Sprouts Farmers Market Inc (SFM) 2015 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Sprouts Farmers Market fourth-quarter 2015 earnings conference call.

(Operator Instructions)

I would now like to introduce your host for today's program, Ms. Susannah Livingston. You may begin, ma'am.

Thank you and good morning, everyone. We are pleased you have taken the time to join Sprouts on our fourth quarter and year-end 2015 earnings call. Amin Maredia, Chief Executive Officer; and Jim Nielson, President and Chief Operating Officer, are also on the call with me today. Sprouts' 10-K, the earnings release announcing our fourth quarter and FY15 results, and the webcast of this call can be accessed 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 2016 expectations and guidance. These statements involve a number of risks and uncertainties that could cause actual results to differ materially from those described in our 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 issued today.

In addition, our remarks today include references to non-GAAP measures. For a reconciliation of our non-GAAP measures to the comparable GAAP figures, please see the tables in our earnings release. We believe these adjusted results provide a good basis to assess the operating and financial results of the Company period over period.

Also, please note that FY15 was 53 weeks, with the extra week falling in the fourth quarter, making it a 14-week quarter. For the fourth quarter ended January 3, 2016, we reported diluted and adjusted diluted earnings per share of $0.18. Adjusted diluted earnings per share increased 50% from $0.12 in the same period in 2014.

On a 13-week comparable basis, adjusted diluted earnings per share increased 33%, to $0.16. For the full year 2015, we reported diluted earnings per share of $0.83 and adjusted diluted earnings per share of $0.86, a 19% increase from 2014. On a comparable 52-week basis, adjusted diluted earnings per share increased 17%, to $0.84.

With that, now let me hand it over to Amin.

Thank you, Susannah. Good morning, everyone, and thanks for joining our call today. We are excited to end the year with a great quarter and momentum into 2016.

I could not be more proud of our team and the remarkable year we achieved through a near zero inflationary environment, challenges in produce in the first half of the year, and an evolving industry. Throughout the year, the business accelerated and our strength in the industry continued to grow, with our focus principles of health, selection, value and customer engagement. During the fourth quarter, Sprouts net sales grew to $930 million, up 27% from the same period of 2014 and up 17% on a comparable 13-week basis, driven by improved comp store sales of 7.4% that well exceeded our expectation and guidance.

While produce remains an important traffic driver, our merchandising and operations teams' ability to drive sales growth across the store in all departments is really starting to differentiate Sprouts. We have competed in both the natural foods and traditional grocery sector for more than a decade.

Operating in this environment has formed our business and execution strategy and sharpened our know-how. This experience in buying, sales and merchandising, and marketing, coupled with a great product assortment, value prices, and friendly customer engagement, are continuing to resonate with customers, as demonstrated by our results for the quarter and the year.

The 2015 holiday season contributed to our strong fourth quarter comps, as we applied learnings from holiday seasons past to deliver a compelling merchandise selection for our shoppers. Online ordering of turkeys and complete holiday meals more than doubled in November over the same period last year and increased in the triple digits in December, as Sprouts continues to establish itself as a healthy holiday destination.

This resulted in a strong traffic to the stores above our historical rates for the fourth quarter. I want to recognize our sales and merchandising team for the exceptional work on our holiday program and the operations team for the excellent execution in the stores which drove this success.

Regional sales performance remained strong in the fourth quarter. We experienced a small benefit of approximately 25 basis points in our comps from our California stores which overlapped with closed Haggen locations.

Let me shift to inflation. Inflation in produce increased in the fourth quarter and was partially offset by deflation in other categories, such as poultry, leading to an inflation of 1% for the fourth quarter. In addition, cannibalization from new Sprouts openings remained consistent with the third quarter, in the 140 basis point range, and we expect this to hold in the 125 to 150 basis points range in 2016.

For the full year 2015, sales grew to $3.6 billion, up 21%, and 19% on a comparable 52-week basis, with comp store sales of 5.8% and solid performance from our 27 new stores. We ended the year with adjusted EPS of $0.86, the high end of our guidance range set at the very beginning of the year.

No doubt the year had its challenges in produce and deflation, but in true Sprouts form, our team worked tireless to deliver in all areas of the business. They worked closely with our vendors, furthered innovation in products, including expansion of our private label program, continued to enhance our deli offering, deepened our connections with our customers through digital engagement, and deepened our bench, as we successfully expanded to the Southeast.

On the new store front, we ended 2015 with a total of 217 stores. Year-to-date 2016, we have opened seven new stores in four states for a total store count of 224 stores. Our pipeline remains strong, with 58 approved sites and 45 signed leases for the coming years.

Our new stores continue to perform well, with new store productivity in the mid-[70%s]. Let me shift to 2016. 2016 is focused on three distinct areas of priority that will continue to maintain our relevance with our customers.

These priorities are focused on sales growth, investment in infrastructure, and investments in our team. Let me start with sales growth. We continue to enhance our product offering each year by listening to our customers and responding to their healthy living needs.

As you know, we tested an improved deli offering in a few stores in 2015, featuring an extensive prepared salad offering, prepared food service case, fresh juices and specialty coffee. We plan to add the new deli offering in approximately 70% of our new stores, as well as over 30 existing stores in 2016.

We will continue to evolve our other parts of our deli, as well, including enhancements to our home meal replacement offering with even better ingredients, more selections, and improved packaging. We believe these deli enhancements will increase our daytime traffic and bring more relevance to our customer shopping experience without adding a tremendous amount of capital to our new store buildout.

Private label will continue to be a key area of focus in 2016. Our private label brands grew by more than 30% in 2015 and represent now over 9% of our sales today, and we believe this category still has plenty of room to expand for years to come.

When asked in a recent study of thousands of customers what they like best about our private label, the top areas were quality and taste. Given this customer response, we will continue to invest in this area in both human capital and innovation of new products.

We are proud of our position as a partner of choice with our vendors, thanks to many years of collaboration. As we scale and grow, so do our partners, and together we are focused on continued innovation and compelling promotional opportunities that attract and engage our customers to Sprouts. We look forward to building on our 2015 successes.

The second area of focus is our investment in infrastructure. To support our unit growth and remain an innovator in the industry, we will invest in improved technology for our teams. Some of the key investments include a business intelligence function which will help our merchandising and marketing teams become even more effective and efficient in our promotional and pricing strategies.

Second, our new human resource systems will give our team members the information they need at the tip of their fingers. Third, we will continue our journey to increase our customer connections through a focus on digital engagement. We will share our plans in this area in the near future.

Collectively, these and other technology enhancements will allow us to continue building a company which is well-positioned to benefit our customers, team members and shareholders. The third and final area is continued investment in our team. We just wrapped up our first all-store managers summit a few weeks ago.

This was a great time to align all of our store leaders with our 2016 priorities. Each store leader left with a clear understanding of the future of Sprouts and specific 2016 initiatives for their stores. Personally, what equally excited me from the summit is the first name basis, personal connections and engagement with team members that we made.

This is an open team member culture that we want to continue to cultivate at Sprouts. We also have launched a very busy 2016 training calendar for our stores and I look forward to seeing the results of these initiatives on sales and customer experience. We look forward to sharing the result of our three areas of focus in sales growth, investment in infrastructure, and investments in our team, as the year unfolds.

Before I turn it over to Susannah, I want touch on the other announcements released this morning. I am thrilled to have Brad Lukow join us as our new CFO. Brad comes to us with over 20 years of experience in retail, six of those years as a public company CFO.

Brad's strong business acumen, experience in scaling retail businesses, ability to work closely with merchants and operators, experience in leading real estate and technology functions, and a strong financial acumen will bring even greater capability to our leadership team. We look forward to having Brad join us soon. I want to thank Susannah for providing strong leadership in her role as interim CFO for the past six months and working closely with Brad as he joins the Company.

I would also like to thank Andy Jhawar for his guidance and leadership to the Sprouts brand and the Board over the past four years. Andy has been an incredible business partner for Sprouts, as we brought three companies together in 2011 and 2012 and then transitioned to a public company. We wish him continued success.

Lastly, I am humbled to be serving Sprouts as the newest member of its Board of Directors. With that, let me turn the call to Susannah to speak about our financial results and 2016 guidance.

Thank you, Amin. As Amin stated, we are pleased with our strong results for the quarter and the outstanding year in 2015.

We targeted sales growth of 19 % to 21% and unit growth of 14%, and we delivered on these targets with top line growth of 21% and the unit growth of 14%. Our comps came in at 5.8%, within our long-range guidance, despite a year with near zero inflation and challenging produce environment in the first half of the year. We also met our adjusted EPS range set at the beginning of the year by achieving $0.86, with a strong acceleration in the business in the back half of the year.

Let me spend a few minutes discussing some of the business drivers for Q4 2015 and guidance for 2016. For the fourth quarter, gross profit increased to $269 million, a 27% increase, and our gross margin rate improved 10 basis points, to 28.9%, compared to the same period in 2014.

This compared to compression in each of the first three quarters of the year. This leverage was primarily driven by the 53rd week, in addition to lower utility costs and higher margins in certain categories due to deflation, partially offset by price investment.

Direct store expense was $187 million for the quarter, and as a percentage of sales was 20.2%, an improvement of 40 basis points compared to the same period in 2014. Excluding the loss and disposal of assets, direct store expense as a percentage of sales decreased 50 basis points to 20.1%. This was primarily due to leverage of store level expense and the 53rd week, partially offset by higher payroll costs, due to an extra holiday in the quarter, and increased training initiative cost, as we continue to invest in our team members.

SG&A totaled $32 million for the quarter and as a percentage of sales was 3.4%, an improvement of 10 basis points compared to last year. This was primarily due to leverage in the 53rd week and lower corporate expense, partially offset by higher stock compensations due to executive changes and higher bonus expense for the quarter.

Adjusted EBITDA for the fourth quarter totaled $67 million, up 25% from 2014. EBITDA margin rate was 7.2%, a 10 basis point decrease compared to the prior year. As we noted on our call last year, a change in methodology of capitalization of new store development costs positively impacted our fourth quarter for 2014 EBITDA by $3.6 million, or 50 basis points, and we cycled that impact this quarter.

Adjusted net income for the fourth quarter totaled $28.4 million, an improvement of 57% from 2014. On a comparable 13-week basis, adjusted net income increased 34%. For the full year 2015 review, gross profit increased 19%, to $1.052 billion, resulting in a gross margin rate of 29.3%, or a decrease of 50 basis points from 2014.

Direct store expense as a percentage of sales for the year, excluding adjustments, was consistent with 2014 at 19.6%. SG&A as a percentage of sales, excluding adjustments, improved 10 basis points to 3% compared to 2014. Adjusted EBITDA totaled $302 million, up 14%.

EBITDA margin rate decreased 50 basis points to 8.4%, compared to 2014, slightly better than we expected. Adjusted net income for the year totaled $135 million, an improvement of 21%. On a comparable 52-week basis, adjusted net income increased 17%.

These results were driven by the strong top line sales partially offset by price investments and increased promotional activities, in addition to lower interest expense as a result of voluntary paydown on our revolver, a decrease of interest rate from our April 2015 refinancing, as well as a lower effective tax rate due to increased charitable donations. Shifting to balance sheet and liquidity, our balance sheet is stronger than ever as we continue to generate robust operating cash flows which reduced our debt during 2015.

For the year, we generated $240 million of cash flow from operations and invested $104 million in capital expenditures net of landlord reimbursements, primarily for new stores. In addition, due to our strong cash flow generation, we voluntarily paid down $100 million of our outstanding debt during the second quarter of 2015. As well, in the fourth quarter we repurchased $26 million of common stock under our $150 million share repurchase authorization and another $59 million of common stock in the first quarter, totaling a repurchase of 3.5 million shares in the fourth quarter of 2015 and the first quarter of 2016.

With our strong operating cash flows and low debt, we are well positioned to self fund our growth plan and build on our strong liquidity position. Now let me turn to 2016 guidance. We believe our strategic focus on the primary initiatives laid out by Amin will continue to drive sales and efficiency to our business while remaining relevant to our customers.

For the full-year 2016, we expect net sales growth of 16% to 19%, driven by 36 new stores and comp store sales growth of 4% to 6%. On a comparable 52-week basis, this would equate to net sales growth of 18% to 21%.

Adjusted EBITDA growth of 9% to 11%. On a comparable 52-week basis, this would equate to 12% to 14%. Adjusted diluted earnings per share of $0.96 to $0.98, all in line with our mid-term targets.

We expect CapEx net of landlord reimbursements to be in the range of $145 million to $155 million. In regards to store opening, due to Haggen bankruptcy proceedings, we picked four of their sites. These are expected to open in 2016 and will be additive to our 14% unit growth for 2016.

As we have always stated, we will be opportunistic when these situations present themselves, especially when they occur in markets where we have deep bench strength and solid teams, in addition to strong brand recognition. For 2016, we would expect to open up 36 stores, but keep our long-term growth rate at 14% unit growth. A few additional items to note on the 2016 guidance.

First, we would expect moderate inflation for the year of approximately 0% to 2%, aided by the current inflation we are seeing in produce. Second, as we have done in the past, we will continue to make price investments as necessary to drive top line sales and have considered that in our guidance. This will result in our overall 2016 gross profit margin to be in line with that from 2015.

In addition, with our established store base in the Southeast, we plan on opening our new produce warehouse in Atlanta area mid to late in the year. This will be a third-party logistics site and therefore, will not incur CapEx for this facility.

Third, on the direct store expense line, while we expect to benefit from leverage from our pre-2015 vintage stores, we plan to invest in our team members with additional training and strategic wage increases. This will lead to a compression in DSE as a percentage of sales compared to 2015 by approximately 20 to 30 basis points. We feel this investment is important to continue to strengthen and differentiate our in-store experience and build a strong pipeline of future leaders, given our unit growth across the country.

Fourth, in SG&A we have laid out today, we plan to make investments in infrastructure as we grow the Company. These investments are expected to result in SG&A expense as a percentage of sales to be flat to modest compression of approximately 10 basis points when compared to 2015. Both SG&A and DSE investments will be more front-end loaded for 2016.

Based on the components of margin, DSE and SG&A above, we expect compression of approximately 40 to 50 basis points to EBITDA margins for 2016, primarily driven by the strategic investments in direct store expense laid out in the call today. Below the EBIT line, we expect to have approximately $15 million in interest expense, including capital leases and other interest expense, a weighted average diluted share count of approximately 154 million shares for 2016, and a corporate tax rate of 38%.

Lastly, for the first quarter of 2016, we expect comp store sales growth to be in the range of 4.5% to 6%. The heavy rains that occurred on the West Coast impacted the January produce crop. While this does not compare to the tightness we experienced last year, it has impacted both quality and availability of produce for the month of January and also led to some inflation on produce.

As we look out, these rains have eased and we don't see any significant headwinds to produce availability in the near term. These factors have been taken into consideration in the Q1 comp guidance.

In conclusion, we are very pleased with our financial and operating performance in 2015, especially as these results have exceeded industry averages. We are on good footing with a strategic 2016 plan focused on top line growth, developing our team members, and appropriate investments in infrastructure and technology to position Sprouts to be relevant with our customers and build an organization for sustainable growth for the long term. With that, we'd like to open up the call for questions.

(Operator Instructions)

Meredith Adler, Barclays.

Congratulations. I was wondering if you could talk a little bit more about the investments you're going to be making in direct store expenses. Specifically I'm interested in understanding what you're seeing on the availability of workers and wages, and then maybe a little bit about turnover and the investments you're making in training. Are you keeping people to justify doing as much training as you are doing?

Good morning.

As far as -- I will take that in two part -- and the first one, as far as availability of workers. We've seen a little bit of flattening, but overall availability is good. Clearly, our ability to have people come in and move through the ranks, given our growth rate, clearly helps us on that front to attract good talent.

And our investment in training is really twofold. One is to improve, get even better on customer service and knowledgeable service and experience in the store, and then at the same time continue to build the pipeline that we need for future store growth at 14-plus percent unit growth.

So in terms of the wages, though, are you actually seeing much pressure on wages?

We're not seeing too much pressure, except in a couple of markets. We are moving up. As we had mentioned on the last call, we've reviewed all of our wages, and there are certain departments where we are really looking at the service element and we're moving on some wages proactively to ensure that we can improve our turnover in those areas and get quality hires, as well as once the team members are trained, to retain it.

So your question about reducing turnover: our turnover is better than industry average. The reduction in turnover is really a focus on twofold, one is improved service and then second is so that we can retain the talent that we need for new stores. I think you also asked a second question about DSEs.

Yes.

As far as the DSE investment is concerned, the primary investments are being made in, as I just mentioned, some for certain positions and wages, some dollars in benefits, and then training, also. And then on the G&A side, we are accelerating some infrastructure investments in business intelligence, some of the digital work that we are currently doing. Those are the two big ones, and then also some hires in our sales and merchandising team.

Great. Thank you very much.

Karen Short, Deutsche Bank.

Good morning. Just a question, starting on comps. You said in your prepared remarks something along the lines of you're seeing continued momentum into 1Q on comps. But your 1Q comp guidance on a one-year and definitely on a two-year basis reflects deceleration. Can you maybe reconcile those to the comments?

Sure. I think the first thing I would say is that exceptional holiday season for the last three years. We've continued to build on our holiday season, and this year was the best. So there's definitely some acceleration that happened in the fourth quarter for the holiday season. In terms of coming into this quarter, the only thing we have seen is January is a little bit -- availability in produce was a little bit tight, and that's gotten better.

So that just impacted some promotional capability early in the quarter, but we seem to be well on track, and our other departments are doing well. So, I think, given all the different components here, we feel pretty good about being in that 4.5 to 6 range, and as produce continues to get better, which we've seen in the last few weeks, we feel good about that range.

Okay. That's helpful. And then a bigger picture, in terms of your gross margin philosophy. I get the sense that you're not necessarily targeting strategic categories in terms of investments in the store. It's more, as you said last quarter, wiggle room. Is that fair, or has anything changed on your gross margin philosophy?

From a philosophy standpoint, I think the strategy is still the same. We do a lot of price checks. We look at all the different categories, based on not only categories, but also different regions of the country. And so what we will do is in areas where we know that over time things can potentially get a little bit more competitive or are getting competitive, we generally take an offense approach and move in quickly. And we feel good about our 2016 guidance having sufficient flexibility to move in some categories, if we need to, as we would normally expect.

And have you seen any changes in the competitive environment more recently?

I'll let Jim jump into that.

Karen, I'll break it down into the components we always talk about in terms of competition. New outlets was neutral on a sequential basis and a year-over-year basis. Regarding assortment, we have seen some more retailers carrying organic and natural products in their stores. Promotions was in line with prior quarters.

And we have seen some pricing investments, and some of you have noticed that, with some retailers and some regions. All that being said, our 5.8 full year comp, which accelerated throughout the year, really speaks to our ability to differentiate through our health, value, selection and service.

Thanks.

Vincent Sinisi, Morgan Stanley.

This is Andrew Rubin on for Vinnie. Thank you for taking the question. Just following up on gross margin. So the impact of deflation was called out as a benefit. I'm just wondering if you could talk more about how you make the decision of where to invest and when to let it drop to the bottom line, and if that calculation is different when you're seeing deflation in produce compared to other categories.

I think overall our philosophy, as we've shared before, is we are very much a top line driven company and a traffic mindset company. So, we do a lot of price checks and look at each of the different categories, as well as the regions of the country and we will generally maintain our produce strategy across the board. And then, depending on competitors and region and how they move, we may take specific strategies in specific departments.

So I think in the fourth quarter, the only thing that most of you already know is some of the retailers, including us, benefited some from poultry and benefited from poultry deflation, and we did gain some margins there. And at the same time, we were able to offset some of that margin investment in other categories that we felt like we wanted to be more competitive in in certain regions, so those two offset each other in the fourth quarter.

That's helpful. Thank you.

And then just in terms of what you're seeing on the produce side, any more detail you can provide in terms of what categories have been affected, what the magnitude is, and timing for it to all work through and what the outlook is for produce throughout the quarter?

This is Jim.

Looking back to Q4, we did see inflation in produce in categories like apples, berries, melon and wet veg. And as Amin alluded to, we saw some of that carry over into early Q1. It was driven by the heavy rains. But the outlook for produce is to be inflationary in the first half of the year, stabilizing in the back half.

Thank you.

Alvin Concepcion, Citi.

Great quarter and congratulations to Brad and thanks, as well, Susannah. Just a follow-up on the same-store sales color. I'm wondering if you could give us any more color on any particular categories or regions that performed better than you expected in the quarter.

This is Jim. We don't speak to regions specifically, but we saw nice comps across the board. But some of the things that Amin alluded to, obviously for our strong holiday program that the sales and marketing and ops team assembled was extremely successful; in fact, our most successful to date. We also saw, some of the items that really drove that were key holiday items, turkeys, ribs, our holiday meals, non-perishable holiday items.

And we had outstanding performance from our private label. The Thanksgiving and Christmas holiday in and outs drove a 40% top line growth in private label, and our private label penetration exceeded 10%. And then we've also seen some really, really strong tailwinds in all the attribute categories, gluten-free, organic, non-GMO, vegan, so all those continue to be an industry leader.

I'm just curious, what kind of inflation have you been seeing lately? Specifically what's baked into your 1Q 4.5% to 6% same-store sales numbers?

I think that we're starting to see -- we saw heavy inflation in January that's start to flatten a little bit in the produce category. But I think the first quarter is we're probably closer to the 2% range, as Jim alluded to. So in our numbers, I think that there's probably, call it, 1.5% to 2% of inflation in the first quarter. And I think as we go through the year, we could see it flattening a little bit.

Got it. And last one for me, question on sourcing. It's been a huge advantage on the West Coast. As you're going to the new markets in the Southeast, is your sourcing advantage translatable? Are you still getting good quality, good prices as you move into these new markets?

We obviously are on the produce side, as well as some of the bulk items, we have, as you see in Dallas and that's always provided to the middle of the country. And as we moved into Atlanta, later this year we are going to be adding a DC in the Southeast. It's going to be a 3PL facility, so it won't have a CapEx implication; however, that will allow us to condense some times and get the product to the stores a little bit quicker and continue to meet our promise of getting produce and other key fresh items to the store in a short period of time.

So we feel pretty good. And as we have mentioned before, is the middle of the country tends to be a little bit higher in distribution costs and it translates into slight higher retail. And so to the extent that the distribution costs are a little bit higher in certain categories to get to that region, you generally see that being reflected in retail. So we're not concerned from a perspective of being able to pass it through to the customer.

Thank you very much.

Scott Mushkin, Wolfe Research.

I just wanted to clarify a couple of things on the store growth. I didn't really get it. Is the 36 inclusive of the 4 stores that you're bringing on from Haggen, or is the 4 stores in addition to that?

The 36 is inclusive. So if you do a 14% calculation, it would be 31 stores, and then we have 4 Haggen, and then we had a late comer in one of our existing markets. We saw a great site. It came available and we just took it. Because it's a mature market and it's a site that can open later this year, we decided to go ahead and add it in.

So the 36 is inclusive of all that, and the revenue grew is inclusive -- top line growth is inclusive of everything. Just wanted to double check I have it right.

Correct. And the four Haggen stores will open in the back half of the year, starting late Q2, beginning of Q3, just because they require quite a bit of work inside the site, demolishing walls, et cetera, because in some cases, we won't keep all the square footage. And we have some good co-tenants that are already lined up and in final stages of works coming to those sites with us.

Okay. Perfect. Thank you. The second question is probably for Jim. Jim, as we've been out in the field, we've been noticing -- it's flattering, you've got copycats out there as far as what you're -- produce, we're noticing -- . I think you have sometimes in your stores limes for $0.25 each, smaller apples, maybe lunch box size apples.

We're seeing this adapted, or this strategy going into some of the traditional grocers. So I look at that and then I also look at, not a direct competitor, necessarily, but Whole Foods and their pricing. And we try to get comfortable that gross margins won't need to come in a little bit as the year goes on, if competition continues to ramp up and encroach.

As far as pricing and pricing investment, what we saw in Q4, as well as what we're seeing in Q1, we are not seeing anything that's not in line with prior quarters. But what we continue to do is solidify how we source the product to ensure that we are getting the bright best price so we can pass that on to the consumer. We're also focused on expanding our variety. So not only the value-added, but the organic side of the business.

And then as Amin alluded to earlier on the training program, one of our major initiatives next year is improving our engagement from our team members. So we think that three-pronged plan gives us the ability to differentiate ourselves.

And Scott, the only thing I would add, in addition to what Jim said, is some of our focus areas in the store are in whether it's growing deli, growing private level label, et cetera, those areas do carry slightly higher margins than the overall blend. And given that, that allows us the ability to translate that into price investments as the market conditions require.

Does the new deal with [Keagy] help, as well, too? Is that something you can use to get some pricing into the market?

The new deal with Keagy?

We've not redone our contract with Keagy. I know Keagy recently announced an acquisition, and so that, we won't speak to the specific contract, but they acquired a fresh business. But Scott, we have not, at this point -- we have not -- both of our contracts expire in 2018, so that is something, obviously, we'll work toward sometime next year. When I say two contracts, I am talking about the Keagy and the unified contracts, so no huge change into this year's numbers, in short, from that contract.

Okay. Perfect. Thank you for the clarification.

Bill Kirk, RBC Capital Markets.

Thank you for taking the question. I'm curious. Why isn't the expanded deli going into all the new stores? I think you said 70% of the new stores, so I'm curious what the difference is between the locations getting it and the locations not.

The biggest driver is the daytime population. Obviously, our location is, we have a very broad segmentation of customers and we're able to put a Sprouts location in a lot of different places. And so probably a better representation is 70% of our stores are going to have the full complement of deli, including the expanded initiatives.

But even in the other 30%, we will still have a good deli offering, plus some additional items that we're putting into all stores from our expanded initiative, but they may not have the full complement that we might. And that's a function of daytime traffic.

Bill, the only exception, the only item that you wouldn't see in there, would be the salad bar. So it will have all the other components.

And so is it a size issue, too, or is it just the market?

It's not size. It's primarily the daytime population that drives the decision on the complement of deli. If you're way out in the suburbs and you might not have as high of a daytime traffic count or an average full population count, then we decide to just put in a more effective complement.

What I will say is that we are wiring and piping all of our stores for the full complement. So to the extent that those stores are doing well on the deli side, it would be very low CapEx cost to add the additional items in those 30% of the stores. So if we are seeing good 12 o'clock, 5 o'clock in the stores, it'll be very easy for us to add those one or two items that we're not adding in going out of the gate.

In terms of unit expansion, is it worth reading into Brad's experience in Canada?

No. That would be way too early. We just really enjoy Brad for his depth and breadth of working with an organization which grew from $3 billion, $4 billion to $13 billion over time, and his wide breadth of business experience, real estate experience, technology experience, finance experience. And the most important, the culture and the fit that he brought to the team. So no, that Canada would be too far of a reach, at this point.

Okay. Thank you.

David Magee, SunTrust Robinson.

Jim, when you mentioned that certain retailers are investing in price, could you talk about whether that's more on the conventional side or on the organic side? And is there any common dynamic that would trigger additional price investment from those competitors?

I can't speak to the other competitors. But when I was referring to price, it's primarily anchored around the natural organic packaged goods and it's only in a few markets, and it's been a slight investment which has been pretty consistent quarter to quarter. So we have not seen a material shift in that type of investment.

With regards, again, to what a retailer's going to do, I could not speak to that. But I feel very, very comfortable about our pricing strategy and the strategies that we've developed that we react quickly and our sales have responded extremely well.

Thank you. Did you all announce any new markets for this year?

No. I think in 2016, all of our openings are going to be in our existing states. So we will be going to some additional markets within states, but we're not going to be expanding any new states in 2016.

Thanks, Amin. And I noticed recently there's a store here in Atlanta that's in town, tucked into a in-town work-live center, which I haven't really seen before you all do. Just curious if that's something that you're happy with and might be provide more opportunities, more openings?

I call those almost, you have urban locations, semi-urban locations, and then suburbs. The specific store that you are referring to, I would put it into that semi-urban location, and we've had great success in that type of environment, where areas are regentrifying, and it's provided us some strong sales. So, that store in Morningside would fit into that category.

And I was at that store and I am pretty excited about we're still doing some additional things on signage, et cetera, with the landlord that can enhance it even further. But we are excited about the starting of that store and how that store is going to work. So we've had great success of those types of locations in Denver and in other markets and in parts of California. So look for us to continue to take that strategy. And frankly, as we keep building out our deli program, that allows us to be more relevant with that type of customer.

Thank you and good luck.

Andrew Wolf, BB&T Capital Markets.

Good morning. I wanted to ask a couple of follow-ups on some of the human resource allocation, things you've been talking about with investing in training, wage increases for entry-level folks. Particularly on the training side, is this an element of trying to catch up to your pipeline? Do you feel you need to get more -- a deeper bench in terms of the number of potential store managers and so forth? Or is it more you just trying to deepen what you can give, the service levels you can provide?

I think it's both. It's to deepen our bench for growth. I think the bigger opportunity, from our perspective, is there are certain departments we can be doing even better from a customer service, and its knowledgeable customer service. With our model, when customers come into stores, they have a lot of questions about attributes and specifics within departments. And as we've added more attribute-based product, whether it's in the meat and seafood section or other areas of the store, customers ask a lot of questions and it allows for an opportunity to engage with the customer and give them that customer knowledge. But that requires you to have the knowledge on the floor at all times.

So I think it's both. It's partially building the bench. Where I'm excited about is providing them that customer experience and the memory to really drive loyalty into the Sprouts store. And we've seen that accelerate in certain departments, where we had started training, and because we had seen that waterfall into expansion of comps into those categories, we feel like that's a good opportunity in other areas of the store to keep expanding the service.

Andrew, as far as far as pay, 90% of our markets are above -- starting wages are above minimum wage. So we feel very, very good about where we've started and we continue to invest there, as well as our average hourly rate is well above the industry average. We've continued to invest there and it's paying dividends, helping reduce our turnover and attract a better group of potential team members.

On the last point, Jim, is that a recent step up, because last quarter I think you referenced entry-level wages. Is that a needed step up?

We did step ups throughout the year last year. So Amin alluded to we took certain departments and job classes and we made some changes. We made some changes within states. But beginning of this year, we made some changes in all markets in order to make sure that we were well-positioned, and we feel very good about our current position.

That's the 30 -- 30, 40 basis points, that part of that 30, 40 basis points that Susannah alluded to in her opening remarks of adding that to the wages, as well as benefits and the training cost. So those three pieces are that 30 basis points she talked about.

Just one last. It's a follow-up in the same questioning. Whole Foods had some staff reductions, a lot of well-trained store employees left or were let go. Has that availability helped you try to recruit talent and some of those people finding their way to Sprouts?

I think our talent process is coming from many different retailers. I won't speak to anyone specific, one specific company. But overall, we see talent coming from a lot of good food retailers and other non-food retailers, as well. And really, when you talk to individuals about why they came to Sprouts, you hear two consistent messages. One is the growth opportunity to advance their personal and professional growth, and the second is just the great work environment, because they can influence people's healthy eating habits and it's a great environment to be in. So we feel pretty blessed and fortunate in being able to work on that front, as well.

Thank you.

Bob Summers, Macquarie.

Just a couple quick questions.

On the new deli offering, what's the lift in terms of margin sales or both, and then what's the right way to think about the cadence of the rollout?

In terms of specific comp lift, and we've only done it in a handful of stores, so we won't talk about it in that context. The only thing I would say is the ROI is well north of 20%, and I will leave it at that. And as far as the cadence of the rollout, I'll let Jim speak to it. It's fairly even throughout the year, but generally we try to get things done in the first nine months of the year.

As Amin mentioned, there were 30-plus stores that we will be launching. Obviously, it was really critical for us to get off to the right start and make sure that we did not have any issues in the first rollout. So we will be completing all of the deli initiatives by the first part, late second quarter, first part of the third quarter.

Okay. Just bigger step back, it seems that there's a tendency to oversimplify what you do and what you have accomplished. And so as you think about sourcing, pricing, store execution, the overall store experience, or the overall experience, just remind us again quickly why the business model is defensible and difficult to replicate?

We wish we had about six or eight hours on this call. I think there's a lot of elements to any business, including the Sprouts business, everything from sourcing to buying to pricing to promotions to the layout of our store, the ease of the shop, the clarity of coming in and know you're feeding your family healthy, the environment, the customer engagement, the customer service.

So when you put all the elements together, as we all know that there are nuances of any businesses that make them special, whether we're talking about Starbucks or somebody else. And we really feel fortunate to have many of those elements at Sprouts. However, Jim and I know that we have opportunities in various areas of customer engagement, continuing to move the private label forward, continuing to move the 12 o'clock, 5 o'clock forward.

And all of these elements that we're really focused on moving forward are not just what we think, but they are also what the consumer is telling us. We continue to every 18 months do a deep consumer engagement customer study of our customers, our competitors' customers, et cetera, and really learn from that and become students of that and see how we can get better.

So, I would say there is a lot of elements today, but we have our differentiations today. But we know in any business, differentiations shift over time and we are not going to be static as a company around those, we're going to keep moving forward as the consumer preferences evolve.

Bob, if you get an opportunity to come out to Phoenix, I'll personally give you a tour of our store and I think you'll gain a really good appreciation of why we are just a little bit different and we differentiate in many different categories. But I think you've got experience it to really feel it.

I'm in agreement that it's differentiated. I just think that others need more convincing.

Okay.

Mark Wiltamuth, Jefferies.

Wanted to dig in a little bit more on your exposure to meats. Because the broader market is nervous about meat deflation, and clearly it did not hurt you this call. Just wanted to get your percentage of sales in the meat area and maybe just contrast how big your poultry is versus your red meats.

We don't disclose what percentage of sales are by department. But as far as the fresh meat side, it's fairly in line with the conventionals. And we did see deflation in poultry and pork, and we continue to see that the first part of the year.

But again, it will taper and move towards inflationary in the back half. So we just did a good job of managing it and managing the prices relative to the market, so we didn't have any exposure.

The one thing I would add is where we're a little bit different than some of the other retailers is produce is 25% of our business, and we did see slightly higher inflation on the produce side in the fourth quarter and into the first quarter here. I would call that out, is our mix is different, so when we talk about 0% to 2% inflation --

-- is still lower. It's like 14%.

--is lower because of our higher produce mix, as well as we have other departments that conventional don't have or where we have a higher mix. So that's correct, our overall -- we actually do disclose -- meat and seafood overall, which includes poultry, for meat, seafood combined, it's about 9% of our business.

Okay. Did you disclose traffic ticket for the quarter?

Traffic for Q4 was almost 70% traffic, so it was about 5% of our 7.4 comp or at 5%.

Okay. Thank you very much.

Zach Fadem, Wells Fargo.

Can you talk a little bit about the impact of the competitor bankruptcies in California? You said it helped the comp by about 25 basis points. Do you expect the same or similar impact over the next two quarters or the next quarter? And separately, are you seeing any slowdown in your Texas and Oklahoma stores due to the energy sector downturn?

In California, that 25 basis points will dissipate over the next couple of quarters. As we talk about, we're opening our 4 stores in June and after that, there are a few other retailers who took those stores, who, some of them did not close the stores, or they turned the stores fairly quickly, opened fairly quickly, and others will be opening them in the next six months. So we will see that taper off in the first half of the year.

And then in terms of Texas, we've seen slight impact in certain pockets of Texas. We have not seen it across the board. But areas which have a higher number of oil and gas jobs or where the economy feels a little bit more sluggish because of the downturn and consumers are a little bit closer to the chest.

We have seen a little bit of an impact. But one of the things that differentiates us is our value prices helps us maintain that momentum in the business, as many of you know that during the last big downturn, in 2008, 2009, Sprouts was one of the few retailers who continued to comp positively throughout the recession. So we feel good about that in our model.

Got it. And on cannibalization, at 140 basis points, that was a little higher than we thought in the quarter, so just with respect to the new stores in FY16, you said most of the openings are existing markets. So does that translate to the 125 bps of cannibalization, or could it be higher? And how does that typically compare, assuming your typical 70/30 split?

Typically, our split if 70/30. And for 2016, it's going to be right around that, maybe slightly higher, but in about that range because of the four Haggen stores. But those additional stores don't really add any meaningful cannibalization to our existing stores.

So I think that because we have that 70/30 split, we would expect that 125 to 150 basis points to be in the wide range. And many times, when we do see that cannibalization, it's purposeful in the sense that our volumes are so high in a nearby store that we'll open a store to peel that, to allow that store to grow again. And we have seen that over and over, so that strategy has played out for us, so we're continuing that.

Got it. Thanks a lot.

Ladies and gentlemen, this does conclude today's question-and-answer portion. I would now like to turn the call back over to our host.

Thank you, everybody, for joining the call today and we really look forward to providing updates throughout the year on our key initiatives, as well as our performance. So we'll see you in the market soon. Thank you.

Ladies and gentlemen, this does conclude today's presentation. You may now disconnect and have a wonderful day.