Sprouts Farmers Market Inc (SFM) 2014 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Sprouts Farmers Market first-quarter 2014 earnings conference call.

(Operator Instructions)

As a reminder, today's conference is being recorded. I would now like to turn the call over to Susannah Livingston.

Thank you and good afternoon, everyone. We are pleased you have taken the time to join Sprouts on our first-quarter 2014 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' Form 10-Q, the earnings release announcing our first-quarter 2014 results and the webcast of this call can be assessed through the investor relations section of our website at www.sprouts.com.

During this call Management may make certain forward-looking 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 release filed today.

In addition, our remarks today include reference to non-GAAP measures. The reconciliation of our non-GAAP measures to GAAP figures please see the schedules in our earnings release. We believe these adjusted results provide a good basis to assess the operating and financial results of the Company year over year. Let me now hand it over to Doug.

Thank you, Susannah. Good afternoon, everyone, and thanks for joining us today. The positive momentum Sprouts experienced in 2013 has certainly continued into the first quarter of this year and I'm proud to report another quarter of strong financial results. We recorded adjusted diluted earnings per share of $0.23, a 64% growth in earnings from the same period in 2013. On a GAAP basis, we reported diluted EPS of $0.22 per share compared to $0.14 in the same period in 2013. These results clearly reflect the power of the Sprouts model and the strong execution of our skilled operations team.

As a growing number of consumers embrace the need for a healthy diet, our focus on health and value continues to generate strong same-store sales, customer traffic and top line sales growth. Our net sales grew to $723 million for the quarter, up 26% from 2013 thanks to improved same-store sales and the strong performance of our new stores.

The first quarter ended with a robust same-store sales increase of 12.8% and 20.8% on a two-year [stacked] basis, representing our 28th consecutive quarter of positive same-store sales growth. The 12.8% comp was driven by a 6.5% increase in customer traffic and a 6% rise in the average basket size.

Now let me take a minute to discuss the drivers of our comp sales over the past few couple of years as well as the first quarter of 2014. The broad appeal of our healthy living for less strategy gross more evident with each quarter as Sprouts continues to outpace not only the overall food industry but also the natural and organic sector. Our value-based approach to natural foods appeals not only to the natural lifestyle customer but to the growing number of everyday grocery shoppers who are looking for healthier food choices.

Sprouts delivers a wide selection of healthy foods at affordable prices along with a well-trained staff focused on delivering product knowledge and friendly service in a non intimidating environment. Our focus on health, selection, service and value continues to separate Sprouts from the competition as evidenced by our accelerating customer traffic and comps during 2013 and the continuation of our strong comp performance during this first quarter of 2014.

More specifically to the first quarter, we continue to see tremendous top line and same-store sales growth across departments, geographies and vintages. Our strong comps for this quarter were driven by our ability to aggressively promote fresh produce which gives us that broad appeal with the everyday grocery shopper. A strong produce comp coupled with our store wide and department promotions drove solid traffic and balanced performance across the store.

During the quarter we also continued to see strong performance at the former Sunflower stores delivering same-store sales in the high teens and contributing 160 basis points to our overall comp store sales. In addition, significant growth in specialty categories such as organic, raw and gluten-free with sales growth of over 30% in each of these categories, continue to drive basket and overall comp growth. The growth in these specialty categories clearly demonstrate the shift in consumer preference toward food attributes and a keen focus on the health benefits on the foods they're eating.

Lastly, our private label category continues to grow as we leverage our scale to innovate and introduce new private label selections. Private label comps during the first quarter grew by 30% over 2013 and our item count increased by 20% over the prior year to more than 1400 items.

Our growing fan base is also evident in social media where our number of Facebook fans increased by more than 180% over the past year as our improved digital strategies successfully engage our customers both inside and outside the store. Our new website, which launched in February, has also seen increased traffic with over one million page views on the day it launched.

On the new store front, we've opened five new stores this year, four of which occurred in the first quarter. In addition, we completed the remodel of seven stores during the quarter. With the opening of our first Midwest store in Kansas City in January, we are now operating stores in nine states.

Our Kansas City stores performing above our expectations and we continue to receive plenty of enthusiasm from our new customers in Kansas and Missouri. Our successful performance in the Midwest further demonstrates the strength of our brand and our healthy living for less model and we look forward to our continued expansion in Kansas City as well as other existing and new markets across all the states in which we operate in today.

Most of our store openings for 2014 will occur during the middle part of the year. We are on track to open six new stores during the second quarter, including five in existing markets and our first new store in the Southeast region in Atlanta. Our expansion plans over the past decade have been very methodical and our move into the Southeast will be no different. We engaged in a comprehensive analysis of the Southeast region when developing our expansion plans, including a review of the real estate availability, the labor markets, customer demographics, competitive landscape, distribution costs and the region's economy.

In addition, our category leaders spent significant time studying consumer preferences in produce, meat and grocery and made minor changes to our product assortment to accommodate regional differences. And of course, we reviewed our advertising and marketing strategies across our print, social and digital channels to successfully introduced the Sprouts brand to the Southeast market.

We've also been building a strong Southeast team and infrastructure which includes a number of experienced store managers and other team members who are relocating to the region. As you know, our unique culture and commitment to excellent customer service and product knowledge is extremely important to the sprouts model. These moves give us further confidence in our Southeast expansion and our overall store level execution. Bottom line, we feel confident that the Sprouts brand will be well received in the Southeast as it has been in the numerous markets we've entered over the past several years.

Our tremendous financial performance this quarter, as in the past, is a direct result of our more than 15,000 team members operating our stores everyday. I'm delighted to report that more than 650 of our team members were promoted in the first quarter alone, further strengthening the Sprouts team. Professional development that results in engaged team members will continue to drive the success of our stores and sustain the positive customer focused culture we foster here at Sprouts.

Of course our growth plan, which currently includes more than 69 approved sites and 49 signed leases for the coming years, helps create meaningful career opportunities for our team members. We're on track to open 23 to 24 new locations this year, representing a 14% unit growth. To date, all new stores are performing better than expected as we continue to serve as the healthy grocery store for our customers.

Before handing the call over to Amin, let me quickly touch on commodities and inflation. First, inflation was moderate during the first quarter at approximately 1%. During the past two months, we have started to see acceleration in certain commodities and would expect higher levels of inflation in the these categories during the coming months mainly meats, dairy, some produce and nuts. Overall, we expect inflation for the full year to be approximately 2% to 3%.

Our ability to pass along modest inflation is very similar to the rest of the industry. Historically, the industry has passed along modest and higher levels of inflation except for the unique period like 2009 when during a recession we saw significant retail deflation. While we aren't seeing signs of retail deflation today, we closely monitor market pricing and competition and maintain our spread to competitors.

Let me specifically touch on produce inflation in both availability and pricing. For the decades of experience we have in the produce business, it's not unusual to see peaks and valleys in this industry driven by freezes, floods and droughts and the resulting impact on availability and price volatility. As many of you know, producer represents approximately 25% of our business and we source quality control and distribute all the produce we sell. Today produce is a global industry and we have dedicated teams throughout the country who have relationships with and source product from a variety of local, regional, national and international suppliers.

The drought conditions in California have resulted in some reduced planting for the Central Valley for this year. The planting in this region represents approximately 5% to 8% of our sales in produce or approximately 1.5% to 2% of our overall sales and is therefore manageable. Now fortunately, the southern parts of the California are producing strong yields due to favorable weather conditions and we expect this trend to continue throughout the traditional growing season into Central and Northern California.

We are seeing modest -- moderate inflation in our overall produce basket and have been passing along the majority of these increases as we've done historically. Given our broad network and strong relationships, we feel very confident -- comfortable in our ability to secure the volume and quality of produce our customers have come to expect from Sprouts.

So in summary, the success of our healthy living for less strategy and our ability to connect with a very broad and fast-growing customer base truly differentiates Sprouts from our competition and positions us well to increase our EPS guidance for the year. With that, let me pass the call to Amin to cover our financial results and full-year guidance.

Thank you, Doug, and good afternoon, everyone. We're very pleased with our record-setting results for the quarter and our continued out performance to targets. Following Doug's highlights of the business drivers, let me spend a few minutes on the full income statement followed by our 2014 guidance.

For the first quarter, gross profit increased 29% to $224 million over the same period in 2013. Gross margin rate as a percentage of sales increased 70 basis points to 31%. This improvement was driven by leverage and occupancy, utilities and buying costs. In addition, merchandise margin improved during the quarter despite minor inflationary pressure experienced in certain categories including dairy, nuts, meat and citrus. The strong produce growing condition in the first quarter lead to improved margin in the produce category.

Staying true to our value focused model, we continued our strong promotional activities to set us apart from competition. This is nothing new to Sprouts, as value has always been the foundation of our model and driving traffic and top line growth remains a priority.

Direct store expenses was $138 million for the quarter. This included a loss on the disposition of assets of $700,000 in the quarter. Excluding this item, direct store expenses as a percentage of sales decreased by 100 basis points compared to 2013. This improvement was driven primarily by leverage in payroll, depreciation and lower utilization of medical benefits during the quarter.

Selling, general and administrative expenses were $22 million for the quarter. SG&A during the quarter included $1.4 million of pretax secondary offering expenses. Excluding this item, SG&A as a percentage of sales was consistent to last year as leverage in advertising was offset by higher corporate overhead as we continue to make necessary investments to support our expansion plans.

Adjusted EBITDA for the first quarter totaled $77 million, up 49% over the same period in 2013 driven by higher sales and improved gross profit margin. This, coupled with the resulting operating leverage and lower pre opening expense, lead to EBITDA margin expansion of 165 basis points growing from 9.1% to 10.7%. Starting 2014 with strong EBITDA margin expansion and overall adjusted EBITDA growth of 49% gives us tremendous momentum and flexibility in executing our business plan as we enter the middle of the year with an increasing number of new store openings.

Adjusted net income for the quarter totaled $35.4 million, an improvement of 90% compared to 2013. This increase was driven by strong business performance as well as reduced interest expense as a result of a lower principal balance on our term loan and a decrease in interest rates from our April 2013 refinancing.

Moving to balance sheet and liquidity. We generated $76 million of cash flows from operations. During the first quarter, we invested $18 million in capital expenditures primarily for new stores. We ended the first quarter with a balance on our term loan of $317 million and a net debt to adjusted EBITDA leverage ratio excluding leases at 0.8 times.

We ended the quarter with cash and cash equivalents of $149 million and $53 million available under our undrawn revolving credit facility. Sprouts continues to maintain significant liquidity and generate strong cash flows to self fund our future growth and also creating flexibility in uses of excess free cash flow for store level initiatives and repayment on our debt.

As you can see, our strong financial performance over the past few years continued into the first quarter of 2014. The robust top line performance leveraged in the business and tremendous growth and profitability in cash flows gives us a high level of confidence as we continue to grow the business. This strong growth in the natural and organic sector, which is well outpacing the overall grocery industry, our broad demographic appeal to a wide range of customers, our solid business performance across geographies and vintages, strong performance in our new stores in both existing and new markets, gives us tremendous confidence to increase our full-year 2014 guidance as follows.

Net sales growth of 18% to 20% driven by 14% unit growth and same-store sales growth range of 8.5% to 9.5%. Adjusted EBITDA growth range of 23% to 25%. 40%-plus growth in adjusted net income and adjusted diluted earnings per share range of $0.63 to $0.65, a targeted growth of 31% to 35% over 2013.

Let me review a few additional items regarding our full-year guidance. First, in our guidance we expect same-store sales growth to moderate in the back half of the year as we are cycling higher same-store sales from the back half of 2013. We expect a two-year same-store sales stack to be in the 19% to 20% range. This 19% to 20% two-year stack comp sales still remains amongst the best in retail and well outpaces the grocery sector.

Second, as Doug said, over the past several months we have started to see increases in commodities and expect higher levels of inflation in certain categories. With a full year 2% to 3% inflation expectation, we assume the ability to pass on inflation in the normal course of business and have reflected this in our guidance.

Third, in 2014 our store openings are more weighted to the second and third quarter and therefore we expect higher pre opening costs during these quarters compared to the first quarter of 2014. Further, as you know, in our model our new stores start off with a lower gross margin than our mature stores and we have built in the compression to our overall margins from the new store openings for the remainder of the year in our guidance.

Fourth, we continue to build our team to support our future growth in our Southeast expansion. We expect to see some increases in SG&A as a percentage of sales for the remainder of the year to support this growth in both advertising expense as well as store level overhead, and again have considered this in our guidance.

After taking this into account, including the increased cost for expansion into a new region of the country, we are very pleased in our ability to continue to grow top line sales and bottom line profitability while above our long-term guidance and at levels separating us from competition. Specific to the second quarter of 2014, we are forecasting same-store sales growth of 8% to 9%, which would lead to a two-year same-store stack comp of 19% to 20%.

In conclusion, our strong results for the first quarter of 2014 gives us confidence as we continue to expand the brand. Sprouts' growth comes from the fastest-growing segment of the natural and organic sector, the everyday grocery shopper who recognizes that eating healthy no longer has to be expensive. This broad appeal, in addition to our low-cost new store economic model, and our significant white space opportunity gives our leadership great confidence in our ability to continue to deliver on our business results and financial targets.

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

(Operator Instructions)

Scott Mushkin, Wolfe Research.

I was wondering what, -- and maybe how the data, maybe I missed it before, but what do think the average income of your customer is, the household income? That's my first one.

Sure. That can depend by market. We generally think of it as median and above-median customers. So, on average, in a normal market, the median income of that customer will be in the $40,000, $45,000 all the way up to the $80,000, $85,000. And our upper middle-income customer will be above -- slightly above the $100,000 in income. Sure, Scott, so when you look at it, it's typically the middle income and upper middle-income consumer that's shopping at Sprouts.

So you guys would say you're right down the middle? Is that how you would think of the grocery-shopping customer -- is that a good way to look at it?

Probably. Like I said, middle-income to upper middle-income consumer. The everyday grocery shopper. As we discussed in the past, the great strength of the Sprouts model is our ability to attract a very broad base of consumers. Which, when you talk about the middle- and upper middle-income consumer, that is a pretty big segment of the population. So, to your comments, is it right down the middle of the path? Probably. Because when you look at the -- our ability to attract the everyday grocery shopper, which goes into pretty much everywhere from where we place those stores to how we market our products, that is the core customer for Sprouts.

Perfect. And then, I was wondering if you could think and maybe what do you think the difference in pricing between you and maybe an upscale guy like Whole Foods on produce, what do you think the differential is there?

Yes. I don't know if we want to disclose individual retailers. We've come out publicly -- and this is Jim, sorry Scott. We publicly have said we try and maintain our 20% to 25% spread with our traditional grocery counterparts. And there's been a lot of research out there that's available to you that shows that sometimes, with specialty retailers, it's much higher than that. So -- but we wouldn't disclose that on this call. But the 20% to 25% -- (multiple speakers).

20% to 25% in produce against the traditional grocery retailers.

So, that would make you probably at least 50% cheaper, it would seem to me. Okay, then one final line and I'll squeeze in. Competition -- I think Lucky's, Fresh Thyme -- how do you guys think about that?

Yes, I think the natural organic sector is growing fairly quickly. So we're going to see new competitors. I think one thing to remember is the natural organic space from 10, 15, 20 years ago has changed quite a bit today. So, we think that scale, sophistication, customer service, bringing strong operational skills are all even more important today. And scale becomes a more important part of the equation, compared to perhaps a new start-up 10 or 15 years ago like Sprouts was in 2002.

All right, perfect. Thank you for taking my questions.

Karen Short, Deutsche Bank.

Actually, following on Scott's question, I'm wondering when you think about the competitive landscape, I'm wondering, who do you think of as your most formidable competitor? Is it conventionals, or --? I'm curious how you answer that.

Sure. Again, like I said earlier, the core customer for Sprouts is just the everyday grocery shopper. So we really look at the traditional supermarkets as more of our competition. Because, again, when you look at the growth in natural and organic coming from that middle-income, upper middle-income everyday grocery shopper, that's really the customer that we're targeting.

If you look at the way we go to market, obviously, leading with produce, that's a common product that the everyday grocery shopper and the natural food shopper both buy, so it's a product they understand. They buy it often. And, when you look at our model, it's based on health, selection, value, and service -- all those components work together to take that everyday grocery shopper, get them into stores using that great prices on produce, and then eventually teach them how to eat healthier and draw more of that weekly shopping trip to Sprouts.

So when you look at the produce quality, and I know you guys have very high-quality produce, but obviously so does one of your larger publicly traded natural and organic retailers, but how do you think of where -- how do you rate the quality of your produce versus some of your competitors?

Well, first of all like Doug said -- this is Jim Nielsen. Hi, Karen. We're focused on the middle to upper middle and we see our primary competitor to be traditional. So, when you look at Spec in sizing, that's who we try and go out and compare ourself to. And I think we're doing an excellent job and there's been a lot of research that's out there today from Wells's most recent study that had us number two, I think, in the country for produce. That just echoes that same message about our produce quality. So we line in terms of Spec in sizing against the traditional grocer.

And I would add, Karen, is that because we sell so much produce -- with that being 25% of our business -- our ability to get produce into the store, typically within 48 hours into the store, and then also turn it faster, allows for a much better quality product to stay in the refrigerator or in ambient temperature when a customer takes it home. So we think that also gives us an advantage from a produce-quality perspective. Not only getting to the store but also sitting at that home with the customer.

And, I think, Karen, one last thing that I'd like to add to that when you really compare ourselves, when we look at traditional groceries, one thing I think we do much better is that our depth and variety of organics. So when we talk about Spec in sizing, I'm being general in terms of commission side of produce, but we do a great job. Our buying team does a great job on the organic side of the business.

Okay, that's -- yes, I agree, that's helpful. And then, I'm curious, on the remodels, obviously, you've been fairly vocal on what your Arizona remodels did to benefit your comp and now you're moving onto remodel the Texas market. I'm wondering, is there any reason why the comp lift in Texas would be any different as a benefit -- from a benefit on your overall comp perspective from the benefit that you saw in Arizona?

It's been fairly similar. The only difference we had Karen -- this is Jim again, I apologize -- is that some of the elements to the store that we did in the remodels here in Arizona were already put in place as part of sales initiatives in 2013. So -- and some of those stores a little bit newer. So, say, for example, frozen doors were already in the Dallas market where, here in Arizona, we didn't have frozen doors, we had coffins. So we have a bit of a -- or better uptick in Arizona. But we're seeing relatively the same results and we're excited about not only the seven we completed but the eight we have for the remainder of the year.

Got it. And then, sorry, last housekeeping, we all calculate in your store productivity, but your numbers are always a little different, so can you provide that number, if you gave it I didn't catch it?

We don't (inaudible) report it, but if you look at our public data, the new store productivity continues to run above 100%. I know different people will calculate it slightly different, but for this quarter it was 110%. So, as Doug alluded to in his opening remarks, is that our new stores continue to perform extremely well, including our new store in Kansas City which is our first in that market.

Great. Thanks very much.

Jason DeRise, UBS.

Sorry if I missed this, but did you comment at all about the Q2 EPS? I guess the consensus range is $0.17 to $0.20, are you comfortable with that? Is there any give on that?

The only guidance we give quarter out is our comp guidance on the top line, so we did not provide the EPS range for Q2, Jason.

Okay. Are you comfortable with that range? Is there anything you can add color wise to that, that we should consider?

I won't speak to that number but what I would say is in Q2 there is nothing unusual. We do have some increased operating costs for getting ready for our Southeast opening. But it's not a material number overall. So I wouldn't -- the only other thing I would point out is our pre-opening cost is going to increase slightly in Q2 and more so in Q3. We're going to open 6 stores in Q2 and then another 13 to 14 stores in Q3. So that -- those are the only two considerations that are -- I would say, are material. I don't know if Doug would add anything else, but both of those items that I spoke to are in our guidance numbers for the full year.

I appreciate that. Want to ask about maybe helping us finish the bridge of why the comps are -- let's take the quarter that just happened, the 12.8% versus the long term of 6% to 6.5%, so I guess 160 basis points is how well the Sunflower stores are doing. Can you help bridge the rest? I mean we've talked about it at various points in time about (multiple speakers) contribution and so on.

Yes, I think this quarter, each quarter it'll vary. In the fourth quarter, we talked about the holiday season. This quarter we got off to the year would be good solid quality and availability of produce. Produce comps are very solid this quarter, so that really helped drive the line. In terms of our overall -- as you heard Doug talk about, is our ticket and traffic are both very strong in terms of basket, up from the basket perspective, we continue to drive additional items into the basket. We had some minimal amount of the basket increase was coming from inflation.

In addition, the mix side has been very strong as well. We're seeing an increase in sales in things like raw foods, vegan foods, organics, gluten-free items, so all of those are performing 20%, 30% plus or higher, from a comps perspective. So that's giving us a nice mix in the basket. So, it's really Sunflower, produce, what we're seeing in terms of the specialty products because of the breadth and depth of specialty products we carry are really moving through the store nicely.

And then, outside of that, all of our vintages, even our oldest vintages are performing very strongly and -- in the high-single digits. So, we're very, very pleased with our vintages across the board and all of the [straights] are performing well.

And, on that point about the vintages, obviously last year's vintage and I guess towards the tail end of the previous year's vintage, your store productivity was very high. Is there anything that we can learn from their first year in the comp base and how they're performing? Is there anything that we can take away in terms of if this is just accelerating the consumer or are these stores potentially have a new high level for maturity?

Yes, so -- good question, Jason. I think two things there. I think the 2013 vintage is not into the comp base yet, it's still a little bit early. But in terms of our 2012 vintage, which was right prior to our full remodel or new prototype that we rolled out, but even our 2012 vintage is running very strongly and running above our typical new store model of 10% to 12% in the second year. So, our 2012 vintages are running above what we would call our normal second-year cycle.

And the 2012 vintage -- hi, this is Doug. The 2012 vintage did contain quite a few new stores in Northern California, which was a relatively new market for us. So, historically, new stores will ramp over time but new markets will ramp over time, so you have a combination of both in those -- in several of those 2012 vintage stores that's really feeling some of those -- some very, very strong comp growth.

We had also just rebranded those as well. They had opened as Sunflowers for a very short time and then we opened them back up as Sprouts. So, we did get a lot of tailwinds there in 2013.

Great, I'll let other people have a chance for questions. Thanks.

Rupesh Parikh, Oppenheimer.

For taking my question, congrats on a very strong quarter. So I want to delve a little bit more further into competition. So in terms of your markets, did you guys see any change in maybe the number of competitor openings this -- in Q1 versus maybe some of the prior periods?

Yes, this is Jim Nielsen. The way we look at it, we're obviously, as a group here, we're very aware of our competitors. So we track any competitors going to open within 5 miles or 10 minutes -- and we actually track even stuff outside of that, but we keep it relative to 5 miles and 10 minutes. But, as you look back at 2013 and looking forward to 2014, we're actually going to see relatively the same number of competitive intrusions of 2013.

So, obviously, we're pretty pleased with the 2013 results and we're pretty pleased with the start of 2014. So, it's going to be fractionally less than 2014, actually, from 2013, but pretty consistent. Which really, I think, speaks to the strength of the brand and its ability to defend itself, from the customer loyalty standpoint, speaks of the strength of our quality of value, selection, and our service and really getting branded out there in market.

Great, thank you. And one quick question on store expenses, again very strong leverage this quarter, it's about 100 basis point of leverage. What were some of the key drivers of the much better trends this period versus maybe some of your prior quarters?

Yes, I think that really three key things is -- first, is with the 12.8% comp we got and the first quarter is always a great start to the year. It's our high-sales quarter of the year typically. So we got great labor leverage in that area. Especially when you have the higher mix, talk about the mix is when you got higher-priced items that really allows you to drive labor cost.

The second piece was with high -- with the 12.8% comp, the depreciation leverage was also a key factor. The third element we saw is -- as far as the healthcare costs, we saw it lower utilization as well in healthcare cost overall. And then -- so from a DSE perspective, the healthcare utilization. So it was consistent across the board. We would see a slight increase from a healthcare cost perspective, we did change our plan last year.

So we're probably not going to see the same benefit. It was about a 20-basis-point benefit in Q1 in healthcare costs that we saw that we probably won't see in the middle and the back half of the year because we're on a higher-deductible plan. And, as those employees pass that deductible level, then we'll be funding some incremental portions of those costs. So I think at least that 20 basis point of healthcare costs I would expect to diminish over the course of the year.

Thank you.

John Heinbockel, Guggenheim.

Guys, have you seen any -- are there any material narrowing in the spread versus -- price spread versus conventional competitors anywhere?

I'm sorry, John, this is Jim, can you repeat the question? I couldn't hear you.

Yes, have you seen any material narrowing in the price spread versus conventional competitors anywhere?

No. I think, John, as you look back -- obviously, your model has been set up as value and we've been price checking our competitors for years, not only in the produce side of the business but the nonperishable side of the business, as well. And, most [recently], 18 months ago, we got into some of our other perishable departments on a little bit smaller scope. But, it's been consistent. It really has been consistent over the last, let's call it, four quarters. Now, I will tell you, John, that in some markets there's been different reaction. But in terms of balance and where the investment is, from an enterprise level for us, it's been, overall, consistent. Just a little bit different by geographies.

And has anyone -- that you can tell -- tried to zone price you? I know it's hard to do when you've clustered, but -- and I wonder if people will do that in Atlanta, but basically have an organic price zone for Sprouts to try to mute your competitive advantage early on. Have you seen anybody do that?

We haven't. And, listen, this is more than just price -- it's quality, value, selection, and service here, too. So, we'll stick to the model that we have in terms of how we're going to price. But we'll continue to perfect the level of engagement we have in-store and creating strong points of difference there, as well. At this point, John, I haven't noticed it. Doesn't mean it can't happen or won't happen.

And I think you've also heard a number of the public competitors certainly talk about -- on their calls, about passing on the inflation to the customer, so we'll continue to see that passing on in the inflation in normal course to date.

Yes, we have, and it happened all the way through the first period in produce and all of the departments.

And then, on inflation, so if you're looking for 2% to 3% for the year, that's for your number 1% in the quarter, that suggests maybe we're 3% to 4% in the back half of the year or now you still think it's in that range?

I think it's generally in that range, John. Obviously, different departments are at different levels. We're seeing meat certainly having higher levels of inflation. Portions of bulks, some of the nuts are higher levels of inflation. And we all know about dairy and cheese. So, it varies by department and the subcategories within department. But, based on what we're seeing today, we would see that 3% to 4% range would be a fair call-out at this point.

And, John, look, there's been some media around milk might get some relief, and cheese. So, are we hopeful that we can see some relief in chicken, third quarter, protein -- or poultry? Absolutely. But that number that we gave earlier is based on status quo and all the information that we have within the marketplace today.

And then, one last thing. If you decided -- some say you're in a better position that many because of your share gains that you're picking up here, if you decided to delay the passthrough on key items for a quarter or so, is the elasticity there where that's a good thing to do or, no, it's a waste of gross profit dollars?

Yes, we're pretty promotional as you know, John. And so, in terms of passing it on to the customer, as you know, our pricing strategy is really market driven. So we're continuing to look to see where the market is. And this year we did increase the number of promotions, the total number of promotions we're doing throughout the year.

Because what we do find is when we -- what we found is when we increase promotions that we'll generate incremental traffic into the stores. Which is really great for not only the promotions for example in produce, but all the other departments within the store, and really drives that cross shopping within the store and brings in incremental traffic, incremental sales. And then brings in incremental margin dollars even though your margin rate may be static.

John, I think what's amazing and what I'm extremely excited about is some of the numbers that we look at -- we look at, obviously, penetration ports that not only show you, add penetration, your EDLP penetration, your monthly promo penetration, TPR penetration, so we look at that very closely. And we started to see that balance out a little bit better, so meaning that some of the consumers are moving more to TPR, EDLP. Which generate little bit higher margin which has helped us offset some times cost increases because people are moving over. Which is even more exciting because it's a better basket. They're buying the products they want, not just what's on sale. So, some good indicators there.

Thank you.

Joe Edelstein, Stephens.

Amin, I might direct the first question to you. You spoke about the comp slowdown that you're expecting in the second half. I'm curious, when would you fully expect to lap benefits from the Sunflower remodel? Is that ending June 30, or is there any bit of a small benefit that might be carrying throughout the rest of the year?

Well, we should -- this is Doug -- we should start lapping that probably in the early part of Q3. Again, we'll lap that at -- how much further it will continue, we won't know. But, we will actually start lapping the actual time that we implemented those changes early on in Q3.

And I think it's -- just to make a note that we've contemplated that in our guidance, and so what we're really excited about is, even with that adjustment and not assuming a continuation into the second year, our two-year stack for two years in a row continues to remain in the 19% to 20% range. Last year, our two-year stack ending 2013 was right at around 20%, I think it was 20.4%. And, this year, our guidance is continuing to be in the 19% to 20% range. And we -- last year we obviously had a great holiday season and we're going to continue to drive that part and that opportunity during the holidays. And so I think that we continue to see strong momentum in the business to date.

I guess I'd like to ask another question on the remodels. I think, today, the average age of the store base is still quite young, only about eight years or so. Can you help give us -- or help quantify the total number of stores that might need to be remodeled looking forward? I'm trying to get a sense of how many years' worth, looking forward, that you might have in which you could still see some comp lift out of each of these remodels.

Sure. When you look at the -- you're right, the average age of our stores is still quite young. But we do have several vintages from 2002 -- in 2002, 2003, 2004, which are the ones we tackled this past year, which were predominately the Arizona stores. But when you look at the Henry's organization, they have some stores that were opened in the 1980s and 1990s as well. So we do have the opportunity to go back and remodel some of those stores. I would probably say that we still have opportunity for probably 30% of the store base for a remodel. So, we probably have at least, call it, three to fours years' worth of opportunity left from a remodel perspective.

And, Joe, I think once you get to that point, obviously, we're continuing to try and reinvent ourselves, and it's obviously a very dynamic industry. So just by the fact that we have sales initiatives we roll out within existing stores every year, so we're very aggressive there. We have a robust remodel program and new store program. But, as you get to that three years, one, people -- stores will be getting a bit older and there'll be a lot of different sales initiatives we'll get through and then rolled out. And some of the stores that are a bit older are going to need to be refreshed and realigned just to improve the overall shopping experience.

Okay, that's helpful. And, earlier somebody mentioned Fresh Thyme, the group that's being led by really the former Sunflower team, they're running the similar farmer's market concept and they've outlined some pretty big growth plans. Has anything changed in your view in terms of whether you would consider additional M&A opportunities as these potential competitors or similar businesses take off in other parts of the country?

From an M&A -- well, from a growth perspective, we're very, very focused on organic growth today. I think when you look at the white space opportunities that are available for Sprouts, there's tremendous opportunities for us to grow, from an organic standpoint. Doesn't mean that we wouldn't look at M&A. You never say never, but it's definitely not on the plans right now, given the opportunities that we have ahead of us.

And we continue to see a lot of existing real estate opportunities also come into market from various sectors which are in consolidation phase. So, the pipeline -- as Doug outlined the number of leases that we approved and signed -- remains very robust.

Sounds great. Good luck with the rest of the year.

Thank you very much.

Stephen Grambling, Goldman Sachs.

This is somewhat related to your response to John. Can you remind us how you think about margins longer term, given the strong performance since the IPO? And, perhaps more specifically, do you have a philosophical view that Sprouts will continue to reinvest margin rate to maintain that 20% to 25% price gap?

Yes, I think that we -- we're all stepping back and looking at the business. We really like the business. On an annual basis, we've been running about an 8% business and we've talked about having a 10 to 20 basis points of accretion in margin annually over time. And a lot of that, we think, will continue to come from continued traffic coming to our stores and that allows for natural flow into the business.

I think that we feel very good about the core value proposition -- Doug, Jim, and I review every month, where we sit within every department from a margin perspective and talk through it. And from what we see out there in the marketplace, we're not seeing a significant amount of change. And, frankly, the highest -- the higher-priced competitors have a ways to go to get to our value statement. So, we feel really good where we're positioned.

And from a -- and, Stephen, from a bigger-picture perspective, we're still -- we're obviously still in growth mode. This is still a very -- we're in a very opportunistic time right now to continue growing, and growing our market share and our store count, given that the growth in natural and organic is in the sector that we cater to the best. It is a core customer of Sprouts being that everyday supermarket customer. So we're going to continue to push hard to really drive our value proposition and continue to grow our basket and our market share -- and, if anything, increase the appeal of the Sprouts model.

Great, that's super helpful. Changing gears a bit, we've been getting a lot more comments from some of your peers, and certainly there's been some new additions to some of your markets regarding online services and grocery, and even another peer enhancing their digital reach. So, what you're seeing in your markets, and how do you think about this channel as a competitor as an opportunity long term?

Yes, I think the e-commerce business we've studied it, we've started to look at it much more closely recently and met with various people in the space. And I think the way we think about this business is, this is a $55 billion, $60 billion sector, natural organic sector, and it's expected to go over $100 billion in the next five to seven years. And, when you look at the capture rate in any particular department, the difference between the growth of the traditional channel -- I'll call it the brick-and-mortar and online -- when you start looking at the sheer dollars that are going online, we still think that, based on that delta, it's not a fast-growing sector.

So we feel pretty good about the customer experience and what the customer expects and people coming to the stores to shop perishables, particularly the perishable department. So, I think the short is that we're continuing to keep our eye very closely on it. We're not seeing a wide divergence today. And, to the extent that significant dollars are starting to flow to that market, then we would look at it at that point in time much more seriously.

And I think, Stephen, to Amin's point, we've met with several people within the sector that have the ability to do e-commerce. And so we look at it with more of a branding opportunity for us and not necessarily as a huge top-line sales driver. So, don't be surprised if, in 2015, you don't see us experimenting on a very light level doing this from a branding standpoint.

That make sense. If I can squeeze one quick follow up to another question in there. It's -- on the acquisition front, is there any way you can help us frame your approach to acquisitions? Is there specific things that you'd be looking for, whether it's either a multiple threshold or something else as you look at potential acquisitions? Thanks.

Yes, I think the biggest challenge with acquisitions is realistically the two that made the most sense are the two that we did with Henry's and Sunflower because they were very, very similar formats, models, go-to-market strategies, customers, products, and so on. The good thing is that not too many people do exactly what we do, and the bad thing is not too many people do exactly what we do.

So when you start looking at M&A, there's not a whole lot of people that are out there that do exactly what we do. So, when you talk about who would we acquire when you look at the natural food industry, typically the typical natural foods store is going to be a bit too small for a Sprouts and have a different assortment. And then, you look at the traditional supermarket, as far as an acquisition for a small, regional supermarket chain, you're acquiring a business to completely change a business. So, it's a very -- it's a little different dynamic when you start looking at M&A and completely changing a model when you're buying a company. But, on the other side, is when you look at the cost from -- on a cost perspective of us opening a new store at about $2.5 million, $2.8 million investment for us to open a new store and the returns that we get on our new stores, organic growth right now makes so much more sense.

Thanks for all the color. Good luck the rest of the year.

Ed Kelly, Credit Suisse.

Hi, guys, nice quarter.

Thank you.

I have a question for you here. Obviously, there's been a lot of talk about pricing and competition, et cetera. The market's worried about it because -- and you can see what your stock price has done. I'm curious how much time internally are you guys actually spending on any of this, do you feel that the market's just over reacting? I'm curious as to -- you're in the business every day, right? So, what you think about all this talk about what's going on, and has it even impacted the way you even think about strategy at all?

Sure. Well, let me tackle that one first and I'll turn it over to Jim to probably give you a little bit more color. But I think the thing to understand about Sprouts is the fact that pricing is something that we always pay attention to because our model has been focused on being a value since the day we founded the Company 12 plus years ago. So, pricing is always top of mind. Doing competitive price checks, which we do consistently on a weekly, monthly, quarterly basis is extremely important to our process here. So, to answer your point directly, yes, it's something that's top of mind, yes, it's something that we spend a lot of time and devote a lot of resources to, to making sure that we fulfill our value commitment to our consumers. And I will let Jim give you probably a little bit more color.

First and foremost is, if we're going to go out with a value statement to our consumers, we're going to make sure we stand behind it. So, I get very involved in it, myself, and make sure the right position. But, do we spend more time than we did two years ago? Maybe a few more hours because we're in more markets and we have more price zones and that would be, really, the only reason. And, as we get great technology that comes in and makes -- simplifies the pricing side of it, we'll probably spend a little less time.

So, from a day-to-day basis, within a market area, no, we don't spend any more time. But just, quite frankly, because we have more markets that we're covering today, there's a bigger overall time investment. But not as a percent of sales.

Yes, what I would add to that is we're spending the time that Jim talked about in pricing where we're really starting to spend a lot more -- more and more time is also talking about how we widen the customer base, how do we bring more people to the store? How do we differentiate ourselves? How do we get better in customer service? How we look to do things from a marketing perspective to accelerate our maturity curve of our new stores. Those are all top-line business drivers that we're spending a lot of time on.

And like I said, we have -- we feel very, very strong that we have a fantastic value statement, and trust and transparency around value with our customers. And so, given that and the fact that we have routine checks, we don't plan on taking any shock-and-awe strategy based on something that a competitor might look to do.

Okay, great. Thank you.

Kate Wendt, Wells Fargo.

Yes, thanks and congratulations on the quarter, which feels like a rare comment over the past 24 hours. I wanted to ask, based on that, actually, there's been some concerns about trends in the supplement industry. I'm wonder if you guys saw any deceleration in the quarter in that category, understanding that you said all categories still comped positive.

How're you doing, Kate? This is Jim. We had a real -- a nice balance in our overall department comps. But we were just a hair light in vitamins but [dhaba] was significantly higher than the overall comp rate. So, there's some nice tailwinds happening over there. As you look at the sector, we're still getting great growth in plant-based proteins. I think some of the bad press that came out on multis and some different things hurt the category for a little bit. But we've seen some nice positive momentum certainly happening over the last, let's call it, two or three months.

But, more importantly, is what we're trying to perfect in that side of the business is that engagement that we've always felt we did a good job, but we're looking to a great job to really separate ourselves. I've noticed people are getting into that category, but unfortunately that product does not sell itself, it takes a high level of expertise and we know that we can really separate ourselves. So we continue to invest in education, service on the floor, and be the leader in the vitamin category.

That's really helpful. And then, on new store productivity, obviously really hitting all cylinders here, can you talk a little bit about what you're doing differently, maybe above and beyond the general appeal of the concept? I know you said you had success with offering lower prices and doing some more pre-opening advertising out of the gate.

Well, that's been -- excuse me, this is Doug, it's been a combination of a handful of things. Obviously, we've gotten ahead of the stores with some additional marketing, both on the grassroots side and on the digital side. But, in addition, I think you're seeing -- what you're seeing a lot of is the success of the newest prototype store that we introduced the beginning of 2013, with the remodels in all the new stores that opened last year.

If you remember back when we talked about the new product type was the combination of the best parts of Henry's, Sprouts, and Sunflower. And, by far, the best product we ever brought to market. So you're definitely seeing the benefit of the greater selection and greater offering at the new prototype. And then I think, on top of that, is you're seeing the strength of our brand. Today, with 170 plus stores, our brand is much more powerful than it was and much more recognizable than it was, say, three years ago.

So I think -- like I said, I think it's a combination of a lot of different things and circling back to, again, to my earlier comment from, I think from the first question, where, when you look at the growth in natural and organic being in that everyday middle-income customer, everyday supermarket customer, that really is the core customer for a Sprouts. And I think when you look at our -- when you look at the Sprouts model and our ability to attract that customer and teach them and transition them into a natural foods customer, that's really the strength. So like I said, it's a lot of different things, but it's definitely heading in the right direction.

Great. Thanks so much.

If our job fair in Atlanta -- the turnout we've had for people wanting jobs to work at Sprouts -- was an indicator of our success we're going to have, I'm pretty excited about it.

Yes, and we obviously haven't opened our first store there yet, but even being 1.5 months away -- or 45 days away from opening our first store there, in our Snellville Facebook page, we already have over 13,000 fans in the region of the country where we don't even have a store. So, when you start seeing that organic excitement build around the brand, that excites us quite a bit.

Awesome, thanks so much.

David Magee, SunTrust.

Yes, hi, everybody, and good quarter.

Thank you.

And, best of luck, by the way, coming into Atlanta. We're looking forward to your stores. A couple questions. At this point, so we should look at inflation picking up in the second half is a positive because the retailers are passing it on. Do you feel confident enough that the sector, in a broad sense, is strong enough to keep that going that way?

As far as ability to pass it on?

Yes, do you take that --

I don't see -- as you look at the back half of the year, obviously the first quarter, as Doug had mentioned, we've been able to pass it on and specifically I talked to produce here. I don't get any overall concerns that we'll be able to pass it through. What our focus has to continued to be is make sure that we do continue to stay focused on our sales and promotions and make sure that we're driving in that traffic. But looking forward, too, there's a lot of great commodities out there -- just on the produce side, we're looking at grapes, tomatoes, watermelons, corn, stone fruit coming out with abundant crops that get us excited, items that we traditionally promote that'll give us the right price point to drive consumers in. But, again, you got look back the last two quarters, and it's been pretty consistent. Everybody's been passing it through, so we have to use that as an indicator.

Thank you. And then, secondly, how do you view the announcements by the discounters that they're getting into this space? Do you think it's probably a positive because they expand the space to more moderate-income customers, or do you see it as something that might peel away some share from you all?

Are you referring to traditional mass grow share?

That's right, but the Wal-mart and Target.

No. Listen, I don't want to speak specifically to one particular retailer, but, for us, we're always aware of retailers. Obviously, most of the traditionals today have a fairly wide assortment and natural, have their own private label within the store. So, we're aware, we shop those, look at the pricing. And, to Doug's point earlier, make sure that it's relevant. Let's make sure that it's our customer and we're not giving away retail sales and/or margin if we don't need to. So, we're looking forward to seeing how that works out.

I think the only point I'd make in addition to that would be, just keep in mind that we're not successful because we carry healthy products -- we're successful because we provide product knowledge and customer experience, and the value around those products, that makes it easier for the customers to eat healthy. So it's not necessarily just about carrying the products, it's about all the other pieces that go with it.

Great. Thanks, Doug. Good luck.

All right, thank you.

Ladies and gentlemen, that is all the time that we have for questions today. I would now like to turn the call back over to Doug for closing remarks.

All right. Well, thanks, everybody, for joining us today and for your interest in Sprouts. And we look forward to speaking with many of you in the coming months. Have a good evening.

Ladies and gentlemen, that does conclude the conference for today. Again, thank you for your participation. You may all disconnect. Have a good day.