Bethany Perkins - IR Lee Bird - Chairman, CEO and President Peter Corsa - COO Judd Nystrom - CFO

John Heinbockel - Guggenheim Securities Dan Binder - Jefferies Joshua Siber - Morgan Stanley Daniel Hofkin - William Blair Brad Thomas - KeyBanc Capital Markets Matt Fassler - Goldman Sachs Curtis Nagle - Bank of America Merrill Lynch

Greetings, and welcome to the At Home Third Quarter Fiscal Year 2018 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Bethany Perkins. Thank you, you may begin.

Thank you, Matt. Good afternoon everyone and thank you for joining us today for At Home’s third quarter fiscal year 2018 earnings results conference call. Speaking today are Lee Bird, Chairman, Chief Executive Officer, and President; Peter Corsa, Chief Operating Officer, and Judd Nystrom, Chief Financial Officer. After the team has made their formal remarks, we will open the call to questions. Before we begin, I need to remind you that certain comments made during this call may constitute forward-looking statements and are made pursuant to and within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. In particular, statements about our outlook and assumptions for financial performance for the fiscal years 2018 and 2019 and our long-term growth targets as well as statements about the markets in which we operate, expected new store openings, potential growth opportunities and future capital expenditures are forward-looking statements. Such forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from such statements. Those are referred to in At Home’s press release issued today and in filings that At Home makes with the SEC. The forward-looking statements made today are as of the date of this call and At Home does not undertake any obligation to update any forward-looking statement. Finally, the speakers may refer to certain adjusted or non-GAAP financial measures on this call, such as adjusted EBITDA, adjusted operating income, adjusted and pro forma adjusted net income, and pro forma adjusted earnings per share. A reconciliation schedule showing the GAAP versus non-GAAP financial measures is available in At Home’s press release issued today. If you do not have a copy of today’s press release, you may obtain one by visiting the Investor Relations page of the website at investors.athome.com. In addition, from time-to-time, At Home expects to provide certain supplemental materials or presentations for Investor reference on the Investor Relations page of its website. I will now turn the call over to Lee. Lee?

Thank you, Bethany. Good afternoon everyone and thank you for joining us to discuss our third quarter fiscal 2018 results. This quarter we once again demonstrated the exciting momentum in our business. We are driving strong results across a variety of price points and style archetypes, indoor and outdoor decor, every day and seasonal product categories, and new and existing stores across the country. Our new store growth of 18%, combined with our merchandising and marketing initiatives, drove net sales growth of 25%, including a 7.1% increase in comp store sales. I'm especially pleased that the third quarter marks our 14th consecutive quarter of 20 plus percent sales growth and our 15th consecutive quarter of positive comp store sales increases. Beyond our top-line I am pleased that we continue to deliver industry-leading profitability by significantly expanding operating margins and more than doubling pro forma adjusted net income and EPS. As we focus on achieving sustainable long-term growth, we are committed to reinvesting in the business to advance the strategic priorities I’ll discuss today. First and foremost, our customer is our top priority in getting to know and serve her better is always a key objective for us. We've delivered five consecutive quarters of mid –to-high, single-digit comp, which demonstrates that customers are embracing the look and superior value of our products. As I mentioned on our last call, we launched the first At Home credit card and loyalty programs during the third quarter to make it even easier for her to get the looks she loves. The customer response to both of these programs, particularly the enthusiasm we have seen with enrollment rates and the basket sizes of new members has surpassed our initial expectation. While the programs are still in their infancy, we are excited about leveraging them as the basis for eventual CRM capabilities so that we can strengthen our customer relationship and overtime provide a targeted and personalized shopping experience. In the meantime we continue to gather insights through customer research, which has recently shown that not only are we attracting a younger customer, but that millennials are now our fastest growing segment and now represent a third of our core customer base. We believe this demographic shift is both as a result and a driver of our strategic focus on providing more decor options to meet her preferred style, which brings me to our second priority assortment. We strive to give our customers the broadest assortment at the lowest prices in the industry. Our large format stores allow her to get a physical sense for trend relevant decor and take it home immediately, while also enabling us to cover all styles of home decor under one roof. We flex the mix of our assortment between categories or style archetypes as customer preferences and demographics change overtime. In recent quarters, we've shifted portions of our mix towards contemporary looks to align with the preferences of our younger customer, not coincidentally contemporary was our highest comping style archetype in Q3. We continue to focus on acquiring customers at earlier life stages from decorating their first dorm room to their first apartment or house and continuing with them to their forever home for an expanding family and again as they downsize in retirement. One of our most successful initiatives on this journey has been the expansion of our back to campus program, which comped positively by double-digits this quarter even as we incorporated more value priced items into the assortments. Finally our category reinvention strategy also drives sales growth by ensuring continuing newness for our customers. Our independent research shows that the majority of our core customers are drawn in by the thrill of the treasure hunt in our stores, which we provide by introducing 20,000 fresh new items annually. Our Q2 reinventions of elevated bedding and patio furniture drove positive results into Q3 and the strong customer response to our seasonal offerings for fall, Halloween and Charismas contributing meaningfully to our third quarter comp. Our multi-year mission to become the home and holiday decor headquarters has generated a lot of momentum in our seasonal business and has enabled us to raise our outlook for the fourth quarter as well. Another strategic priority is to expand the At Home brand, which we have funded through sales and profit growth over the past few years. Ramping our targeted marketing spend from zero just a few years ago to 3% of sales in fiscal 2018 has enabled us to support even more priority markets and invest additional dollars in a new TV campaign, digital engagement and expanded influencer program. We are measuring our TV and digital activities against a control group of markets before, during and after the advertising run and we are very pleased that it has driven increased sales and traffic in the supported stores. Our efforts to continue to drive positive outcome including progress on increasing brand awareness, which remains a significant opportunity for us. In Q3, we focused on launching our Insider Perks loyalty program and optimizing our website particularly for mobile users, as now more than half of athome.com visitors access our website through mobile device. We’ve reduced the time users spend loading our webpages by 65%, upgraded our visual branding with creative photography and enhanced our online search and filter functions to make it easier for customers to pre-shop our broad selection at low prices. As a result, we drove an almost 80% increase in page views since Q3 of last year. We showcased our new and enhanced imagery and our weekly email, and our email open rate increased by more than 50%. Our loyalty strategy continues to -- our loyalty strategy includes converting our over 3 million email members to our Budding Insider Perks program including our efforts to enhance our customers' digital experience. We believe we are focusing on the right areas to support the expansion of our brand and continue to driving comp store sales. Another strategic priority and major opportunity for At Home is new store growth. At 149 stores today, we have grown our store count by over 21% on a compounded annual rate over the last five years, but we are still less than one fourth of our potential U.S. footprint. We continued to address our substantial whitespace in Q3 by opening eight stores divided evenly between new and existing markets and between new builds and second generation leases. Newly entered markets included Odessa and El Paso in Western Texas, Rochester, New York in the Northeast and Shreveport, Louisiana in the South. Our existing market expansion included in the Phoenix, Washington DC, Detroit and Houston metro areas. If you recall at our second quarter call, we were uncertain if two Houston area ground up builds planned for Q3 would open this year due to the impact of Hurricane Harvey. As we did before and during this storm, I am proud to say that our teams embodied our core value of working together to open locations in Richmond Texas in Q3 and in Pearland, Texas soon after. We continue to deliver new store performance ahead of expectations for the broader class of fiscal 2018 adding to the confidence we have in our fully identified fiscal 2019 pipeline and our growth strategy moving forward. Speaking of our team, they have critical to propelling our business thus far. And we believe they should share in the At Home success. At the beginning of Q3, we awarded restricted stock units to every At Home store director, as well as to expanded group of home office team members. Additionally, the second half momentum of our business has increased our targeted incentive compensation for both the home office and the field with the broader retail industry focused on wage pressures, I'm incredibly pleased that our store level associates can earn a 5% bonus of their annual earnings while store directors and managers have uncapped bonus potential. We strive to take great care of our store team members knowing they will in turn do the right thing for our customers. Our commitment to providing a great culture and exciting growth environment compelling workplace opportunities and rewarding compensation structure has recognized this quarter by Great Place to Work Council which makes us eligible for Fortune Magazine's Best Places to Work List in 2018. Better yet the enthusiastic feedback from our team members validates that we are indeed achieving on yet another strategic priority. With that, I'd like to turn the call over to Peter Corsa, our Chief Operating Officer, who will discuss the progress we are making on our operational objectives. Peter?

Thank you, Lee. Good afternoon, everyone. As Chief Operating Officer, I focus primarily on two strategic areas. First, providing our customers with an exceptional self-help shopping experience, and second, ensuring that we have the right operating systems, processes and procedures in place to efficiently and cost effectively deliver that experience and scale for growth. On the customer facing side, we continue to drive results by merchandising our seasonal assortment along specific themes making it easier for the customer to design an entire room in her basket. We launched this strategy several years ago with our Christmas assortment and given its positive performance over the past three years, we expanded it to Halloween in fiscal 2017 and then to our fall tabletop and back to campus assortments in fiscal 2018. Customers can now explore each theme collection online, if they prefer to browse and price compare before coming into the store. As we mentioned, we focused our back to campus assortment on lower price items this year, giving us an opportunity to highlight compelling value in our check lane, and end caps and to drive units sold. With regard to the holidays, this year we incorporated blade signage and lifestyle photography to bring our products to life and visually inspire our customers’ decor, both on and around the Christmas tree. We applied this signage to tabletop decor in our main aisle, which also houses our feature tables that continue to show exceptional strength. Our success in these initiatives continues to demonstrate the importance of creating an inspirational atmosphere, through compelling visual merchandising. It also gives our customer an opportunity to see, touch and feel our products, so she can be even more excited about incorporating them into her home. And finally the key to scaling our business and reaching more customers is to ensure we are operating efficiently and effectively. In the third quarter, we completed the implementation of a yard management system to manage receipts more efficiently at our single cross stock distribution center. We also hired David Heartquist previously from Michaels in Wal-Mart to lead our direct sourcing team. The progress the team has made in the short amount of time has positioned us to receive our first wave of directly sourced decor in Q4 of this year. We are proud to share that we achieved our targeted product costs savings on these basic commodity items, which we recognized over the turn of the inventory in fiscal 2019. While this initial wave is immaterial to our total assortment, it represents the first return against our two penny direct sourcing investment this year and we look forward to growing the program in the years to come. As the program ramps, we believe it will enable us to redeploy the product savings into lower prices, increased brand awareness and better quality to further strengthen our customer value preposition. With that, I’d like to turn the call over to Judd, who will walk through our financial performance in more detail and discuss our outlook for the remainder of fiscal 2018. Judd?

Thank you, Peter. Good afternoon, everyone. I will begin my prepared remarks with the review of our third quarter fiscal 2018 results and then discuss updates for our outlook for fiscal years, 2018 and 2019. As always, additional information is available in our earnings release, which can be found on our Investor Relations website. As Lee highlighted, our 7.1% comp in the third quarter once again demonstrated broad based strength across our entire business. We drove positive comps in both every day and seasonal categories and across all major geographies and vintages. In addition, stores more than five years old continued to drive the majority of our comp. Overall, we delivered our 14th consecutive quarter of 20 plus percent net sales growth, and our 15 consecutive quarter of positive comp store sales increases. Our comp sales were consistently strong throughout the quarter, despite tougher comparisons and the disruption of hurricanes Harvey and Irma early in the quarter. Excluding the impact of the third quarter hurricanes, we estimate that we would have delivered an 8.3% comp sales increase. On a two year basis, our comps accelerated for the third straight quarter as we continue taking market share in a large and growing industry. We are also very pleased with the consistent strength in the rest of the business that has continued into the fourth quarter. In Q3, we delivered 25% net sales growth, driven by strong results from both comp and new stores with new store productivity at its highest level in 10 quarters. We continue to believe that our fiscal 2018 class of new stores will be one of our strongest ever. Along with our substantial top-line growth, we delivered a 61% increase in adjusted operating income and 130 basis points of adjusted operating margin improvement year-over-year, which we achieved through expense leverage as we continue to expand the business. While third quarter marketing expense dollars remained flat to prior year, on a year-to-date basis we continue to ramp our spend to advance the brand awareness initiative Lee discussed. In the context of our 25% sales increase and 18% store growth in Q3, net inventories increased only 12% versus the prior year. There were two primary drivers of our inventory dynamic this quarter. The first driver is the normalization of inventory and capitalized freight levels now that we have completely cycled our prior year strategic investment in incremental low price inventory. The second driver is that we are exiting the third quarter with the clean inventory positions due to targeted markdowns on products largely related to our fiscal 2018 and 2019 category reinvention. While these targeted markdowns resulted in a headwind to gross margins during the quarter, they position us to continue driving critical newness to customers over the next year and deliver significant gross margin expansion in Q4. We continue to maintain our consistent track record of over 80% of our net sales at full retail price, which we have delivered every quarter during our nearly five years as a management team. As a reminder, we include all store level occupancy and distribution cost in reported gross margins. Therefore, we plan for gross margin to fluctuate quarterly based on a variety of strategic factors. In the third quarter, for example, we generated tailwinds from lapping distribution costs related to last year's strategic step up in inventory and by achieving meaningful occupancy leverage on our 7.1% comp. On the other hand, we experienced headwinds from increased outbound freight, as well as the timing of sale leaseback transactions in fiscal 2017 and 2018. As a management team, we focused on delivering consistent gross margin on an annual basis, which we have done for the previous four fiscal years. We expect to deliver consistent annual gross margin again in fiscal 2018. Ultimately, we are very pleased to have increased pro forma adjusted net income by 150% and pro forma adjusted EPS by 133% to $0.07 in the third quarter. Turning now to our fiscal 2018 outlook, our strong year-to-date performance and continued momentum enable us to raise the expected range for fiscal 2018 net sales to $939 million to $944 million, which would represent growth of over 23% over fiscal 2017. In addition, we are increasing our annual comp store sales outlook to approximately 5.7% to 6%. Given this top-line strength and the hard work of our team members to deliver on our full year plans, we expect to incur $0.01 to $0.02 of incentive compensation in Q4, which is in addition to the incremental penny we incurred in Q2. Including the incentive compensation and the $0.02 investment direct sourcing that we committed to earlier this year, and continued investments in price and brand awareness, we are very pleased that our outlook of 33% to 37% pro forma adjusted net income growth is above our long-term growth target of 25%. We are also raising our pro forma adjusted EPS outlook for the year to $0.77 to $0.79. Our EPS outlook assumes annual gross margin consistency that I mentioned earlier, continued operating margin expansion as laid in our long-term growth targets, interest expense of $21.5 million, up 37.5% annual effective tax rate and $63.5 million diluted shares outstanding. Net of total expected sale leaseback proceeds of approximately $110 million, fiscal 2018 capital expenditures are expected to be between $110 million and $130 million. Our outlook for the fourth quarter is net sales range of $281 million to $287 million and comp store sales growth of approximately 4%. The implied 11% two-year stack is on par with the 11% two-year comp we delivered in Q3 and illustrates the continued momentum in our business. We expect to deliver at least 120 basis points of gross margin expansion driven primarily through product margins and the lapping of incremental distribution costs incurred last year. We expect some adjusted SG&A deleverage driven primarily by incentive compensation, as well as by preopening costs and marketing investments to continue to support our biggest growth opportunities new stores and brand awareness. Ultimately we expect to deliver meaningful operating margin expansion and pro forma adjusted EPS between $0.33 and $0.35 in the fourth quarter of fiscal 2018. To further support our capital plans, including new store expansion, we expect to complete a sale leaseback transaction of $45 million to $50 million in Q4, which is in addition to the $62.6 million in proceeds we have generated in the third quarter this year. As we look towards fiscal 2019, we are very excited about the continued strong growth that lies ahead. We will provide more robust annual and first quarter guidance in our conference call in spring, but we would like to highlights that our fiscal 2019 new store pipeline is fully identified and approved given us confidence in our top and bottom line potential for next year. While new opportunities for second generation locations, typically arise throughout the year and especially in January. Our pipeline is currently comprised of approximately 75% lease and 25% owned stores. Factoring in the economics of this projected mix, we expect to deliver 25% pro forma adjusted net income growth next year as we maintain our focus on driving consistent quality results and increase in the bottom-line faster than the top. In summary, our performance and more importantly our potential continues to be very promising, we look forward to taking great care of our customers, team members and shareholders, as we near the end of a very exciting and strong fiscal 2018. I will now turn the call back to Lee for his final remarks.

Thank you, Judd. In the third quarter our exceptional top-line performance and meaningful income growth once again demonstrated the broad base strength in our business. As we think about the future, we believe At Home is ideally positioned as the low price trend nimble value player in a fragmented home decor industry that continues to grow. As we expand across our significant wide space, we are committed to reinvesting in the right people, products and opportunities to continue to give our customers the compelling in-store experience for years to come. Operator, please open the line for questions.

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions]. Our first question is from John Heinbockel from Guggenheim Securities. Please go ahead.

So Lee, let me start with -- Lee it looks like for a while now comps are running better than you thought at the time of the IPO. Is that sort of a permanent step up or at least directionally because of the brand that you are building? And then I am so curious as if that’s true that obviously will give you a lot more dollars to play with investment wise, right, as you go forward. Do you think it will pull forward some investments that you otherwise might have made later, and what would be the most fertile places for you to -- is it direct sourcing, is it taking marketing beyond three. What are the areas with the greatest potential?

Thanks John. Yes, I would say we are really grateful first and foremost for our recent higher comps. In the retail industry, we're really pleased that we've got that type of performance. It's been aided by those low priced units, certainly in the first half. If we had easier compares in the first half, one of the best parts of what we had for third quarter was it was actually against tougher compares. So, we had strong momentum going through the summer, we mentioned that at the end of our second quarter call, and we said it maintained itself and continued into the third quarter. But we had a question about the hurricane, we're able to weather that storm literally and be able to bounce back, and we're really pleased with that. Our momentum has continued into the fourth quarter, so we're really grateful for that. I would say -- and Judd has always mentioned the fact that we always focus on multiple levers, and we always reach for higher. We look at all the levers and see opportunities, we will see opportunities going forward, and we already reiterated the forecast for the fourth quarter. As we have that performance being strong, we will reinvest it. The areas that we like the most are direct souring, for sure. We’ve already -- we pulled that ahead into this year because we had better performance than expected, at least better than planned, we hope for better and we plan for better, but we can’t necessarily commit to that. So we invest against direct sourcing and we'll start to see the benefit of that next year. The marketing campaign, we've been investing against marketing, and we'll continue against investing against marketing, and that's gaining traction our brand awareness is growing. We're going to continue to reinvest against price and value all day along. We want it -- and you can see if you look at our pricing, we continue to be below our competitors’ sales prices, we have great value, we've invested more in quality and continued to drive price down. And on the marketing side, we're working on digitally enabling sales. So all that investment we mentioned in my prepared remarks. And the last one, the investment that is coming up is our second DC that's not going to hit next year at all, but it will be an investment that we have to make in the future, we’ll be planning it next year, we'll be investing in the following year, but those reinvestments are necessary for the long-term strategy.

And then, maybe as a follow-up, as you think about pricing, right, which is a little bit opaque in your product categories because we’re on brands, what are the analytics around price elasticity? And how much as you get some of those savings, how much should go to the customer in the form of lower pricing and how much -- and I know it will vary by category and probably by item, but what work you do into kind of test elasticity to make sure that you are -- when you take pricing down you are getting bang for your buck?

Yes, we look at the competitive pricing model all the time; it's not necessarily if we can increase price we will or decrease price. We look at our price versus our competitors, each and every competitor. So, we look at if it's an items that looks similar to a competitor, we look at that competitor and make sure we’re a certain percent off their sales price. So, and we do that across all of our -- and every single department has -- we comp shop every single month and every single quarter. We've 10 competitors we compare against for every single department because every department has a different competitor group, for example Wall Art may have art.com, and art.com doesn't show up obviously for Halloween, Harvest and Christmas, where maybe it's another set a players like a Michaels or Hobby Lobby or some of the NAS guys and home improvement guys and so on. So, we just -- we make sure that we've got the best value and the right price against every single one of our competitors every single month, and that’s what drives our pricing equation, and we want to make sure that ours has the best value and we've talked about investing against quality to make sure the value is there and not just make it cheap for example.

Thank you.

Thanks, John.

Our next question from Dan Binder from Jefferies. Please go ahead.

Thanks and congratulation on a good quarter. Given the clearance and the price investments is it fair to say that most of the comp was driven by traffic or did you have ticket in there as well?

So I'll hit that Dan, what we'd tell you is we're very pleased overall with all the levers of comp, candidly. We've been focusing on them for years. What we’d tell you is basket has maintained that relative $65 that we had when we had the IPO. So we’re doing it in units and we're doing it through transactions and so forth. But it's been a very measured approach, different drivers move in different quarters. But we are making a tremendous amount of progress we're very pleased with the quarter and how it turned out the momentum we have carried into Q4.

Great thanks. My other question around comp store sales, you noted the disruption from the Hurricanes, I am just curious subsequent and during this recovery period certain categories will benefit have improvement mainly, but I imagine there is a lot of home furnishing type items that get ruined from flooding as well, I am just curious if you are seeing any kind of unusual benefits in particularly in Houston market?

So we went into the hurricane in those markets that were impacted and they were doing great. The hurricane impacted -- obviously impacted sales it was net 120 basis points. The stores rebounded back and they are slightly higher than where they were before, but it hasn’t meaningfully changed the comp. Overall, what we tell you is we continue momentum, we don’t expect there to be a significant tailwind from it. For our category it’s the customers not repairing their home and doing things related to that, so we don’t expect there to be a tailwind. We’re pleased that we started with strong momentum and we continue with strong momentum in those markets.

Great. And if I could just one more question on the reinvention strategy, can you give us a little bit of clues on to what the focus would be for next year you cited in your formal remarks some of things you did in Q2 and Q3. I am just curious what’s left to do for next year?

Yes Dan, for FY 2018 this year, as we mentioned before better patio was the focus, better betting was a focus and our holiday -- and upgrade to the holiday business continue in multiyear effort. Those have proven to be very successful; FY19 is wall decor and patio. And so we mentioned in our remarks, as we prepare for a reinvention, we end up having to clear the department a little bit more than usual. So for example our margins were slightly affected in Q3 due to these planned reinventions for next year. So for wall decor and patio, specifically patio cushions. We typically have a usually a higher carry over for the inventory for that for patio cushions, we always keep them selling at full price, the ones that our carryover styles, but we have dramatically improved the assortment with a lot newness. So a lot of styles were discontinued that would have been carried over. So we mark those down, we are grateful that the markdown strategy has worked and we have cleared the inventory that’s why inventory finished the quarter so clean as well. But we work really -- and we are really excited about what’s coming and I would say that this strategy was planned, it’s delivered the outcomes and these reinventions continue to be the engine for our growth going forward and we have a five year plan for our reinventions. So we know what we are going to doing next year and the following year, it allows us to tell our customers something is new going on in the stores and gives us the competitive advantage we feel like against the competition.

Great, thank you.

Thanks, Dan.

Thanks, Dan.

Our next question is from Simeon Gutman from Morgan Stanley. Please go ahead.

Hey this is Joshua Siber for Simeon. One question, if you look back over to the last four quarters, how much of the accelerated comp would you estimate which is driven by the lower price inventory that you have added to stores?

Yes, this is Judd. What I would you tell is that, it varies by quarter, but this quarter it was only 1%, in prior quarters it was 1% to 2% just dependent on the quarter. In Q2 it was a little bit higher because we were up against our lowest unit volumes and unit comps when you look at it year-over-year it might have been a 3% or a 4%, I think we highlighted in the transcript a 4%. But last quarter in particular Q3 it was 1% and when we look at it, we have already now lapped it, so it shouldn’t be that going forward.

So, go ahead.

And that’s why we are really pleased about this quarter, it wasn’t about the lower price unit, it was a broad based comp performance. We hit regions across the country all -- think about all of our districts continue to be strong, product categories every day and seasonal, all price points, it was a broad based comp performance not driven by one particular area.

Okay. And regarding the e-commerce and Omni-channel, what’s the next step of your Omni channel build out?

Well our thinking on e-commerce hasn’t changed Joshua. We focused on the digital opportunities, we’ve always talked about digital enabling sales, I shared in my prepared remarks the progress against that, I think the page loading faster, number of page views and so on. We've increased our digital spend, we’re seeing great traction. We launched the loyalty program. Our focus really is on the consumer, and there is a lot of research out there that even done by other analysts like yourself that have said the four most important things in this category to customers that look for home furnishings and home decor lowest price, largest selection, see, touch and feel and take it home immediately. You can do that every day all day in our stores. But they price compare online, so we've improved our website; we've made it mobile, enabled for mobile in August. We've got the lowest prices in the industry and I will tell you price is our biggest advantage as well as assortment, and we win all day with that.

Okay, thanks very much.

Thank you.

Thanks, Joshua.

Our next question is from Daniel Hofkin from William Blair. Please go ahead.

Good afternoon. Just a question I guess about the targeted markdowns, if you could quantify perhaps how much you think it hurt the gross margin within the quarter and then conversely presumably helped your comps how much of a benefit do you think that was? That's my first question.

Sure. Dan, this is Judd. For the targeted markdowns to be clear, they were planned for the whole year. We had an opportunity and we're opportunistic within the quarter and saw some of that demand come in and we're very pleased with our inventory levels we’re up 12% as of the end of the third quarter so we're very, very clean. What we’d tell you also that when we look at some of the markdowns overall it didn't contribute to our comps that much, it was not the largest driver at all. What we’d tell you is when we look at our performance for our comps it comes back to all geographies, base for a premium are good better best all comp 5% plus or better. And the comp store sales on a two year stake accelerated from where we were at the beginning of the year. So we're seeing more customers come into our store and we're seeing them more frequently, and the exciting part is we're focused on the loyalty program and credit card that will help us.

Okay. And then as far as kind of some of the investments that you've talked about including it sounds like second DC a couple of years out. What's kind of your latest thinking about the free cash flow profile looking out over the next few years, what point do you feel like your earnings base kind of hits a certain level where you're outstripping your capital investments? Is that a couple of years out, further out than that what's your latest thinking on that?

It's a few years out. I mean, we're committed to reducing our leverage and improve our free cash flow. Leverage has been reduced by almost two turns over the past two years so 4.8 times about 3.2 times. We're going to continue to focus on new store growth, and as a reminder our paybacks are less than two years. And the pipeline set for next year and we're already working on the following year. So I would say it's a couple of years out, but we're focused on running the business and delivering great outcomes and I highlighted in my prepared remarks we feel very comfortable delivering another year of 25% pro forma adjusted net income growth.

Okay, great. And then someone may have asked this earlier, I missed part of it, but you address any early learnings from the loyalty program right after that?

Yes, Daniel, this is Lee. I would say we're really pleased right now with the enrollment. And so far the overall performance is not only the loyalty program but the credit card program has surpassed our initial expectations it's driving basket. And overall it's been baked into our guidance. And we'll give you update so as the program matures. And so we're just pleased with what we're seeing, we're grateful that our customers want to be part of the program and we feel it's going to provide benefits for them, but the best part as they think so too because the enrollment rate is even higher.

Terrific. Best of luck in the fourth quarter.

Thanks, Dan.

Our next question is from Brad Thomas from KeyBanc Capital Markets. Please go ahead.

Yes, thank you good afternoon. And let me add my congratulations as well to you guys.

Thanks, Brad.

Judd gave a little color on at least the gross margin outlook for next year being about flat. I guess anymore color you can provide on the puts and takes on gross margin next year and maybe the cadence as we start to model out the quarters for next year?

Sure, so I can give you a macro view of 2019, we will give more color on the quarters, when we do our conference call, coming up in the spring. What we tell you in terms of tailwinds, Peter talked about the direct sourcing, the direct sourcing is making its way into our DC and is now hitting the stores, that will be a tailwind, it will show up more to the back half of next year, but that will be a tailwind for the whole year. We will continue to leverage some of our fixed costs within supply chain and occupancy and so forth next year. So the continued momentum we have in our business, we believe is going to carry into next year and we’re well positioned from an inventory perspective to get that newness, so that should be a tailwind. Sale leaseback transactions which we are doing right now in the fourth quarter and we will do another one next year will be a headwind factor that altogether we’ll be roughly flat for hopefully for the sixth consecutive year. So we manage our gross margins on an annual basis, I said that in the prepared remarks and we are confident we can do that again in fiscal ‘19.

Great. And then a follow-up on the earlier e-commerce question. I guess as kind of a broader digital question. We are seeing more and more companies start to offer these AR, VR capabilities. I guess as you guys think about your digital capabilities, are there any other areas not necessarily tied to delivering to the consumer, but just digital capabilities more broadly that we may be seeing you invest in sooner than rather than later.

Yes, Brad, this is Lee. I would say we are continuing to work on making the digital experience better, some of those are pretty -- I’ll say that some people out there pioneering some of those things and we are not ready to be a pioneer. We have got lot of opportunities just sitting there right in front of us around how to improve the digital shopping experience and how to connect our customer from online into the store. And so we are focused on those kind of things. We want to invest against the compelling in-store experience that to us is the biggest opportunity. So we’re going to continue to make future investments to make it easier to shop, you should see that over the next couple of years as well. We already have an easy store, easy shopping experience for the customer, but we’d like to make it even easier and there is ways to do that going forward. The investments would be around that versus some of the pioneering efforts some other people are trying.

Very helpful. Thanks again.

Thanks, Brad.

Thanks, Brad.

Our next question is from Matt Fassler from Goldman Sachs. Please go ahead.

Thanks a lot guys and good afternoon. A couple of questions, the first relates to the targeted markdowns that you took in the third quarter, to what degree do you think it took a little bit of weight off the fourth quarter gross margin, I know that the markdowns were contemplated through the year, it sounds like perhaps they were accelerated a bit and is that one of the reasons you have the fourth quarter gross margin anticipated up as much as it seems to be?

Yes, you are correct Matt, the short answer is, we pulled some of that forward and we told in the last quarter we expected gross profit to be flat roughly for the year, nothing extreme relates to that. The sequence between the quarters did change a little more in Q3, obviously higher in Q4 we expect at least 120 basis points of gross profit expansion in the fourth quarter and for full year flat.

Second question just -- sorry go ahead.

Just to provide a little bit more color on our third quarter we did have some really nice momentum on those clearance items that we needed to prepare for the reinvention. But remember over 80% of our sales were at full price and continue to be that for the third quarter. We continue to focus on being everyday local [ph] leader. When we have reinventions we do clear some products and thankfully it moved a little faster than we had planned. But it continued to stay within our model more than 80% of our sales are full price.

Got you. The second question I want to ask relates to your fourth quarter same-store sales guidance. So you are guiding to what would be turnout to be the softest comp of the year at 4%, having them 6% and if you back out the storms essentially an 8% and you did say it sounds that you exited the quarter well, and started the fourth quarter well, at the same time it is fair to note that you have two consecutive pretty stiff compares, your best comps of each of those ‘15 and ‘16 by far came in Q4. So how should we think about balancing this, as we think about the realistic comp and what’s behind your forecast, the momentum that you clearly have in the absolute numbers that you have been printing with the tougher comparisons that you face in Q4?

Yes, Matt. we feel great about our business momentum. The third quarter was the strong quarter the momentum as we said has continued. The compare is harder in the fourth quarter, but if you look at the third quarter we did a 7 off a 4 so it’s an 11 two year stack we've given you the forecast of 4 off of a 7 so that's 11 and two year stack. So you can see the momentum is just as strong in the fourth quarter as is the third quarter. It’s just tougher comparison. And compares get even harder in the back half of the fourth quarter.

Couple of things I would add, Matt, four years ago we focused on our holiday assortment and becoming the holiday headquarters. When you look at the comp including the outlook we’ve provided for the fourth quarter of a four comp and you add up the last four years, on a same-store sales basis, we're up 25%. Clearly our focus, our strategic initiative, our store execution, the product we're buying is working. And while they are more close comparisons a four comp at least on a two year stack if an 11 we're halfway through the quarter from a sales perspective. We feel really good about it, we have a lot of momentum, but we're also mindful that we have some tough comparisons in January and where we have outstanding weather, we know weather evens itself out over the course of the year. So we feel good about the four, we have tremendous momentum, and we look forward to sharing our results in the spring.

My last question still on the top-line related new space productivity. We had modeled, I think, very consistent with your guidance, the best new space productivity that you would have put up in more than two years. And obviously there are corks to measuring this and the timing of store openings, et cetera. But you came out even better roughly 100% productivity of new space relative to the average. Was there anything in particular and I realize that this calculation represents four quarters or so worth of openings. Is there anything in particular that you saw either with the cohort of stores or kind of real estate type of one or two stores in particular that you were able to identify that would explain kind of a pop in new space productivity and it seems to have accelerated to a greater degree than your comp did over the course of the year.

Sure, Matt. What we'd tell you is as a management team we've been opening stores for five years now. And for four consecutive years we've actually seen our average unit volumes increased for four years. I said in my prepared remarks, we believe this will be our strongest vintage ever, and we're very, very confident in that, we're looking at average unit volumes. What we’d tell you specifically to your question is sometimes we can have ground up sales which generate higher sales and we experienced some higher in the third quarter like we did this year we had four ground up builds versus last year we had two ground up builds overall. But what we keep coming back to is we're getting better at opening locations. We're doing it in what we call opening them perfectly, we have a team focused on that cross functional team. And we're very pleased with the outcomes and the new store pipeline we have for next year we believe positioned us to have even the strongest pipeline yet.

Understood. Thank you so much for all of that.

Thanks, Matt.

Our next question is from Curtis Nagle from Bank of America Merrill Lynch. Please go ahead.

Great, thanks very much. Just a quick question on new openings for next year, I guess, would you guys consider accelerating growth if you were to come across what could be particularly high returning second new sites that might come available earlier in the year. As you suggest they could?

Yes, Curtis, this is Lee. We have a model that we have been successful operating within. And we've talked about that top-line growth driven by high-teens unit growth low single-digit comp store sales so revenue roughly 20% and then earnings growth of 25%, we like that model. We stay very disciplined with it. There may be a larger amount of excess big boxes out there, that allows us to be more picky. And so now that the pipeline for next year is locked, we're looking at the following year so we'll be thoughtful about the following year, this gives us a chance by having a larger quantity to look at pick out better locations allows us to be improve our new store performance by having better locations, also allows us to spend more time negotiating leases to make sure we get the right rents and to be more thoughtful about it. So we're spending time focused on delivering the outcomes on a consistent basis. And the larger pipeline and we've had the deepest pipeline we've ever had; it just works in our favor.

So effectively it sounds like favoring quality over quantity, that makes sense. And then just a quick…

You have been 20% unit growth that’s still a lot, but we're going to deliver and deliver a really strong outcome with that 20% growth.

Understood. And then just as a very quick follow-up, in terms of I guess where you expect inventory to be on a year-over-year basis at year-end?

Sure, Curt, this is Judd. So, Q3 we were at 12% inventory growth and as a reminder we had 18% increase in the stores. So we exited inventory in a clean position for the fourth quarter and expected to tick up a little bit we might be closer to store growth so call it 18% - 21% neighborhood. We do have inventory that we're accumulating for stores that are going to open in fiscal ‘19. So we'll see some of that build in and that will increase that and be the biggest driver as well as bringing in some of the reinvention inventory particularly in patio, that's going to drive us we want to make sure we're in a great position, but our inventory overall will be very clean existing this year.

Very good. Thanks very much and good luck for the rest of the year.

Thanks, Curt.

Thank you. This concludes the question-and-answer session. I would like to turn the call back to management for closing comments.

Well, thank you all of you for joining us today. We were really excited about sharing our performance with each and every one of you. We've put a lot of time and energy against it, we continue to focus on delivering great outcome and we look forward to updating you at end of this coming quarter.

This concludes today’s teleconference. Thank you again for your participation. You may disconnect your lines at this time.