Greetings and welcome to At Home Second Quarter Fiscal 2020 Earnings 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'd now like to turn the conference over to your host, Bethany Perkins, Director of Investor Relations.

Thank you, Dana. Good afternoon, everyone, and thank you for joining us today for At Home's second quarter of fiscal year 2020 earnings results conference call. On the today are Chairman and Chief Executive Officer, Lee Bird; President and Chief Operating Officer, Peter Corsa; and Chief Financial Officer, Jeff Knudson. 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 fiscal years 2020 and 2021 and our long-term growth targets, as well as statements about the markets in which we operate, expected new store openings, real estate strategy, potential growth opportunities, future capital expenditures, future cash flows and the expected impact of tariffs 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 statements. Finally, the speakers may refer to certain adjusted or non-GAAP financial measures on this call, such as adjusted EBITDA, adjusted operating income, 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 investor.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 results for the second quarter of fiscal 2020. When we last spoke in early June, I shared that our first quarter results were impacted by cold and wet weather that continued into Q2. I'm pleased that we navigated the unseasonable conditions in the first part of May and saw a two year trends in our business rebound afterward. Excluding our results for the first two weeks of May, our Q2 comp store sales were modestly positive. We also successfully expanded our store base during the quarter, surpassing an important milestone by opening our 200th store. Our teams worked diligently to sell through seasonal inventory, and we are making significant progress towards our fourth quarter goal of inventory growth in line with sales. We remain extremely pleased with the performance of our recently opened second distribution center and as expected, we will see freight efficiencies help offset its operating cost beginning in the fourth quarter. Drilling further into Q2, we are pleased with sales of $342.3 million and a modest comp decrease of 0.4% were within our expectation. We opened 13 new stores and drove strong sales growth of nearly 19%, representing our 22nd straight quarter of at least high teens revenue growth. Comps in nearly every department improved sequentially from Q1 to Q2. And outside our weather impacted patio assortment, our reinvention in digital merchandising efforts continued to drive growth. Gross margin was in line with our teams -- gross margin was in line as our teams made significant progress clearing through higher levels of patio and garden products as we described last quarter. Our store teams made it easier for customers to shop by consolidating clearance items within each department. Store level and district level leadership teams emphasized markdown compliance, cleanliness and sharper merchandising within the stores. As a result, standards have improved alongside inventory levels. Our targeted efforts to control shrink and execute clean, accurate inventory counts have been very effective as well. Overall, we narrowed inventory growth in Q2, while positioning ourselves to support an exciting back half seasonal assortment, and was laser-focused on rightsizing our inventory by the end of fiscal 2020. During Q2, we put a substantial effort around our tariff mitigation strategy. Trade negotiations with China are incredibly fluid, but let me briefly recap our actions over the last year to mitigate the dollar impact of Chinese tariffs. First, when tariffs on List 1 through 3 went into effect last September at 10%, we work closely with our product partners, took selective price increases and absorbed the tariff with no material margin impact. Next, as those items were elevated to a 25% tariff this summer, we committed to sharing the incremental impact with our product partners. We reaffirmed that as part of our EDLP strategy, we would monitor the market and be slow and tactical in taking price increases as an offset. We have seen market prices come up in Q2 and we have begun surgically increasing certain prices as a result. Then, List 4 tariffs were announced at 10%. This round is disproportionately weighted to our seasonal items on List 4B, the majority of which were already be in stores when most of the tariffs take effect in December. Therefore, we do not expect List 4 tariffs to materially impact our fiscal 2020 profitability. We are proactively working on solutions for the non-seasonal items covered by List 4. In recent months, our merchant teams have met with over 400 product partners to review tariff mitigation and country diversification plans. And we asked our List 4 suppliers to fully absorb the tariff impact. Our interactions have been positive so far, and our partners brought creative and practical solutions to help At Home remain a price leader and deliver strong profitable growth. We also have made progress diversifying outside of China, by direct sourcing program, which has nearly doubled in volume in the last 12 months and should exit this year at 15% penetration, will help us continue to diversify over the next three years. We've also identified numerous supply chain enhancements to help us manage tariff risk going forward. Finally, we continue to monitor pricing trends. We'll take -- and we'll take surgical pricing increases where appropriate. We're still assessing the additional 5% tariff increase announced less than two weeks ago, but we are confident that the disciplined and comprehensive approach we have refined over the last year will help us mitigate this dollar impact as well. If you look to the future, we believe that as a low price leader, we are well positioned to take share in the market, while softer industry traffic has continued to play a role in our fiscal 2020 performance. We are being very proactive in analyzing our business and refining our playbook for the back half of the year to drive offset. First, from a marketing standpoint, we are reallocating our media mix in Q3 and Q4 to lean into digital outreach and direct mail. These channels have been our most efficient and successful at driving store traffic. All of our digital programs, including social media, search and CRM drive positive returns. With our Insider Perks loyalty program doubling its membership in the last 12 months and reaching more than 5 million members by second anniversary, we continue to focus on increasingly targeted messaging. Within our direct mail program, our Fall LookBook and Black Friday mailers are reaching more households and we're increasing our emphasis on recent movers. From a merchandising standpoint, we recently rolled out a new program we call EDLP Plus, which is intended to both highlight our already low product prices and improve the sellthrough of our planned markdowns. We're bundling our weekly Flash Find deals into our existing twice annual clearance into a new strategy. EDLP Plus will feature longer and more category focused customer event, execute on a rolling 12 month basis. This process enables store teams focus on one department at a time, refreshing it and consolidating markdowns, before marketing the exciting event to our customers. While it's still very early on, our pilot categories have demonstrated improvements in both comp sales and clearance sellthrough. In the medium term, we're also digging into opportunities to further refine our business and drive comp store growth, such as evaluating our mix of good better and best products, exploring product price point analysis and customer sensitivity, and elevating the quality in lower priced items to increase our value proposition. We also recognize that customers continue to shift dollars online. Therefore, we continue to build our omnichannel capabilities that leverage our 200 plus stores across nearly 40 states. We're on track to roll out our buy online, pickup in store test in this Q4. And based on the results, we could launch it in a broader group of stores by the end of fiscal 2021. These and other initiatives are part of a multi-quarter journey to reaccelerate our comp performance and we will update you on learnings and solutions as we generate further insights. Our comp performance this year has been below our own standards, but it motivates us to be better and do better. Our commitment to generate long-term shareholder value is unwavering. At its core, we have a great business model. We grew from $364 million to nearly $1.2 billion in sales over six years, while delivering very healthy profit margins at both the store and consolidated levels. Our concept is highly differentiated with the customer value proposition focused on the dual pillars of largest selection and lowest prices. We showcase more than 50,000 unique and constantly refreshing items in a big box format with over 70% of our products being private label or exclusive to At Home and over 80% of our net sales at full price. We offer unmatched breadth and depth in a one-stop self-help shopping experience that gives the customer the opportunity to see, touch and feel the product. We enable customers to easily mix-and-match and truly make their house At Home. Utilizing our low cost structure, we're committed to being the low price leader in the marketplace. The At Home brand is only five years old and with only 17% unaided brand awareness and a $65 average basket, the upside opportunity remains significant. Our new stores have produced strong returns over the past six years as well, and we continue to see significant whitespace opportunities across the country. Our real estate strategy is both flexible and opportunistic, enabling us to move into second-generation boxes, as well as new builds. Because of the ample supply and low demand, on average, we pay $6 per square foot in rent, which helps us deliver strong adjusted EBITDA margins. On average, our new stores pay back in less than two years and generate more than $2 million in first year store adjusted -- store level adjusted EBITDA. Our older stores are strong as well. In Q2, stores older than three years delivered positive comps above the chain average. Our pipeline of new stores remain as attractive as ever. In fact, we've already approved all of our locations for fiscal 2021. We have the potential to nearly triple our existing footprint and the future is bright as we drive toward our long-term goal of 600 plus stores. With our long-term growth in mind, over the past three months we've been thoroughly analyzing our business, benchmarking ourselves and our performance and reflecting upon shareholder feedback. As a result, we have reassessed our growth rate. Going forward, our priority is to balance store expansion and profitability alongside leverage improvement and free cash flow. Compared to our existing long-term target of high-teens unit growth rate, we will now target 10% store growth in each of the next three years. Through that balanced approach, we expect to strengthen our balance sheet and generate positive free cash flow. The change will begin with fiscal 2021 and flow through the rest of our financial targets, which Jeff will discuss in greater detail. Our executive team and board of directors are tightly aligned and moderating our store growth rate is the best way to improve liquidity, reduce leverage, ensure consistent growth and ultimately drive long-term shareholder value. Though our growth rate may be changing, our growth strategy is not. We continue to have full confidence in the strength of our business model and our long-term potential of at least 600 stores. With that, I'd like to turn the call over to our CFO, Jeff Knudson, who will update you on our Q2 performance and our outlook for Q3 and fiscal 2020. Jeff?

Thank you, Lee, and good afternoon, everyone. As a reminder, additional information is available in our earnings release, which is posted to our Investor Relations website and which includes reconciliations illustrating our non-GAAP results as if the new lease accounting standard had been effective in fiscal 2019. Our discussion of adjusted metrics on the rest of this call will be on a lease adjusted basis with fiscal 2019 results recast to illustrate the standards impact. I would also refer you to investor presentation we posted, which includes the updated growth targets that I will discuss shortly. First, I'll address our second quarter results. Our top line grew 18.7% to $342.3 million, which was in line with our guidance. Comparable store sales decreases 0.4%, also within our expectations, given unseasonably cold and wet weather at the beginning of May. On a two year stack basis, comps of 2.4% accelerated during the quarter and improved 230 basis points over Q1. Second quarter gross profit increased 3.1% to $100.4 million, while gross margin rate decreased to 29.3%. Adjusting for the new lease standard, gross margin decreased 360 basis points, at the low-end of our outlook. As expected, gross margin was impacted by incremental markdowns, the operating costs of our second distribution center, which opened earlier this year, increased occupancy costs from sale leaseback transactions executed in the last 12 months and fixed cost deleverage on lower year-over-year sales growth. We have been executing additional markdowns in fiscal 2020 to sell-through clearance products, and we are pleased with the amount of patio and garden inventory we cleared during Q2. We significantly reduced inventory growth from 44.1% in Q1 to 31.7% in Q2. And we continued to expect sequential improvement in Q3. We remain on track to have inventory growth in line with sales in the fourth quarter. Adjusted SG&A of $75.4 million improved 50 basis points to 22% of net sales. We expect that a flat adjusted SG&A rate heading into the quarter, but timing of store labor cost drove favorability that will reverse in Q3. As a result of these factors, we delivered a 6.8% adjusted operating margin above our outlook of 6.2% to 6.6%. Q2 adjusted operating income declined to $23.2 million, interest expense increased to $8.2 million due to increased borrowings to support our growth and higher interest rates. We recognize $3.2 million of income tax expense in the second quarter with a 23.5% adjusted effective tax rate. In Q2 last year, our adjusted effective tax rate of 9.1% included $3.8 million of tax benefit related to non-IPO stock based awards. In total, we are pleased to deliver $0.18 of pro forma adjusted EPS in the second quarter of fiscal 2020. From a liquidity standpoint, we executed a $75 million accordion feature on our asset based lending facility in June and ended the quarter with total liquidity of $146.2 million. Looking to the back half of this year, we are reiterating our EPS guidance for the full year, but expect to see a couple of timing shifts between the quarters. As I mentioned earlier, we shifted about $0.02 of store labor expense from Q2 into Q3 to support the timing of freight processing and other store projects. Based on the current sell-through rates, we also estimate that planned everyday markdowns representing about $0.02 of EPS drag will pull forward into Q3 from Q4. As we have previously shared, Q4 will generate the majority of our fiscal 2020 earnings per share due to timing dynamics around the second DC's rollout, new store pre-opening costs, non-product cost and gross margin and the lapping of significant tax benefits from stock award exercises in the first three quarters of fiscal 2019. Drilling down to our third quarter guidance, we plan to open 12 gross and nine net new stores and generate $312 million to $317 million in net sales, representing 17% to 19% growth year-over-year. Our comp store sales outlook is down 2.5% to down 0.5%. Last year our 5.2% Q3 comp was the strongest of fiscal 2019 and included an estimated 120 basis point tailwind from lapping hurricanes in the prior year. Adjusting for last year's hurricane tailwind, on a two-year basis, our Q3 comp outlook is a positive 1.5% to 3.5%. We are assuming adjusted operating margins of 1.9% to 2.4% or lease adjusted decline of roughly 400 basis points at the midpoint. Our outlook incorporates 110 basis points of second DC cost, the markdowns I mentioned earlier and fixed cost deleverage, primarily in occupancy. To a lesser extent, we expect margin headwinds from the higher freight rates and tariff impacts we flagged last quarter and increased occupancy costs from sale leaseback transactions. All in, we expect an adjusted net loss of $1.0 million to $2.5 million, assuming approximately 65 million shares outstanding, our Q3 outlook calls for a pro forma adjusted loss of $0.01 to $0.04 per share. For the full year, we are flowing through our Q2 top line results and the continued performance of our new and non-comp stores as we narrow our fiscal 2020 sales outlook. We now expect net sales in a range of $1.373 billion to $1.388 billion, still representing 18% to 19% growth. Our updated full year comp store sales outlook of down 1.5% to a positive 0.5% incorporates current trends, as well as a range of outcomes for Q4. Our guidance implies an acceleration in the two year comp stat trends from the first half to the second half of the year, due to weather improvements, our refined marketing spend and our EDLP Plus initiative. That said, we are pleased to reaffirm our outlook for gross margin, adjusted operating margin and pro forma adjusted EPS. We continue to expect adjusted operating margins of 6.6% to 6.9% in fiscal 2020, which incorporate to 80 to 90 basis points of net margin headwind from the second DC, along with the impact of markdowns, higher freight rates, some fixed cost deleverage and tariffs that have been announced to date. We are lowering our fiscal 2020 interest expense outlook to $32.5 million, due to reduced interest rates. We expect a slightly higher adjusted effective tax rate at 23.5% and a slightly lower diluted share count of approximately 65 million shares. With adjusted net income of $44 million to $48 million, our pro forma adjusted EPS outlook of $0.67 to $0.74 remains unchanged. Our fiscal 2020 net capital outlook is $65 million lower to reflect an additional sale leaseback transaction that we expect to execute this fall, as well as a reduction in capital spend for planned fiscal 2021 openings. We continue to pursue efforts to reduce our capital outlay and improve our free cash flow profile, by exploring build-to-suit and buy-to-suit financing alternatives, executing on capital reductions in our second generation sites through value engineering, strategic procurement and a refined market-by-market approach, while also focusing on working capital improvements. As Lee touched upon in his opening remarks, after a thorough analysis of our strategic priorities, we are refining our vision with a heightened focus on delivering positive free cash flow next year. As a result, we plan to moderate our new store growth rate to 10% in each of the next three years to enable us to improve the balance of new store growth and profitability on the one hand, with free cash flow and reduced leverage on the other. A reduced growth rate has that added benefit of mitigating the cannibalization that is a byproduct of our opportunistic real estate model and creating bandwidth for our teams to lean into critical organic initiatives, including the omnichannel opportunities, direct sourcing penetration and enhancing our marketing and loyalty programs. Our revised top and bottom line growth targets for fiscal 2021 through 2023 are as follows. New store growth of 10% and same store sales growth of 1% to 2%, translating to overall net sales growth of low double digits and adjusted EPS growth in the low to mid teens. Enabled by these new assumptions, we are establishing targets for our balance sheet for the first time as a public company. I shared earlier this year that we plan to be free cash flow neutral in fiscal 2021. We now plan to drive positive free cash flow in fiscal 2021 and beyond. We also expect sequential annual improvement in our adjusted leverage ratio with an ultimate target of less than 2.5 times. We feel that emphasizing free cash flow, enhancing our liquidity and strengthening our balance sheet has enabled by our lower growth rate are key to supporting our initiatives and driving consistent shareholder returns over the long term. The depth of our pipeline, strong productivity of our new and older stores and the strategic opportunities we have in both merchandising and marketing, continue to give us confidence in our business model and a longer term potential for 600 plus stores. With that, I'll now turn it back over to Lee for his final remarks.

Thank you, Jeff. In summary, our business model is strong and we are well positioned to capture market share and capitalize on a significant whitespace opportunity. In the near term, we're refining our marketing approach and leaning into growth initiatives like our newly introduced EDLP Plus strategy to reaccelerate comps and continue to grow total sales. The health of our inventory continues to improve and we're excited about the roll out of our buy-online-pickup-in-store test this year to better enable us to meet our customer's needs, no matter how they shop. I'd like to thank our team members for their continued hard work and dedication to these initiatives, as we grow our business. Our focus isn't on delivering value for our team members, our customers and ultimately our shareholders. Looking beyond fiscal 2020, we are confident that these growth initiatives, along with a stronger balance sheet between store growth -- stronger balance between store growth, profitability and free cash flow generation are the right path forward to generating that long term value. We're excited about the future for At Home and look forward to updating you on our progress in future quarters. Dana, please open the line for the questions.

At this time, we'll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Brad Thomas with KeyBanc Capital Markets. Please proceed with your question.

Good afternoon and thanks for taking my question. I was hoping we could just first talk about some of the recent trends that you've seen in the business, you addressed this a bit in the prepared remarks, Lee, but just curious how your assessment of the state of the industry and the pace of your operations has evolved as you reflect on another quarter that the industry continues to experience some weakness here?

Sure, Brad. What I would say is, the marketplace feels choppier, but that's the same as we saw in Q1. So no change from what we experienced in Q1. The sector is seeing traffic challenges, down 4% in Q2 and which was down 5% in Q1. So what we're focused on is what we can control. We're determined to get our business back in shape and so we've been put a discerning eye on our business. We've been working on offsets, we've adjusted, as I mentioned, our marketing mix. We outlined and executed already outlining and rolling out a EDLP Plus approach to highlight the great prices we already have, because we are an everyday low price leader and also to get better sell through on our clearing. We focus on inventory management, we're making progress there and we've been investing in omnichannel and we're excited about the launch of that in Q4. And as you noticed -- you may have noticed, we've maintained the midpoint of our FY 2020 sales outlook, which means our non-comp stores and our new stores are outperforming, which says that, we're continuing to drive share and performing with these new stores. And we are targeting positive comps to start in Q4 this year.

That's helpful. And then, I want to ask a follow up about the decision to slow the pace of growth. Very clear what you're trying to expect out of this. But I was hoping you can give a little more color around how we should think about what the CapEx levels may be next year with this slower pace of growth? And what potential benefits, if any, we may see to margins next year, given all the slower pace of growth?

Sure, Brad. I'll start and Jeff will finish on that. We've been analyzing our business and we've spent a lot of time benchmarking our peers. How the high growth retailers set up their business for a sustained growth and profitability, which is our intention as well and we've also been listening and talking to investors. And we clearly see from our benchmarking that investors, and more importantly, from our peer group, we're seeing that a more balanced approach is the approach for sustainable high growth retailers. And so by focusing on not only growth and profitability, which we have strong profitability, even in our worst year, we've got great profit margins. We need to balance that with delivering because being free cash flow positive to pay and fund that growth and reduce our leverage to deliver long term shareholder value. And so that's what we've done by moderating our growth. The capital impact is -- Jeff, you want to cover this.

Yeah. So you obviously saw a change in our fiscal 2020 CapEx guidance, there was a gross reduction of $65 million on the net side with $50 million in sale leaseback and then pulling out $15 million as it relates to the fiscal 2021 vintage. As it relates to next year, we still do have a strong pipeline; we have over 15 stores that are currently owned. So we will be able to continue our sale leaseback cadence, as we move into next year. And as we get further into this year, we'll provide more specifics on the CapEx guidance for fiscal 2021. As it relates to the operating margins, there's obviously a lot of dynamics in play as it relates to fiscal 2021, we do have some tailwinds next year as it relates to lower markdowns. We'll start to see efficiencies from the second distribution center, as well as direct sourcing. But obviously, with the tariff wrap and the elevated tariffs that were just announced a week and a half ago, we also had some freight rate impacts as well as the sale leaseback. So, as it relates to fiscal 2021 margins, the tariff situation is very fluid right now. We're still working, as Lee said in his prepared remarks to mitigate the dollar impact of those tariffs. And as that plays out over the next couple of weeks and months, we'll get back to you later in the year with specifics around next year margins.

That's helpful. Thank you very much.

Thanks, Brad.

Our next question comes from the line of John Heinbockel with Guggenheim Securities. Please proceed with your question.

So, Lee, let me start with EDLP Plus. Is the current rug event an example of that? And then, when you think about the execution of it, is the idea that, I don't know, how many times a year, but I don't know, multiple times a year, enough every quarter, a category will be highlighted and promoted for several weeks at a time? Is that the idea behind the execution? And then is it sort of the reason that EDLP doesn't kind of work as well in this space, because it just happens to be a promotional space and you need to do that to generate customer interest?

John, the EDLP Plus approach is a double down on everyday low price, so it's not a departure from that, it to give us credit for what we already do, but also to enhance an emphasis around events to highlight those categories themselves. So we started with our home org event in the beginning of August, so this started back in the beginning of August. So we did home org and we did furniture and those were targeted events highlighting full priced items, our flash finds and then also identifying and showing our clearance department. They were preceded by department cleanups for those departments.

Yeah.

So our teams cleaned off the department, made sure everything was priced appropriately, easy to shop and then we had the organization event, then we had the furniture event, now we have the rug event. And the rug event actually matches up to an approach we're using now when you have retail -- retail sale time period, so think about Labor Day in 4th of July and Memorial Day and Presidents Day, those are highly promotional. Those will be timed, we're going to be -- we're going to lean a little bit into the promotion side, but not change our model, but just highlight that. And then that will be for a short period time. And then we'll roll back into the next event as well. So that's going to be our model, you'll see that. We're pleased with the performance against that on full price selling, which is our primary emphasis and clearance of our markdowns. We like that, but it's not a departure of the model. It's actually just allowing us to actually freshen the store over time. And you'll see starting in January the next level of this. So we're piloting, refining it, getting it better and by -- once you get out of Christmas, we'll be able to add another level of EDLP Plus from an in-store experience that will show even stronger the highlight of these product categories.

Okay. Thanks. And then just long-term sort of to tag on the last question. When you look at the three-year target, I don't think, at least I always thought because next year is an extra week and you get the recapture right of some of this year's cost pressures. The three-year is not meant to be -- it's meant to be a target, it's not meant to be a sort of an algo for each year. Next year, I assume, would differ from that a bit. And then if I think about your leverage target, it looks to me like you probably need over that three-year period to pay down somewhere $200 million to $250 million of debt. Again, it depends how fast you grow EBITDA, but that sort of -- $200 million plus, and Jeff, is that fair? Is that a fair target?

Yeah. It's close John. That's right.

Okay.

But on the targets…

On the targets, we didn't think about those, so those -- we did not factor in the 53rd week next year, John, into those targets, those are on a 52-week comparable basis. And we have thought about those, as you know, longer-term targets, but each year operating within those parameters as well.

Okay. Thank you.

Thanks, John.

Our next question comes from the line of Daniel Hofkin with William Blair. Please proceed with your question.

Good afternoon. I apologize if you answered this already, but just as it relates to the tariff impact, which you talked about is being not much for the List 4B for this year, given when you'll have the product in, but can you characterize that for next year? What that's likely to be based on what you know now? And then I have a follow-up question.

Yeah. From a tariff standpoint, what we've said is, basically List 1, 2, 3 obviously had 25 basis points baked into our back half for those for List 1, 2, 3 at the 25%, because remember, our inventory turns slowly. And so it doesn't get through the churn of the inventory. List 4 is more weighted towards seasonal product which still be in the stores already, so we don't expect a material impact on FY 2020. Now from an FY 2021, we've been working very closely with our supply partners. We actually had -- we've met with 300 of our product partners, not only in the U.S. we brought our top 100 suppliers in. But then we went to China, we went to Vietnam and India and met with our product partners in product partners summits, and required them to come to those meetings, prepared to discuss creative and practical solutions to offset these tariffs. Now, this is obviously before the 5% incremental increase on top of the 10% that we knew in List 4, but they came back with great plan. We've been working through those plans, we've also told them that they had to eat List 4, the cost of List 4. But then we've been -- so we've been working on a very disciplined approach to mitigate the impact of our tariff. And I would say, right now, it's too soon to give FY 2021 margin percent, but we're confident the EPS growth have outpacing sales growth next year and that's incorporated the impact of those tariffs going forward.

Okay. And then, as it relates to your comments before on the question earlier about the overall environment. It's not really clear that the consumer is spending last or spending less on value. So it implies that there's some more competition, I'm just curious where you think that's coming from and what -- how this sort of the EDLP Plus strategy, how you think that will help more going forward?

Sure. I would say that the promotional environment and the competition is no different really than what we saw in Q1. So it's not different from them, but it is different than it was a year ago. So it's more promotional. And I would say, and what we've found too is that, we are -- we're not a high, low player. So we've realized that since the marketplace is promotional, we're not getting credit for the low prices we already have. So this EDLP Plus program is really more to highlight the prices we have in the store, both out of store and in-store more clearly to our customer to be clear on our website, how our prices are lower than the competition and expect to be lower than the competition. And so, what we're trying to do is, highlight categories, be clear about the price. And then when there is a clearance customer out there, to be a little bit more open and transparent and inviting to our customer to go buy the clearance. We make it too hard for them to find a clearance in our stores. We're trying to make it easier for them to find it, buy it so we can sell through faster. And that's how we're going to approach it. That allows us to continue to have 80% of our sales at full price. That allows us to be profitable and continue to grow and take share, because by the way, the marketplace may be choppy, but we are taking share. When we're growing 18%, 19% in a quarter where the marketplace is going backwards, we're a share taker.

And where do you feel like -- okay. So understood regarding that, but will you be reducing your prices during sort of in a pulsed way in line with when others run promotions, companies that are not on an EDLP or that are more on a high, low type of system?

No, I think what we're going to do is what we always do is, we -- our prices are below other people's sales prices, they just don't see it sometimes, they're not noticing it, because there's a lot of noise out there about the promotion or the ad and they don't spend the time to go look at ours. And we don't make it clear to them the value that we offer. So we're trying to make sure our prices are sharp. We're focused on making sure we are the lowest price out there. And then, but at times where it is highly promotional, we may have an offering that's more consistent to what they have, which we were doing before, but may not have been timed at the same time that they were doing theirs. And so, for example, our Rug Event that we're having right now, it's an event that we bought into, we bought volume for our rugs to expect a higher velocity selling period to then highlight that value, while other people are talking about their offer. We have ours. It's not the first time we've done a rug offer, but it's the first time we're doing it over Labor Day to get credit, while other people are promotional as well. So it's just to sync up with the industry at the times they're doing that. But it's not changing our model, it’s just getting credit for what we're already doing.

Okay. Thank you. Good luck.

Thank you.

[Operator Instructions] Our next question comes from the line of Jonathan Matuszewski with Jefferies. Please proceed with your question.

Great. Thanks for taking my questions. I guess, just for the 3Q guide, you said it's in soft industry traffic in 2Q. So just curious, what your expectations are for 3Q? Are you expecting industry traffic for the category to worsen, stay the same or improve? And I guess how have trends been shaping quarter-to-date relative to your comp guidance range? Thanks.

Yeah, Jonathan. When we think about our comp trends going into Q3, remember we do have a tough compare out of 5.2 [ph] from last year that has the 120 basis points from the hurricane in fiscal 2018. So on a two-year stack basis, those trends are pretty consistent with where we ran in Q2. If you look at the midpoint, and with that how -- so we don't see any dramatic shifts from a traffic standpoint or moving into Q3. When we look at those traffic trends that Lee talked about, and the down 4% Q2 off of 5% in Q1, I would say that we are outpacing the industry from a traffic standpoint and when you exclude the cannibalization in past, we are happy with where our traffic is trending right now.

Great. That's helpful. And then I guess just on the select price increases, I know you mentioned you'd be doing them surgically. If you could just elaborate there a bit, that’d be helpful? Anything you could share in terms of maybe just the blended level of increases you're looking to take. I'm sure it varies by category, but maybe just how much price you're looking to pass on and how that level of increase compares relative to what you're seeing the industry do. Thank you.

Sure. We comp shop every other week. Our team spend their Fridays comp shopping every other week, buy item to know what the competition is doing from a price standpoint. So we're super methodical about it. Our List 1, 2, 3 last year had no meaningful financial impact on those price increases that we made, the surgical increases. We focus on the value proposition. We focus on being the low price leader. We may see where there is an opportunity to take price. We may decide to do it to monitor where that price is. We may see where we actually need to increase the quality to make sure the value is there. So we're working on that. So we've been slow and very tactical to take price. Some people have some questions around that approach after Q1 with us, because we said we weren't going to take price just yet, because I would tell you that goes against our model. We need to be slow to take price because we need to be the low price leader out there. And when we do take price, we do look at offsetting margin dollar impact and the margin percent impact. So -- and we -- and since Q1, the Q1 results were announced, we have taken targeted price increases this past summer. But our goal always is to maintain price leadership. And we're working with our suppliers and we're using direct sourcing to continue to find offsets in our supply chain to keep our prices low.

And I guess, that's helpful. Just a quick follow-up for those select price increases that you have taken, have you seen any material unit degradation?

On the List 1, 2, 3 that we had starting last year, we hade not, we've been able to protect the revenue on that. But I would say, it's too soon on the most recent price increases. We're just going to keep watching them.

Thank you.

Thanks, John.

Our next question comes from the line of Chuck Grom with Gordon Haskett. Please proceed with your question.

Good afternoon. Just on the second quarter gross margins. Jeff, can you just unpack for us a little bit more granularity, the four negative factors that you called out? And then when we look ahead to the third quarter, can you just hold our hands on exactly what you're thinking for the gross margin line?

Sure. So on the Q2 gross margins, again, they were in line with our expectations. We had 85 basis points of unfavorability from the second DC. 50 basis points on sale leaseback, deleverage within our occupancy that came in as expected and the remainder was from markdowns and fixed costs deleverage on occupancy. Again, we were pleased with the amount of inventory we were able to move with those markdowns and the operating margins when you exclude the timing of the store labor came in, again, within our guided range for Q2. Moving to the full year, again, we reiterated our full year gross margin and operating margin outlook. There is some timing element on those markdowns between Q4 and Q3, but our full year outlook remains the same from the last call.

Any color for the third quarter, specifically on the gross margin line. I know, you gave an operating margin target. Just wondering how you -- how we should get there in terms of those components that you just laid out for the second quarter?

Yeah. It's predominantly within the gross margin. There's a little bit of SG&A benefit in Q3, but the vast majority ends the same drivers, we've been talking about you do have the introduction of the tariff impact in Q3 that wasn't in Q2, that we had talked about in the last call. But it's the second distribution center, it's the markdowns and it's the sale leaseback and occupancy deleverage on the lower sales growth is really the drivers.

Okay. That's helpful. And then when we think about next year, it sounds like you're trying to set the table that some of the benefits you're going to see from cycling some of the markdowns and distribution costs are going to be offset, potentially by the tariff wrap. I mean, you probably don't want to peg in operating margin target for next year, but – which we think about flattish as what you guys are thinking of at a preliminary rate at this point in time?

Chuck, that's exactly why we didn't give an operating margin, with the last tariff increases being announced a week and a half ago and how we mitigate those, and again, we're always trying to mitigate the dollar impact and not the rates and how those dynamics are going to play out between gross and operating margins. We just need time to work through the process that we've established over the last year to mitigate those tariffs and we'll get back to you with more details on how we see fiscal 2021 margins playing out. But, again, I would reiterate that we do feel good about the mid to low teens adjusted EPS growth.

Okay, great. Thanks and good luck.

Our next question comes from the line of Simeon Gutman with Morgan Stanley. Please proceed with your question.

Hi, Lee. Hey, Jeff. I wanted to ask about the sales environment. If you look back to last six or so quarters, they mostly been bumpy, there's been some reasonable reasons why whether -- not enough seasonal merchandise, we had some Black Friday bumpiness. So in Q3, you have a tough compare, which you're lapping, Q4 I think the implied midpoints are around flat. So I just want to step back and try to diagnose what's changing. Is it business moving online, you had a backdrop that has gotten weaker. I think merchandising may have gotten stale, I don't know if you’d go as far and say that, store conditions, et cetera. Just so we can try to establish some chain of what's going to get better as we move back into next year?

Yeah. So I'll start with the implied comp for Q4 around. It's slightly better than flat, Simeon, is where we are for Q4. We did take with our Q2 results and the outlook for Q3 with that tougher compare, we did take the full year down 50 basis points to the prior guide, so our full years down 1.5% to up 0.5%, that is reflective of the current environment and the trends we're seeing. We did say in the last call that we did see the two-year stack stabilizing as we move through the back half. When you look at our Q2 results and then our Q3 guide, adjusted for the hurricane impact that's in that two-year stack, that's how it's playing out and we have -- saw the weather impact in the first half and -- to continue to drive traffic and improve our comp trends, that's why we're going after the marketing initiatives that we talked about, redirecting some of that spend as well as the time that we've spent on the EDLP plus initiative. And then I'll let Lee chime in.

Yeah, Simeon. For us, as you know, because you've been with us now for -- I’m not sure, over four or five years and talking about this business and learning about this business and sharing back and forth ideas. We've walked stores together. This is not a comp store, it’s never been a comp store. Now, obviously, we expect of ourselves positive comps. So don't get me wrong, and we're not pleased with our performance, I'm certainly not pleased with the performance that we've delivered in Q1 and Q2. But I would tell you, it's never been a comp story. We have new stores that come in that are highly productive. They have no comp waterfall. So, we don't have that tailwind that other retailers have. We have to get through it with blocking and tackling. And I actually have to overcome the second year, which is a tougher year for us of a new store. But I would say that -- and we've delivered positive comp and we expect that of ourselves. The first half of this year was a weather challenge and I would tell you now that we've been able to stabilize our two year stacks. By the back half of the year, those have come in towards this new guidance range of one to two comp. And that's we -- you should expect of us. And we're mindful of the environment with that expectation as well, we've said it's choppier, it was not choppy three years ago, four years ago. And so now it's choppier. It's not necessarily about other factors that you've mentioned, obviously, yes online is a factor, that's been a factor for -- that's been in the business for six and a half years. Obviously, we're working an online approach, we've been doing that for four years now, we're now bringing our buy-online-pickup- in-store we've always said we're going to do that e-commerce our way, which means let's do this profitably. Other people don't. And so we're focused on that. And so we're just mindful of our model, we're mindful of the environment, but we expect positive comps, we expect positive comps for ourselves, obviously, next year. And obviously, for the fourth quarter, the midpoint of our Q4 expectation is a positive comp as well.

And my follow up, just two parts, they'll be unrelated, do you need to speed up or do you want to speed up online any quicker than the rough timetable that we've talked about. I think its buy-online-pickup-in-store through at some point to the end of next year. And then the unrelated part, just some of the merchandising changes that you've -- the business has embarked on, a new person helping with trend, product, display. Could you just walk through them and what you're seeing thus far with some of the changes you've made?

Yeah. I'm excited about those. Let me start first with your first question around our omnichannel approach. As you know, first and foremost, it's always about the customer. And for us, we continue to get research from our customer where the vast majority of all sales in this category are still done in physical brick and mortar stores and they're looking for price, selection and see, touch and feel and that's what we offer in our store today. And we feel we've got a very compelling offering, our EDLP plus approach will help highlight our already existing great prices and our selection. And then be able to highlight categories and sell. We do know that customers are increasing their spend online over the past number of years and we've been on a multiyear journey, we've been thoughtful about this, other people rushed way too fast and blew up their business on that. We're not going to do that. We had a demand where four years ago, we put our products online, we put a recommendation engine in about a year and a half ago, we put all their inventory online buy store this spring, so all of our stores have visibility buy store for their inventory. So you can exactly see the item you want and how much is in each particular store near your home. We've added partners through that platform to be ready for a buy-online-pickup-in-store. We've added our OMX partner and a credit card partner as well, so that we're ready for that to do this test in Q4. As we see that perform we intend to then roll that out to a number of stores on a larger scale by the middle of next year. By the end of next year, we should have that fully built. And then we're using this store as the basis of our omni business. And so, you should expect as we look at it, what's the next capability is same day delivery from store, because our stores are warehouses, over 200 of them. So how do we get that to the customer on the same day? And then how do you ship from store? From those existing warehouses, using those existing inventory pools that should help our inventory turn faster and meet our customer expectations. And so that should allow us to continue to deliver low prices to our customer and the financial returns while preserving the treasure hunt approach for our customer and still delivering profitability. So, we're very thoughtful about it. We don't -- I don't feel like we need to pick up the pace, because when you go faster, sometimes you don't execute as well. And you know us to be thoughtful and we're going to do that and deliver a good outcome. Now on the merchandising part, I'm excited about the changes and enhancements we've made in merchandising. Chad Stauffer is our Chief Merchant. He has been in the seat for now three months. He and I are completely aligned on our approach to EDLP Plus. He's been with the company for over a year. He joined us about 18 months ago and ran the everyday business and the progress we're seeing in everyday business afforded us the confidence to promote him into the chief merchant role. And now he's running the whole thing. The EDLP Plus was actually his and Ashley Sheetz, our Chief Marketing Officers co-developed idea and they're the ones co-executing this. And I think they're doing a brilliant job of planning it and putting the plans in place, executing thoughtful tests and enhancing that program throughout the back half of this year to see the full experience by our Q1. We've added and enhance our trend department. We have our new head of trend and design has been at West down Anthropologie, we're thrilled that Christian and his efforts, he's just brilliant and we love his work and the way that he's thinking about how do we take our archetypes to the next level. He'll be actually previewing all of that with our board just next week with our approach. So I like where we're taking trend. We're taking those trend incites to each and every one of our departments, for making sure that we build assortment plan based on what we're seeing in trend and make sure that we have the most current and appropriate styles in our assortment. And then, we take this comp shopping every other week to make sure our prices reflect where we need to be. And then on top of that, you should know that we're -- we've been adding members of our team to the inventory side to merch planning, to help us better buy and better plan our inventories. So we're sharper and smarter on their inventory investment, so we don't get into the situations that we've had historically around inventory to become better and better as a retailer.

Thanks, Lee.

Thanks, Simeon.

Our next question comes from the line of Curtis Nagle with Bank of America. Please proceed with your question.

Good evening. Just a quick question on the changed expectations on the leaseback. So, I think it was 75, now 125. I guess what drove the changes, is that a pull forward from perhaps next year or is it something else?

No, I would think about it as a preliminary step or migrating step to our build to suit and buy to suit model. These are actually going to be a handful of stores that are all recent fiscal year '20 openings and an opportunity. Typically, we would say we expect leaseback after 12 months of operating performance and we were able to do a handful of stores that all have opened within the last quarter, so -- and this is -- with our track record of excellent sale leaseback. This will allow us to transition more fully next year to our build the suit and buy the suits on our ground up sites.

Okay.

It reflects also, Curtis, just the confidence that are our partners on that side that we have in our business and also in the stores themselves. They know our stores, they've owned a number of them. We've worked with them for a number of years and they feel comfortable to not wait the year. And we feel as well comfortable not waiting a year because our stores have been so predictable right out of the gate.

Okay. That makes sense. Thanks very much for the clarification.

Thanks Curtis.

Ladies and gentlemen, we have reached the end of the question-and-answer session, and I would like to turn the call back to Lee Bird for closing remarks.

All right. Well, thank you, everyone, for joining us this afternoon. We're excited about the opportunities in front of us and the long term growth ahead. And we look forward to talking to you in the coming days and weeks. Take care.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.