went throughout the quarter. So altogether, very happy with the Q4 margin profile and what made it up.

Any thoughts for how 4Q could play out?

Chuck, it's Lee. I'll jump in on fourth quarter. Just to set the stage for that question, let me just reiterate some of what Bob said on the membership because it is the bedrock. We feel great about the membership, we have more members. The quality of them is really strong. And so we track the underlying quality, looking at how many people we have in different cohorts, how much they pay. And we're seeing more or less every cohort paying more with more members. They're younger, they're digitally engaged, and they're shopping more.

And so the business began to strengthen in the back half of Q3, particularly in the last couple weeks of October. As we said in the prepared remarks, that's continued into November.

And if you think about the broader environment obviously Q3 as it relates to the pandemic was a period of more relative normalcy with warmer weather, the ability to eat in restaurants, et cetera. And as that changes in our footprint, we would expect to see a strong business.

The big question, clearly, is the kind of holiday gatherings and parties. We are expecting fewer of those, which is a big part of our business, but just an increase overall in at-home food consumption and investment at home and investment in gift-giving for the holidays. And so as we sit here today, we feel like Q4 is in very good shape.

Okay. Great. And then just to follow-up on that. You guys continue to make great progress on the SKU rationalization program. I guess can you talk about some of the things you're changing for the holiday? And I guess just to kind of dovetail to Bob's comments about -- it seems like the baton is getting passed a little bit from CPI being a major driver on the core margins, to potentially some of these assortment changes helping you guys lean into higher merchandise margin rates in the home categories or furniture category. Just maybe if you could just talk a little bit about SKU and then also how that could help on the gross margin line?

Sure. So I think the overall premise of your question is right. In the short term, the team, the merchants, the planning team, the supply chain team have been extraordinarily focused on keeping the stores well-stocked. Clearly, when you're running at the comp levels we've been running, it begins to stretch the system, and there's been shortages on key products. And so we have made a number of changes to just keep the buildings in stock, the members satisfied.

As you think about the longer-term shifts that we're driving, you're right, we're thinking about how do we drive growth in the business. That includes a simplification in some of the core categories where we've been overassorted and an investment in categories that are on trend, things like healthy organic food. We talked about alternative snacking but also in few categories where we haven't historically played. And so as an example, we launched fitness equipment in this past quarter with a treadmill and an exercise bike at significantly higher AURs than we normally would carry and are seeing really good results with those items.

And that overall shift away from real concentration in places where, frankly, we just felt like we were overassorted to new categories that are growing on trend, where we have an ability and a right to play, it brings more excitement to the club. It's the change we'll make. It's also worth highlighting services in that shift. And services is an area where we're just incredibly excited about the growth potential. This has historically been our optical business, our travel business. And as we invest more on that, including a dedicated merchant team, we're just finding really fantastic and exciting growth opportunities in new areas.

As we said this past quarter, we relaunched major appliances and believe, that alone, can be a material contributor to growth going forward. And so you'll see us keep going down that path.

The only piece that we didn't touch on is private label. That will continue to be a focus area given the ability to offer better values to members that improved economics for us.

In the short term, we've obviously been really just focused on getting product in the building, so a little bit less on private label. But over the long term, that's a major focus as well.

Our next question comes from Peter Benedict of Baird.

Two questions. First, just on the MFI growth. Just given the dynamics of what you know today, just curious, how do you think about the shape of the growth curve? And I'm not asking for investor-specific numbers, but would you think that the growth rate kind of peaks in 4Q of this year and then starts to moderate a little bit for earlier next year is the peak? Just trying to understand how you think about that given the current sign-ups you have? That's my first question.

I think the right answer is it's a little bit hard to say. There's no doubt that the broad trends in the pandemic are causing members to seek out value, buying in bulk sizes in our particular value proposition. And I think as you've seen that flow through the business, particularly with the Northeast being heavily affected at the start of a pandemic in Q1, kind of rolling into the broader geographies in Q2, somewhat of a return to relative normalcy in Q3, those trends are clearly paying forward.

The hope is, as we move into winter months, the public health crisis is more controlled, although that doesn't seem terribly well aligned with the headlines and where we're heading in the short run. And so I suspect you'll see growth that falls out of that overall situation as people are eating more at home or they're seeking value, we're just incredibly on trend.

The long-term question is, how many of those members will we be able to hold onto as the world hopefully returns to normal in the middle to the latter part of next year? And based on what we see now, we feel good about that. We have members who are engaging with us in a more elevated way than we would normally see. The quality of the membership is high.

We know that a lot of the changes we've made to the base platform were things we wanted people to experience, and the pandemic has created a platform to do that. And so our hope is that we'll be able to hold on to the membership gains and see a multiyear growth story fall out of the kind of the one-time unique event we're experiencing now.

That's helpful, Lee. And I guess my second question is just you kind of alluded to this a couple of times, your sense that for '21, I would expect some of these trends to continue at least through the first half. So I'm just curious, with the benefit of hindsight, we went through the first lockdown last spring. Obviously feel like, unfortunately, moving into something similar here. How are you buying for the first half of '21?

I mean, given the experience you had earlier this year, are there things that you're doing now that may position you better to be able to handle what could be ahead? I'm just curious on how you're just planning the first half overall of '21. It certainly sounds like you're not expecting any material slowdown but just wanted to hear you out on that.

Yes. We're buying as aggressively as we can. The buildings are very clean from an inventory standpoint, particularly in some of the general merchandise categories. And we are still running at an in-stock level below what we would like. There have just been shortages in a number of categories, and the inventory is turning so quickly that it's -- frankly, hard to keep up. If we could trade cash for inventory, we would definitely do that.

And I think we all hope that the public health crisis abates as quickly as possible. It -- but as you sit here today and you look at the kind of the incidence of disease, the testing rates and then the likely time line for the vaccine distribution, it unfortunately seems like we're in for an extended period of hardship eating at home, renewed bans on restaurants, et cetera. Again, we hope those things don't come to pass. But as we plan and buy for the business, we're anticipating that elevated demand continues certainly for the short term.

Your next question comes from Chris Horvers of JPMorgan.

A couple of expense questions and one follow-up. So first, on the gas profitability side. How much would you say you sort of overearned on gas, if at all, here in the third quarter as we're building out our models for next year? And then on the expense front, can you talk about COVID costs accelerating in the fourth quarter relative to the cost in the fourth quarter? What drives that? And then within gross margin, would you expect higher COVID costs plus higher parcel ship to mitigate any merchandise margin expansion in 4Q?

Chris, it's Bob. The expenses story in Q3 was, frankly, a great one as you could see the incredible leverage we had on SG&A. I think the look forward and updating a little bit of guidance from the $17 million of COVID expenses in Q3 and more towards somewhere in the neighborhood of twice that really dovetails nicely with Lee's comments about our view of the course of the public health crisis.

And this is an incredibly hard thing to predict, but we will do the same thing we've done the entirety of this public health crisis and do everything in our power to protect our members and our team members as they're in our stores and distribution centers and home office.

And unfortunately, the path of the disease looks like it's accelerating. And so we are tying our estimate of COVID-related costs to that fact. Should it improve, we'll do better. Should it get worse, we will spend more keeping our members and team members safe. It's really as simple as that.

And so that's why we chose to give that increasing guidance. Hopefully, we'll be able to do better than what we put out there, that the virus won't be all that bad. Certainly, the gas business had a great quarter this quarter, and it has throughout the entire year. We've gained tremendous share.

As we talked about in the prepared remarks, our comp -- gallons sold at comp clubs were up 2, and the market is down double digits, call it, 15. So we are gathering tremendous market share. That's been a fact all year as well. And profitability-wise, call it, a handful of million dollars extra in this quarter as you think about the setup for Q3 next year.

So a great quarter for sure but not going to bend the trend of our overall growth for next year as we go. Maybe I'll let Lee jump in and talk a little bit about your parcel question on gross profit and talk about our omni business.

Yes. I think we're certainly seeing some constraints in the broader freight market, including parcel rates. As you think about our omni business, which, as we noted, is still growing at a remarkable rate with about 200% growth. The bulk of that growth and the bulk of the demand comes through buy-online-pickup-in-club, same-day delivery, both of which aren't impacted directly by freight expense other than the broad supply chain challenge of getting those items to the store just like every other item.

And so in those regards, we expect to see increased demand for those services. Curbside, in particular, fresh curbside is working very well for us.

When it comes to the shift to home business, we did see this coming and negotiated contracts and -- in parcel rates, ahead of time, along with increased levels of demand. And so we feel pretty good about where we are. The levels of inventory we have, the likely markdown exposure of that inventory will be lighter than normal just given how quickly things are turning. And so from an overall margin standpoint, we're not terribly worried about the parcel cost given those kind of those broad factors.

Got it. That's very helpful. Just as a follow-up then on the membership side. I understand you don't want to guide, and there's a lot of variables and maybe the recent surge helped sign-ups and reacceleration of customer acquisition. But maybe you could give us cash MFI in the third quarter, relative to the 15%, 16% that you saw in the first half? Just as we try to take a shot at building out the model right now, the consensus is looking for about another 12% gain in MFI dollars year-over-year in 4Q?

Yes. I'll take that, Chris. So we didn't offer cash MFI this quarter and probably won't. We offered that statistic in the prior 2 quarters having never talked about it before because we thought it would help illustrate the incredible momentum we had behind the business.

And while it might have done that, it also created a lot of confusion and misunderstanding in the analyst and investor communities. And so we -- and stepping back after the second quarter, we thought we might have created a problem when we were trying to just illustrate the tremendous trends in our business. So we hesitate to offer it again.

We'll certainly talk about accounting MFI, which was up 11. We've talked about the total net member growth, up 630,000. We've talked about our hopes for renewal rates as the member data would look like, these folks will be sticky. And so I hesitate to give you the cash MFI. Instead, I'd concentrate on the record MFI, the record membership counts, the strong momentum we've had and the improving quality throughout the membership base as well.

Okay. So then just as a follow-up. So if the membership base is up sort of 12% year -- on a year-over-year basis, and you've got transition up to higher tiers and a more expensive sort of fee there, plus the fact that it seems like the level of discounted membership is below what you had been running last year, sort of that 12% growth in membership sort of sets the base -- sets sort of at a minimum, the baseline in terms of the growth rate.

I think you're thinking about the pieces of it correctly, right? There's the total net member growth, which is up as you point out. There is a bit of a favorable mix shift in the premium memberships as we get people more up into the tiers and into the co-brand product as you point out that would build upon the member growth as we try and build out MFI.

There's also a slight offsetting mix shift as you just think about the math involved with just having more new members versus more tenured members, more renewal members. Those renewal members are generally paying full freight across the board, and the new members are somewhat discounted. And so you just have to think about those 2 mix shifts that somewhat offset, and you kind of get back to that something around the net member growth.

Your next question comes from Kate McShane of Goldman Sachs.

This might be a little too narrow, but I was just curious to hear a little bit more about the Michigan stores, the membership for store being, I think you said, 20% higher than the company average, is impressive. Just wondered if you could give some insight as to what you think the combination of factors are that's helping drive this? And as you think about introducing BJ's into new markets, are there any learnings from Michigan being out of the newer market?

Yes. Why don't I start, and Bob can jump in. We're very excited about the results in Michigan. I would now -- 3 clubs with 2 open for a longer period of time. And as we noted, we are seeing membership accounts that are 20% above what we would see across the chain.

It's a combination of things that are driving that growth. One is just investing more in membership acquisition, preopen and during the open. And with more confidence about the potential for our franchise and a greater ability to invest into the buildings and the membership drive, we've been able to drive more excitement in the market, see higher sign-ups, both pre and postopen, which has been very exciting.

Two is we've really refined the offering. And so a number of the changes that we aspire to make across the chain when it comes to assortment, the in-club environment, signage, the integration of omni, we do from the very start in new clubs.

And so as you put those kind of 2 pieces together, more members at open and improved experience right out of the gate. We are very hopeful about the potential for those clubs. And it gives us confidence to -- and to invest into new geographies.

The big question about Michigan was we didn't have much in the way of brand equity unlike you would see on the eastern seaboard. But we've quickly built a franchise there that we're very excited about, and it gives us confidence that we can grow into more new markets at an accelerated rate. And so as we think about upping the comp to 6 clubs next year, hopefully closer to 10 or more in the out-years, we do that quite bullishly.

Your next question comes from Edward Kelly of Wells Fargo.

So Lee, my question is for you. When you went -- when you guys went public, you introduced an earnings algorithm that now kind of seems conservative. You talked about 1% to 2% unit growth, 1% to 2% comps. Could you just maybe take a step back for us and fundamentally talk about -- talk fundamentally about what's really changed with the business since then? And how that potentially could impact the algorithm of the company over time?

Sure. Thanks, Ed. I think it's a really good question. We certainly feel like the long-term algorithm today is considerably ahead of what we would have described at the IPO.

There's a few things playing out. One is the variety of investments and initiatives we had talked about in the IPO are gaining traction. And so it's our ability to invest into the membership with greater data and science. It's our changes to the merchandising, the assortment, the marketing. It's our building of the omni system. And then it's our acceleration of real estate. And those were the same basic themes that we talked about at IPO, but we've just further developed our ability and capability.

And then clearly, the pandemic is just such a unique circumstance, where one of the things that we wanted members to experience or new members to try were all accelerated by just the incredible relevance that we have, right?

We operate very large buildings that I think afford more of a sense of safety because people are more spread out. We're selling bulk groceries as people need to eat more at home, and we're doing it at industry-leading prices as people need to save money.

And then the omni offerings really, really work. And so the recent launch of curbside and curbside-fresh is just incredibly relevant. And the advantaged economics we have there, we think, is a part of the equation that can give us the long-term ability to invest in those businesses, ahead of what others might be comfortable doing.

And so it's kind of a combination of acceleration in the broad themes we talked about at IPO from some of the initiatives getting more steam and then just an incredible shot of adrenaline tied to the pandemic at an increased relevance. But we do feel really good about the long-term state of the business.

And just from a store growth standpoint, as we think about where you're going over time, when you talk about 6 next year and I think the hope to get to 10 or better, why can't the number be higher than that? If you're having success in these new markets and the merchandising side is aligning and Michigan is going very well, what's the Governor around that?

I think the short answer is it can be. The Governor is finding real estate and developing it. And so we have a quite aggressive push internally to find and develop sites and properties, and we'd love to move at a faster rate. But as you just think about a challenge of finding that many sites and moving at a faster rate, we're governed simply by our ability to make progress. It's less so from a financial attractiveness standpoint.

Your next question comes from Stephanie Wissink of Jefferies.

Most of our questions have been asked, but I wanted to just talk on a couple of threads based on your response to the prior question. If we're hearing you correctly, it sounds like one of your agendas is to really attract that millennial household, fitness equipment, you've talked about furniture, good-for-you food, health and beauty. So if you can talk a little bit about how you think about marketing, digital activation, customer acquisition through the lens of that next-generation household? And how you might be the chosen club for that emerging household?

And then secondarily, how that factors into your thoughts around real estate and cotenancy? Are there certain retailers as you think over the course of the next 3 to 5 years that are the more ideal cotenants maybe versus what would have been 3 to 5 years ago?

Yes. Thanks, Stephanie. Let me take the first part and then maybe, Bob, you can jump in on the real estate side of things. For us, the relevance of our channel is really around home ownerships and family formation. And as we think about growing the membership, the ideal thing for us to do would be to engage people right at those 2 life moments. And the sooner we're able to do that, the better because you see an acceleration in spend. And so as we look at the members that spend the most, it will tend to be the family of -- with 3 or 4 teenage children in the house who are just eating you out of house and home. But to get them earlier, we need to market to them to make sure our assortment is relevant.

And frankly, we just -- we needed to revolutionize the assortment of it, and that's what you're seeing us doing. It's really understanding what the growth rates look like across different food, nonedible grocery categories. How do you invest in things that are relevant to a younger consumer that will tend to skew towards healthier foods, natural household cleaners and the like.

It will also apply to our general merchandise assortment. We're getting bigger into connected home, investing more in furniture, as you know, into fitness equipment, are all categories that we know will appeal and work with that younger member, and we have the right to play. And so we are broadly transforming our assortment to fit that demand.

And then as we said, we think services can be a big part of that as well, where there's just a whole host of categories where we can offer phenomenal value that are relevant to a new homeowner, a new family. And so you'll see us continue to invest into those developments. And Bob, do you want to talk about the cotenants, the real estate part?

Yes. Thanks, Stephanie. I think that's a really smart extension of your question and really highlight something that we've been doing for the last couple of years, which if you think back to some of the older clubs in our base and in our competitors, our club competitor's base, you'd see clubs in distribution parks and office parks and hidden behind berms and all sorts of things. And in more recent years, they've been in places that have much more classic retail gravity.

And I think you'll see us continue to do that, where the retail gravity and the traffic that, that brings outweighs what might be extra cost in those sites versus something in an office park or the like. And so as we look at real estate going forward, we are very much looking for active, great traffic sites. And there are other retail names you would not be surprised by, right, the TJX Companies, DICK'S Sporting Goods, Cabela's. The really high draw retailers are great for our business when we are positioned nearby or next door in the same shopping center. So it's a great question. It's certainly something we're looking at.

And your last question comes from Rupesh Parikh of Oppenheimer.

So I have a quick one just on cash flow. So we saw a pretty significant improvement in your AP leverage. So just curious as you look at your -- the improvement, what you view as more onetime in nature versus more sustainable? And also, just in general, as you look at your cash flows, was there anything that is more transitory in the cash generation this year?

Here, Rupesh, I'll take that one. So we're very pleased with our Q3 cash flows. As we talked about in the prepared remarks, we typically don't make cash in Q3 as we're buying inventory ahead of the holidays. We came out of the quarter with $20-odd million in free cash. And to your point, good AP leverage. It is really a tale of 2 cities, right? We added a bunch of inventory during the quarter, which we're happy about, to Lee's earlier comments.

We are buying inventory with both hands as the business has picked up in the last couple of weeks. And AP decelerated a bit in the beginning of the quarter and now has accelerated back up a little bit as the inventory spins a bit faster. And so there is going to be some variation from an AP leverage perspective going forward that is probably most closely tied to comps.

But this quarter, as we built inventory, you had a little bit of an offset to that, too. So I think we'll watch that. We're not worried about the AP leverage. We do expect over the long term, as the public health crisis abates, that comps will moderate a bit. And as that happens, AP leverage will moderate a bit. But in any case, as with nearly everything we've talked about, the post-pandemic BJ's will be better than the prepandemic BJ's. And our AP leverage is no different than that.

Okay. Great. And then maybe just one follow-up. So the quarter-to-date strength that you guys saw, what did you see from consumers, I guess, stocking up again? And also, any sense of whether your November so far is benefited from maybe early promotions versus the prior year?

Rupesh, this is Lee. I think we're certainly starting to see the signs of another stock-up wave as you look at things like canned vegetables and paper products, people are buying more aggressively. And so I suspect that's happening.

There's no doubt there's a little bit of benefit from the early Black Friday promotions. But if you think about the breakdown in our business and the scale of general merchandise versus food, we're seeing really good momentum in the food and traditional grocery categories. And that's the overriding thing that will make or break kind of the quarter, particularly the holiday season. So, so far, momentum looks quite promising.

I'll now turn the call over to Mr. Lee for closing remarks.

Great. Thank you, everyone, for listening to the call, for your engagement and for your interest in the company. We really appreciate your time and your interest. Until we talk again, please stay safe and healthy. We wish you all the best for the holidays. Take care.

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