BJ's Wholesale Club Holdings, Inc. (BJ) FY 2024 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis is intended to promote understanding of the results of operations and financial condition of the Company and is provided as a supplement to, and should be read in conjunction with, our audited consolidated financial statements and related notes thereto included in Item 8. in this Annual Report on Form 10-K. The following discussion contains forward-looking statements that reflect our plans, estimates and assumptions. Our actual results could differ materially from those discussed in the forward-looking statements. Factors that could cause such differences are discussed in "Item 1A. Risk Factors".

We report on the basis of a 52- or 53-week fiscal year, which ends on the Saturday closest to the last day of January. Accordingly, references herein to "fiscal year 2023", "fiscal year 2022" and "fiscal year 2021" relate to the 53-weeks ended February 3, 2024 and to the 52-weeks ended January 28, 2023 and January 29, 2022, respectively.

Overview

BJ’s Wholesale Club is a leading operator of membership warehouse clubs concentrated primarily on the eastern half of the United States. We deliver significant value to our members, consistently offering 25% or more savings on a representative basket of manufacturer-branded groceries compared to traditional supermarket competitors. We provide a curated assortment focused on groceries, continuously refreshed general merchandise, gasoline and other ancillary services, coupon books, and promotions to deliver a differentiated shopping experience that is further enhanced by our omnichannel capabilities.

Since pioneering the warehouse club model in New England in 1984, we have grown our footprint to 244 large-format, high volume warehouse clubs and 175 gas stations spanning 20 states as of the date of this filing. In our core New England market, which has high population density and generates a disproportionate part of U.S. GDP, we operate more than three times the number of clubs compared to the next largest warehouse club competitor. In addition to shopping in our clubs, members are able to shop when and how they want through our website, bjs.com, and our highly rated mobile app, which allows them to use our BOPIC service, curbside delivery, same-day home delivery or traditional ship-to-home service, as well as through the DoorDash and Instacart marketplaces where members receive the same preferential pricing as in-club shoppers by linking their membership. We also offer Same-Day Select, which offers BJ’s members the ability to pay a one-time fee for either unlimited or twelve same-day grocery deliveries over a one-year period.

Our goal is to offer our members significant value and a meaningful return in savings on their annual membership fee. We have over 7 million members paying annual fees to gain access to savings on groceries and general merchandise and services. The annual membership fee for our Club Card membership is generally $55, and the annual membership fee for our Club+ membership, which offers additional value-enhancing features, is generally $110. We believe that members can save over ten times their $55 Club Card membership fee versus what they would otherwise pay at traditional supermarket competitors when they spend $2,500 or more per year at BJ’s on manufacturer-branded groceries. In addition to providing significant savings on a representative basket of manufacturer-branded groceries, we accept all manufacturer coupons and also carry our own exclusive brands that enable members to save on price without compromising on quality. Our two private label brands, Wellsley Farms® and Berkley Jensen®, represent approximately $4.1 billion in annual sales. Our customers recognize the relevance of our value proposition across economic environments, as demonstrated by over 25 consecutive years of membership fee income growth. Our membership fee income was $420.7 million for fiscal year 2023.

Our business is moderately seasonal in nature. Historically, our business has realized a slightly higher portion of net sales, operating income, and cash flows from operations in the second and fourth fiscal quarters, attributable primarily to the impact of the summer and year-end holiday season, respectively. Our quarterly results have been, and will continue to be, affected by the timing of new club openings and their associated pre-opening expenses. As a result of these factors, our financial results for any single quarter or for periods of less than a year are not necessarily indicative of the results that may be achieved for a full fiscal year.

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Factors Affecting Our Business

Overall economic trends

The overall economic environment and related changes in consumer behavior have a significant impact on our business. In general, positive conditions in the broader economy promote customer spending in our clubs, while economic weakness, which generally results in a reduction of customer spending, may have a different or more extreme effect on spending at our clubs. Macroeconomic factors that can affect customer spending patterns, and thereby our results of operations, include, among others, employment rates, changes to the Supplemental Nutrition Assistance Program (SNAP), government stimulus programs, tax legislation, business conditions, changes in the housing market, the availability of credit, interest rates and inflation, tax rates and fuel and energy costs. In addition, unemployment rates and benefits may cause us to experience higher labor costs.

Size and loyalty of membership base

The membership model is a critical element of our business. Members drive our results of operations through their membership fee income and their purchases. The majority of members renew within six months following their renewal date. Therefore, our renewal rate is a trailing calculation that captures renewals during the period seven to eighteen months prior to the reporting date. We have grown our membership fee income each year for over 25 consecutive years and the quality of our membership mix is strong as evidenced by our higher tier penetration growth in fiscal year 2023. Our membership fee income totaled $420.7 million in fiscal year 2023. Our tenured membership renewal rate, a key indicator of membership engagement, satisfaction and loyalty, was 90% at the end of fiscal year 2023.

Effective sourcing and distribution of products and consumer demands

Our net sales and gross profit are affected by our ability to purchase our products in sufficient quantities at competitive prices. Further, our ability to maintain our appeal to existing customers and attract new customers primarily depends on our ability to originate, develop and offer a compelling product assortment responsive to customer preferences. As a result, our level of net sales could be adversely affected due to constraints in our supply chain, including our inability to procure and stock sufficient quantities of some merchandise in a manner that is able to match market demand from our customers.

Infrastructure investment

Our historical operating results reflect the impact of our ongoing investments to support our growth. We have made significant investments in our business that we believe have laid the foundation for continued profitable growth. We believe that expanding our club footprint, bringing substantially all of our end-to-end perishable supply chain in-house, enhancing our information systems, including our distribution center and transportation management systems, and investing in hardware and digitally enabled shopping capabilities for convenience, such as BOPIC, curbside pickup, and same-day home delivery will enable us to replicate our profitable club format and provide a differentiated shopping experience. We expect these infrastructure investments to support our successful operating model across our club operations.

Gasoline prices

The market price of gasoline impacts our net sales and comparable club sales, and large fluctuations in the price of gasoline may produce a short-term impact on our margins. Retail gasoline prices are driven by daily crude oil and wholesale commodity market changes and are volatile, as they are influenced by factors that include changes in demand and supply of oil and refined products, global geopolitical events, regional market conditions, and supply interruptions caused by severe weather conditions. Typically, the change in crude oil prices impacts the purchase price of wholesale petroleum fuel products, which in turn impacts retail gasoline prices at the pump. During times when prices are particularly volatile, differences in pricing and procurement strategies between the Company and its competitors may lead to temporary margin contraction or expansion, depending on whether prices are rising or falling, and this impact could affect our overall results for a fiscal quarter.

In addition, the relative level of gasoline prices from period to period may lead to differences in our net sales between those periods. Further, because we generally attempt to maintain a fairly stable gross profit per gallon, this variance in net sales, which may be substantial, may or may not have a significant impact on our operating income.

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Inflation and deflation trends

Our financial results can be directly impacted by substantial changes in product costs due to commodity cost fluctuations or general inflation, disinflation, or deflation, which could lead to a reduction in our sales, as well as greater margin pressure, as costs may not be able to be passed on to consumers. Changes in commodity prices and changes in inflation rates have impacted several categories of our business in fiscal year 2023 and may continue to do so. Inflationary volatility can be attributed to macro economic factors including supply chain disruptions, government stimulus, interest rates, and other factors. In response to general inflationary volatility, we seek to minimize the impact of such events by sourcing our merchandise from different vendors, changing our product mix or increasing our pricing when necessary.

Results of Operations

Information pertaining to fiscal year 2022 was included in the Company’s Annual Report on Form 10-K for the year ended January 28, 2023 in Part II. "Item 7. Management’s Discussion and Analysis of Financial Position and Results of Operations," which was filed with the SEC on March 16, 2023.

The following tables summarize key components of our results of operations for the periods indicated:

(a) Basic and diluted EPS are calculated using net income.

(b) See "Fiscal Year 2023 Compared to Fiscal Year 2022," "Non-GAAP Financial Measures" and "Liquidity and Capital Resources" within "Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations" for definitions.

(c) Adjusted EBITDA for the fiscal year ended January 28, 2023 has been recast to exclude adjustments for pre-opening expenses and non-cash rent expense to conform to the current period definition.

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Fiscal Year 2023 Compared to Fiscal Year 2022

Net Sales

Net sales are derived from direct retail sales to our customers, net of merchandise returns and discounts. Fluctuations in net sales are impacted by opening new clubs and comparable club sales.

Net sales for fiscal year 2023 were $19.5 billion, a 3.3% increase from net sales reported for fiscal year 2022 of $18.9 billion. The increase was due primarily to strength in the grocery division and an increase of eight clubs, partially offset by lower gasoline sales.

Comparable Club Sales and Merchandise Comparable Club Sales

We believe net sales is an important driver of our profitability, particularly comparable club sales. Comparable club sales, a key performance indicator, also known as same-store sales in the retail industry, includes all clubs that were open for at least 13 months at the beginning of the period and were in operation during the entirety of both periods being compared, including relocated clubs and expansions. Comparable club sales allow us to evaluate how our club base is performing by measuring the change in period-over-period net sales in clubs that have been open for the applicable period.

Various factors affect comparable club sales, including customer preferences and trends, product sourcing, promotional offerings and pricing, shopping frequency from new and existing members and the amount they spend on each visit, weather and holiday shopping period timing and length. Sales comparisons can be influenced by certain factors that are beyond our control such as changes in the cost of gasoline and macro-economic factors such as inflation. The higher comparable club sales, the more we can leverage certain of our selling, general and administrative ("SG&A") expenses, reducing them as a percentage of sales and enhancing profitability.

Merchandise comparable club sales increased by 1.7% in fiscal year 2023 driven by an increase in sales of groceries of approximately 3.5%, partially offset by a decrease in sales of general merchandise and services of approximately 8.2%.

Sales of groceries increased during fiscal year 2023 as demand for paper products, beverages, candy, snacks, fresh fruit and vegetables, dairy and bakery categories increased compared to fiscal year 2022, partially offset by a decrease in demand for meat and seafood categories.

General merchandise and service sales decreased during fiscal year 2023 due to decreased demand for home goods and seasonal merchandise, as well as lower ancillary income, compared to fiscal year 2022.

The impact of gasoline sales is a result of lower retail prices during fiscal year 2023 as compared to fiscal year 2022, as total gallons sold grew year-over-year.

Membership fee income

We continue to see growth in the size of our membership base and continued quality.

Membership fee income was $420.7 million in fiscal year 2023, compared to $396.7 million in fiscal year 2022, a 6.0% increase. The increase was primarily driven by membership renewals, new members, and penetration of higher-tier membership levels, evidencing the strength of our membership quality.

Cost of sales

Cost of sales consists primarily of the direct cost of merchandise and gasoline sold at our clubs, including costs associated with operating our distribution centers, including payroll, payroll benefits, occupancy costs, and depreciation; freight expenses associated with moving merchandise from vendors to our distribution centers and from distribution centers to our clubs; and vendor allowances, rebates, and cash discounts.

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Cost of sales was $16.3 billion, or 83.5% of net sales, in fiscal year 2023, compared to $15.9 billion, or 84.0% of net sales, in fiscal year 2022. Merchandise gross margin rate, which excludes gasoline sales and membership fee income, increased 50 basis points compared to fiscal year 2022. Merchandise margins were positively impacted by our category management process, moderated supply chain costs, and the mix of sales.

Selling, general, and administrative expenses

SG&A consists of various expenses related to supporting and facilitating the sale of merchandise in our clubs, including the following: payroll and payroll benefits for team members; rent, depreciation, and other occupancy costs for retail and corporate locations; share-based compensation, advertising expenses; tender costs, including credit and debit card fees; amortization of intangible assets; and consulting, legal, insurance, acquisition and integration costs, and other professional services expenses.

SG&A includes both fixed and variable components and, therefore, is not directly correlated with net sales. We expect that our SG&A will increase in future periods due to investments to spur comparable club sales growth and our expanding footprint as we open new clubs. In addition, any future increases in wages, stock-based grants or modifications will increase our SG&A.

SG&A increased by 5.8% to $2.8 billion in fiscal year 2023 from $2.7 billion in fiscal year 2022. The year-over-year increase in SG&A was primarily driven by increased labor, occupancy, and depreciation expenses as a result of new club and gas station openings, as well as other continued investments to drive strategic priorities, such as the restructuring of certain corporate functions. Our growth profile this year was weighted toward owned clubs as opposed to leased clubs, elevating our depreciation expense. We expect to continue to invest in member engagement, marketing and digital strategies.

Pre-opening expenses

Pre-opening expenses include startup costs for new clubs and costs for relocated clubs. Expenses will vary based on the number of club openings, geography of the club, whether the club is owned or leased, and timing of the opening relative to our period end.

Pre-opening expenses were $19.6 million in fiscal year 2023 compared to $24.9 million in fiscal year 2022. Pre-opening expenses decreased due to timing of spend for club openings year-over-year.

Interest expense, net

Interest expense, net was $64.5 million for fiscal year 2023 compared to $47.5 million for fiscal year 2022. The increase was primarily due to rising interest rates year-over-year on outstanding borrowings.

Provision for income taxes

The Company’s effective income tax rate from continuing operations was 28.8% for fiscal year 2023 and 25.5% for fiscal year 2022. The increases in the effective tax rate and income tax expense were driven by lower tax benefits from stock-based compensation as well as an immaterial adjustment to certain deferred tax assets related to prior periods.

Non-GAAP Financial Measures

The accompanying Consolidated Financial Statements, including the related notes, are presented in accordance with generally accepted accounting principles ("GAAP"). In addition to relevant GAAP measures we also provide non-GAAP measures, including adjusted EBITDA, comparable club sales, adjusted free cash flow, adjusted net income, and adjusted net income per diluted share ("adjusted EPS") because management believes these metrics are useful to investors and analysts by excluding items that we do not believe are indicative of our core operating performance. These measures are customary for our industry and commonly used by competitors. These non-GAAP financial measures should not be reviewed in isolation or considered as an alternative to any other performance measure derived in accordance with GAAP and should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items. In addition, adjusted EBITDA, comparable club sales, adjusted free cash flow, adjusted net income, and adjusted EPS may not be comparable to similarly titled measures used by other companies in our industry or across different industries.

Adjusted Net Income

The adjusted net income and adjusted EPS metrics are important measures used by management to compare the performance of core operating results between periods. We define adjusted net income as net income as reported, adjusted for

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non-recurring, infrequent, or unusual charges, net of the tax impact of such adjustments. We define adjusted EPS as adjusted net income divided by the weighted-average diluted shares outstanding.

We believe adjusted net income and adjusted EPS are useful metrics to investors and analysts because they present more accurate year-over-year comparisons for our net income and net income per diluted share because adjusted items are not the result of our normal operations.

Adjusted EBITDA

Adjusted EBITDA is defined as income from continuing operations before interest expense, net, provision for income taxes and depreciation and amortization, adjusted for the impact of certain other items, including stock-based compensation expense; acquisition and integration costs; home office transition costs; restructuring and other adjustments.

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The following is a reconciliation of our income from continuing operations to Adjusted EBITDA and Adjusted EBITDA as a percentage of net sales for the periods presented:

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Liquidity and Capital Resources

Our primary sources of liquidity are cash flows generated from club operations and borrowings from our ABL Revolving Facility. As of February 3, 2024, cash and cash equivalents totaled $36.0 million and we had $802.3 million of unused capacity under our ABL Revolving Facility. Our principal liquidity needs for the next twelve months and beyond are to fund normal recurring operational expenses and anticipated capital expenditures; fund possible acquisitions; fund share repurchases and meet debt service and principal repayment obligations. We believe that our current resources, together with anticipated cash flows from operations and borrowing capacity under our ABL Revolving Facility, will be sufficient to finance our operations for at least the next twelve months.

During fiscal year 2023, we repurchased 1,958,218 shares under the 2021 Repurchase Program for a total purchase price of $130.2 million.

We do not have any off-balance sheet arrangements that have, or are, in the opinion of management, reasonably likely to have, a current or future material effect on our results of operations or financial position. We do, however, enter into letters of credit and purchase obligations in the normal course of our operations.

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Summary of Cash Flows

A summary of our cash flows from operating, investing and financing activities is presented in the following table:

Net Operating Cash Flows

Net cash provided by operating activities was $718.9 million for fiscal year 2023, compared to $788.2 million for fiscal year 2022. The $69.3 million decrease was primarily due to $95.3 million related to accounts payable as a result of timing of inventory receipts and payments, as well as commodity and fuel costs; $49.4 million of lease-related activity primarily due to prepaid rent based on the timing of year-end; $28.7 million related to an increase in merchandise inventory due to the increase in club counts and fuel stations; and $18.7 million related to prepaid expenses and other current assets driven by prepaid advertising and IT maintenance contracts due to the timing of year-end. The decrease in net operating cash flows was partially offset by a $71.7 million reduction in accounts receivable due to favorable timing of vendor and customer cash receipts, as well as a $10.6 million increase in net income, inclusive of increases of $26.8 million of depreciation and amortization expense and $27.5 million of deferred income tax expense.

Our net cash from operating activities can fluctuate from period to period due to several factors, including: the timing and mix of sales, which are typically higher in the second and fourth quarters due to seasonality; the timing of inventory purchases as the Company prepares for holiday seasons, lease-related activity, income tax and other payments.

Net Investing Cash Flows

Cash used in investing activities was $454.8 million in fiscal year 2023, compared to $747.1 million in fiscal year 2022. The decrease is primarily due to $376.5 million of cash outflows in the prior year related to the Acquisition, partially offset by an increase in capital spending, net of proceeds from sale-leaseback transactions, of $84.2 million as our growth profile in fiscal year 2023 was weighted toward owned clubs as opposed to leased clubs.

Net Financing Cash Flows

Cash used in financing activities in fiscal year 2023 was $262.0 million, compared to $52.6 million in fiscal year 2022. The increase in cash used in fiscal year 2023 is primarily due to a $491.0 million reduction in net proceeds from our ABL Revolving Facility, partially offset by a net decrease of $253.0 million of principal payments on long-term debt, a decrease of $17.1 million for the acquisition of treasury stock, and an increase of $11.3 million of proceeds from financing obligations compared to the prior year.

Adjusted Free Cash Flow

We present adjusted free cash flow because we use it to report to our board of directors and we believe it assists investors and analysts in evaluating our liquidity. Adjusted free cash flow should not be considered as an alternative to cash flows from operations as a liquidity measure. We define adjusted free cash flow as net cash provided by operating activities less additions to property and equipment, net of disposals, plus proceeds from sale-leaseback transactions.

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The following is a reconciliation of our net cash provided by operating activities to adjusted free cash flow for the periods presented:

Adjusted free cash flow decreased to $264.1 million for fiscal year 2023 compared to $417.6 million for fiscal year 2022. The decrease is primarily the result of lower cash flows from operating activities primarily due to unfavorable fluctuations in working capital, an increase in capital spending as we open new clubs, and lower proceeds from sale-leaseback transactions.

Debt and Borrowing Capacity

Our primary sources of borrowing capacity are the ABL Revolving Facility and the First Lien Term Loan, which are further discussed in "Note 7. Debt and Credit Arrangements" of our consolidated financial statements included in this Annual Report on Form 10-K.

On July 28, 2022, the Company entered into the ABL Revolving Facility with an aggregate ABL Revolving Commitment of $1.2 billion pursuant to that certain credit agreement with Bank of America, N.A., as administrative agent and collateral agent, and other lenders party thereto. The maturity date of the ABL Revolving Facility is July 28, 2027. As part of this transaction, the Company extinguished the ABL Facility.

On January 5, 2023, the Company amended the First Lien Term Loan to extend the maturity date from February 3, 2024 to February 3, 2027 and transition the interest rate, from LIBOR to SOFR and change the applicable margin from LIBOR plus 200 – 225 basis points per annum to SOFR plus 275 basis points per annum. In connection with the amendment the Company paid approximately $151.9 million of the principal amount.

On January 28, 2023, there was $405.0 million outstanding in loans under the ABL Revolving Facility and $11.5 million in outstanding letters of credit. The interest rate on the revolving credit facility was 5.63%.

On January 28, 2023, the interest rate for the First Lien Term Loan was 7.11% and there was $450.0 million outstanding.

On October 12, 2023, the Company amended the First Lien Term Loan to extend the maturity date from February 3, 2027 to February 3, 2029 and reduce applicable margin in respect of the interest rate, effective immediately, from SOFR plus 275 basis points per annum to SOFR plus 200 basis points per annum. Prior to the amendment, the Company repaid $50.0 million of the principal amount outstanding under the First Lien Term Loan.

At February 3, 2024, there was $319.0 million outstanding in loans under the ABL Revolving Facility and $18.2 million in outstanding letters of credit. The interest rate on the revolving credit facility was 6.44%, and unused capacity was $802.3 million.

At February 3, 2024, the interest rate for the First Lien Term Loan was 7.33% and there was $400.0 million outstanding.

Material Cash Commitments

Refer to the descriptions of our material cash commitments, financing arrangements, and contractual obligations outlined below within the following notes to our consolidated financial statements.

See “Note 6. Leases” for future operating lease and finance lease commitments. Lease liabilities exclude legally binding minimum lease payments for certain real estate and gas station leases that have not yet commenced. The liabilities do not include variable costs such as increases in rental payments based on an index or a percentage of sales, insurance, real estate taxes, and other operating expenses.

See “Note 7. Debt and Credit Arrangements” for future payments on the ABL Revolving Facility and First Lien Term Loan, including outstanding borrowings and applicable interest rates.

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See “Note 17. Other Non-current Liabilities” for long-term liabilities for which it is not reasonably possible for us to predict when they may be paid, including insurance reserves and asset retirement obligations, as well as financing obligations arising from sale-leaseback transactions.

We also have cancellable and non-cancellable purchase obligations under purchase orders for merchandise, agreements for capital items, gasoline, products and services used in our business, information technology, executive employment, and other agreements.

Critical Accounting Policies and Estimates

The preparation of our financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. We review our estimates on an ongoing basis and make judgments about the carrying value of assets and liabilities based on a number of factors. These factors include historical experience and assumptions made by management that are believed to be reasonable under the circumstances. Although management believes the judgment applied in preparing estimates is reasonable based on circumstances and information known at the time, actual results could vary materially from estimates based on assumptions used in the preparation of our consolidated financial statements. This section summarizes critical accounting policies and the related judgments involved in their application.

Workers’ Compensation and General Liability Self-insurance Reserves

We are primarily self-insured for workers’ compensation and general liability claims. Amounts in excess of certain levels, which range from $0.3 million to $1.0 million per occurrence for workers' compensation and general liability, and up to $2.0 million per occurrence for auto liability, are insured as a risk reduction strategy to mitigate the impact of catastrophic losses on net income. Reported reserves for claims are derived from estimated ultimate costs based upon individual claim file reserves and estimates for incurred but not reported claims. The estimates are developed utilizing actuarial methods and are based on historical claims experience and other actuarial assumptions related to loss development factors. The inherent uncertainty of future loss projections could cause actual claims to differ from our estimates. When historical losses are not a good measure of future liability, we base our estimates of ultimate liability on our interpretation of current law, claims filed to date and other relevant factors which are subject to change. These accruals, if any, are included as insurance reserves in accrued expenses and other current liabilities and other non-current liabilities in the Company’s consolidated balance sheets.

Recent Accounting Pronouncements

See "Note 2. Summary of Significant Accounting Policies" of our consolidated financial statements included in this Annual Report on Form 10-K for additional information regarding recently issued accounting pronouncements.