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Edited Transcript of HOME earnings conference call or presentation 28-Mar-17 12:30pm GMT

Thomson Reuters StreetEvents

Q4 2017 At Home Group Inc Earnings Call

Mar 28, 2017 (Thomson StreetEvents) -- Edited Transcript of At Home Group Inc earnings conference call or presentation Tuesday, March 28, 2017 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Bethany Perkins

At Home Group Inc. - Director of IR

* Lee Bird

At Home Group Inc. - CEO

* Judd Nystrom

At Home Group Inc. - CFO

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Conference Call Participants

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* John Heinbockel

Guggenheim Securities - Analyst

* Simeon Gutman

Morgan Stanley - Analyst

* Matt Fassler

Goldman Sachs - Analyst

* Oliver Wintermantel

Evercore ISI - Analyst

* Daniel Hofkin

William Blair - Analyst

* Denise Chai

BofA Merrill Lynch - Analyst

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Presentation

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Operator [1]

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Greetings and welcome to the At Home fourth-quarter and fiscal 2017 earnings call. (Operator Instructions). As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Miss Bethany Perkins, Director of Investor Relations for At Home. Thank you, you may begin.

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Bethany Perkins, At Home Group Inc. - Director of IR [2]

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Good morning, everyone, and thank you for joining us today for At Home's fourth-quarter and fiscal year 2017 earnings results conference call. Speaking today are Lee Bird, Chief Executive Officer and President, and Judd Nystrom, Chief Financial Officer. After Lee and Judd have made their formal remarks we will open the call to questions.

Before we begin I need to remind to that certain comments made during this call may constitute forward-looking statements and are made pursuant to and within the meaning of that 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 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 at 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.

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Lee Bird, At Home Group Inc. - CEO [3]

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Thank you, Bethany; good morning, everyone. Thanks for joining us to discuss our fourth-quarter and fiscal 2017 results. As you saw in our earnings release issued earlier today, we delivered strong fourth-quarter performance which exceeded our expectations, driven by a very positive customer reception to our holiday assortment and our investments in incremental inventory.

The strength of our business continues to illustrate that value that customers demand in today's retail environment. And our value proposition is resonating with home decor shoppers now more than ever. We have been and will continue to be focused on delivering a compelling and unparalleled assortment of home decor at affordable prices. And both our fourth-quarter and fiscal 2017 fiscal results reflect the success of our unique value proposition.

In our fourth-quarter we delivered a 26% increase in sales, which is our 11th consecutive quarter of 20% plus sales growth, driven by a 23% increase in stores and a 7.1% increase in same-store sales, representing our 12th consecutive quarter of positive same-store sales increases. Our top-line performance, along with gross margin expansion and expense leverage, fueled a 62% increase in adjusted operating income and a 100% increase in pro forma adjusted EPS of $0.28.

Turning to fourth-quarter comp store sales, our 7.1% increase outperformed against both our long-term target of low-single-digits and the outlook we shared with you in January, driven by two main factors. The first is the journey we started on three years ago to carve out a position as the holiday decorating headquarters for customers who want great holiday style and unparalleled value.

We began transforming our fourth-quarter offering from basic commodity products to a creative assortment that has firmly established us as the go-to destination for holiday decorating. We've seen the success of this transformation deliver a 6.4% comp in Q4 last year and a 6.1% comp in Q4 of fiscal 2015. In fiscal 2017 we continue to merchandise the seasonal assortment along our archetype, but we also expanded those decor themes and improved our inventory planning to ensure we had enough on hand to satisfy our customers and deliver a very strong three-year trend.

The second driver of our robust fourth-quarter comp was the incremental inventory we brought in during the back half of last year. As we discussed in our third-quarter earnings call, we conducted a thorough analysis of our inventory in the second quarter and identified an opportunity specifically in items below $10 and $25. We capitalized on this opportunity beginning in Q3 and our customers responded resulting in a broad-based sales lift in our everyday assortment.

From both a top- and bottom-line perspective, the fourth quarter was an exciting end to a year during which we achieved many important milestones and made progress against all of our strategic priorities, which I will go over shortly. In fiscal 2017 we grew our store footprint by 23% to end the year with 123 stores, strong new store performance along with a 3.7% same-store sales increase to over a 23% overall sales increase for the year.

In combination with a 23 basis point improvement in adjusted operating margin, we drove a 26% increase in adjusted operating income and a 44% increase in pro forma adjusted EPS for fiscal 2017. As I discussed on last quarter's call, we were very disciplined in executing against our strategic priorities that cover the following areas.

First is our customer. We want to know the home decor shopper and specifically the At Home customer very well. To this end, in fiscal 2017 we grew our email database by over 120% year over year. We also announced a partnership with Synchrony Financial to provide customer financing options and began laying the groundwork for the private label and co-branding credit card program that we plan to launch later this year. Progress we made in each of these initiatives is an important foundation for designing more targeted personalized marketing efforts in future years.

Second is our assortment. We want to provide the largest and freshest assortment in home decor at the best value in the industry. This includes ensuring we have the right amount of inventory in every store to meet the needs of our customers. This past year we continued to focus on our category reinvention strategy in which we refresh and elevate portions of our offering to highlight that there is always something fresh and exciting about our assortments. These reinventions not only create a reason to buy for our customer but also create additional opportunities for -- to communicate with her throughout the year.

As I mentioned earlier, we also strengthened our value proposition by investing more in inventory at our lowest price points which received a great customer response in the back half of the year.

Our next priority and our biggest growth opportunity is our new store growth. We have substantial whitespace; at only 123 stores at year end we believe we can grow our nationwide footprint almost 5 times to at least 600 stores. We have discussed before customers respond quickly and enthusiastically to our concept, which enables us to open our stores with relatively high first-year sales volume and generate payback on an initial store investment in less than two years. In fiscal 2017 we opened 24 stores expanding our store based by 23%.

The reception to At Home has been and continues to be consistently strong across a wide variety of markets whether new or existing, large or small, urban or suburban. And our fiscal 2017 new stores were the strongest performing At Home class to date. For instance, opening in new markets for Minneapolis, Minnesota and Jackson, Mississippi and Albany, New York significantly outperformed our initial expectations and highlighted the geographic diversity and affordability of our [store mix].

By the same token we saw encouraging outperformance when we opened new stores in existing markets such as our fourth location in the Salt Lake City area and a very successful relocation in our home market of Plano, Texas. Overall the success of our fiscal 2017 stores gives us even more confidence in our long-term unit growth targets.

Our fourth strategic focus is our in-store experience; we want to ensure that when our customers come to At Home they find our self-help shopping experience easy and enjoyable. In fiscal 2017 we concentrated on making sure our customers understood the value they were getting when they walk through our doors.

For example, we implemented a one week only special called Flash Finds to showcase products that are typically 50% off our everyday low prices. We also increased signage and value messaging throughout the store and involved end cap and feature tables. We were very pleased with the response of these value communication initiatives. We will continue to assess them and refine them in fiscal 2018.

On to our fifth priority, operating efficiencies. This means making the necessary investments consistent in infrastructure to ensure we are operating efficiently and effectively while simultaneously solidifying our foundation to support the substantial growth that lies ahead. For several years At Home has operated a best-in-class, super lean, self-help labor model.

This year we continue to find efficiencies and improve processes at the stores and our distribution centers, ultimately contributing to gross margin improvement through a reduction and non-product costs like shrink, damages and [crates]. Other fiscal 2017 investments were dedicated to improving product acquisition and distribution. In the second quarter we brought new expertise in our transportation function by outsourcing it a best-in-class supply chain partner.

We implemented a merchandise planning tool which, combined with the inventory allocation tool we implemented in 2016, will further support our objective to ensuring the right inventory at the right store at the right time. In the fourth quarter we also completed the expansion of our cross dock distribution center in Plano, Texas resulting in capacity to support up to approximately 220 stores.

Sixth is our brand. We are focusing on thoughtfully and aggressively expanding the At Home brand. In fiscal 2017 we expanding our marketing spend to 2.6% of sales from a little over 2% in fiscal 2016. This incremental investment was largely dedicated to driving long-term brand awareness through a partnership with HGTV that showcased a wide variety of indoor, outdoor everyday and seasonal home decor at value oriented prices.

This year we also concentrated on customer acquisition and critical touch points by successfully testing and rolling out the new mover program, intensifying our back-to-campus efforts, as well as adding direct mail to our marketing playbook for new store openings. In each of these initiatives we saw customer response rates significantly above the industry averages.

We expanded our online presence as well enabling customers to browse almost 50,000 items on our website and more than doubling the number of pages viewed. We grew our social media followed by combining 50% across Facebook, Instagram, Pinterest and Twitter as millennials became a bigger part of the picture across retail. Due to the visual nature of our business we used videos for the first time to better showcase our cost. We were extremely encouraged by the viewer engagement results and expect to build on this success of visual media in fiscal 2018.

Finally, we enhanced the overall look and feel of the At Home branding across digital, social and traditional media to better communicate with and inspire our customers and At Home -- home decor enthusiasts.

Our final priority and the foundation of all others is our team. Our success is the direct result of solid execution by an extraordinarily talented team of individuals. They are the heart of At Home and we are committed to making sure At Home is a great place for our team members to work, grow and build their career. In fact, we were named one of North Texas' best places to work this past year.

The excellent team we have assembled has consistently delivered above plan results every year. I am thrilled to announce that fiscal 2017 is the first year that every single team member was eligible to participate in our bonus program. From our part-time hourly associates that could earn up to 5% of their annual wages to our store directors who already have an unlimited bonus potential plan.

We continue to drive consistent annual reductions in store turnover and promoted the highest number of field employees to date. We also promoted a significant number of home office and distribution center team members including promotions into both our new Chief Accounting and Chief Operating roles. In our fast-paced high growth world we expect a lot from ourselves and once again I couldn't be more pleased with the great outcome we delivered together.

Looking back fiscal 2017 was a momentous year for At Home, we completed our initial public offering becoming one of the few retail IPOs in recent memory. Over the past four years we have delivered a 20% top-line compounded annual growth rate positioning us as one of the fastest-growing retailers in America. This year we continue to bring great trends at affordable prices into the homes of our customers, made substantial operating progress and ultimately outperformed our financial expectations.

As we look ahead to fiscal 2018 we remain committed to building upon this progress by focusing on the same strategic objectives I just laid out with an even greater concentration on the two areas that we believe present the biggest growth opportunities: driving brand awareness and opening new stores. To support our brand awareness effort this year we are increasing our marketing budget to 3% of sales while continuing to focus on maximizing the productivity and effectiveness of every dollar spent.

We issued a press release earlier this morning announcing that for the first time at the At Home brand we are launching a fully integrated marketing campaign called, Unleash Your Inner Decorator, that will support the (inaudible) expanding footprint with advertising in more than twice the number of markets in fiscal 2017.

This is our first marketing effort of this magnitude and it utilizes a holistic customized approach that includes television commercials on national programming aired specifically in our priority markets across the country. The national campaign launches next week and draws on our own unique brand personality to highlight our seasonal and everyday assortment, enjoyable self-help experience and everyday low prices.

We also plan to launch our credit card program late this summer that will not only provide attractive financing options for our customers but will eventually allow us to communicate with them in a more personalized manner and deliver an even better shopping experience.

Finally, this past month we welcomed Ashley Sheetz as our new Chief Marketing Officer -- we are excited to have lead these fiscal 2018 initiatives.

Turning to new store growth. I am excited about our fiscal 2018 pipeline that reflects our core competencies being flexible and opportunistic. Judd will cover our outlook in more detail shortly. At a high level we will be expanding our store count by 20% through 25 net new store openings this year and early indications that this will be another strong class.

We are ramping our new unit growth for the fourth year in a row and have made new -- and have more new At Home stores planned in fiscal 28 than we have ever had. I mentioned earlier that our newly expanded distribution center can support up to approximately 220 stores. But consistent with our disciplined and thoughtful approach to everything we do, we already have a cross functional team in place that is analyzing the requirements and developing an optimal plan for a second DC to be opened in the coming years as we continue our high-growth journey.

With that I would like to turn this call over to Judd to walk you through our financial performance in more detail and provide an outlook for fiscal 2018. Judd.

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Judd Nystrom, At Home Group Inc. - CFO [4]

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Thank you, Lee, and good morning, everyone. I will begin my prepared remarks with a review of our fourth-quarter and fiscal 2017 results and then discuss our outlook for fiscal 2018. As a reminder, additional information is available in our earnings release which can be found on our IR website.

During our fiscal fourth quarter we increased net sales by 26.4% to $234.5 million driven by the strong performance of our new stores and a 7.1% increase in comparable store sales on top of a 6.4% comp store sales increase in the fourth quarter last year. As Lee mentioned, this quarter reflects the multi-year effort we have made to provide our customers with an unmatched assortment of value priced decor especially during the holidays.

It also illustrates the broad based positive response our customers had to the additional low-priced inventory we brought in and represents our 11th consecutive quarter of 20% plus net sales growth and our 12th consecutive quarter of positive comp store sales increases.

Fourth-quarter gross profit dollars increased 28.6% driven by the 26.4% increase in sales as well as a 60 basis point increase in gross margin to 32.3%. As expected, we saw merchandise margin improvement driven by vendor contributions to support our brand awareness efforts as well as a reduction in our shrink and damage rates as a result of operational and process improvements we implemented in fiscal 2017.

This was partially offset by an increase in distribution center costs to process the incremental inventory that helped drive sales in the quarter. Despite these inventory processing costs, as well as higher incentive compensation, our top-line outperformance enabled us to further leverage our adjusted SG&A by 250 basis points and deliver 60% growth in adjusted operating income in the quarter.

Our 36.4% effective tax rate for the fourth quarter was favorable to our outlook and partially impacted by items discrete to fiscal 2017, including some tax benefits related to the sale-leaseback transaction executed in previous years. We are very pleased to have doubled our bottom-line results relative to the fourth quarter of fiscal 2016. Pro forma adjusted net income for the fourth quarter was $17.4 million or $0.28 per share compared to pro forma adjusted EPS of $0.14 in the fourth quarter of last year.

Looking at our results for the full year, net sales increased 23.1% to $765.6 million driven by a 23% store growth and a comparable store sales increase of 3.7%. Gross margin increased 10 basis points due to the same factors that impacted the fourth quarter largely offset by an increase in occupancy cost as a result of sale-leaseback transactions.

We generated more than $62 million in gross sale leaseback proceeds in fiscal 2017 which we used, along with cash from operations, to self fund our new store growth. As Lee shared, we are committed to delivering value to our customers and driving brand awareness.

Therefore we continue to reinvest sales and margin upside back into the business through initiatives such as our Flash Finds, which help ensure our value proposition remains fresh for our customers, and through incremental marketing spend, which increased as a percentage of sales by 60 basis points from fiscal 2016.

Despite this reinvestment we are very pleased to have increased our adjusted operating income 26% and expanded adjusted operating margin by 23 basis points to 10.3% of sales while simultaneously investing in all of our strategic objectives, as Lee discussed.

Our tax rate for fiscal 2017 was 36.7% driven partially by discrete items benefiting our rate in the fourth quarter. The fiscal 2016 tax rate of 133.8% was primarily impacted by changes in the valuation allowance on our deferred tax assets, which was substantially reversed in the fourth quarter last year.

As such we have (inaudible) normalized 35% tax rate to pro forma last year's results for comparative purposes. Factoring in this normalized rate, we generated a year-over-year increase in pro forma adjusted net income of 44% to $36.5 million or $0.59 per diluted share.

Turning to the balance sheet, yearend inventory increased 38% driven by three factors. First, approximately half of the increase is due to the 23% new store growth we delivered in fiscal 2017. Second, almost a third of the increase is related to an acceleration in purchase timing, which includes the impact of an earlier Chinese New Year in 2017 and a pull forward of certain seasonal items to better meet customer demands. And finally, our incremental inventory investment in lower priced inventory in the second half of the year drove the remainder of the overall inventory growth.

Adjusted for the timing of yearend shipments, on a comp unit basis we are roughly flat to fiscal 2015 inventory levels. From a debt perspective we significantly improved our leverage ratio as a result of the payoff of our second lien term loan using the proceeds from our third-quarter IPO as well as contractual principal payments. We expect to see interest expense continue to decrease in fiscal 2018 due to a fourth-quarter rate step down on our term loan. I would like to emphasize again that we remain committed to reducing our leverage over time.

Now I'd like to cover our fiscal 2018 outlook. In fiscal 2018 we expect net sales to be in the range of $903 million to $910 million, which represents a growth rate of 18% to 19% over fiscal 2017. Given the opportunity to expand our store footprint by approximately 5 times, new stores are the primary driver of sales growth. We anticipate opening 28 stores this year, or 25 on a net basis when considering one relocation, one rebuild and one closure due to an expiring lease term.

As we mentioned on our third-quarter call, the availability of high-quality second-generation locations for fiscal 2018 is greater than we initially expected. Since August 2016 there have been over 400 big-box closures announced, 300 of those announced year-to-date in 2017 presenting us with an even greater pipeline of leases than we had contemplated a year ago or even a quarter ago.

Given our flexible and opportunistic real estate strategy we are very excited to be in to be in the position to capitalize on this opportunity. As a result we have shifted our plan mix of fiscal 2018 openings towards more leases versus owned stores impacting fiscal 2018 EPS by $0.06 given associated occupancy and preopening expenses.

We have also added one additional store to fiscal 2018 store operating plan, impacting fiscal 2018 EPS by a penny; as well as we moved up the timing of some of our fiscal 2019 openings resulting in a $0.01 of additional preopening expense being absorbed in this fiscal year.

In summary, we now expect 20 leased stores, seven newbuilds and one purchase for fiscal 2018. As Lee mentioned, our fiscal 2017 class of At Home stores was our strongest to date, which gives us a tremendous amount of confidence in our fiscal 2018 pipeline. Our top-line guidance also assumes a low-single-digit comp store sales increase of 2.5% to 3%.

This reflects expected comp performance higher than this range until we anniversary fiscal 2017's incremental inventory investment in the third quarter and lower comp performance in the second half of the year as we lap strong prior year comparisons.

Pro forma adjusted net income for fiscal 2018 is expected to grow 25% to 30% based on a range of $45.5 million to $47.5 million, which excludes approximately $11 million of pretax non-cash stock-based compensation expense related to the special one-time IPO bonus grant. We expect a full year effective tax rate of 37.5%, which does not consider the potential impact of the new stock-based compensation accounting standards that became effective at the beginning of fiscal 2018.

We will separately disclose any impact of the accounting treatment as we experience it on a quarterly basis. Based on an estimated 63.5 million diluted weighted average shares outstanding we expect pro forma adjusted EPS of $0.72 to $0.75, which reflects the $0.08 impact of the opportunistic shift in store mix, incremental new store opening and preopening expense with the timing related to fiscal 2019 new stores I just discussed. This is being partially offset by the strength in our top line exiting 2017, resulting in expected pro forma adjusted net income growth of 25% to 30% for fiscal 2018.

We also wanted to provide some color on the cadence of our fiscal year outlook. We expect that capitalized transportation costs related to our fiscal 2017 incremental inventory will disproportionately impact our second-quarter gross profit and we expect our marketing cost to be more heavily weighted in the first half of the year as we elevate our annual spend to 3% of sales and continue to increase our customer awareness, which is a key growth strategy.

As a result we expect to realize approximately 45% of our annual pro forma adjusted net income in the first half of fiscal 2018 with a relatively equal distribution between the first and second quarters.

From a capital standpoint we expect CapEx to be $110 million to $130 million in fiscal 2018, which is net of expected sale-leaseback proceeds of $100 million. The majority of our capital investment is funding new store growth in fiscal 2018.

As is typical for us, the timing and mix of new store openings in this [final] year can have a meaningful impact on capital spend in the current year. Therefore a portion of our fiscal 2018 capital investment will support our objective to open stores earlier in fiscal 2019 compared to previous years. The remaining investment is earmarked for refreshing and maintaining our existing stores as well as information technology initiatives.

Overall we are very pleased with the progress we have made against all of our strategic priorities which has driven our strong performance in both Q4 and fiscal 2017. I would like to thank our team members for their dedication to our customers and for their strong execution on our strategic priorities. Our team is focused and committed to deliver on our operational and financial goals which should result in another fantastic year for the Company.

The fundamentals of our business remain strong and consistent with our compelling value proposition resonating with customers now more than ever. Ultimately we believe we have the right initiatives in place to build on our progress in fiscal 2018 and to achieve our long-term targets of high teen sales growth and 25% net income growth.

I will now turn the call back to Lee for closing remarks.

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Lee Bird, At Home Group Inc. - CEO [5]

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Thanks, Judd. At a high level we believe At Home has all the pieces in place to be a leader not only in home decor but all of specialty retail. The home furnishings sector is growing and highly fragmented, leaving us well positioned to continue to take share. We are a value player at a time when value is resonating more than ever with consumers not only in our industry but across all of retail. We have some of the best store level economics in specialty retail and our new stores continue to outperform year after year.

And finally, we have tremendous whitespace and the long term potential to grow our current store footprint to almost 5 times. We're excited about the growth we have right in front of us and we look forward to fiscal 2018, which we believe will be another record year for At Home. Operator, please open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions). John Heinbockel, Guggenheim Securities.

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John Heinbockel, Guggenheim Securities - Analyst [2]

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So two things on real estate. How would you characterize the 2018 class as it stands today versus 2017 in terms of quality of location? And then given what has gone on in retail, what is your current thought on nonlinear expansion and the potential for that?

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Lee Bird, At Home Group Inc. - CEO [3]

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Yes, John, I will tell you the nice thing about our situation is there a whole lot of big boxes that have become available and that is why we mentioned that we've got more leases than we originally planned. When you have a lot of options you can be more selective. So with that selection process -- and you have spent time with us, you know how disciplined we are around real estate.

But we are super disciplined analytically, we look at every single site on paper, we run it through a model that we run with -- now on our third-generation with a [Buxton] model to help us analyze specifically a location. We have got qualitative assessments as well.

So I feel really good about our 2018 because we have been able to be selective, because we had more options to choose from and we did pick more leases this year. Because that was available we could push out some of our ground up build plans. And then we can also front end load next year which has some capital implications. But it just means we had a really nice supply of things to look at but we could be even more selective than ever. So that is the first thing.

On the non-linear move, we are going to continue to focus on delivering consistent growth performance for our Company. There is more options, we are just going to be more selective about it. So as we mentioned before, we build a plan upfront, we are opportunistic, there happens to be more to choose from. But we are just going to take what we need to to deliver our growth expectations every year. And if we push -- if there is some more available next year because those that came available this year will still be around that will be great; that may help with economics in the future.

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John Heinbockel, Guggenheim Securities - Analyst [4]

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All right, and just secondly, when you think about the right marketing spend long-term, so we go to 3% this year, you think about your model looking out, where should we be or could we be in let's say three years? And what do you think is a steady-state level to be at relative to sales?

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Lee Bird, At Home Group Inc. - CEO [5]

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Well, we are financially disciplined all along the way. So what we said is we will spend more if we can afford more to build our brand. Some companies do it the other way around, they spend upfront and they don't worry about profitability. We focus on profitability and performance consistently, so we have been building that spend. We will do it 3%, we will measure it and we will make sure it is effective.

We will make sure it is effective in every medium that we choose. We are going to use national media now on a spot buy though locally. As we measure that, if it is more effective at driving the outcomes that we'll look for we will spend more against it. And you will see the outcomes; we have committed to a long-term financial model that we are committed to. As we had better improvement in margin and profitability we said -- as Judd has always mentioned and I have too, we will plow it back into better price points and more marketing to build our brand over time.

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John Heinbockel, Guggenheim Securities - Analyst [6]

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Okay, thank you.

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Operator [7]

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Simeon Gutman, Morgan Stanley.

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Simeon Gutman, Morgan Stanley - Analyst [8]

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So two questions. First, on the top line, can you give us a sense -- when you pre-announced earlier in the quarter, I feel like early January, I think at the time you said you were running like 4.5 to 5-ish. I guess were you being conservative at that point anticipating that there was some choppiness? Or was there a pretty big step up at the end of the quarter?

And then I'll ask my second question as part of this in case my phone cuts off. In thinking about you are leasing more stores, you are going after more favorable real estate. I am assuming that the top-line performance of those stores may look better on paper than what you were also expecting. Is that fair? And is that reflected in your 2018 -- in your fiscal 2018 guidance? Thank you.

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Judd Nystrom, At Home Group Inc. - CFO [9]

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All right, Simeon, this is Judd. What I would tell you about Q4, we provided the updated outlook in early January. At that point in the quarter we had strong comp store sales momentum. We know that January typically can be choppy; just weather can impact us in the month of January. We actually had a very strong January, weather was actually a bit of a tailwind associated with that. But we felt very strong with the momentum through the quarter and how we exited fiscal 2017. So that provided a comp upside overall.

Your question around leasing more stores, what we'd tell you is we leased more stores as a percentage of the portfolio mix last year. And as Lee mentioned, both of us mentioned on the call, our vintage fiscal 2017 was our strongest new store class as a management team.

So as we look at the mix of leases for 2018, we feel really good about the stores we have. And the sales upside associated with that class of stores is baked into our guidance of what we provided from top-line growth of 18% to 19%.

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Simeon Gutman, Morgan Stanley - Analyst [10]

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Okay, thanks, Judd.

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Operator [11]

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Matt Fassler, Goldman Sachs.

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Matt Fassler, Goldman Sachs - Analyst [12]

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I understand the role that inventory -- incremental inventory has had at helping to drive the top line. The year-on-year increase accelerated a bet, so I guess a couple of parts to this. Can you isolate the piece associated with Chinese New Year? Presumably that is truly nonrecurring. And then talk about the quality inventory in terms of the magnitude of pack away that you might have of seasonal goods? And at what point you would expect inventory growth to begin to converge with sales growth?

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Judd Nystrom, At Home Group Inc. - CFO [13]

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Sure. So, Matt, this is Judd. As I mentioned on the call, we had a 38% increase in overall inventory. Half of that was due to the 23 new stores that we opened last year. About 20% is due to the incremental inventory and about a third is due to the earlier timing, earlier Chinese New Year. A pull forward of some Q1 seasonal to better meet the spring demand and then other incidental freight purchase timing overall.

What we'd tell you as a retailer, we don't pack anything away. We want to sell what we have and it is never a good thing to pack it away. So we feel really good about our ability to position our inventory in front of the demand for the spring. And what we could tell you is we have a history of when you look at our Company, 80% of our net sales are at full retail price. And when we do have to take markdowns it is still positive.

We have done liquidations of stores where we relocated stores and we still deliver positive gross margin dollars. Our third-party reviews us and audits our inventory for our ABL and they, for four consecutive years, have actually increased the liquidation value of our inventory, which tells you the quality level of the inventory continues to get stronger.

So we would expect our inventory to more normalize in the third quarter after we lap the incremental inventory that we brought in at low price points. The other thing I would tell you is the lower price point inventory actually has a lower markdown as well. So we feel we are insulated from that perspective.

What we are trying to accomplish strategically is to capture the demand in the store where that customer can add on items in her basket and she can ultimately have a better customer experience. That is what we are trying to (inaudible).

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Matt Fassler, Goldman Sachs - Analyst [14]

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That is super helpful color. If I could ask one quick follow-up on real estate. Obviously some of the same forces that are driving more opportunities to you are likely to drive further disruption down the road. And as plentiful as the opportunities are, I am sure you are being even more diligent and careful about where you plant your flag anew going forward. Is there a meaningful change to the kinds of sites that you are taking in terms of adjacencies, centrality of the location as you see these opportunities begin to sprout?

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Lee Bird, At Home Group Inc. - CEO [15]

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Matt, this is Lee. I will tell you because we can be more selective, yes, we are finding better locations. We look for friend -- we call it friends. We want really nice co-tenancies and adjacencies, access and visibility. Those are the four key elements that we look for.

So I will tell you this last class, it was our best class ever and fiscal 2017 had that. We had better co-tenancies, we had better adjacencies, much better visibility from the highway, much better access as well from the arterial roads. And we look for that; we want it to be as easy as possible to find and shop at an At Home store. And when people are already shopping we like to draft off of people that are already shopping at other stores. And because we can be more selective we can look for higher quality locations and we have done that.

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Matt Fassler, Goldman Sachs - Analyst [16]

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Thank you, guys, appreciate it.

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Operator [17]

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Dan Binder, Jefferies.

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Unidentified Participant [18]

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Hi, this is (inaudible) on for Dan, thank you for taking our questions. Just on the merchandise reinvention, did you guys see that outperform over the quarter? And looking ahead over the next year, can you give us any color on what categories or what products you might target for reinvention? Thank you.

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Lee Bird, At Home Group Inc. - CEO [19]

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You asked about the holiday reinvention, is that right?

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Unidentified Participant [20]

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No, just your overall program to rework merchandise -- to reinvent merchandise. And going forward I think you guys look to reinvent merchandise continuously. So I just want to know -- the stuff that was reinvented, did that outperform? And looking over the next year, kind of what categories can we see being affected?

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Lee Bird, At Home Group Inc. - CEO [21]

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Okay, sure, thanks for the clarifying. So are reinvention strategy essentially is unchanged since we started it over three years ago. We decide a certain portion of our inventory is going to -- we actually look at a three-year plan and we say what parts of the inventory are going to be reinvented, updated or sustained. Each of them have their own financial target.

So reinvention has to do a double-digit comp, low-double-digit comp. An update has to do a high-single-digit comp and then sustain is a mid- to low-single-digit comp. And we have a certain portion of our assortment that gets categorized that way -- the whole assortment gets categorized that way over every year for three years.

And so, for example for Christmas, so the Christmas season, we put together a three-year plan against that because it was such a big portion of our business in the past we want it to be a foundation for us as being the holiday headquarters. We focused on continually updating that business for three years running and that has outperformed our expectations for three years running. So we were very pleased with holiday and that was part of a three-year update process, for example.

In other categories like patio furniture, that is a two-year transition for us, a two year reinvention. And last year we brought in six patio sets, this year -- and we saw great success on that. We are very thoughtful in our approach to adjusting our assortment. So we brought in six sets, we love the performance on it, now we have 12 sets. And so that was a two-year.

One could have said you have good done all of that in one year. We are very thoughtful we want to test and measure performance. We use test and control on all of our analysis and then we roll it forward. So I would say next year's reinvention plan or this coming year's reinvention is consistent with prior years. It is a very methodical approach.

We always have a running three-year plan and we are not doing any more than we did before. We are not going to do any less than we did before. I will tell you we are getting better at executing against those reinventions. I will tell you the holiday assortment, both Halloween, harvest and Christmas, reflected that better execution. And we are continuing to learn as we do it on how to become better and better at it.

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Unidentified Participant [22]

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Thank you for taking my questions.

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Operator [23]

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Oliver Wintermantel, Evercore ISI.

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Oliver Wintermantel, Evercore ISI - Analyst [24]

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I had a question regarding your comp performance in the fourth quarter, the 7.1%. Can you maybe desegregate it into ticket versus traffic? And are you saying that 2.5% to 3% comp, what the driving forces are behind that is more ticket or more traffic?

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Judd Nystrom, At Home Group Inc. - CFO [25]

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Sure. So what we can tell you -- we are consistent with this every quarter. It was broad-based growth, organic metrics were focused on moving the needle on all of them over time. And each quarter can be a different driver. What we commit to is low-single-digits. And overall we have initiatives in place to drive all the metrics. So Lee talked about brand awareness, we talked about the private label and co-branding credit card, those should be driving traffic.

We talked about baskets, the reinvention, the lower priced inventory, that should be driving baskets as an example. What we are focused on is moving all the metrics. For any particular quarter, as we have highlighted on previous calls, it can be different drivers.

But ultimately what we need to do is make sure we move the needle on all of them to deliver consistent comp store sales growth. And we are really proud of the fact that we've delivered 12 consecutive quarters of positive comp store sales growth averaging over 5%. That is what we are focused on, that is what we are committed to.

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Oliver Wintermantel, Evercore ISI - Analyst [26]

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Okay, great. And just you mentioned that you invested in digital and have now more items online to browse. Is there any update on buy online pickup in store, or maybe even a transactional webpage in the near future?

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Lee Bird, At Home Group Inc. - CEO [27]

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Yes, our processing approach hasn't changed. We are consumer focused. We know that the top things that she is looking for in home decor from the home decor shopper, whether that be any channel, she wants price; she wants selection; she wants to see, touch and feel it; she wants to take it home immediately. We offer that today in our stores.

But we are thoughtful and disciplined about what we are doing; we are not going to trade off -- make any trade-offs to a more expensive channel. We do look at our stores as warehouses that could be leveraged at some point. What we are doing is we are looking at making sure that right now, since we know that she likes to pre-shop, we are continuing to make sure that pre-shopping experience is the best possible.

And then we are price competitive against all the online guys, against Wayfair and Amazon. I will tell you that our prices are at or below our competitors' sales prices, even Wayfair and Amazon. You can check it out, we do all the time. We price compare every single month against all of our top competitors.

And we continue to make some great investments; the Demandware platform can be e-commerce enabled. We have -- we are focused on increasing our visibility of inventory for our sales associates and our customers over time. And our digital marketing spend has continued to go and grow up and get even stronger. If you look at our social media it is up 50%, our email database is 120%. So we are on a journey. The process hasn't changed, we are thoughtful about it and that is where we stand today.

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Oliver Wintermantel, Evercore ISI - Analyst [28]

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Great. Thanks very much. Good luck.

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Operator [29]

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Daniel Hofkin, William Blair & Company.

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Daniel Hofkin, William Blair - Analyst [30]

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I'm going to take one more stab at that last question on comp sales. Would it be fair to say that traffic was one of the contributors to the upside as the month or as the quarter progressed, particularly January?

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Judd Nystrom, At Home Group Inc. - CFO [31]

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What we can tell you is we are very pleased with the fourth-quarter results, it was a 7.1% comp, it was very broad-based. We don't get into the mechanics of each quarter providing that. We are committed to delivering consistent comp store sales growth, we have demonstrated it 12 consecutive quarters.

And what you need to ensure is: one, we need to deliver against the comp store sales growth which we have done. And that we have enough initiatives underway in each of the drivers of comp metrics to ensure we continue to consistently deliver comps.

We feel really good about programs like our new credit card financing, marketing campaign, the work we have done on (inaudible), planning and allocation, the value messaging, the flash finds, the reinvention, the in-stock opportunity, the low price point.

All of those I can point to a different lever of comp of an organic metric. But ultimately what it comes down to is each quarter it can be a little different. But we are extremely pleased with the 7.1% comp and we remain committed to delivering consistent comps going forward.

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Daniel Hofkin, William Blair - Analyst [32]

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Okay, great. And then just on CapEx and free cash flow, maybe can you tie together a little bit for fiscal 2018 what you are expecting? It sounds like free cash flow is likely to be close to breakeven, maybe a little bit negative. When would you see that turning potentially positive on an annualized basis?

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Judd Nystrom, At Home Group Inc. - CFO [33]

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Sure. So, Dan, this is Judd. We provided in the outlook CapEx on a net basis of $110 million to $130 million, that assumes $100 million in sale-leaseback proceeds, which we have a history of doing $188 million of transactions over six different transactions. There is about $20 million to $30 million for maintenance remodel IT and we will continue to invest in the future our business.

The remainder of the CapEx it is important to note is related to FY19 timing. So the ground up build we have assumed to be this year; the nice part is when you have more lease opportunities we can just slow the pace of that ground up build and move it into the next fiscal year, but we'd spend money this fiscal year from a capital standpoint, which we intend to do and that is why you see an elevated level of CapEx, but also a little bit more of a drag on preopening-related expenses.

What we'd tell you overall from a free cash flow perspective is we are committed to reducing our leverage and improving our free cash flow. And what we'd tell you also is there is an assumed use of cash overall, but if we were to slow down the pace or not pull up the pipeline as much we would actually have positive free cash flow overall.

What we are focused on is making sure that: one, we reduce the leverage; and we deliver consistent results. And we are committed to our long-term growth targets of high-teens and as well as 25% net income growth. And overall we have factored that in and make sure our plans are focused on delivering against that.

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Daniel Hofkin, William Blair - Analyst [34]

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Okay, great. Thanks very much.

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Operator [35]

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Denise Chai, Bank of America.

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Denise Chai, BofA Merrill Lynch - Analyst [36]

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I have got a couple of questions on gross margin. I think you mentioned that merch margin was up from vendor contribution and also reduction in shrink and damages. How much more is there to come from these initiatives? Are we still in the early innings?

And then my second question on gross margin is, in the back half comp was -- to some extent [doesn't buy] the lower ticket items that you introduced. Was there any positive or negative impact on gross margin from that mix?

And just, you had mentioned that there was a lower mark-down on those lower priced products. But do they also start from a lower margin because say shipping and distribution costs are just going to be relatively higher on that lower price point? Thank you.

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Judd Nystrom, At Home Group Inc. - CFO [37]

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Okay, so what I would tell you from a gross margin perspective, your question around some of the operational improvements, there is some opportunity related to shrink and damages. But what I would tell you is the team has been focused and committed on that over the past four years and they have done a fantastic job making those operational improvements which we saw really manifest in the fourth quarter. [Bill's] team did a fantastic job overall.

When we look at some of the other opportunities, there are things out there that we are exploring related to global sourcing, as an example, which could be an opportunity for us to improve our margin rate. But as we have communicated, we expect our operating income dollars from our long-term growth targets to slightly outpace sales. So if we get favorability from our gross profit rate we'll look to reinvest it either in price or in marketing.

Back to question regarding the third and the fourth quarter from a gross profit perspective, what we'd tell you is the back half of the year had a higher amount of costs associated with bringing that inventory in, most of which is expensed in the quarter because it is a period cost. So cost to move the freight through our DC, cost to put the freight up in the store, that came through. And most of that actually hit gross profit other than the cost of the stores put the inventory up.

There is a piece that was capitalized that is actually from the distribution center to the store is the delivery and that goes over the churn of the inventory. As we highlighted in our prepared remarks, we expect that to hit primarily in the second quarter. That will be a gross profit headwind in the second quarter, that is factored in our outlook. We provided more clarity on that and more color to make sure that you understood what that impact can look like.

But overall we feel really good about our opportunities to improve gross profit. But what we'd tell you is we are actually I think pretty good at managing it. When you look at the multi-year outcomes our gross profit rate has traveled within tens of basis points. So where you see others that might have wild swings in gross profit, we are actually very disciplined and very true to our model to maintain our gross profit rate and any improvement we expect to reinvest back into the business.

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Denise Chai, BofA Merrill Lynch - Analyst [38]

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Okay. So are you able to size up the gross margin headwind in the second quarter? And also, just maybe comment on the -- on margins on the lower-priced products being brought in the back half just from a pricing standpoint, the fact that they are less expensive than your other goods.

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Judd Nystrom, At Home Group Inc. - CFO [39]

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Yes, so two things. For the second quarter the way to think about it is it's probably roughly 100 basis points that we would expect in this, not merch margin, that is just the cost that we are going to see of turning that inventory based on what we invested in the third quarter.

Your question around lower price margins, what we'd tell you is it has a very consistent margin profile. So we are not going to have a mix impact related to the lower-priced items. The good news is the lower-priced items also have typically less markdowns, so they can last longer. They are less fashion oriented, they are more practical for the customer to add onto their basket. So ultimately we wouldn't expect a margin impact related to that shift or that mix.

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Denise Chai, BofA Merrill Lynch - Analyst [40]

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Okay, thank you so much.

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Lee Bird, At Home Group Inc. - CEO [41]

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Denise, this is Lee. One thing that is unique about our business is margin is relatively consistent across all of our product categories. So, as we shift to our -- where customer demand may shift by category and by season and during the year, we can maintain consistent margins of across-the-board and we actually like that because it is far more predictable as well.

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Denise Chai, BofA Merrill Lynch - Analyst [42]

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Thank you.

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Operator [43]

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Thank you. Mr. Bird, there are no further questions at this time. I will turn the floor back to you for final remarks.

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Lee Bird, At Home Group Inc. - CEO [44]

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Great, thank you. Well, thank you, everyone, for joining us on our call today. We look forward to speaking with you again in the coming days and weeks we look forward to your support for the At Home brand. Take care.

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Operator [45]

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