Sprouts Farmers Market Inc (SFM) 2014 Q3 法說會逐字稿

Good day, ladies and gentleman, and welcome to Sprouts Farmers Market third-quarter 2014 earnings conference call. At this time all participants are in a listen-only mode.

(Operator Instructions)

As a reminder, this conference call may be recorded. I would now like to turn the conference over to Ms. 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 third-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 third quarter 2014 results and 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-looking statements including statements regarding our future performance and 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 from those described in the forward-looking statements. 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 filed today.

In addition, our remarks today include references to non-GAAP measures. For a 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. For the third quarter ended September 28, 2014, we reported diluted earnings per share of $0.17 and adjusted diluted earnings per share of $0.18. Adjusted diluted earnings per share increased 38% from $0.13 in the same period in 2013.

With that, let me turn the call over to Doug.

Thank you, Susannah. Good afternoon, everyone, and thanks for joining us today. 2014 is shaping up to be an incredible year for Sprouts as we remain focused in providing high-quality, fresh, natural and organic products at prices the everyday grocery shopper can afford. This focus reminds paramount to the success we have achieved in becoming the healthy grocery store for today's growing number of health-conscious consumers. And, of course, this focus continues to produce strong topline sales growth and excellent bottom-line financial results.

Our net sales grew to $766 million for the quarter, up 21% from 2013 thanks to strong performance in our new stores and improved comp store sales. In a competitive environment, I'm proud to report that our comp sales increased by 9% for the third quarter and 19.2% on a two-year [stack] basis. This represents our 30th consecutive quarter of positive same-store sales growth with comp levels that well exceeded overall sector growth. During the third quarter, our comp performance was balanced between traffic and ticket, as we continue to grow new customers and increase visits from existing customers. Traffic increased by 4% during the quarter. And average basket increased by 4.5% from the prior year.

Comp performance was strong across the store as everyday consumers seek healthier alternatives to the traditional supermarket and more affordable options to the specialty food store. From our extensive selection of fresh produce to our choice natural beef, cut to order in our all-time butcher shop, to our wide selection of natural and organic packaged foods, Sprouts continues to win new customers while making healthy eating easy and affordable. Additionally, as more customers embrace the need for a healthy diet, the demand for products with specialty attributes continues to grow. These fast-growing specialty categories continue to provide strong sales momentum as we leverage our extensive product offering and knowledgeable service to help customers make the educated choices needed to reach their health goals.

For the quarter, specialty categories like organic, raw, non-GMO and allergy-free all experienced comp growth well above our Company average and sales growth well outpacing industry trends. This growth in product assortment also included our Sprouts private-label products which continue to see strong comp and sales growth as consumer demand for healthier food choices continues to grow. Our Sprouts private-label is a quality, natural product line with strict ingredient standards that include no artificial colors, flavors, or preservatives. With more than 1,500 Sprouts private-label items today, we continue to expand our selection of unique items that can only be found at Sprouts, like my favorite salsa that includes flax, Chia and quinoa.

The success from our promotional strategies always drove traffic and improved sales during the quarter. Using promotional strategies like our prices and quality you can trust campaign, we continue to build loyalty with everyday consumers by providing quality, selection, and value across the store. In addition to strong traffic and category growth, the former Sunflower stores continue to perform well, hosting third-quarter comps above the company average and adding approximately 80 basis points to our overall comp for the quarter.

Now let me quickly touch on commodities and inflation. During the third quarter, as we expected, we continue to see high levels of inflation in certain categories such as proteins, nuts, dairy and produce. We also experienced tightness in certain produce categories as the growing season moved to California Central Valley, a region heavily impacted by the drought. This tightness in supply was limited in scope and mainly impacted to some stone fruits, lettuce and melons. Overall, on an average sprout basket, cost inflation during the third quarter was approximately 4%.

We expect inflation to remain near these levels for the remainder of the year, resulting in the full year 2014 inflation in the 3% range. As we move into the latter part of the year and the growing season transitions further south, we're starting to see some improvements in produce quality and supply and moderating inflation which should positively impact the margin compression that we've been experiencing in the middle of this year including the third quarter. Even during these inflationary periods, our commitment to healthy foods at affordable prices remains intact, and we continue to deliver solid traffic and comp [ex] growth across the store.

On the new storefront, we had an incredible third quarter with the opening of 14 new stores with four of those stores in our two newest markets in Kansas City and Atlanta. Opening 14 new stores in a quarter is a record for Sprouts, and I have to thank our more than 17,000 team members who helped deliver this incredible achievement. During this quarter, we also completed our remodel program for 2014, ending the year with15 stores remodeled. As most of you know, we typically don't open new stores in the fourth quarter, so we will end this year with191 stores in 10 states across the country.

In true Sprouts form, we're quickly completing our 2015 new store schedule. We're excited to enter our 11th new market, Alabama, in the first quarter of the year. Consistent with our new market entry strategy, we thoroughly studied the market and feel confident in our ability to attract new customers with our healthy living for less approach to grocery shopping. We will continue to announce new store locations for 2015 over time and look forward to our further expansion into the Southeast. Our current real estate plan includes 64 [per] new sites and 41 signed leases for the coming years, keeping us well on track with our growth strategy and long-term 14% unit growth target.

Speaking of new sites, new stores overall continue to perform well above expectations with new store productivity running north of 100% when calculated on a weighted basis. Although new stores and new markets have been part of Sprouts since the start, I'm very proud of what our team accomplished in a competitive and evolving marketplace. We constantly receive positive feedback from our customers and I'm pleased to report that our initial entry into the Southeast region has proven successful and we look forward to expanding healthy living for less into more markets in the coming years.

As we turn the corner into Q4, we are very excited about our holiday program and building on our success from 2013 we'll be adding ever wider assortment of holiday grocery items this year, including private label and specialty attribute items giving our customers everything they need for a healthy holiday celebration. In fact, several of our new Sprouts private-label pumpkin items, like our pumpkin seed tortilla chips and pumpkin gelato are already in stores and quickly becoming crowd favorites. With the best people, the best products, and the best value, we're looking forward to wrapping up our successful 2014 campaign with another strong holiday performance.

With that, let me turn the call over to Amin to talk about our financial results and full-year guidance.

Thank you, Doug, and good afternoon, everyone. We are very pleased with our strong results for the quarter. Following Doug's highlights of the business drivers, let me cover the operating results and updated guidance. For the third quarter, gross profit increased to $226 million, a 19% increase over the same period in 2013. Our gross margin rate of 29.5% decreased 50 basis points compared to the same period in 2013. Leverage in occupancy, utilities and buying costs were more than offset by margin compression in certain categories.

We remain focused on our core strategy of value in pricing decisions. During the third quarter, we noted that the industry was slow to pass through price increases in categories with higher levels of inflation such as produce, dairy and nuts. Based on this, we took the opportunity to pass along inflation in certain categories like meat, while continuing to invest and absorb inflation in other areas like produce, dairy and nuts to preserve value for our customers. In addition, we continue to invest in price-sensitive items in the grocery department to maintain our value proposition.

Maintaining and staying within certain price points and price ranges is an important element of demonstrating value to our customers across the store and it remains a core tenet of our strategy. To summarize the margin discussion, our strategy of staying attuned with the market and focusing on value and price points has continued to pay dividends in driving sales which continues to provide strong leverage down to the EBITDA margin line. Direct store expenses was $149 million for the quarter and as a percentage of sales was 19.4% an improvement of 100 basis points compared to 2013.

This improvement was driven primarily by leverage in payroll and benefits including lower utilization of medical benefits, leverage and depreciation in store level expenses, and a benefit from capitalization of store development cost due to a greater number of store openings during the quarter. Selling general and administrative expenses were $24 million for the quarter. SG&A included $900,000 of pretax secondary offering expenses in the quarter and $3.2 million of IPO bonuses in the third quarter of 2013. Excluding these items, SG&A as a percentage of sales improved 10 basis points to 3% compared to last year. This improvement was mainly driven by leveraging corporate overhead, offset by higher advertising costs, driven by expansion into new markets.

Adjusted EBITDA for the third quarter totaled $65 million, up 24% over the same period in 2013. As most of you know, our new store model starts with a lower store level EBITDA margin than our mature stores, and with the opening of 14 new stores this quarter, we expected the new stores to result in a compression in the overall EBITDA margin rate. However, given the strong comps, resulting leverage, and strong new store productivity, total EBITDA margin was 8.5% an expansion of 20 basis points compared to the prior year. Adjusted net income for the third quarter totaled $27.4 million, an improvement of 41% 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 an interest rate reduction under our credit facility. For the 39-week period ended September 28, 2014, net sales increased to $2.2 billion up 22% compared to 2013 driven by comp sales of 10.4% and new store openings performing well above expectations. Gross profit increased 22% to $674 million, resulting in a gross margin rate of 30.2% year to date or an increase of 10 basis points versus the prior year. Year-to-date adjusted EBITDA totaled $212 million, up 35% from the same period of 2013 well above our long-term guidance.

Shifting to balance sheet and liquidity, we continue to maintain a strong balance sheet and improve liquidity. For the 39-week period, we generated $151 million of cash flows from operations and invested $96 million in capital expenditures primarily for new stores. Due to our strong cash flow generation, we will voluntarily pay down $50 million of outstanding debt during the quarter. At quarter end, the principal balance on our term loan was $263 million leading to a net debt to adjusted EBITDA leverage ratio excluding capital and financing leases of 0.6 times.

We ended the quarter with cash and cash equivalents of $118 million and $53 million available under our undrawn revolving credit facility. With robust returns on investments, and a strong cash position, our investment focus remains on opening new stores, continuing to enhance our business through innovative sales initiatives, and maintaining superior store conditions.

Let me now turn to guidance. Our strong value proposition of promoting quality products continues to drive traffic to our stores and is clearly resonating in both our existing markets and in our new markets. That coupled with our disciplined investments and focus on management of direct store expenses and corporate costs are providing results that are exceeding our long-term guidance. Due to the seller performance to date, we are increasing our full-year 2014 adjusted diluted earnings per share guidance to $0.67 to $0.68, or a forecasted growth rate of 40% to 42%. In addition, we're increasing the following guidance as well. Full-year adjusted EBITDA growth range of 28% to 30% and 50-plus% growth in adjusted net income.

Let me review a few additional items regarding our full-year guidance. First, we expect the one-year comp sales for the full year to be in the 8.5% to 9.5% range and the two-year comp sales stacked to be in the 19% to 20% range. Second, as many of you know, during the fourth quarter our average sales on gross profit are typically the lowest of the year due to seasonally slower produce sales in the winter months. In addition, during the fourth quarter, we will be cycling a 13.8% comp from 2013 and therefore are forecasting a comp sales growth of 5.5% to 6.5%, which would lead to a two-year stack comp sales growth of 19% to 20% for the fourth quarter consistent with our performance year to date.

Lastly, as in past quarters, we expect to make priced investments as necessary to drive topline sales, a strategy that continues to drive higher bottom-line profits. However, we do expect moderation of gross margin compression versus the third quarter as the higher levels of inflation normalizes. In conclusion, Sprouts' growth is fueled by the everyday consumers' growing interest in improving their diet by making healthier food choices. This broad appeal, coupled with our promotional approach, continues to drive traffic to our stores and has led to another strong quarter of performance and gives us confidence as we plan for the future years.

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

(Operator Instructions)

Kelly Bania, BMO Capital.

Hi, good evening. Thanks for taking my question. Doug, I guess this first one for you.

I notice in the press release you mentioned a competitive environment, and I guess it doesn't seem like we've been hearing that from you quarter or year-o-date. So I'm just wondering if anything changed in the competitive environment from your view, either from some of the specialty players or from -- reaction from the traditional supermarkets?

Hello, Kelly. We haven't seen a tremendous change, obviously a significant change, in the competitive environment.

What we are seeing is some of the conventional competitors in certain parts of the country are becoming a bit more promotional on some of the high-velocity items within certain departments and categories. However, we definitely felt far more margin pressure from inflation during the third quarter, as we continue to stay within certain price points and price ranges just in order to continue demonstrating value to our customers.

Kelly, this is Jim Nielsen. From a competition basis, unit basis, new units, we didn't see anything on a sequential basis, and looking forward into 2015, we don't see any increase over 2014.

Great. That's very helpful. And just if I could just ask one more on the Q4 comp guidance, maybe for Amin.

How much of the guidance in the 6% range, how much of that reflects just the comparisons, the two-year run rate and the impact of the Sunflower comp starting to normalize? Is that kind of the best way to characterize that?

I would say it's less so the Sunflower, the Sunflower in the second and third quarter continued to sustain at about a 80 basis point improvement. So it's really more so we're hurdling, as you know, Kelly, a 13.8% comp from last year. What I would say is, we have a very solid start for the quarter, and we're pretty excited about the holiday program that we continued to build on from the prior-year, and some of the new products, as Doug mentioned, that we've roll out, we are seeing the greatest excitement from the customers. I think to the extent we continue to see that through the holiday season, that can provide some additional momentum in the business that we haven't considered in our comp guidance for the fourth quarter.

Great. That's very helpful. Thanks.

Thanks, Kelly.

Edward Kelly, Credit Suisse.

It's actually Lauren Wood on for Ed. Thanks for taking our question. I was hoping we could just focus on the gross margin performance.

So it sounds like from your comments that inflation was the main issue, and so with -- if you were expecting margin [expansion] to be lower next quarter, does that's what hinge on inflation coming down? What happens if it doesn't come down, and I guess we just trying to figure out how to think about it over the next few quarters? Thanks.

Sure, good question. We did leverage occupancy, utilities and buying cost. However, as I noted the scripted remarks, inflationary pressures negatively impacted our merchandise margins. The high levels of inflation we had in produce and diary, and nuts, that we didn't pass through to our customers accounted for substantially all the gross margin pressure we had in this quarter.

But as I noted, also noted, we have started to see some inflationary relief in produce which should positively impact the margin compression we experienced in the third quarter moving forward. And again we are -- even in this quarter, we are still experiencing some compression from inflation, but again, we're starting to see some relief is primarily in produce, and we don't expect to see margin compression to the extent we saw it in the third quarter.

Okay.

There is no material increase. All the other departments are neutral as of today, and looking forward through the rest of the quarter, and so produce is favorable.

And just as a quick follow up, can you maybe talk about your expectations for inflation next year as well?

I think what I would say is we're starting to see relief in produce, as Doug talked about, going into the back end of this quarter. In terms of next year, we see -- were able to pass on inflation in the meat department.

We are seeing poultry starting to come down, but we're continuing to see inflation in other parts of meat like beef. And in terms of bulk, we're seeing some relief in certain categories of bulk, but certain other items are still up.

So I think overall we've seen 4% inflation this quarter, and we would expect the fourth quarter to be closer to the 3%. And then as we go into the next year, we'll be looking closely at what some of the nut categories do and what some of the dairy does, and that will really help us set up to understanding inflation, which we'll share on the year-end call on what we think. But to date, were seeing about a 3% [deflation], which is good news from the elevated 4% of the third quarter.

Okay. Thanks so much.

Thank you. Karen Short, Deutsche Bank.

Just a couple of questions. In terms of competitive pressure, just a follow-up on that question.

How many SKUs are you actually feeling pressure competitively? Is it broad-based or is it just limited to certain categories? Any color you can give there?

We're not going to give SKU-specific information on the call, but what we look at, Karen, grocery frozen and dairy, as a group -- and it's only in a handful of markets that we saw some competitive pressure on retails. And we passed those -- adjusted those retails early in the quarter. So that kind of flowed through the quarter, all the way through.

So to the extent of some competitors maybe changing their pricing strategy in some of the categories that directly overlap with you, do you guys think of it -- do you guys think of your go-to-market strategy and pricing strategy in terms of maintaining a spread, or just maintaining a better price positioning? Is that strategy changing?

Our strategy has not changed, and we have a price strategy by department. And so we've adhered to that through the third quarter, and were not seeing any new competitors coming into that to affect the way we view our pricing strategies.

Okay. And then just last question, I know you have for several quarters this commentary regarding internal control issues on costing of inventory. Can you just give me an update on where you're at with the process of evaluating how you're costing inventory, and when you think it might be resolved?

Karen, obviously our auditors have to complete the audit, but we have gone to the new inventory system, so for all practical purposes we're on the new system now -- or I shouldn't say practical purposes, we are on the new system now. We just have to wait until year and to be able to formally remove the material weakness. So we don't see it as an issue, except for just waiting until year end to be able to formally remove it.

Got it. Thanks. I'll get back in the queue.

John Heinbockel, Guggenheim Securities.

For Doug and Jim, when you think about -- philosophically, when you think about pricing, are you looking to tweak more every day price or promotional, number one? And then number two, when you look at conventional competitors, right, who you are really targeting, as they make changes in their pricing, is that something that registers right away with the customer?

Do you react right away or is it more, let's see if they're getting a response from the customer? You don't wait for that?

First of all, from a competition standpoint, we always look at things as a full basket, so we know the department, we don't react to pricing the day someone changes a line item on a cost sheet. We look at 1,300 items in the grocery department, and we have a strategy based on all of those items and the influence they have on our shopper.

Back to the original question, what are we investing in promo or everyday pricing? It's a combination of both, and what we did see is a higher level of penetration on some promo. So good news bad news, good traction on the promo, but it is a little bit lighter on the margin side.

If you look price perception, you versus a variety of conventional competitors, do you find they're making any in-roads or not really? It's going to take a fair bit of time to do that, since they -- it's not a core part of what they do and they don't have a lot of authority in that area?

Yes, I think our customers look at it as a market basket. I think when terms of the spread that we had, when we were at IPO and today, they're very similar.

So the confidence that our consumer has in value in 2013 is the confidence they have today. There's been no material change.

And then just for Amin, when you guys think about -- as we look at your fourth quarter, is there anything expense wise, direct store expense, SG&A, because we touched on margin, anything sort of unusual or a step up in any of the expense items that we would see in the fourth quarter?

No, nothing outside of just the comps hurdle that we talked about earlier. There's some a one-off items, like I think there was a pretax secondary offering expense, but that's adjusted, in our adjusted numbers. So from a overall quarter perspective, there's nothing unusual that we're hurdling this quarter.

Okay. Thank you.

And John, if I could just touch on the competition thing, just to add little bit to what Jim said. The way we look at it, really, from the long-term, I think what I would say is it's about innovation, it's about staying ahead of the curve. It's about carrying the products that are not just the leading trends today, but where -- those that are coming to the forefront.

So for those popular items, we need to ensure that we maintain the depth of offering, not just the high-velocity items. But also a broad selection of natural and organic; the branded, the specialty, the [attribute] base, and expanding our private label products, along with the knowledgeable service to help that customer make those -- the right product decisions for them. So again it's more of -- it's not solely hanging your hat on price, but it's about a lot of the value we bring, and the depth of our offering and the service, and all the other components that make Sprouts successful.

Thank you.

Rupesh Parikh, Oppenheimer.

Just wanted to touch on the gross margin line as well. In terms of new store openings, did they have any meaningful impact on gross margins this quarter?

Yes, the new store openings definitely had an impact. Obviously, we have our opening promotions that we get from our vendors, which partially offsets that. But the 14 stores did have an impact on really all the lines throughout the P&L, on the gross margin line, on -- labor is typically higher in the first several quarters, and supplies, etc.

So 14 new stores definitely impacted our overall margins, but as I talked about earlier, is really -- the great comps of 9% really helped us leverage in all of the lines in our core stores, where we were still able to hurdle 50 basis points compression and gross margin, to flip to a 20 basis points margin expansion, despite of having margin compression and opening 14 stores in the quarter.

Okay. And then next question is just a higher level question on the produce category. We hear a lot from other conventional players, and even though they are specialty players, about their increased focus on the produce category. As you look out in your markets, do you guys see any meaningful changes in what your competitor is doing in the produce category at this juncture?

Well, there's obviously a retailer out there that took a different position in a handful of markets, and we've noticed that, but it hasn't impacted us. But relative to the conventionals, there's always been slight adjustments throughout the year, throughout the years. But there's been no material change that we've seen last quarter or the prior four quarters.

Thank you.

Stephen Grambling, Goldman Sachs.

Good afternoon. Based on the guidance, it looks like you going to be coming in well above the long-term algorithm that you kind of laid out, and your op margins are essentially at parity with some of your peers. I'm just hoping you can comment on how you're thinking about the opportunity from here, and how do you balance reinvesting in a bigger way, to focus on the top line versus future margin expansion?

It's a great question. Thanks, Stephen. I think a couple of things is, what we've done the last several years we think has been very successful, is we really think about our gross margin line as flat year-over-year and continue on that basis. What that really does is, it allows us to -- gives us a flexibility to invest and price to drive sales, and that's been very successful, as we can see what that's done to EBITDA growth of over 30% last year, and a range of 28% to 30% for this year.

When you really look at the components of it is this year, even with gross margin flat year to date, we've really been able to drive the synergies in the middle of the P&L, to drive bottom line growth into the high 20s and low 30s. So we really like that strategy of giving ourselves that flexibility around, as long -- in addition to that, from a capital standpoint, we spend a lot of time and energy around looking at what are the areas that continue to give us sales, and our sales initiatives pipeline looks very robust, probably our most aggressive yet for next year.

And it's all about -- we're very, very focused on the top line as a company. And so that's where I always say, is that even if we have to give a little bit up in margins, and give the value to the customer, it still leverages all the way to the bottom.

One other thing, it's not a frivolous investment, either. I think as we look at it, we try and balance everything out, and we always use the return on investment, not only on the department -- or excuse me, on a category basis, on a department basis, and a total company basis. So every time we do make that investment, we reflect on it to make sure that we're getting the proper ROI out of our investment.

As a follow-up, you had mentioned in the past that there was some price optimization that was going on, and some software that was being put in place. Can you just remind us what the timeline and milestones are for those?

That will be rolled out first quarter of 2015.

One last one, if I can, just with all this excess cash, you were able to pay down some debt here. As you look forward, is there any change in the thought process of where you're going to redeploy capital? Can you expand quicker, accelerate square footage growth in any areas, or are there other thoughts in terms of redeploying to shareholders? Thanks.

I would say it's the same foundational -- the foundation is new store growth. The secondary is sales initiatives.

And outside of that, making sure that our stores are in good condition. We'll continue to remodel 5 to 10 stores a year, and make sure that our stores look very consistent across the board. Next year, we've really driven out more of our sales initiatives to help continue to generate that topline sales growth, is what you'll expect us to see. As far as other dividends for dividends or buybacks, that type of policy, we'll start looking at something, but we have nothing in the pipeline at this point.

Thanks so much. Best of luck in the holidays.

Thank you.

Scott Mushkin, Wolfe Research.

Thanks for taking my question. Can you hear me?

Yes.

Terrific. Wanted to think about long-term growth targets. Maybe you can refresh us on kind of where those stand? The fiscal year's coming in, I think, a lot above where you thought you would be, and so as we think about the long-term growth algorithm of the Company, and as we move into 2015, how should we view your growth?

Sure. I think I would make a couple of points is, as we've outlined our long-term targets, I think those remain -- again, long-term is the key here. You know, 15%-plus topline sales, 6%-plus comp sales, and gross margin to be relatively flat, yet continuing to leverage in the middle of the P&L, to get leverage all the way down.

As far as the growth rates are concerned, we've clearly -- our net income's grown over 50% for two straight years now. And as we get to year end and into next year, what really we're going to continue to focus on is driving our sales above our comp targets of 6%-plus, is where our focus really is, and that's the upside in the model.

We still call the net income and EPS growth of 20%-plus, and when we get to year end, we'll talk about something dynamics for this year and next year, and how that works into our numbers. But I think again, as long as the topline continues to generate at the pace that it has been, I think I would see for the next 12 to 24 months opportunities to outperform our long-term targets.

That's perfect. That leads to the second question, and I'm not good on my feet on math sometimes, but it does seem as I've looked at the numbers and gotten some emails, that the fourth quarter guidance is implied to be kind of flattish, even though we're at a 6% comp on EBITDA and EPS; is that right, number one? And number two, why would that be, given we are at that 6% comp level?

What I would say is, if you look at the EBITDA growth for the fourth quarter and the guidance, it's about 15%, and that assumes that 5.5% to 6.5% comp. As I said earlier, this fourth quarter has started off really well, and to the extent that we see the holiday season continuing at that pace and momentum, I think it could provide some upside in both the topline as well as the bottom line targets there.

When you say really well, do you mean that you're kind of tracking right now above that 5.5% to 6.5%? How should we frame that?

I think that's fair. Last year, the holiday season was really robust for us, so it was really the November and December periods were very robust, and that's where we just want to be -- make sure we're a little bit optimistically cautioned here around it.

And so the guidance we provided, we've really looked at our two-year comps and really guided to our two-year comp rate. To the extent that our holiday program, as I said, continues to build from last year, I think that would provide some upside to that number.

Perfect. Do I have time to sneak one last one in, or am I -- is this --

You're fine, Scott.

Thanks, guys. My last one is, and I know we've talked about this about -- our pricing surveys have shown that you've always been priced pretty -- at a pretty large discount on perishables, or fruits and vegetables, to Whole Foods, somewhere in the 35% range. We've now seen that price discount come into the rest of the store.

And I know you guys said, hey, we don't -- we're a value-driven retailer, and we want to give back to our consumers, but -- and I heard you about the gross margin, a lot of it had to do with the produce and timing of stuff. But how do we judge when you guys are going to far, and you're just not throwing dollars away on the price investment front? Because it does seem like you really have opened up a pretty wide distance between you and most people throughout the store now, and it's not just in produce?

I think the key is, when we reinvest in the business, Jim touched on this earlier, we look at every -- we have 20 price zones -- we look at every region of the country and we look at every department. So when we're reinvesting in the business, we are typically focused on trying to drive sales within certain categories, and based on what's happening in that marketplace and looking to the best conventional, we're generally well below the other specialty retailers.

So we really focus on the conventionals, and where we're seeing -- where we can get more promotional or do our extended programs, and we're seeing the traffic come in the store, either increased traffic or greater basket, we view that as all positive. And we can see that in our numbers, so we feel like we have a pretty decent handle when we see the comp numbers, and when we see the traffic numbers by region, by department, that we're not giving away margin, if you will.

Scott, our pricing model that we used, our strategies that we've developed, that we've had in place since 2013, that are proven to be successful, are what's been in place in the third quarter. So to Amin's point, we don't price off of every retailer, we price off some of the most competitive retailers within the market, so -- which, again, has proven to strike the right balance between sales and margin for us.

Thank you, guys. Appreciate it.

Thanks, Scott.

Meredith Adler, Barclays.

Thanks for taking my question. A lot of really good questions have been asked.

I thought maybe you could talk a little bit about what's going on with the real estate environment, how your performance in Kansas City is? I know Atlanta was good; are you still happy there? How you see the Southeast sort of developing over time?

Sure, Meredith, this is Doug. Obviously, we're still seeing solid success there in a Southeast, with our first four stores opening in Atlanta. We have obviously more sites in Georgia coming next year, as well as the addition of Alabama.

So we certainly see the Southeast as a growth vehicle for us, for several years. From the real estate side, we continue -- I think as I noted in the script, we have quite a few signed leases -- executed leases, and a lot of pre-sites in the pipeline, obviously to support our growth plans at -- growth targets at 14%.

So again, on the real estate front, we're doing well. The new stores are doing well. You saw the new store productivity.

So again we've -- we are certainly seeing the success of the improvements we've made in merchandising and assortment, and a lot of the marketing and branding strategies that we put in place over the last two years. And again, a lot of it is pushing that new store productivity. And from the real estate standpoint, we're continuing to grow in existing markets, and then pushing obviously for expansion into the Southeast.

And Meredith, just to add there that Kansas City is going very well. We opened a third store -- I'm sorry, our second store in the third quarter, and that store has started off fairly well, also. So we look forward to opening more stores in Kansas City next year.

And the only other thing I would add on real estate is, with the Sprouts brand, and the traffic that we're driving to our centers, we're seeing more and more opportunities today, whether it be tenant improvements of existing sites, as well as build-to-suits. We are seeing a lot of good build-to-suit opportunities, so we're being very sharp in the sites that we take now, probably more than ever, because we see -- we're seeing more opportunities today than ever. And obviously, as we add 11 and 12 states, as we add our 11th state, that gives us just more markets to build in.

And then maybe you could just talk about whether you're expecting anything in Southern California there? We haven't heard anything yet.

There will be some to divestitures and maybe some closings, when Albertsons actually buys Safeway. Do you see that's going to be an opportunity for you, either in terms of real estate or just in terms of market share?

We've been in close contact, obviously, with that whole process. And again, there's not a lot of visibility into what the final outcome is going to be. But we obviously are staying very close to the -- to what's going on, and hopefully we'll see some opportunity. Obviously, Southern California is a really good market, very mature market for us.

So, again, as we -- with the opportunity to add more sites down there, I guess, obviously gives us greater leverage on a lot of the fixed expenses we have in that market.

So we would certainly look at the opportunity. As the process plays out, hopefully we'll get our opportunity.

Great, and then I just have one more question about distribution, and I believe your primary supplier was acquired. I'm just wondering whether that has changed anything at all, good or bad?

Meredith, this is Jim.

Hi, Jim.

There's been no material change to our business. In fact, we're excited about the idea of on-boarding [k-hee], with all the distribution houses they have, and it's really going to help with our ability to scale across the country.

Great. Thank you very much.

Thank you.

Kate Wendt, Wells Fargo Securities.

Thank you. I guess one thing that hasn't come up on this call is, I think, how impressive actually your two-year stack, maintaining it in the 19% to 20% range has -- given the pretty widespread slowdown in the supplements industry. And then I'm just wondering if you could talk about what you're seeing in that category in the store?

I know it had been comping still positive, but at a lower rate than the rest of the store. And if it makes you rethink at all, I guess, longer-term, the square footage in the store devoted to that category?

Hi Kate, this is Jim. Obviously, we're outpacing the industry. Not only the news that came out on the 3.8, but we're very excited about how the fourth quarter started for us, getting a lot of sales momentum out of the wellness category.

But as we look at the sales per square foot, we feel like we've optimized it, and feel like -- that we have the right product offering for our customers, and we're going to continue just to refine that and continue to invest in our team members around education and engagement with our customer.

Okay. That's good to hear. And then, Amin, does your fourth quarter guidance assume any continued benefit from Sunflower, in the comp?

I think we have basically continued a partial momentum into -- we would expect it to settle down a little bit. We have not seen this settling, but we've included a partial drop for the fourth quarter. So again, that could be potential upside, to the extent that it sustains at the 80 basis point level.

Great. Finally, I'm just wondering if you guys are thinking about changing your mind at all, in terms of the opportunity for a loyalty program, given that one of your specialty competitors is now starting to roll out one, and your conventional competitors all offer one?

This is Doug. Obviously, the loyalty or rewards program, we've had that under review for, gosh, probably half of the year, trying to figure out what is the best approach for Sprouts and for our customers. So I wouldn't say we've closed the door on it, I think we still have it under review, and trying to figure out what the right approach for us is going to be.

Okay, great. Thanks so much.

Vincent Sinisi, Morgan Stanley.

This is Andrew Rubin on for Vinny. Thanks for taking the question.

I just wanted to touch on the private label side. You'd mentioned some SKU introductions in the back half of the year. Any update on that, and how private label has trended, and if the new SKUs have any effect on overall private label penetration?

Yes, we're not going to disclose the overall penetration, but fourth quarter, we're launching [69] items, the most we have launched all year, so we are extremely excited about that. From a top line basis, private label's outpacing all of the other departments, and on a comp basis it is, as well.

So we're not only excited about the overall performance, but just some of the new innovative items that are creating a lot of customer loyalty with our store. And we saw that as we launched the pumpkin items we had out this year, the commentary we got on Facebook and here in the office was fantastic, and couldn't be more proud.

Great. And then in terms of some other categories, you mentioned gluten-free, raw, I think you called out allergy-free? Are there any emerging categories that you're focused on that are showing outsized growth.

And then also in terms of prepared foods, I think you've talked about that opportunity. Any update on prepared foods as well? Thank you.

Grass fed is an upcoming category that we are seeing great growth from, it's obviously very small. Low glycemic, still very small. So those are not material impacts.

One that continues to drive our business is organics, and you guys probably can see this data as well. Our topline is out-pacing not only natural, but the conventional market as well, in terms of topline growth, at 28%.

So we're extremely pleased with that. And your second half of the question, I'm sorry, was?

On the prepared foods, I think you talked about expanding a hot food or meal offering, or looking into that?

It's going to be a combination of a lot of things in that. So where we really see the opportunity in deli is on our HMR side, not only continued to improve the ingredient decks, but get into a lot of different ethnic categories.

We have a broader variety, and it becomes more of a destination, but were also rolling out -- we'll have 34 juice bars in our stores next year. We are continuing to invest in the Boars Head program, which has proven to be extremely successful for us, and we will continue to improve the offerings on the hot food side for 2015.

Great. Thank you.

Chuck Cerankosky, Northcoast Research.

Good afternoon, everyone. Can you talk a little bit about how the consumer's behaving, in terms of sales mix? Obviously, you touched on that a little bit, with the reaction to more promoted merchandise. I guess that would be in produce.

But are you seeing any signs that the economy is getting a little better for them, willing to buy more discretionary items? Maybe you could speak to what's going on in the meat department, where it sounds like you were able to pass through inflation?

Sure. Obviously, the consumer is continuing to evolve. We've seen solid growth, as Jim mentioned, in organics and some of the other specialty categories across the board.

And I think as the consumer continues to become more educated in the products that we sell -- again, we continue to show tremendous value to the consumer, and continue to transition, and accelerate that transition, of the everyday grocery shopper over to a natural food consumer -- you are going to continue to see growth in those categories.

Yes, I think one thing we'd like to add there is, what we're very excited about is the categories, we've talked about non-GMO, organic, raw, gluten-free, those categories which would drive, obviously, higher retails, the consumer's resonating towards. But you still have to have value.

You still have got to make sure that when you carry those items, whether it's even a Suja drink, that you still have to be priced relative within the category. So it's striking the right balance with those, but we're excited about the consumer's ability to want to be more of an attribute shopper.

Can you speak to the meat and seafood category, as well?

Meat and seafood category, we've had great success. We have a quality product. We have a huge point of difference there that I don't think we've communicated that well, in terms of level of service on the counter, the quality of product that we provide for our consumer.

We get fantastic marks in third-party research that we do. And next year, we're going to roll out better messaging in the store around those products, and get behind it from a social front, and also on a print front.

So we're not seeing a huge change in what's in the basket, but we are happy with the overall sales performance, and see it as a huge upside, and becoming even more of a destination department for Sprouts.

And what we've seen is, despite the inflationary increases in price, that department continues to outpace the overall comps, so that's pretty exciting. Our seafood program is getting stronger and stronger, and we're seeing the customers really resonating well in that program, also.

The meat departments are those departments people -- they have to trust you as a retailer. So it's good for us that we continue to see that, that shows a lot about the strength of the brand.

All right. Thank you.

Thank you. David Magee, SunTrust.

Good afternoon. At what point will you have enough information to feel good about the holiday assortment that's been expanded this year, and is there any markdown risk with those products?

We're adding a significant amount of new items from last year, but we have a lot of proven items. We've got a team we've assembled here in the office, been together for quite a long time, and the operators in the field, the program, we're very comfortable with how we execute it.

We understand the timelines for -- we're confident that we'll clean up well, and the forward looking numbers will reflect that, that Amin discussed. So we don't see any risk in markdown, we see more upside in sales.

And I would say there is probably more upside in forward baskets. If you recall from several of our calls, that we really focused on being a healthy grocery store versus being a specialty food store. So as you look at the products we've brought in, and the assortment that we've expanded, we've been able to meet a broader need for our consumers, and get a more -- a fuller basket shop at Sprouts.

So obviously, as we continue to roll through the holidays, a lot of the success we had last year was being able to fill out more of that full basket shop in our stores for the holidays, as consumers really focus on healthier products for the holidays. So again, I think we're going to build on that success. We're excited about building on that success in 2013, and look forward to another successful holiday.

Thanks, and then secondly with regard to the -- back to the gross margin issue, and that number been down 50 bps. If I were to put the impacts in buckets, and maybe, say, 30 bps of that came from the inflation aspect, and then maybe 10 bps to conventional competition, and maybe 10 to the new store impact, would I be far off with those numbers?

What I would say is, substantially all of that margin impact came from the categories where we did not pass on full inflation, that being produce, dairy and nuts. To a lesser degree, we've seen, as Doug spoke to in his opening remarks on high-flow items in grocery, we've seen some increased competition on that front, but that did not have any material impact to our overall margin in the quarter.

So I think, David, the other way I would answer that is that to the extent that inflation sort of normalizes, or as it normalizes, or competition continues to pass on the pricing, and less promotional activity, we would see that margin compression coming back, and we're seeing it with lower inflation starting into this quarter. We're already seeing, and we expect for the fourth quarter, an improvement in the compression, from the 50 basis points in the third quarter to a lesser compression in the fourth quarter, for sure.

Thank you, guys. Thanks, Amin

Okay, that concludes our call for today. I'd like to thank everyone for joining us, and wish you all a safe and happy holiday, and a healthy and prosperous New Year. Have a great evening.

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