BJ's Wholesale Club Holdings, Inc. 10-Q

Item 2. 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 condensed consolidated financial statements and related notes thereto included elsewhere in this Quarterly Report on Form 10-Q, as well as the audited consolidated financial statements and the related notes thereto in our Annual Report on Form 10-K for the fiscal year 2021. The following discussion may contain 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 the sections of this Quarterly Report on Form 10-Q titled "Forward-Looking Statements" and in Part I. "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the fiscal year 2021. 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 2022" relate to the 52 weeks ending January 28, 2023, and references herein to "fiscal year 2021" relate to the 52 weeks ended January 29, 2022. The second quarter of fiscal year 2022 ended on July 30, 2022, and the second quarter of fiscal year 2021 ended on July 31, 2021, and both include thirteen weeks. Overview BJ’s Wholesale Club is a leading warehouse club operator concentrated primarily on the east coast 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 perishable products, continuously refreshed general merchandise, gasoline and other ancillary services 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 229 warehouse clubs spanning 17 states. In our core New England markets, which have high population density and generate a disproportionate part of U.S. gross domestic product, we operate almost 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, www.bjs.com, and our highly rated mobile app, which allows them to use our buy-online-pickup-in-club ("BOPIC") service, curbside delivery, same day home delivery or traditional ship-to-home service, as well as through the DoorDash marketplace where members receive preferential pricing by linking their membership. We also launched Same-Day Select in the first quarter of fiscal year 2022, 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. As of the end of the second quarter of fiscal year 2022, we had more than 6.5 million members p aying annual fees to gain access to savings on groceries, consumables, general merchandise, services and gasoline. The annual membership fee for our Inner Circle® membership is $55 and the annual membership fee for our BJ’s Perks Rewards® membership, which offers additional value-enhancing features, is $110. We believe that members can save over ten times the price of their $55 Inner Circle 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®, represented over $3.0 billion in annual sales for fiscal year 2021 and are the largest brands we sell. Our customers recognize the relevance of our value proposition across economic environments, as demonstrated by over 20 consecutive years of membership fee income growth. Our membership fee income was $381.2 million for the trailing twelve-months ended July 30, 2022. On May 2, 2022, we completed our acquisition of the assets and operations of four distribution centers and the related private transportation fleet from Burris Logistics, which brings our end-to-end perishable supply chain in-house. See Note 12, "Acquisitions" of our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for additional information regarding the Acquisition. 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 20 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. Impact of the COVID-19 Pandemic As the impact of the COVID-19 pandemic has evolved, we have continued to face several operational challenges directly or indirectly related to the pandemic, including supply chain constraints, inflation, and wage inflation. The COVID-19 pandemic is unprecedented and demand may continue to change in the future if consumer purchasing behavior changes as the COVID-19 pandemic continues to evolve, and the long-term impacts to our financial condition and results of operations are still uncertain. The COVID-19 pandemic may impact many of the factors discussed in this section, including, among others, overall economic trends, consumer preferences and demand, product mix, quarterly fluctuations, sourcing and labor shortages, which in turn could adversely affect our business, financial condition and results of operations. During the thirteen weeks ended July 30, 2022 we continued to experience elevated supply chain costs, including commodity prices, logistics, and procurement costs. We expect these market disruptions and inflationary pressures to continue throughout 2022. Factors Affecting Our Business 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 . Inflation and deflation trends Our financial results can be directly impacted by substantial increases in product costs due to commodity cost increases or general inflation, which could lead to a reduction in our sales or units sold, as well as greater margin pressure, as increased costs for goods may not always be able to be passed on to consumers. We continue to see increased commodity prices and general inflation, which have impacted several categories of our business, and expect to continue to see the same throughout 2022. Events such as the COVID-19 pandemic have resulted in market disruptions, supply chain disruptions and inflationary pressures. In response to increasing commodity prices or general inflation, 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. 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 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, 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 21 the reporting date. We have grown our membership fee income each year for the past two decades and the quality of our membership mix continues to improve as evidenced by higher tier penetration growth in the first half of fiscal year 2022. Our membership renewal rate, a key indicator of membership engagement, satisfaction and loyalty, was 89% at the end of fiscal year 2021. 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. Recently, we have experienced challenges related to the global supply chain, which we expect to continue for the foreseeable future. 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 continuing 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 our end-to-end perishable supply chain in-house with the Acquisition, and enhancing our information systems, including our distribution center management system, 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. Results of Operations The following table summarizes key components of our results of operations for the periods indicated: Statement of Operations Data Thirteen Weeks Ended Twenty-Six Weeks Ended (dollars in thousands) July 30, 2022 July 31, 2021 July 30, 2022 July 31, 2021 Net sales $ 5,005,030 $ 4,088,402 $ 9,404,840 $ 7,870,236 Membership fee income 98,786 88,753 195,411 175,141 Total revenues 5,103,816 4,177,155 9,600,251 8,045,377 Cost of sales 4,243,769 3,413,625 7,949,043 6,555,122 Selling, general and administrative expenses 651,236 598,113 1,287,180 1,198,023 Pre-opening expenses 5,901 1,633 10,801 2,194 Operating income 202,910 163,784 353,227 290,038 Interest expense, net 10,874 16,428 18,715 35,713 Income from continuing operations before income taxes 192,036 147,356 334,512 254,325 Provision for income taxes 51,022 36,359 81,041 61,742 Income from continuing operations 141,014 110,997 253,471 192,583 Loss from discontinued operations, net of income taxes (7) (9) (14) (16) Net income $ 141,007 $ 110,988 $ 253,457 $ 192,567 Operational Data: Total clubs at end of period 229 222 229 222 Comparable club sales 19.8% 4.0% 17.2% 2.2% Merchandise comparable club sales increase (decrease) 7.6% (3.4)% 5.9% (4.2)% Adjusted EBITDA (a) $ 273,700 $ 220,140 $ 494,501 $ 422,549 Free cash flow (a) 300,417 239,680 254,192 430,585 (a) See "Non-GAAP Financial Measures" within Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations for a definition of Adjusted EBITDA and Free cash flow 22 Thirteen Weeks Ended July 30, 2022 (Second Quarter of Fiscal Year 2022) Compared to Thirteen Weeks Ended July 31, 2021 (Second Quarter of Fiscal Year 2021) Net Sales Net sales are derived from direct retail sales to customers in our clubs and online, net of merchandise returns and discounts. Growth in net sales is impacted by opening new clubs and increases in comparable club sales. Net sales for the second quarter of fiscal year 2022 were $5.0 billion, a 22.4% increase from net sales reported for the second quarter of fiscal year 2021 of $4.1 billion. The increase was due primarily to a 19.8% increase in comparable club sales. Comparable club sales We believe net sales is an important driver of our profitability, particularly comparable club sales. Comparable sales growth is a function of increasing shopping frequency from new and existing members and the amount they spend on each visit. Sales comparisons can be influenced by certain factors that are beyond our control such as changes in the cost of gasoline, macro-economic factors such as inflation and supply chain disruptions. 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. Thirteen Weeks Ended July 30, 2022 Comparable club sales 19.8 % Less: contribution from gasoline sales 12.2 % Merchandise comparable club sales 7.6 % Merchandise comparable club sales increased by 7.6% in the second quarter of fiscal year 2022 compared to the second quarter of fiscal year 2021 driven by an increase in sales of groceries of 8% and an increase in sales of general merchandise and services of approximately 4%. In grocery, sales increased as demand for beverages, fresh fruit and vegetables, fresh meat, candy, dairy and active nutrition categories increased compared to the second quarter of fiscal year 2021. General merchandise and services sales increased primarily due to our services business and seasonal categories within general merchandise. Membership fee income We continue to see growth in the size and quality of our membership base. Membership fee income was $98.8 million in the second quarter of fiscal year 2022 compared to $88.8 million in the second quarter of fiscal year 2021, an 11.3% increase. The increase was primarily driven by membership renewals, new members and increased 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. We continue to experience inflation across most categories and have invested in certain categories to preserve our member value proposition. Cost of sales was $4.2 billion, or 84.8% of net sales, in the second quarter of fiscal year 2022 compared to $3.4 billion, or 83.5% of net sales, in the second quarter of fiscal year 2021. Merchandise gross margin rate, which excludes gasoline sales and membership fee income, decreased 50 basis points over the second quarter of fiscal year 2021. Merchandise margins were impacted by increased freight costs as well as investments in inflationary categories and markdowns in general merchandise inventory. 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; 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. 23 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 made 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 8.9% to $651.2 million in the second quarter of fiscal year 2022 from $598.1 million in the second quarter of fiscal year 2021. The year-over-year increase in SG&A was primarily driven by increased labor costs as a result of last year’s wage investments as well as the acquisition, integration and operating expenses related to the Acquisition. Pre-opening expenses Pre-opening expenses include startup costs for new clubs and expenses will vary based on the number of new 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 $5.9 million in the second quarter of fiscal year 2022 compared to $1.6 million in the second quarter of fiscal year 2021. Pre-opening expenses increased due to timing of spend for club and gas station openings year-over-year. Expansion plans remain on track with 11 new club openings expected in fiscal year 2022. Interest expense Interest expense was $10.9 million in the second quarter of fiscal year 2022 compared to $16.4 million in the second quarter of fiscal year 2021. The decrease is due to lower debt balances outstanding throughout the second quarter of fiscal year 2022 as compared to the second quarter of fiscal year 2021 before refinancing the ABL Facility on July 28, 2022. In addition, the second quarter of fiscal year 2021 included net losses on our ineffective cash flow hedges in connection with the payment of outstanding amounts under the ABL Facility. Provision for income taxes The Company’s effective income tax rate from continuing operations was 26.6% and 24.7% for the second quarters of fiscal years 2022 and 2021, respectively. The increase in the effective tax rate is due primarily to lower excess tax benefits from stock-based compensation in the current year period. Twenty-Six Weeks Ended July 30, 2022 (First Six Months of Fiscal Year 2022) Compared to Twenty-Six Weeks Ended July 31, 2021 (First Six Months of Fiscal Year 2021) Net Sales Net sales are derived from direct retail sales to customers in our clubs and online, net of merchandise returns and discounts. Growth in net sales is impacted by opening new clubs and increases in comparable club sales. Net sales for the first six months of fiscal year 2022 were $9.4 billion, a 19.5% increase from net sales reported for the first six months of fiscal year 2021 of $7.9 billion. The increase was due primarily to a 17.2% increase in comparable club sales. Comparable club sales We believe net sales is an important driver of our profitability, particularly comparable club sales. Comparable sales growth is a function of increasing shopping frequency from new and existing members and the amount they spend on each visit. 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 and supply chain disruptions. The higher comparable club sales, the more we can leverage certain of our SG&A, reducing them as a percentage of sales and enhancing profitability. Twenty-Six Weeks Ended July 30, 2022 Comparable club sales 17.2 % Less: contribution from gasoline sales 11.3 % Merchandise comparable club sales 5.9 % 24 Merchandise comparable club sales increased by 5.9% in the first six months of fiscal year 2022 compared to the first six months of fiscal year 2021 driven by an increase in sales of groceries of approximately 8% offset by a decrease in sales of general merchandise and services of approximately 4% . I n grocery, sales increased as demand for beverages, candy, active nutrition, fresh meat, dairy and bakery categories increased compared to the first six months of fiscal year 2021. General merchandise realized headwinds in consumer electronics, apparel and seasonal categories as consumers face pressure around discretionary spend due to inflation. Membership fee income We continue to see growth in the size and quality of our membership base. Membership fee income was $195.4 million in the first six months of fiscal year 2022 compared to $175.1 million in the first six months of fiscal year 2021, an 11.6% increase. The increase was primarily driven by membership renewals, new members and increased 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. We continue to experience inflation across most categories and have invested in certain categories, such as our full service deli, to preserve our member value proposition. Cost of sales was $7.9 billion, or 84.5% of net sales, in the first six months of fiscal year 2022 compared to $6.6 billion, or 83.3% of net sales, in the first six months of fiscal year 2021. Merchandise gross margin rate, which excludes gasoline sales and membership fee income, decreased 40 basis points over the first six months of fiscal year 2021. Merchandise margins were impacted by increased freight costs, investments in inflationary categories and market driven markdowns in general merchandise categories. 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; 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 made 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 7.4% to $1.3 billion in the first six months of fiscal year 2022 from $1.2 billion in the first six months of fiscal year 2021. The year-over-year increase in SG&A was primarily driven by increased labor costs as a result of last year’s wage investments as well as the acquisition, integration and operating expenses related to the Acquisition. Pre-opening expenses Pre-opening expenses include startup costs for new clubs and expenses will vary based on the number of new 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 $10.8 million in the first six months of fiscal year 2022 compared to $2.2 million in the first six months of fiscal year 2021. Pre-opening expenses increased due to timing of spend for club and gas station openings year-over-year. Expansion plans remain on track with 11 new club openings expected in fiscal year 2022. Interest expense Interest expense was $18.7 million in the first six months of fiscal year 2022 compared to $35.7 million in the first six months of fiscal year 2021. The decrease is due to lower debt balances outstanding throughout the first half of fiscal year 2022 as compared to the first half of fiscal year 2021 before refinancing the ABL Facility on July 28, 2022. In addition, the first half 25 of fiscal year 2021 included net losses on our ineffective cash flow hedges in connection with the payment of outstanding amounts under the ABL Facility. Provision for income taxes The Company’s effective income tax rate from continuing operations was 24.2% and 24.3% for the first six months of fiscal years 2022 and 2021, respectively. The slight decrease in the effective tax rate is due primarily to higher excess tax benefits from stock-based compensation in the current year period. Non-GAAP Financial Measures The accompanying Condensed Consolidated Financial Statements, including the related notes, are presented in accordance with GAAP. In addition to relevant GAAP measures we also provide non-GAAP measures, including adjusted EBITDA, comparable club sales, free cash flow, adjusted net income and adjusted net income per diluted share 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, free cash flow, adjusted net income and adjusted net income per diluted share may not be comparable to similarly titled measures used by other companies in our industry or across different industries. 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; pre-opening expenses; non-cash rent; strategic consulting; offering costs; club closing and impairment charges; reduction in force severance; acquisition and integration costs; and other adjustments. 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: Thirteen Weeks Ended Twenty-Six Weeks Ended (in thousands) July 30, 2022 July 31, 2021 July 30, 2022 July 31, 2021 Income from continuing operations $ 141,014 $ 110,997 $ 253,471 $ 192,583 Interest expense, net 10,874 16,428 18,715 35,713 Provision for income taxes 51,022 36,359 81,041 61,742 Depreciation and amortization 49,984 45,448 97,093 89,834 Stock-based compensation expense 9,387 7,334 18,502 34,634 Pre-opening expenses (a) 5,901 1,633 10,801 2,194 Non-cash rent (b) 1,256 1,765 2,102 3,182 Acquisition and integration costs (c) 3,588 — 11,467 — Severance (d) — — — 2,300 Other adjustments (e) 674 176 1,309 367 Adjusted EBITDA $ 273,700 $ 220,140 $ 494,501 $ 422,549 Adjusted EBITDA as a percentage of net sales 5.5 % 5.4 % 5.3 % 5.4 % a. Represents direct incremental costs of opening or relocating a facility that are charged to operations as incurred. b. Represents an adjustment to remove the non-cash portion of rent expense. c. Represents costs related to the acquisition and integration of assets from Burris Logistics, including due diligence, legal, and other consulting expenses. d. Represents severance charges associated with labor reductions that resulted from the realignment of our field operations. e. Other non-cash items, including non-cash accretion on asset retirement obligations, obligations associated with our post-retirement medical plan and incremental rent expense as the Company transitions from the current home office to a new home office building in fiscal year 2022. 26 Comparable Club Sales and Merchandise Comparable Club Sales Comparable club sales, also known as same-store sales, 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 consumer preferences and trends, product sourcing, promotional offerings and pricing, customer experience and purchase amounts, weather and holiday shopping period timing and length. Merchandise comparable club sales represents comparable club sales from all merchandise other than our gasoline operations for the applicable period. Free Cash Flow We present free cash flow, which is not a recognized financial measure under GAAP, as we believe it assists investors and analysts in evaluating our liquidity. Free cash flow should not be considered as an alternative to cash flows from operations as a liquidity measure. We define 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. The following is a reconciliation of our net cash provided by operating activities to free cash flow for the periods presented: Thirteen Weeks Ended Twenty-Six Weeks Ended (in thousands) July 30, 2022 July 31, 2021 July 30, 2022 July 31, 2021 Net cash provided by operating activities $ 398,744 $ 310,348 $ 443,052 $ 559,313 Less: Additions to property and equipment, net of disposals 101,001 73,118 191,534 147,808 Plus: Proceeds from sale leaseback transactions 2,674 2,450 2,674 19,080 Free cash flow $ 300,417 $ 239,680 $ 254,192 $ 430,585 Free cash flow increased to $300.4 million for the second quarter of fiscal year 2022 compared to $239.7 million for the second quarter of fiscal year 2021 as a result of increased income from operations as well as positive changes in working capital. Free cash flow declined to $254.2 million in the first six months of fiscal year 2022 compared to $430.6 million in the first six months of 2021 as a result of cash outflows for higher working capital, specifically inventory related to new club growth and other strategic actions we’ve taken to better position our business, such as improving in-stock levels over last year. Adjusted Net Income The adjusted net income and adjusted net income per diluted share 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: stock-based compensation related to acceleration of stock awards; acquisition and integration costs; incremental home office expenses; loss on cash flow hedge; expenses related to debt payments; severance charges; offering costs; gains on sale leaseback transactions; club closing and impairment charges; and the tax impact of the foregoing adjustments on net income. We define adjusted net income per diluted share as adjusted net income divided by the weighted-average diluted shares outstanding. We believe adjusted net income and adjusted net income per diluted share 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. 27 Thirteen Weeks Ended Twenty-Six Weeks Ended (in thousands) July 30, 2022 July 31, 2021 July 30, 2022 July 31, 2021 Net income as reported $ 141,007 $ 110,988 $ 253,457 $ 192,567 Adjustments: Stock-based compensation related to acceleration of stock awards (a) — — — 17,494 Acquisition and integration costs (b) 3,587 — 11,467 — Incremental home office expense (c) 600 — 1,199 — (Gain) loss on cash flow hedge (d) — 3,245 (165) 7,954 Charges related to debt payments (e) 389 — 389 657 Severance (f) — — — 2,300 Tax impact of adjustments to net income (g) (1,287) (909) (3,624) (7,953) Adjusted net income $ 144,296 $ 113,324 $ 262,722 $ 213,019 (a) Represents accelerated vesting of equity awards, which were related to the passing of a former executive. (b) Represents costs related to the acquisition and integration of assets from Burris Logistics, including due diligence, legal, and other consulting expenses. (c) Represents incremental rent expense as the Company transitions from the current home office to a new home office building in fiscal year 2022. (d) Represents the reclassification into earnings of accumulated other comprehensive income associated with the de-designation of hedge accounting. (e) Represents the expensing of fees and deferred fees and original issue discount associated with the partial prepayment of debt in fiscal year 2021 and extinguishment cost related to the ABL Facility in fiscal year 2022. (f) Represents severance charges associated with labor reductions that resulted from the realignment of our field operations. (g) Represents the tax effect of the above adjustments at a statutory tax rate of approximately 28%. Liquidity and Capital Resources Our primary sources of liquidity are cash flows generated from club operations and borrowings from the ABL Facility and the ABL Revolving Facility. As of July 30, 2022, cash and cash equivalents totaled $163.7 million and we had $576.7 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 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. In the first six months of fiscal year 2022, we used $58.6 million of available cash to repurchase 923,506 shares under the 2021 Repurchase Program. In addition, we used $50.0 million of available cash to extinguish the term loan associated with the ABL Facility. 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. Summary of Cash Flows A summary of our cash flows from operating, investing and financing activities is presented in the following table: Twenty-Six Weeks Ended (in thousands) July 30, 2022 July 31, 2021 Net cash provided by operating activities $ 443,052 $ 559,313 Net cash used in investing activities (565,381) (128,728) Net cash provided by (used in) financing activities 240,574 (431,689) Net increase (decrease) in cash and cash equivalents $ 118,245 $ (1,104) Net Cash from Operating Activities Net cash provided by operating activities was $443.1 million for the first six months of fiscal year 2022 compared to $559.3 million for the first six months of fiscal year 2021. The decrease in operating cash flow was primarily due to cash 28 outflows due to inflation in inventory, improvement in inventory position for key categories, partially offset by income from operations c ompared to the prior year. Net Cash from Investing Activities Cash used for capital expenditures was $565.4 million for the first six months of fiscal year 2022, compared to $128.7 million for the first six months of fiscal year 2021. The increase is primarily due to the Acquisition, as well as the timing, volume and cost of property, plant and equipment additions as we continue to expand our footprint. Net Cash from Financing Activities Net cash provided by financing activities for the first six months of fiscal year 2022 was $240.6 million compared to net cash used in financing activities of $431.7 million for the first six months of fiscal year 2021. The change is due primarily to the draw down of debt on the ABL Facility and the ABL Revolving Facility in the first six months of fiscal year 2022 as compared to debt payments in the six months quarter of fiscal year 2021. Debt and Borrowing Capacity On April 30, 2021, the Company used $150.0 million of cash and cash equivalents to pay $100.0 million of the principal amount outstanding on the First Lien Term Loan and $50.0 million of the principal amount outstanding on the ABL Facility. In connection with the payment, the Company expensed $0.7 million of previously capitalized debt issuance costs and original issue discount. On July 28, 2022, the Company entered into the ABL Revolving Facility in 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. At July 30, 2022, there was $350.0 million outstanding in loans under the ABL Revolving Facility and $12.9 million in outstanding letters of credit. The interest rate on the revolving credit facility was 3.42% and unused capacity was $576.7 million. At July 30, 2022, the interest rate for the First Lien Term Loan was 3.96% and there was $701.9 million outstanding. See Note 4, "Debt and Credit Arrangements" of our condensed consolidated financial statements included in this Quarterly Report on Form 10-Q for additional information. Material Cash Commitments Our material cash commitments consist primarily of debt obligations, interest payments, leases and purchase orders for merchandise inventory. These material cash commitments impact our short-term and long-term liquidity and capital needs. As of July 30, 2022, other than those items related to the ordinary course of operations of our business such as inventory purchases, new leases and lease amendments, there were no material changes to our material cash commitments from those described in our Annual Report on Form 10-K for the fiscal year 2021. Critical Accounting Policies and Use of Estimates This discussion and analysis of our financial condition and results of operations is based on our condensed consolidated financial statements, which we have prepared in accordance with GAAP. The preparation of our financial statements and related disclosures requires us to make estimates, assumptions and judgments that affect the reported amount of assets, liabilities, revenue, costs and expenses, and related disclosures. Except as described below, there were no material changes in critical accounting policies and estimates during the period covered by this Quarterly Report on Form 10-Q. Refer to Item 7., "Management’s Discussion and Analysis of Financial Condition and Results of Operations— Critical Accounting Policies and Estimates," in our Annual Report on Form 10-K for the fiscal year 2021 for a complete list of our Critical Accounting Policies and Estimates. Business Combinations We account for business combinations under the acquisition method of accounting in accordance with ASC Topic 805, Business Combinations, which requires an allocation of the consideration we paid to the identifiable assets, intangible assets 29 and liabilities based on the estimated fair values as of the closing date of the acquisition. The excess of the fair value of the purchase price over the fair values of these identifiable assets, intangible assets and liabilities is recorded as goodwill. The valuation of acquired assets will impact future operating results. We utilize third-party valuation specialists to assist us in the determination of the fair value of the assets acquired. Specifically, the fair value of the buildings and site improvement were determined using a combination of the cost, income and sales comparison approaches with the ultimate valuation primarily based on the income approach and the market approach was utilized to determine the fair value of trailers acquired. The remaining useful lives of depreciable assets have a significant impact on earnings. The selected lives are based on the expected periods that the assets will provide value to the Company subsequent to the business combination. The Company may adjust the amounts recognized for a business combination during a measurement period after the acquisition date. Any such adjustments are based on the Company obtaining additional information that existed at the acquisition date regarding the assets acquired or the liabilities assumed. Measurement-period adjustments are generally recorded as increases or decreases to the goodwill recognized in the transaction. The measurement period ends once the Company has obtained all necessary information that existed as of the acquisition date, but does not extend beyond one year from the date of acquisition. Any adjustments to assets acquired or liabilities assumed beyond the measurement period are recorded through earnings. Recent Accounting Pronouncements There have been no recent accounting pronouncements since those disclosed in our Annual Report on Form 10-K for the fiscal year 2021.