Sprouts Farmers Market Inc (SFM) 2013 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to Sprouts Farmers Market's fourth quarter 2013 earnings conference call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session, and instructions will be given at that time.

(Operator Instructions)

This conference call is being recorded. I would like to turn the conference over to Susannah Livingston, Vice President of Investor Relations. Ma'am, you may begin.

Thank you, and good afternoon everyone.

We are pleased you have taken the time to join Sprouts on our fourth-quarter and fiscal year-end 2013 earnings call. Doug Sanders, President and Chief Executive Officer; Amin Maredia, Chief Financial Officer; and Jim Nielsen, Chief Operating Officer, are also on the call with me today. Sprouts's Form 10-K, the earnings release announcing our fourth quarter and 2013 results in the webcast of this call can be assessed through the investor relations section of our website at sprouts.com.

During this call, management may make certain forward-look statements, including statements regarding our future growth, product expansion, new store openings, and 2014 expectations, and guidance. These statements involve a number of risks and uncertainties that could cause actual results to differ materially. For more information, please refer to the risk factors discussed in our filings with the Securities and Exchange Commission, along with the commentary on forward-looking statements at the end of our earnings release file today.

In addition, our remarks today include reference to non-GAAP measures. For reconciliation of our non-GAAP measures to GAAP figures, please see the schedules in our earnings release.

Lastly, in comparing our results, the comparable periods in 2012, we discussed the company's results on a pro forma basis as if our May 2012 acquisition of Sunflower Farmers Market, which we refer to as the Sunflower transaction, had occurred at the beginning of our 2012 fiscal year. We believe these pro forma adjusted results provide a good basis to assess the operating and financial results in the performance of the combined company year-over-year.

Let me now hand it over to Doug.

Thank you, Susannah. Good afternoon everyone, and thanks for joining us today.

2013 has been an amazing year at Sprouts, and we're very pleased to report another quarter of strong results and a terrific first year as a public company. To quickly hit the EPS for the fourth quarter, we reported adjusted diluted earnings per share of $0.07, a 75% growth in earnings from the same period in 2012. On a GAAP basis, we reported EPS of $0.06 per share compared to $0.03 in the same period in 2012.

The positive momentum driven by the everyday shoppers' growing demand for healthier food choices continued to generate strong top-line growth for Sprouts. Net sales grew 27% during the fourth quarter, thanks to improved same-store sales and the strong performance of our new stores opened in 2013. Our ability to attract a broad customer base was even more evident during this quarter as we widened the gap within the industry.

The fourth quarter ended with an impressive same-store sales increase of 13.8% and 22.4% on a two-year stacked basis, representing our 27th consecutive quarter of positive same-store sales growth. The 13.8% comp was weighed more towards traffic growth during the quarter, where we saw an 8.5% increase in customer traffic and a 5% increase in basket size.

Now, this was obviously an exceptional quarter, and it's important to understand the specific drivers of this performance. First, the sales in the former Sunflower stores accelerated with fourth quarter comps in the high teens. The sales growth at these stores was driven by merchandising and promotional alignment established in late 2012 and improved operational execution we achieved throughout 2013.

Second, we continue to see accelerating comp sales in states experiencing economic recovery, such as California, Nevada and Arizona. And lastly, comp sales growth in our produce department out-paced our overall compo performance, driven by strong promotions and sales growth in organic produce. The benefit from the Sunflower same-store sales, economic recovery and strong produce performance accounted for approximately 400 basis points of incremental comp sales during the quarter.

In addition to our strong comp sales performance, our efforts in innovation, marketing, and operations continue to drive the Sprouts brand forward. Our private label program is delivering results as we ended the year with our best quarter to date in same-store private label sales growth. Our improved holiday offerings and marketing efforts resonated well with customers in the fourth-quarter. Enhanced holiday sales were achieved through a wider assortment of holiday grocery items, special holiday gluten-free offerings, new private-label baked goods and improved and expanded holiday meal offerings.

Fiscal 2013 ended with adjusted diluted earnings per share of $0.48, or 55% higher than 2012, and exceeded the guidance we provided last quarter of $0.45 to $0.46 per share. On a pro forma basis, net sales grew 22% for the year. This was the result of 10.7% same-store sales growth and the addition of 19 new stores during the year.

Our new stores continue to perform above expectations, growing new customers each week as the Sprouts brand continues to gain recognition. For the full year, store traffic increased approximately 6% and the average basket size increased approximately 5%.

These impressive top and bottom-line numbers are record-setting for Sprouts, and I can't overemphasize the strong operational execution that drove our 2013 performance. These results are a direct reflection of the exceptional teams we have within our stores, distribution centers, and support office, and their commitment to help our customers eat well, live better and spend less.

Throughout 2013, we brought forward the best merchandise offering in the history of Sprouts while maintaining our affordable prices that set us apart from the competition. This expanded offering in areas such as organic produce, raw and vegan foods, deli, bakery and private-label successfully broadened our customer appeal and drove success across all stores, including our remodeled stores and new stores opened in 2013. The tailwinds created as the everyday consumer embraces a healthier diet are reflected in our strong customer traffic and growing brand awareness.

Our promotional marketing programs also played a key role in our success in 2013. This year, all stores, including the former Sunflower stores, participated in more than 30 store-wide promotions that we regularly offer at Sprouts. These successful programs drive customer traffic and reinforce our value proposition that's been synonymous with the Sprouts brand since day one.

As our unit growth expands, so does the Sprouts brand. And the additional exposure resulting from our public offering has continued to position our brand for growth. We ended the year with 167 stores and each new store opening brings more opportunities for greater customer engagement, education and loyalty.

As we set the pace for 2014, our dedication to grow the company is no less ambitious. Product innovation, improving the customer experience and new store growth remain our top priorities. We have plans to further enhance our product offerings especially when it comes to specialty, organic, non-GMO and local products. We'll continue to expand our private-label offering, which currently features more than 1,400 items. And in 2014, we're focused on unique, signature products that can only be found at Sprouts.

We'll also continue to reinvest in our stores with at least 15 store remodels during the year, mainly focused in the Texas region. And, of course, we will reinforce our value image by maintaining our competitive pricing structure and promotional strategies, which we communicate to our customers weekly through our print, social, and digital channels.

We also want to address the California drought situation. Our produce team is in continuous dialogue with our growers in and outside of California, and we believe that if the dry conditions persist into the summer, we can expect some tightness in certain categories. But we do not expect a significant issue for 2014. It's important to remember that we deal with weather events including freezes, downpours, and droughts throughout the season, but our supplier relationships on the local, national and international level enable us to secure the volume of produce necessary to support our business.

Of the nearly 60 sites we have approved for the coming years, we plan to open 22 to 24 new locations in 2014, representing 13% to 14% unit growth. And by the end of the year, we will be operating in ten states across the country. To date, we've opened three new stores, including our first new store in Kansas in early January. All new stores are performing well, and our reception by the Kansas market has been impressive. Our next new market is Atlanta, where we will be opening four new stores starting this summer. As we always stated, our unit growth will be very balanced, and in 2014, we'll open new stores at nine of our ten states with less than 25% of these new openings in new markets.

And finally, we will continue to invest in our future growth by enhancing our teams and deepening our bench within each region. This will allow us to serve our existing and new stores as we expand our reach into the Southeast. With the best people, best products and best prices, we're confident that 2014 is going to be another successful year for Sprouts.

With that, I'll turn the call over to Amin to cover our financial results in greater detail and our 2014 guidance.

Good afternoon, everyone. During the fourth quarter, we exceeded our expectations and built on our momentum to deliver strong results. Following Doug's discussions on the sales drivers, let me start with gross profit. For the fourth quarter, gross profit increased 28% to $174 million over the same period in 2012. Gross margin rate as a percentage of sales increased ten basis points to 28.6%. This improvement was driven primarily by leverage and occupancy cost and was partially offset by lower merchandise margins from increased holiday promotions. We remain excited about our ability to pass on savings to our customers while leveraging gross margin.

Direct store expenses were $129 million for the quarter. We continue to leverage on variable labor during the quarter. However, direct store expenses, as a percentage of sales, increased 30 basis points, driven primarily by a health care cap reimbursement credit recorded in 2012, which did not repeat in 2013. Selling, general, and administrative expenses were $22 million for the quarter.

SG&A during the quarter included $2 million of secondary offering expenses. In the fourth quarter of 2012, SG&A included $4.1 million of acquisition and integration cost related to the Sunflower transaction. Excluding these items, SG&A decreased as a percentage of sales by 40 basis points, mainly as a result of leverage and corporate overhead and store level advertising cost.

Adjusted EBITDA for the fourth quarter totalled $38 million, up 31% over the same period in 2012. This increase was driven by higher sales, the resulting operating leverage yielding EBITDA margin expansion of 20 basis points. Adjusted net income for the fourth quarter totaled $11.4 million, an improvement of 119% compared to 2012. This increase was driven by strong business performance, as well as a reduction in interest expense from the prior year.

For the full year 2013, gross profit increased 23% to $725 million. The gross margin rate for the full year was 29.7% or an increase of 20 basis points from 2012. The improvement in margin for the full year was driven by leverage in occupancy and buying cost. This was partially offset by first, lower margins in produce driven by inflation in certain commodity items when compared to the exceptional produce growing season we had in 2012. And second, lower margins in vitamins and supplements as a result of markdowns from merchandise alignment during 2013.

Direct store expense for the full year were $496 million. DSE included a loss on disposition of assets of $400,000 in 2013 and $1.4 million in 2012. Excluding these items, direct store expenses as a percentage of sales increased 10 basis points, as we utilized the leverage and payroll to invest in store-level compensation and to fund increased healthcare costs.

Selling, general and administrative expenses were $82 million for the year. SG&A for the year included $2 million of secondary offering expenses and $3.2 million of bonus paid concurrently with our IPO. For 2012. SG&A included $17 million of acquisition and integration cost related to the Sunflower transaction, $600,000 on loss on disposition of assets and a $2.7 million legal settlement charge. Excluding these items, SG&A decreased as a percentage of sales by 40 basis points, mainly as a result of leverage in payroll and store advertising costs.

Driven by leverage and margin and SG&A, adjusted EBITDA for 2013 totalled $195 million, up 33% from the prior year. And EBITDA margin rate expanded by 60 basis points to 8%. Adjusted EBIT for the year totalled $148 million, up 38% as we continue to leverage depreciation and amortization costs throughout the year. Adjusted net income for the year totalled $67 million, a 68% growth. The strong increase in adjusted net income is a reflection of the exceptional business performance and the reduction in interest rate from our April 2013 refinancing.

Moving to balance sheet and liquidity, we continue to find organic growth in the business through our operating cash flows. We generated cash flows from operations of $161 million for 2013 and invested $87 million in capital expenditures, primarily for new stores. In addition to the principal amortization paid during the fourth quarter, we voluntarily paid down an additional $40 million on our debt. And as a result, ended 2013 with a balance on our term loan of $318 million. As a result of this debt pay down, our year-end net debt to adjusted EBITDA leverage ratio, excluding leases, was 1.2 times. We ended the year with cash and cash equivalents of $78 million and $53 million available under our undrawn revolving credit facility.

As this past year has proven, Sprouts continues to maintain significant liquidity and generate strong cash flows to self-fund our future growth. Our strong performance this past year gives us a high level of confidence as we enter 2014. With the strong tailwinds of the natural and organic sector, momentum in our business across geographies and vintages, and our focused 2014 business goals that Doug discussed earlier, our 2014 guidance is as follows.

Net sales growth target of 16% to 18%, driven by 13% to 14% unit growth and same-store sales growth range of 7% to 8 %. Both of which are above our long-term guidance of 6% comp sales growth and 15% sales growth. Adjusted EBITDA growth range of 17% to 20%. Adjusted net income growth of 30%-plus and adjusted diluted earnings per share range of $0.58 to $0.60. We expect CapEx will be in the $110 million to $120 million range funded from cash flow from operations.

A few additional items to note on our guidance. First, we expect our 13% to 14% unit growth to be weighted in the second and third quarters of the year. We plan to open four stores during the first quarter, and the remaining 18 to 20 stores during the second and third quarter. Second, we expect same-store sales growth strong to be strong across the year, but more so than the first half, as we will cycle higher comps in the back half of 2014. Third, EPS guidance assumes a weighted average share count of approximately 154 million shares for 2014 compared to a weighted average share count of 140 million for 2013, driven primarily by shares issued during the IPO.

Fourth, our CapEx guidance for 2014 is higher due to strong store opening schedule during the first quarter of 2015, which will drive higher CapEx in Q4 of 2014. Fifth, we continue to benefit on cash tax payments due to the deductibility of the difference between the strike the price and exercise price as employees exercise options. Sixth, for the year, we expect to have approximately $24 million in interest expense, including capital lease interest, OID amortization, and other interest expense.

One last item to note that EBITDA growth and associated leverage is slightly impacted by increased cost from the Southeast expansion and higher healthcare costs from the Affordable Care Act. These two items, which are embedded in our guidance, impact adjusted EBITDA margins by approximately 20 basis points.

As we are nearly two months into the year, let me specific speak to the first quarter of 2014. We continue to experience strong momentum in sales for the first quarter of 2014. We have opened three new stores to date during this quarter, and the stores are performing very well. We are forecasting same-store sales growth of 10.5% to 11.5% for the first quarter of 2014, which equates to a two-year stacked same-store sales growth of 19% to 20%.

In conclusion, our strong results for 2013 and our expectations for 2014 demonstrate the confidence that we have in the sector momentum, our operations team, our store expansion capabilities and the growing awareness of the Sprouts brand across the country.

With that, we would like to open up the call for questions. Operator?

(Operator Instructions.) Our first question comes from Kelly Bania of BMO Capital.

Hi, good evening. Thanks for taking my question.

I guess the first question just on same-store sales. As you think about that 7% to 8% outlook for the year, what's the kind of underlying factor for the slightly-above-average same-store outlook? You talked a little bit about the Sunflower strengths, but what do you think is the underlying factor as you look out over the next year?

Kelly, thank you. This is Amin.

As we look out to 2014, as we mentioned, the first two months of the year have started off to a strong start, and we expect first-quarter comp sales in the range of 10.5% to 11%, which puts us at an 18%,19% two-year stack. Consistent with that, again, 2013 our comp sales were 10.7% for the full year, and with the 17% to 18% range, that also puts us on an 18% to 19% two-year stack.

A couple of things, as Doug mentioned, you know, the strength of the Sunflower separation and comps that we've seen over the last few months, we would expect that to settle down in the back half of the year. The second item is in several economies, like California and Nevada, we've seen extremely strong comps in 2013. And as we move through 2014, we're anticipating those comps to continue to -- those comps to settle down. To the extent that they remain strong, then that would position us for higher comp range.

That's very helpful. And just as you -- on the increased holiday promotions, maybe can you talk a little bit about the impact you think those had on both comps and merchandise margins during the quarter, and were they more proactive or reactive, and what was the timing of those during the quarter?

Yes, Kelly, this is Jim Nielsen. We look at as about 20 basis points of investment we put into promotions for the holiday period, and it was a planned investment. Obviously, as we look at the execution of the holiday, not only the new private label, you know, we're really focused laying out a really, really good holiday plan for our stores and communicated it well.

We had enhanced marketing materials and then a great execution in the stores. We really came across and put a little investment in price, and it just picked up momentum. It was planned and it was about 20 basis points.

Great. One last one, if I could squeeze more in, what kind occupancy leverage are you -- should we expect in 2014 with a 7% to 8% comp?

You know, with a 7% to 8% comp, we generally see about a 15 to 20 basis point occupancy leverage in that range. And generally what we see is very strong leverage in our -- in this case, in our pre-2013 vintages and then, of courser, the 2014 vintages, where here we're going to be opening 22 to 24 stores. The occupancy on those new stores will weigh down the overall occupancy cost, but on a blended basis across the entire portfolio, we'll see about a 15 to 20 basis points leverage.

Great. Thank you very much.

Thank you. Our question comes from John Heinbockel from Guggenheim.

Sure. A couple of things. The guidance seems to imply a moderation in initial productivity, right, and I assume that's more conservatism than any change in the mix of new stores or change in the environment. Is that fair?

Yes. I think -- hi, John. Generally, I think that would be true. The only other change in environment is southeast being our new market. We now will continue to invest fairly heavily in the market overall in terms of both pricing as well as just anticipating what we would expect productivity to be in that market. As we've talked about before, new markets tend to take a little bit longer to mature, and we would anticipate something similar in the southeast.

And then when you look at new unit growth -- so 13% to 14% this year. Have you thought how high is up, in terms of what growth in the organization digest effectively? Is it more than that, is it that? I don't know what work you've done on that, but have you given that some thought?

Hi John, this is Doug. Yes, we've looked at it, obviously from a growth perspective in front of you, what can the Company handle today. We're very, very comfortable with the 13% to 14% that we put out there. Obviously, as the Company continues to grow and we continue to build in infrastructure, we'll continue to monitor that as we move forward. But what we're comfortable with today is the 13% to 14%.

And then lastly, when you think about the price gap versus whether it's conventionals or Whole Foods, it is a wide price gap today. What's the thought process on the maintenance of that price gap? Is there an overwhelming desire to maintain the gap you have today, reopen it if they were to make some price investments? How do you guys think about that?

We always stay true to the 25% on the produce side. It's something, obviously on a weekly price check, we stay within that. We found that is the sweet spot for us. So if the conventionals are out there investing, then we'll invest as well. But we see that as the sweet spot for produce is 25% below our competitors.

But if you look at grocery, dairy, frozen, that's less visible, so that could lapse a little bit or no?

It's dependent upon markets, and obviously we've had this conversation before. So depending on market and the proximity of our competitors, the investments are different by market. But overall, we obviously manage this on a weekly basis, and look at those price sensitive items and feel very comfortable with the current strategy that we have, and really reinforces our value model. Don't see anything different looking forward.

Okay, thank you.

Thanks, John.

Thank you. Our next question comes from Rupesh Parikh, Oppenheimer.

Thank you. My first question has to do with real estate. So if you guys continue to expand towards Atlanta, how does the availability of real estate compare to maybe some of your existing markets in California and Arizona? And also, are you seeing more favorable real estate costs in some of these newer markets?

The real estate availability in the southeast is more plentiful than what we're seeing in the California market at this time. Obviously, there's a lot of white space in the country as a whole, as far as what we do, but we definitely are seeing real estate availability in the southeast.

From a cost perspective, it's been pretty stable. We're not seeing any material shifts in cost. Remember, you know, as a company, we only operate in nine states today, so there's quite a bit of opportunity for us from a growth perspective, and we see the southeast as an avenue for that growth for the next several years.

One thing I would add is in 2014, we're continuing to open stores in all markets. We'll be opening -- in fact, this year we'll opening stores in nine of our ten states, tenth being -- Georgia being the tenth state that we're going to open in this year. So we're opening stores across all of our markets.

Thank you. One last question. In terms of pre-opening costs, should we expect higher costs if you go to Atlanta, just in terms of pre-opening ones?

No. Generally, the way we -- we might spend a little bit more on pre-opening in new markets because we advertise higher, our training costs are little bit higher, and that was similar to the investment we made in Houston. And so, similar to what we did in Houston this year, we expect 2014, we will invest more dollars than we typically would on average for the four stores that we open in Georgia this year.

Thank you, and good luck next quarter.

Thank you.

Thank you. Our next question comes from Scott Mushkin from Wolfe Research. Your line is open.

Thanks for taking my questions. Hopefully you can hear me okay. I'm on the road.

Just wanted to poke at guidance a little more. It seems like to me that you are projecting a little bit of a slowdown in that stack top, which has been running 20 or north of 20. I was just wondering, are we building in some conservatism, just don't know the environment? And then on the EBITDA line, are we building in some conservatism for Atlanta, and just give your flavor on that, because it does seem like you are building in a little bit of a slow down as we look through the year?

Yes. You know, I think that the way we think about this year is that, you know, one area that we might, perhaps, anticipate visibility is that Sunflower stores, which as we mentioned, have been comping very strong, much stronger than the overall comp. As Doug mentioned, Sunflower comps were in the high teens this past quarter, so we've seen a widening gap in the Sunflower stores. So we would expect that, as we get into the back half of the year, we would lapse that.

So to the extent that we continue to see the brand awareness drive more and more traffic to the store, I think that would add upside to the model. I think that the economies we've seen in California and Nevada for two straight years, and in Texas for three years now, are very strong comps. So we're anticipating a flattening, and so again, if the traffic continues to generate at the level that it has been, then we would anticipate upside.

And in terms of EBITDA margin, that's a great question. We're leveraging very well in our pre-2013 vintages, and so the two areas that -- which EF margins, if you will, as we're increasing the number of new stores with 13% to, you know, 13% to 14% growth, 22 to 24 stores. As you're aware, that in the first couple of years, our new stores have a lower EBITDA margin, so that weighs on the overall EBITDA margin.

And as I also mentioned earlier, the southeast expansion and increased health care costs from the Affordable Care Act impact our EBITDA margins by about 20 basis points. So with all that said, you know, embedded in our numbers is 10 to 20 basis points of EBITDA margin expansion overall as a business from the 8% mark to the 8.1%, 8.2% mark.

That's appropriate. I appreciate it. Then I have one, I get the question all the time, and I know I've talk to you guys offline about it. The drought in California, 25% of your sales are produce. Walk us through, again, how you handle it (inaudible).

A couple things to remember is in the conversations we've had in the past, if you remember our distributed buying model, obviously gives us a lot of flexibility. Keep in mind that produce is a global business, so we have strong relationships with growers, you know, both the local, regional, national, and international level, to make sure that we can supply the produce that we need for our business.

Again, you know, coming back to the produce business as a whole, every year we battle some type of weather, whether it's a freeze, whether it's a downpour, whether it's a drought, and this isn't anything that's uncommon in the produce business. So -- but again, when you go back to our distributed buying model, we feel confident that we can -- we'll be able to supply the volume of produce necessary for our business, just because of the relationships we have throughout the country and internationally.

Looking back at Q4 -- you know, the performance we had in Q4 in produce, obviously we've had some citrus gaps and some cooking green gaps as well, but the flexibility of our buying team, the relationships, as Doug mentioned, drove really, really strong comp for produce. So obviously we have done this historically, and we've dealt with this on an ongoing basis.

Thank you, guys.

Thank you. Our next question comes from Edward Kelly, Credit Suisse. Your line is open. Please go ahead.

Hi, good afternoon, guys. Nice quarter.

Thank you.

Let me just start with Sunflower, and I was hoping you could drive maybe a little bit more color on what you've been doing in these stores, the acceleration in the comp. Put a little bit more perspective -- I don't know if it's possible to sort of talk about the sales productivity of those stores relative to the core Sprout stores as a way of sort of branding, whether there's additional opportunity there?

I think Jim and I both can tackle this one. From the Sunflower perspective, we've made -- as we've put the companies together, obviously we took -- our goal was to take the best parts of all three companies, whether it was Henry's, Sprouts or Sunflower, and build one really complete model that expanded our offerings in several categories. And that's what we accomplished as we went through the mergers.

So what you're seeing in the Sunflower stores is basically the product alignment and the additional offerings that we put into the stores, in addition to improved marketing, improved promotions, improved operational execution at store level. So you're really seeing the by-product of that in the back half, starting in the back half in 2013 and continuing into the first half of 2014. So Jim, you can probably expand it a little bit more?

Yes, I'm just going to echo the same thoughts as Doug. I mean, if you've been in those stores, and I don't know if you were there, on pre-post, I mean the operations team has done a fantastic job of really tightening up the execution, the service levels. We did apply some, you know, more service in departments like vitamins as well as the meat department. We saw nice results there.

Improved the quality of produce and produce's comps for Sunflower are outpacing the Sprouts comps. And then, the unique promotions that we had, we talked about that before. We talked about the 33 unique promotions they were not doing historically, so they got a nice benefit there as well.

I guess the question is, sort of like, you talk about the comps in the store sort of normalizing in the back half of the year. Does that mean you expect the productivity of the stores to sort of then elevate to the level of the core by then?

Yes. I think what we really saw is late, late in the third quarter, or starting in the middle of the third quarter but late in the third quarter more so, we started seeing widening of sales across categories and particularly in categories that Jim, where we added assortment as well as invested in training, etc. So we've seen that margin continue to widen through the year end, and remain strong in the first quarter. So based on what we see now, we would expect for the benefit to continue until we lap it sometime in the third quarter.

Question on first quarter comps. The Easter shift, does that have much of the an impact on sales shifting from Q1 into Q2?

No. Easter -- based on the calendar, Easter doesn't really have a big impact, if I understood -- if that was the question.

It's not material.

It's not a material sale shift. The momentum has continued to remain strong. I think the strong holiday promotions Jim talked about gave us some really extra leverage in the fourth quarter. But still in this quarter, as we said, overall the business is staying quite strong in double digit comps, and we're expecting the quarter to come in at 10.5% to 11.5%, which is well above our long-term guidance and what we're seeing in the overall space today.

Okay. And then last question for you. CapEx guidance a little bit -- probably a little bit higher, I guess, than what we had modeled. Could you maybe speak to that a little bit and talk maybe the breakout of, sort of, new stores, maintenance, distribution, corporate, you know, just sort of how that shakes out?

As we said, it's about $110 million to $120 million. The biggest difference is really we have a very strong pipeline from these stores today. And we anticipate opening a strong number of stores, probably in the double digits number of stores in Q1, and as a result -- in Q1 of 2015, and as a result, we'll probably end up spending $25 million of capital in Q4 of 2014, and that number is really about $20 million higher than what we spent in Q4 of 2014 -- I'm sorry, Q4 of 2013 for new stores.

In terms of overall breakdown from a CapEx perspective, the new stores are roughly about -- new stores as well as some revenue-enhancing CapEx is about $90 million of our overall spend. And then we have an incremental -- about $7 million to $8 million of spend for remodels on top of that, and then, again, supply chain, corporate infrastructure, and store IT initiatives would be another $5 million to $7 million. And lastly, R&M CapEx would be in the $7 million to $8 million range.

Quickly to follow up, is that, you know, basically open the door for maybe some acceleration in square footage growth in 2015?

You know, I think we're -- right now, we continue to think that the 13% to 14% growth is about the right range, and up from the 12% range. In terms of overall for 2015, as Doug mentioned earlier, the key for us is continuing to see our operational execution, continuing to see our customer service scores, and we monitor on a fairly monthly basis.

And as we feel comfortable with our teams out there, executing and ensuring that the customer experience is high, then we'll continue to revisit that number every 6 to 12 months. But I think at this point, 13% to 14% is a good assumption for 2015 and beyond.

Thank you.

Thank you.

Thank you. Our next question comes from Stephen Grimley from Goldman Sachs. Your line is open. Please go ahead.

Hey, good evening. Thanks for taking the question. Just a follow-up on the capital allocation questioning here.

You know, given the free cash flow that you are generating, how do you start thinking about, you know, debt levels. At this point, you did pay down some right now. It just seems like you have some excess as we move forward into 2014 and 2015?

Hi, Steve. You know, sitting here today, as we mentioned, we anticipate interest expense to be around $24 million for the year. So what I would say is that, you know, we're always looking for best use of capital with revenue enhancement capital, remodel capital, and we're seeing some good results in both of those, to deploy those there first.

And currently we're expecting, you know, in the range of $50 million to $70 million of incremental debt paydown during the year, but we'll continue to look at all, you know, uses of capital with 4% interest rate and our debt levels being at 1.2 times, or, you know, net debt to EBITDA ratio -- we feel fairly comfortable at our current levels and we will continue to pay down some debt as we go along in time.

And then another question, just, given the strength in comps and where new store product -- or overall productivity is right now, do you feel like you reached saturation in any of your markets?

Hey, Stephen, this is Doug. We haven't reached saturation in any of our markets at this point. If you remember back to some of the earlier discussions we've had, we still have a lot of opportunity for growth in existing markets, and that lends itself well to more of the balanced approach that we talk about for expansion, where we obviously want to grow in existing markets and have that underwrite the success of the new markets. So, again, we haven't reached saturation point in any of our existing markets at this point.

Great. Good luck ahead.

Thank you. Our next question comes from Joe Edelstein, Stephens, Inc.

Thanks for taking the question.

Thank you.

Just to follow-up a bit on the capital allocation and also questions about the store remodels. I'm curious, given the success you've already had with that, what is, perhaps, holding you back from taking on more remodels during the year?

Yes. You know, if you recall that Sprouts -- overall our average age of our stores is about eight years. So basically, we started our remodel program in 2013 for the first time, but we remodeled 15 stores, primarily the Arizona area, and so the way we think about remodels is two-fold. We look at the age of our stores, as well as the store conditions themselves, and then we try to cluster our remodels in areas because when we remodel, we also bring in additional products and additional offerings to the store, and we try to ensure that the offerings that we bring are consistent in a particular market.

For example, when we did our remodels in 2013, we did them across Phoenix, because we wanted to make sure our stores were fairly consistent with similar products throughout the store. So really, when we look out, we don't feel like we're behind in any way or there's any large opportunities to do a mass-scale remodel simply because the average age of Sprouts is only eight years old.

And we did get -- on the first set of remodels we got a nice bump because some of the Sprouts stores are a little bit older so they didn't have some of the elements. So there was big enhancements in deli, bakery, grocery, frozen, and then, of course, we tied it all together with brand-new decor that's reflected in the new prototypes. So some of that as we get down the road with some of the remodels will already be in place, so you probably won't get as high a return on some of those. We have to be obviously a bit more strategic.

Can you give us a sense for how many remodels you might expect to do in 2015? I know that's looking out a little bit further, but if you're looking to continue with that 13% to 14% store expansion. I'm just curious also as it would relate then to the store remodels.

Store remodels are going to stay pretty consistent. We're looking probably anywhere from 12 to 15 stores again, similar to last year and then in 2014.

Okay. That's helpful. And I'd also recently seen an article about, you know, a new distribution, you know, warehouse for you in north Texas, in the Dallas area. You know, do you feel that your distribution needs are being met in your other existing markets, or do you need to upgrade, you know, to a larger facility to support the continued expansion?

That supply chain capacity is something we've been focused on probably the last two years. We expanded the Arizona facility last year, in 2013.

We'll expand the Texas facility, which will support our continued expansion in the near-term into the southeast as well. From a capacity standpoint, we're -- with the expansion in Texas, we'll be in good shape

As far as California, we still have at least three to five years of runway for all DCs. And we actually are moving our DCs -- there's a 3PL, but we're moving to a bigger facility here in probably towards the tail end of the year. So lots of runway in all three DCs, once we open the Dallas DC.

At what point would you need to potentially open a DC in the southeast to support that growth, behind Atlanta?

We're looking probably for a southeast distribution center, probably late 2015, early 2016.

One of the nice things to recall is that we only self-distribute produce, which is about 500 to 600 SKUs, so the average range DC expansion net of landlord allowances are typically $2 million to $3 million, so not a large capital investment for us.

Okay. Sounds great. Thank you.

Thank you.

Thank you. Our next question comes from Karen Short from Deutsche Bank.

Hi. Just a couple questions, back to the drought for a second. So you guys mentioned that there might be some kind of supply noise, I guess, not really so much to say constraints, but I would think that there might be some benefit from just -- from the supply constraint as it relates to the potential for inflation in produce, so can you maybe talk to that a little bit?

Yes. I mean, historically, we see a little bit of retail inflation. We're able to pass it through and there is some benefit, but if you see any kind of hyperinflation, it actually becomes more of a detriment to us, and you need to start to sell less product so it kind of equals it out.

So there could be a small benefit, it really depends upon how, you know, tight the supply gets and, right now, it's too early to tell. These are just on row crops. I think we've got to remember that.

This is really, really affecting probably 80 of our stores, so it's really too early to tell as far as the level of impact. We'll disclose that next earnings.

Sorry, was there any embedded inflation assumption in your guidance for next year?

No. Relatively modest inflation, so no heightened inflation in produce, Karen. And then we are seeing a little bit of inflation in certain bulk items and certain dairy and cheese products, so those we've incorporated in, but overall, not on the produce side.

Okay. And then just turning to operating expenses in general. Obviously, you have expenses related to new store openings, but are there any, I guess, areas you that need to focus on to build up your infrastructure in terms of operating expense investments that you plan on doing in fiscal 2014, and anything to talk to there?

Karen, I think we've been very systemic over the last two, three years in pushing on scale and infrastructure and different parts of the organization, and similarly this year, we'll tackle a couple of areas where we want to on the supply chain side as well as some on the technology side. You know, we'll be rolling out our new website here fairly shortly, so we've been doing some work around that and some continued investments behind there.

We've been very balanced and systemic and forward-looking around investments and various areas of the business. You know, we've not been shy in investing in the infrastructure, and will continue to do so for the foreseeable future as we keep going in the business. Nothing I would call out that would be of magnitude.

Okay. I guess last question. Obviously you've had unbelievable success so far in terms of your comp, and obviously building brand equity, but any color on how you think about further brand building, customer, cultural awareness, as you continue to grow in new markets? Any thoughts there?

From the branding side, obviously we've invested pretty heavily over the last few months, several months, in developing a new digital platform, which we'll be launching the first phase of that, which is the new website in the coming days. So from a customer engagement standpoint, we have been focused on obviously improving our customer engagement in the store, and then outside the store from the social media side, and we have a really good partnership with the guys at salesforce.com.

We have been working in partnership with them to increase our social engagement and across all the digital platforms. So to the extent -- on the inside from the operational execution and the customer service, we've been focused on that. And then from the outside, obviously, the social engagement as well, the digital and the new website, new mobile app that should be coming out later this year.

Okay. That's helpful. Thanks.

Thank you. Our next question come from Jason DeRise from UBS.

Thanks for taking the question. I want to drill in a little bit more about the new store productivity. But maybe first -- for some of these more recent classes, the new store productivity's been very good. Now that we're further into the life of those classes, do you have any better guess if this has been accelerating the evolution of your consumers? Or do you think there's a bigger upside for maturity for these stores?

Jason, I would probably say a couple of things. When we look at the 2013 new store productivity, two things -- as you know, a lot of the stores that we opened in 2013 were in our existing markets. And then second, our new-store productivity also benefited in 2013 from -- in 2012, we opened a number of stores in northern California which was a newer market for us, and those stores had not come into our comp base, or were not in our comp base for the full year, so that also drove useful productivity.

What I will say that is that we are seeing sort of, you know, much better productivity than average in stores where we're branded well. And so as we continue to -- we really like the markets where we're branding well because those stores tend to open up at a much higher rate than the typical 75% fourth share productivity. As we go in time, every opportunity we get to open new stores in branded markets, we aggressively love to do that. Another couple drivers, Doug, do you want to add anything else here?

To tack on that, what we saw last year, was obviously the success of the improvements we made to the model and all the different offerings we brought in, the expanded improvements -- the improvements we made, pretty much across the store as we put the three banners together. We definitely saw that success across the new stores, in new markets and in existing markets. And, you know, one year doesn't make a trend so, obviously, as those stores continue to mature over the next year or two, we'll definitely find out if we've created a step function or if we've accelerated the maturity of the stores.

In terms of the guidance -- I guess the guidance implies roughly a 75% new-store productivity, and I think one of the first question was about this -- that you're building in conservatism for Atlanta, but, I mean, we're talking about four stores and the rest are evenly spread. I don't know. Unless you're kind of assuming like doomsday scenarios for Atlanta, I can't imagine the average works out to be 75%. So I guess, again, is it just being conservative because of this idea that we're just not sure how these stores are actually maturing or 2013 could have just been a one-off.

Yes. I think it's all of the things that Doug and I mentioned a minute ago, and as we sort of go in time, and I think if we see a couple of vintages which are just starting overall higher, I would say that we've got good, factual data to suggest that we would have a step function, as Doug mentioned in our model, and it's not really 75%, and it's 80% or 85% productivity or higher. But at this point, we felt that it would be pretty mature to look at one vintage and assume otherwise.

Okay. And one last question. Just wanted to shift gears. As your company evolves, have you noticed a change in who your core customers -- has it evolved as well? Because obviously you're bringing in people that are new to the category and mature you them through the store.

But I guess in your older stores, are you finding that evolution continues beyond that five-year path to getting them to the vitamins? Does it continue beyond that and they just really become fully converted, and they're not even interested in the conventional produce anymore and they want something higher. Have you found that to be the case, that there's a even a bigger upselling opportunity?

Well, I think, you know, obviously the customer is evolving. You know, the industry is growing. The customer is -- the demand for healthier food choices is growing, and it's growing across demographics. So we've always been very, very focused on the middle-income, everyday grocery customer, and I think you're starting to see the growth in natural organic really focused in that sector, if you will. And then on top of that, with the improvements that we made to our model, to all the additional offerings that we brought in, you're seeing the appeal of our brand in their offering extending beyond the middle income customer probably to the upper-middle income customer, if you will.

When you look at the growth category that really, really took off last year, organic was very big, raw foods was very big, vegan products are very big.

You definitely see the growth in the categories we were really focused on, but you're definitely seeing the growth in the channel itself and transition of the customer into healthier food choices. Is there an upside into that?

Obviously, as a customer continues to mature through the trial and the transition process, absolutely. We're definitely seeing a maturing of the customers in our more mature markets, probably capturing a greater portion of that basket, and you're seeing it in the traffic growth and in the basket growth.

When you break down the basket -- what's fascinating about the basket, you look at what's really driving that is department mix improvements with grocery, dairy, deli, bakery, driving that, as well as the item mix improvements where you're seeing people shift up to, as Doug had mentioned, raw food and organics, which have a higher average selling price. And then there's actually a little bit more items in the basket, so really almost no inflation in that, which is pretty fascinating and see how the consumer shift.

That's really helpful. Thank you.

Thank you. Ladies and gentlemen, due to time constraints, we have time for one more question from David Magee with SunTrust Robinson.

Thank you. In under the wire here. Congrats on a good quarter, guys.

Thank you.

Two quick questions. One is the conventional players have been very positive about this category, it seems, in the past year. In your more mature markets, are you seeing a noticeable difference in the level of competition you get from those guys? Are they doing anything more effectively than in the past?

Yes. This is Jim. We're seeing them obviously expand their offering. We're seeing that really -- I think the conventional that does it best is Kroger. We're seeing them expand their offerings. But what we're not seeing is a negative result as -- to our stores that are in the neighborhood.

When you look at it -- I think what's really helping us is they're helping with the awareness, and we truly are the destination. So we've seen them add variety, but they still can't -- for our consumer, completely complement their peer shopping experience for natural. So while we've seen them take a shift, we haven't seen that impact for business. In fact, in some cases, it's helped our business.

Okay. Secondly, what are you seeing with the supplements and vitamins relative to the rest of your mix? Are you happy with that performance right now?

Vitamin and supplements continues to be a great department for Sprouts. Obviously, we dedicate a tremendous amount of floor space and service behind that department to grow that category. You know, on a two-year stack basis, it's probably the fastest-growing category that we have within the store.

Now, we obviously -- this year you're seeing a little bit of softness because we're cycling a very, very strong cold and flu season from last year, which obviously impacts that category, but overall, still a lot of growth in the category. It's a category that we -- from an offering standpoint and from a focused and a knowledgeable staff standpoint, invest heavily in it, and it takes that to grow that customer.

Great. Very helpful. Appreciate it.

I think most importantly, it provides a really strong moat around our business, too, is how to do it.

I would like to hand the conference back over for any closing remarks.

Thanks, everyone, for joining us today, and we look forward to speaking with you on our next call. Thank you.

Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect and have a wonderful day.