Sprouts Farmers Market, Inc. (SFM) Q4 2014 Earnings Report, Transcript and Summary

Good day, ladies and gentleman, and welcome to the Sprouts Farmers Market Fourth Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions]. As a reminder, today’s conference is being recorded. I would now like to turn the call over to Susannah Livingston.

Thank you, and good afternoon everyone. We are pleased you have taken the time to join Sprouts on our fourth quarter and year-end 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' earnings release announcing our fourth quarter and fiscal year 2014 results and the webcast of this call can be assessed through the Investor Relations section of our Web site at sprouts.com. In addition, Sprouts’ 10-Q will be filed tomorrow. During this call, management may make certain forward-looking statements including statements regarding our future performance and growth, product expansion, new store openings and 2015 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 filed today. In addition, our remarks today include reference 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. For the fourth quarter ended December 28, 2014, we reported diluted earnings per share of $0.11 and adjusted diluted earnings per share of $0.12. Adjusted diluted earnings per share increased 71% from $0.07 in the same period in 2013. For the full year 2014, we reported diluted earnings per share of $0.70 and adjusted diluted earnings per share of $0.72, a 50% increase from 2013. With that, let me now turn it over to Doug.

Thank you, Susannah. Good afternoon, everyone, and thanks for joining us today. We are excited to report another great quarter to end an incredible year for Sprouts, and I couldn’t be more proud of our team as they delivered outstanding execution and customer engagement throughout the year. This included bringing new and innovated fresh, natural and organic products to our customers, delivering excellent customer service during our numerous remodels, entries into new markets, new states and a record 24 new store openings during the year. Additionally, our support office teams did a fantastic job supporting our growth while working through bouts of inflation and severe weather by droughts and freezes that occurred throughout the year. The focused execution on our strategic plan in 2014 once again produced strong top line sales growth and excellent bottom line financial performance even surpassing our own expectations. For the fourth quarter, our net sales grew to 735 million, up 21% from the same period in 2013, thanks to improved comp store sales and the strong performance in our new stores. We were very pleased with 8.5% comp sales growth we achieved for the quarter, especially in the face of a 13.8% comp for the same period in 2013 and a 2014 fourth quarter produce season that was tight in availability and quality driven by those weather conditions. Despite these headwinds, our financial results exceeded our guidance and generated an industry-leading 22.3% two-year stack, representing our 31st consecutive quarter of positive same-store sales growth. Our comp performance was balanced 50/50 between traffic and ticket, as we continued to gain new customers and increased visits from existing customers. Strong customer traffic, a fantastic holiday campaign and expanding private label program and continued momentum in specialty categories are just a few of a factors that drove this exceptional performance. The appeal of the Sprouts brand, especially for the middle income, consumer looking for healthier, affordable food choices continues to resonate across the country. And during this past holiday season, the desire for healthier holiday choices was very more apparent. Thanks to the continued growth and success of our holiday campaigns, more and more consumers are beginning to view Sprouts as the holiday destination from organic turkeys to a wide variety of specialty items like gluten-free stuffing, we continue to strive to meet the customers’ needs for healthy and tasty holiday celebration. As a result of these efforts, we produced holiday sales that well exceeded the average company sales trends for the quarter, and in addition our Grab & Give food drive had a record year that contributed to the 3.4 million we raised for local charities throughout the year. Sprouts private label also contributed to our successful fourth quarter with comp and sales growth exceeding our company average. Innovation continues to be a focus in this area as we introduced more unique and seasonal private label products during the fourth quarter. We were very pleased to see the enthusiastic response to many of our new pumpkin holiday items for this year like Pumpkin Snaps that were such a fan favorite they were hard to keep on the shelf. We continue to improve the depth of our product offering in the fast-growing specialty categories that provide strong sales momentum. Specialty categories like organic, raw, non-GMO and allergy-free continued to experience comp and sales growth well above our company average throughout the quarter. As for inflation for the fourth quarter, we continued to see higher levels in certain categories including produce, nuts, proteins and dairy. While we were able to pass along the majority of this inflation, we continued to invest in staples primarily in the dairy department and nut category recognizing the importance of certain price points and thresholds to our customers. As expected, the full year 2014 inflation rate was approximately 3%. Lastly, comps for the former Sunflower stores settles to be in line with the company average for the quarter. We were very pleased with additional tailwinds that these rebranded and re-merchandised stores brought to our overall 2014 performance and look forward to their continued success. New store productivity for the quarter was in the mid to upper 80s and while lower sequentially, it remains strong when compared to historical averages, internal expectations of 75%. This was mainly driven by the large number of new stores we opened in the third quarter of 2014. Typically, new stores that opened toward the end of the year performed softer during their initial holiday season when compared to those that opened toward the beginning of the year when customers have had time to become more familiar with the Sprouts brand and our offering. This same trend has occurred in many of our past vintages over the years and was magnified in the fourth quarter as 58% of our 2014 vintage opened in the back half of the year. For full year 2014, our net sales grew to 2.97 billion, up 22% from the prior year, thanks to impressive comp store sales growth of 9.9% and strong performance from our 24 new stores. Our two-year stack comp store sales remain consistent with 2013 at 20.6%. For the year, our comp performance was balanced 50/50 between traffic and ticket, as we continued to attract a wide variety of middle-income consumers wanting healthier and affordable food choices. Throughout 2014, we improved our products offering, continued to innovate and most importantly grew in all areas of our business. We increased our Sprouts private label offering by 16% with sales and comps that were well above the company average for the entire year. In addition, we continued to partner with our vendors to bring forth leading and cutting-edge products in the fresh, natural and organic industry at prices our customers can afford. We experienced significant growth in specialty categories like organic, raw and non-GMO, which drove basket and overall comp growth clearly highlighting the shift in consumer preferences towards attribute-based foods. We also successfully opened 24 new stores including new market entries in Kansas and Georgia. All the new stores are performing well with new store productivity for the year ending just shy of 100% well above our historical average of 75%. Each day, the recognition of the Sprouts brand continues to grow exponentially and our digital and social marketing programs play a key role in this success. We had over 40,000 Facebook fans in Atlanta before even opening our first store and during this year, we surpassed 1 million fans on our main Sprouts Facebook page. Our digital and technology strategies continue to engage our customers with the launch of our new Web site this past year, enhanced educational content on an array of social channels and the installation of NFC in all of our stores for Apple Pay and Google Wallet. We also kicked off 2015 with our Every Meal Is a Choice Facebook campaign by giving away an entire year of free groceries to three lucky customers. We ended the year with 191 stores in 10 states, and with each new opening brought more opportunities for greater customer engagement, product knowledge and loyalty. Our more than 18,000 team members deserve tremendous credit for the success we achieved thanks to their unmatched commitment to inspiring, educating and empowering every customer to eat healthier and live better. The successful growth we have experienced has also created numerous career advancement opportunities, and I’m proud to say that nearly 20% of our entire workforce was promoted this past year, a trend that has continued over the past three years. These impressive industry-leading results are a strong indication that our model is resonating with a broad base of consumers across the country. With our knowledge and focus on fresh, natural and organic products across the store, our team members continue to make healthy eating easy, understandable and affordable for all. Now let me turn to 2015. Our proven success in new markets is bringing new opportunities as we expand into three new states this year. Our 2015 new store program will include the addition of Alabama, Tennessee and Missouri while continuing to focus 70% of our overall growth in our existing markets. Year-to-date, during 2015, we have already opened seven new stores including new stores in Missouri and Alabama. Our current real estate plan includes 62 approved sites and 45 signed leases for the coming years, keeping us well on track with our long-term 14% unit growth target. We remain a very desirable tenant thanks to our strong customer traffic volume and continue to have great success obtaining new sites. With a long-range target of 1,200 stores across the country, we are still in the early stages of our growth plan. Our 2015 growth initiatives are well underway as we focus on improving our customer engagement to drive repeat traffic and basket growth; expanding our private label program with the focus on health, uniqueness and value; increasing our specialty product offering; testing new deli offerings in a number of stores; reinvesting capital to maintain our high standards and building out infrastructure to support our long-term growth. Our knowledgeable team members do an incredible job engaging and assisting customers and we hear positive feedback from customers almost daily. As we continue to grow investing in our team members with the training in the latest products and trends is of the utmost importance and as a result, we are expanding our product and service training programs for 2015. Private label remains a great growth vehicle for our company that will only increase with our growing scale. For 2015, we will continue to focus on innovation to expand our private label offering with a continued focus on value prices. We look to attract further loyalty by expanding our private label non-GMO and organic offerings as well as building out our private label raw and imported product lines. And throughout the year, our every day variety and private label will continue to be enhanced with additional seasonal and holiday items both new and fan favorites. We’re excited about the continued enhancements across the store including additional healthy offerings in our delis to build up on our lunch and evening food service business. We will also continue our aggressive reinvestment program through a variety of sales initiatives. By the end of 2015, we will have updated all stores with the expanded product offerings found in our new stores opened since 2013. These efforts have proven to create good returns for the company and will also ensure consistent shopping experiences across our stores. And last but not least, we plan to launch the Sprouts Healthy Communities Foundation in 2015. We have always been a large supporter of autism research and family support services raising $5 million over the past five years with the support of our customers, vendors and team members. The establishment of the Sprouts Healthy Communities Foundation will allow us to diversify our giving to other worthy causes as well. Improving the health of the communities we serve has always been at the core of the Sprouts mission and in 2014 we diverted more than 8 million pounds of food from landfills by partnering with Feeding America and local food banks to make sure the food gets to the people in need. And in 2015, we are launching a Zero Waste initiative in a number of our stores to divert produce from landfills that would not otherwise meet our strict food donation criteria. In addition, all of our sites are being built to LEED certifiable standards utilizing energy efficient equipment. I look forward to discussing these growth initiatives in more with you as the year unfolds and I’m confident that 2015 is going to be another successful year for Sprouts. With that, let me turn the call over to Amin to talk about our financial results and 2015 guidance.

Thank you, Doug, and good afternoon, everyone. As Doug stated, we are very pleased with our strong results for the quarter and the outstanding year in 2014. Following Doug’s highlights of the business drivers, let me cover the operating results and guidance for 2015. For the fourth quarter, gross profit increased to $211 million, a 21% increase and our gross margin rate improved 20 basis points to 28.8% compared to the prior year. Leverage in occupancy and buying costs were partially offset by margin compression in certain categories. During the fourth quarter, inflation was still elevated though not as high as in the third quarter. We passed on inflation in most of our departments except in the nuts and dairy categories. Reinvestment in price, as necessary, which provides a strong value proposition to our customers has continued to drive our top line sales and margin dollars, which in turn has provided strong leverage down to the EBITDA margin line. This approach continues to be a productive strategy for Sprouts. Direct store expense was $152 million for the quarter and as a percentage of sales was 20.6%, an improvement of 60 basis points from 2013. This improvement was driven primarily by leverage in payroll and benefits, a decrease in insurance premiums and leverage of store level expenses. SG&A totaled $26 million for the quarter. SG&A included pre-tax secondary offering expenses in the fourth quarter of 200,000 in 2014 and 2 million in 2013. Excluding these items, SG&A as a percentage of sales increased 30 basis points to 3.5% compared to last year. This increase was primarily due to higher advertising expense from additional promotional activities as well as the impact of higher corporate expenses as we continue to build out infrastructure to support our growth. Adjusted EBITDA for the fourth quarter totaled $53 million, up 41% from 2013. EBITDA margin rate was 7.3%, a 110 basis points expansion compared to the prior year. Let me note that 3.6 million or 50 basis points of the 110 basis points of margin expansion was driven by a change in methodology of capitalization of new store development costs. The remaining 60 basis points of leverage was driven by the strong comps, resulting leverage and new store productivity above our historical averages. Adjusted net income for the fourth quarter totaled 18.2 million, an improvement of 59% from 2013. This increase was driven by strong business performance as well as reduced interest expense as a result of additional voluntary pay down on our term loan. The 3.6 million pre-tax benefit in new store development costs capitalization mentioned earlier was offset by a $4.4 million pre-tax depreciation adjustment. These two adjustments on a net basis did not have a material impact to our adjusted net income or adjusted EPS for the quarter but did positively impact adjusted EBITDA by 3.6 million or 50 basis points, which we did not expect to see in the fourth quarter of 2015. Now let me recap the full year of 2014. Gross profit increased 22% to $885 million resulting in a gross margin rate of 29.8% or an increase of 10 basis points from 2013. Direct store expenses as a percentage of sales for the year, excluding adjustments, improved 70 basis points and SG&A as a percentage of sales, excluding adjustments, was consistent at 3.1% compared to 2013. Adjusted EBITDA totaled $265 million, up 36%. Adjusted margin rate expanded to a record 8.9%, an improvement of 90 basis points compared to 2013. Adjusted net income totaled 111 million, an improvement of 65% and well above our long-term targets. These results were driven by the strong comp sales, resulting operating leverage and strong new store productivity, and were offset by an inflation, price reinvestments, increased promotional activities and our continued investments in growth infrastructure. Shifting to balance sheet and liquidity, our balance sheet is stronger than ever as we continue to generate robust operating cash flows and continued to pay down debt during 2014. For the year, we generated $181 million of cash flow from operations and invested $108 million in capital expenditures net of landlord reimbursements primarily for new stores. Due to our strong cash flow generation, we voluntarily paid down $50 million of our outstanding debt during the third quarter of 2014. At year-end, the principal balance on our term loan was $261 million and our net debt to adjusted EBITDA leverage ratio, excluding capital and financing leases, was 0.5x. We ended the year with cash and cash equivalents of $131 million and $53 million available under our undrawn revolving credit facility. With our strong operating cash flows and lower debt, we are well positioned to self-fund our growth plans and continue to build on our strong liquidity position. Now, let me turn to 2015 guidance. First, let me note that 2015 will be a 53-week year with the extra week falling in the fourth quarter. The company estimates the impact on earnings for the 53rd week to be approximately $0.02 per diluted share. As we look to the full year 2015, we expect net sales growth of 20% to 22% driven by 14% unit growth and comp store sales growth of 67%. On a 52-week basis, this would equate to 18% to 20% net sales growth. Adjusted EBITDA growth of 16% to 19%, adjusted net income growth of 18% to 22% and adjusted diluted earnings per share of $0.84 to $0.87. We expect CapEx will be in the range of $100 million to $110 million for 2015. In addition to a strong pipeline of new stores, we have remained bullish on the momentum in the natural and organic growth sector and are targeting our sales growth above our long-term target of 15%. Our focus on driving sales has greatly improved our sales per square foot over the last few years and we believe our focus on new product innovations combined with rolling out tested initiatives to more stores will continue to drive comp sales and efficiency in our existing stores. In comparing our 67% comp sales guidance for 2015 versus 2014, we expect the leveling out of the Sunflower store comps to impact comps in 2015 by approximately 1%. Second, lower inflation is also expected to impact comp by another 1%. A few additional items to note on our 2015 guidance. First, for 2015, our store openings are frontloaded as we expect to open approximately 66% of our stores in the first half of the year. In 2014, 14 of our 24 new stores or 58% of our stores were opened in the third quarter. Keeping in mind our new stores start at a lower store level EBITDA margin in the first couple of years and as a result, the frontloaded opening cadence in 2015 combined with the back-loaded opening in 2014 will compress gross profit, DSE and EBITDA margins in the first quarter. We expect each of these lines to normalize as the year progresses. I do want to stress that the compression in margin is mainly due to the timing of store openings. To provide further color on this point, we expect our pre-2014 vintage stores to leverage by 30 to 50 basis points down to that EBITDA margin line, including positive leverage in the gross margin and DSE lines. Second, as we have done in the past, we will continue to make price investments as necessary to drive top line sales growth and have considered that in our guidance. This, along with the previous comments on the timing of new stores, results in our expectation for overall 2015 gross profit margin to be line with that of 2014. Third, on the direct store expense line, while we expect to benefit from leverage from our pre-2014 vintage stores, we expect a slight deleverage to overall DSE for the year. This deleverage is mainly driven by the timing of the new stores as our new stores have a higher labor as a percentage of sales in the first year. Fourth, in SG&A, we continue to invest in infrastructure as we grow the company. Based on the components of margin, DSE and SG&A above, we expect a slight compression to EBITDA margin for 2015 primarily driven by the timing of the new store openings. Below the EBIT line, we expect to have approximately 24 million in interest expense including capital leases, OID and other interest expense, our weighted average share count of approximately 157 million shares and a corporate tax rate of 39%. Lastly, for the first quarter of 2015, we expect the comp store sales growth to be in the 5% to 6% range, the lowest for the year as we cycle the 12.8% comp from the first quarter of 2014. This range still equates to a strong two-year comp stack range of 18% to 19%. The tightness in availability of produce in fourth quarter that Doug spoke about continued into January and February, however, we are starting to see improvements in availability and the quality of produce, which will greatly enhance our ability to be more promotional and we’re expecting strong momentum into the spring season. We have taken the produce factors into consideration in our Q1 cost guidance. In conclusion, we are very pleased with our financial and operating performance in 2014, especially as these results have well exceeded our long-term targets and the industry targets. We are on good footing for a focused 2015 plan coupled with the momentum fuel by the everyday consumers growing interest in eating better. With that, we would like to open up the call for questions. Operator?

[Operator Instructions]. The first question comes from Robert Ohmes from Bank of America Merrill Lynch.

Thanks. Great quarter, guys.

Hi. Thanks, Robbie.

Amin, just maybe a follow up on your comments. Can you walk us through – so you have a lot of new stores that are opening at very high productivity levels, but at the same time new stores can pressure your operating margins. Can you just help me understand why the fact that your newer stores are coming out of the box closer to chain average productivity levels, why those operating margins aren’t coming at higher? Number one. And number two, as we look at those higher productivity new stores coming in, are you expecting a different comp ramp up rate versus the ones that used to come in at sort of lower than chain average? Thanks.

Thanks, Robbie. Good questions. So as far as our new store productivity for 2015, in our guidance we are assuming new store productivity in the mid-80s. So to the extent that we see high user productivity than those, that would be upside in the guidance that we’re providing. In addition – so that would be partially the cause of the margin or the sales as well as the margin that you spoke about. And in terms of timing, as I mentioned that we’ll be opening a majority of our stores, 66% of our stores in the first half of the year, so that’s putting on additional pressure onto the overall margin given the year-over-year.

Robbie, this is Jim Nielsen. Obviously in a new store there is, from a labor standpoint there’s training, there’s a ramp up in terms of productivity, there’s margin investment on that promotional side to make sure we get the consumer in. And there’s additional advertising that we spend against in that first quarter of operation.

Yes. And historically at 75%, 80% productively – generally see our first share in our stores, 3% to 4% store level margins and that builds to low double digits over time, over two years, three and four. So if you think about that ramp up, to the extent that our productivity runs high again in 2015, which we have not assumed in our guidance, then that would provide some incremental margin upside.

Got it. Thanks very much.

The next question comes from Meredith Alder from Barclays.

Hi. Thanks for taking my question. You did have an outstanding fourth quarter and I’m struggling a little bit to understand if the produce issues are lessening, why the year is likely to be – the growth rate is likely to be less? Is there something about the holiday that really boosted the fourth quarter? I understand what you’re saying about the timing of new stores, but that should wash out to a very strong second half?

Sure. Thanks, Meredith. I’ll start and then let Jim and Doug add. In terms of what we saw in 2014 for the full year, we had a close to 10% comp rate. And when we think about 2015, for the full year again, we expect the Sunflower comps – the leveling of the Sunflower comps to have about a 1% impact. Second, with lower inflation, we’re starting to see year-over-year inflation subside. We think on the retail side that will impact our comps by another 1%. And then lastly, we’re – in 2014 we saw incredible growth in the specialty categories and while they’re still high and above the company average, we’re starting to see and we think that we’ll start to see year-over-year smaller comp growth while above overall comps for the company. We’ll start to lap the extremely high comps and so that would bring the comps down slightly. So that’s the way we think about how we got to our 6% to 7% comp guidance. So you are right that the new store productivity for 2015 or the late 2014 store certainly don’t really have an impact on our guidance.

And then I guess I’m still also struggling with the profitability for the year. I understand the comps could be a little less and you won’t leverage everything quite as much, but I guess I’m still – in my experience there’s a certain level of momentum in a business like yours and you seem to be guiding to – the momentum disappearing practically in terms of the profitability of the business. I’m not saying that not still to profitability but much slower and I guess I’m just confused.

From a momentum standpoint, as I’ve said in the remarks, we really saw – when we look at our pre-2014 vintage and the momentum in those vintages, we still are expecting a 30 to 50 basis points of leverage in the business, which is quite significant. And when you look at just purely on the 2014 and 2015 stores, until those stores continue to reach and the timing of the openings of those stores, the maturation of those stores are really what’s dragging down the margin rate, but overall if you look at our core portfolio we’re still continuing to see really good momentum and for the year, I think it will be very positive. We saw some slight softness, as Doug talked about, in January and February in produce because of the availability and the tightening, but we’re starting to come around and that’s not anything unusual for us. If you look at over the last 5, 10 years, we frequently see these types of cycles. And in 2014, the last comment I would make is in first and second quarter of 2014, we had an incredible produce season in terms of both comps and margin and due to the super tightness this first quarter, that’s a massive lap year-over-year. So, I think it’s a combination of timing of the stores and then what we’ve seen over the last couple of months in produce that make the numbers look like they do.

I’d just add on that. This is Doug. Again, to Amin’s point and back to your original question talking about Q4, our holiday performance was extremely successful. A lot of programs that we put in place this year were very successful, which kind of muted some of the impact of the produce headwinds we had in Q4. So obviously those headwinds continued into the first several weeks of Q1, which obviously we didn’t have the holiday performance to offset that for Q1. So that’s a piece of it. And to Amin’s point, having been with Sprouts for – basically for the duration the company been in existence, we’ve seen the effect of stores that opened late in the year and it kind of mutes their maturation process initially. So with 58% of our stores last year opening in Q3, we’ve kind of baked that in and said, those stores are probably going to be a little bit behind on the maturation curve. And again that’s just taking in historically what we’ve seen. So this year we have a much smoother cadence of new stores, so we shouldn’t see that effect moving forward. But again that was just really a byproduct of those 58% of our stores in 2014 opening in Q3.

Meredith, this is Jim Nielsen. Just one last point is that one of our major initiatives is to continue to invest in our people. So, we’re not getting the leverage this year that we had in the past because we’re investing a significant amount of money into training, product knowledge training, operational training, leadership training. So some of it there is just a [indiscernible] there as well, but we’ve also adjusted some weight scales in markets in order to stay in front of the market.

Okay. Thank you very much.

The next question comes from Kelly Bania from BMO Capital.

Hi. Good evening. Thanks for taking my questions. Just wanted to follow up on the new store productivity. You mentioned some seasonality dynamic going on with the fourth quarter and I’m just curious, it doesn’t look like from my model at least that that’s happened in the last year or two, but it sounds like it has happened in the past for you. So I was just wondering if you could expand on that a little more and what you would expect new store productivity to be kind of over the next couple of quarters and the beginning of 2015.

Sure. Hi, Kelly. This is Doug. The best part of the year for us opening stores in the first half of the year because since we are so produce centric and produces is more plentiful in the first half of the year gives us a lot more ability to be more promotional and it also gives a longer runway for the consumer to really understand Sprouts, to understand our brand, what we sell our offerings and understand how to shop Sprouts. So what we’ve seen historically and we’ve seen this – again, every time we’ve opened a good number of stores in the back half of the year is the customer just hasn’t had a chance to understand our brand, get familiar with our offerings, especially in new markets. So the initial holiday season for those stores that opened in the back half of the year is typically pretty soft. And again, they’ll obviously rebound at the first of the year. And again, the customer has a long runway to begin understanding our products and our offering. Again, we’ve seen this historically. And what you’re going to see is those stores that opened in the back half, they just take maybe a little bit slower on the maturation process but they will catch up. As far as mutual productivity, what we’ve factored into our guidance for 2015 is mid-80s. So again, that’s above our historical average of 75 and internal expectations of 75 that we had in the past, so mid-80s for 2015 guidance. And again, the 2014 stores for the full year we’re still just shy of 100% productivity.

That’s very helpful. Then I just have one follow up, bigger picture I guess as it relates to online delivery services, and I’m just curious, if anything, there with your thoughts as changed. It seems like there’s a lot of emerging concierge options that some of your competitors have partnered with, and I’m just wondering if you could talk about your thoughts there and what would be the drawbacks of partnering with one of those outside delivery vendors?

Kelly, thanks. This is Amin. We’ve met with a number of companies in this space to evaluate the different approaches and what they’re seeing in adoption. And particularly in our case, the adoption to that every day supermarket customer and the middle-income customer and today, we haven’t found a model that successfully delivers on the value commitment to our customers as well as address our customers telling us of their ability to choose their own products, particularly in the perishable departments. However, with that said, we are looking very closely with a couple of programs and to the extent that one of these programs we can get it to work, we would probably look to pilot it in one or two markets and see how that works and how our customers respond to that. And so we’re getting closer to looking to see if something would make sense here, but we don’t want to jump out and work on something that’s not going to bring a lot of value to our customers given all the priorities that we have in various areas that Doug spoke about including private label, expanding our deli, really pushing on improving our produce programs, so really focusing on the things that we know that are going to drive additional value to the customer and additional sales for us. So that’s how we’ve been thinking about it. The last thing I would say is besides just selling product, service and education is also a huge piece of our business model and obviously doing home delivery doesn’t allow for that, but that’s a smaller consideration. So let me see if Doug or Jim want to add anything here.

Yes. All I’ll say is – it’s Jim Nielsen. We’ve had several under review and kind of taking a way to approaching what the adoption rate has been with some of the retailers that are picking up that service, so I think we’re getting close to figuring out what strategy we’re willing to take, but again not to get too far ahead of ourselves, so we’ll just kind of leave it at that.

Thanks, very helpful.

Thank you.

The next question comes from Jerry Gray from Cowen.

Hi, guys. Thank you for taking my question. I’m just looking at your DSE lines from this year. It seems like a significant portion of the leverage that you were able to gain came from some medical expenses, so I want to know – that’s probably not repeatable, that’s why you’re down or how is that going to be impacted by the slower comp rate into 2015?

Sure. Thanks. Jerry, I think you see that is roughly about 80 basis points for the full year in DSE leverage and it’s really about a third, a third, a third, a combination of pay and benefits and you’re right, healthcare insurance was close to about 20 basis points for us there. We also saw great leverage from DSE controllables as well as leverage in the NSD line and also of course depreciation. So it was balanced with a little bit of a skew in health insurance. One of the comments that we were talking about for 2015 was we’re expecting a – we had a very low utilization of 2014 of our health insurance and we’re expecting a slight uptick in 2015 in the utilization compared to 2014 in our forecast. So you’re absolutely spot on that we’re not expecting in our guidance to be able to repeat that. If anything we’re calling for that number to be slightly higher and that’s embedded in our 20% plus EPS growth rate.

I think what I would add, this is Doug, last year was our first year on a full consumer directed healthcare plan. So we don’t have a lot of history to go with saying, this is – we don’t have a lot of run rate information with that, because we’ve only been on it for a year. So we didn’t want to get too far ahead of ourselves when we looked at 2015. So again, after we’ve been on the new structure for a year or two, we’ll be able to better predict what the following year might hold.

All right, great. Thanks. And also just when you look at the guidance for the comps on a two-year stack basis, it seems to imply that beyond Q1 we’re going to have a little bit of a slowdown through the rest of the year. I guess with kind of the challenges you’ve had in produce for Q4 and then into Q1, I guess with the stores opening closer to the second half of the year in Q3, a little lower on the maturation curve, shouldn’t we expect those stores to kind of pick up in productivity as the year goes on rather than slow?

Jerry, good question. You’re right. We’re expecting Q1 comps – our guidance is 5% to 6% for the first quarter. We’re expecting full year to be 6% to 7%. So if you’ll recall last year in 2014, Q1 was our highest comp quarter of the year so we’re actually calling for an acceleration going into the middle of the year with the improvement in produce as well as having to hurdle lower comps from 2014. So we actually are calling for an improvement.

Thank you.

Thank you.

The next question comes from Andrew Wolf from BB&T Capital Markets.

Thank you. Good afternoon. Could you comment, is Q1 in that 5% to 6% range for the comp?

I’m sorry, Andrew. Can you repeat that question?

Is Q1 comps running in that 5% to 6% guidance range for the quarter?

We don’t give intra-quarter comps but based on what we’re seeing right now, the trend and trajectory by weeks including some improvements in produce, we would expect the quarter to at this point come in somewhere in that range.

You guys were short produce Q4 and it’s continued into this quarter so far, and Q4 operating leverage, again is that because the holiday programs kicked in and the other things you’re talking about on the SG&A line, so you got the comp lift and the SG&A and you’re not expecting that Q1 because you don’t have holidays, is that kind of what you’re telling us sort of on an earnings basis?

Yes, that’s a fair assessment.

Yes. And let’s not forget that the holiday items – the great holiday we had was driven by a lot of incremental items that we didn’t have historically. So it was definitely an added value and there has been a bit of a struggle in the first period with personnel ability. I think it’s obviously very public the port issues we’ve had out of California, which good news is that they signed an agreement here Monday. But it did put a little bit of burden on us.

Okay. I thought maybe – I was reading that and I thought with the docks having all the excess produce, maybe they’d give you a call and ask you to take it.

They only last so long.

Okay. And I just wanted to ask you if you – I look at your guidance a year ago and it was kind of almost the same except instead of a little deleverage on the operating line, it was a little leverage, and so it proved to be very conservative. At the top end you’re looking for 25% EPS growth. You hit 50%. Can you just give us a very quick kind of postmortem on why you had such upside? Was it all in the comps or was there stuff also in the SG&A line? Why did the year come in so much better than you guys have anticipated?

Yes. Thanks. I think if you look at it, those three or four big areas, the first one is what you said is comps. The second one was mutual productivity and when you have mutual productivity in the 100% range compared to targeting in the 75% range, the leverage you get from that incremental sales is quite significant. The third element is the health insurance that also provided a tailwind. We gave some tailwind and leverage during the year that we talked about that we don’t think will repeat again. I think those were I would say would be the third biggest areas. We’ve continued to reinvest in the business where needed, so I think all that has worked fine. So I think those were the biggest clip items that I would call out.

I guess all I would add was a lot of the sales initiatives that we did, obviously we launched a new prototype at the beginning of '13, so as we roll a lot of those initiatives back into existing stores and obviously in the new stores, you’re seeing some of the success of that. And then obviously the success of the Sunflower stores which continued to get tailwinds of that throughout 2014.

Just one more thing if I could. On the new store productivity, I heard your explanation, it’s more of a seasonal phenomenon. But you did open five stores in Atlanta and just one recently in Alabama. Could you just comment on those since they’re in a completely new part of the country? Are they within that 80% to 85% range that you’re talking about or are they materially different either way?

This is Jim Nielsen. I’m not going to speak [ph] specifically to a specific market, but I’d only tell you that as Doug communicated opening the tailwind is a bit difficult just because we are produce centric and some of the items that really drive traffic are not available at that time. The stores we’ve opened out of the gate in 2015 performed extremely well.

Okay. Thank you.

Thank you.

The next question comes from Edward Kelly from Credit Suisse.

Hi, guys. Good afternoon. Good quarter.

Thanks, Ed.

I think they’re probably mostly follow ups at this point, but just back onto the comps. I know we had the produce issue in Q1, but have you started to see your sales reaccelerate a bit yet from better produce stocks or that’s something that you think is still to come?

Yes. So just to kind of give you some cadence of where the produce issue was or is. Obviously beginning of the quarter, we did have the port issues affecting key categories for us; grapes, blueberries, asparagus. So what they are is really big traffic drivers for us that we feature, they are called anchors for us. So they weren’t available. We also suffered from a little bit of northern Cal weather hurting our kind of leaf categories and lettuce categories. But for us obviously the port issue is going to subside. Everything is moving into the northern hemisphere, so you’ve got Mexico, southern Cal. The outlet for the spring season is solid, so it’s just overcoming that first six to eight weeks.

We’re starting to see the quality that’s hitting the stores now is significantly better than what we were seeing in January and early February.

Okay. And then the reason that we see such – I guess a bigger sequential decline is just because the holiday performance was very good in Q4. I mean you crushed Q4 relative to your guidance, right. Was that all holiday?

Yes, I think it’s partially that and then also remembering that Q1 last year was – comp was at 12.8, so a fairly high comp coming into Q1 and momentum that we had. And part of that Q1 last year was one of the strongest produce season and we talked about it on our first quarter call last year is one of the strongest seasons we’ve seen in terms of availability and quality, which drove a lot of traffic to the stores and also just generated a ton of margin dollars for us. And we didn’t see competitors drop prices significantly and we didn’t either. So it was really a windfall last year, so we’re really hurdling a fantastic crop, especially in some of the areas that Jim talked about in berries and some of the other feature items when you don’t have those to feature, it just becomes a little bit tougher. But as Doug said, it’s a temporary phenomenon. It happens from time-to-time and we’re not concerned about it at all from a long-term business perspective I think would be the key message there.

Sure. And I think that’s the thing – this is Doug – the thing just to remember about Sprouts is the first couple of months of the year, because of produce and because of weather, can be like this and it specifically won’t be the same year-to-year. Amin’s point last year was a phenomenal year. This year has been tougher for the first couple of months, but again it’s the first couple of months and then the import issues that Jim was talking about, we’re just going to be transitioning over into more domestic growing areas. So it’s really just a temporary thing.

Okay. And then just one last one for you. Sunflower, why is Sunflower is drag on 2015?

Yes. So just for the full year and 2014, Sunflower benefited our comps of about 100 basis points. For the first quarter of 2014, it was closer to 160 basis points. And the reason it’s a drag is as we brought on Sunflower onto our promotional program, our operational standards and lot of new products that we’re putting into those stores into the back half of 2012 starting in August-September of 2012 and we expect it to start seeing the tail-off in third quarter of 2014 and we started to see that and during the fourth quarter of 2014, they have come back to the company average. So we basically had an additional year of tail of 100 basis points in 2014, which is now we have lapped and we’re back on a normal cadence for Sunflower. Hopefully, that answers the question.

So you’re saying it’s just not getting the benefit, not the Sunflower comps are going to be negative?

No, they’re back in line with the company average.

They’re acting more like a mature Sprouts store.

That’s right.

Okay, I got you now. Thank you.

Thank you.

The next question comes from Karen Short from Deutsche Bank.

Hi. Thanks for taking my question. So not to beat a dead horse here but I guess on – first question on 1Q comp guidance. Have you quantified the produce impact? If you did, I didn’t catch it.

We’ve quantified it internally but --

Would you be willing to quantify it publicly?

Yes, I think if you look at it on a trend perspective that could be 100 to 200 basis points. I’m going to use a wide number here to the overall comp number, because it’s part of our traffic driver. Our team has done a good job of putting on other items in other departments like chicken and some of the other items that can typically drive customers in the door. But for us is produce is so key to driving people into the store. But the teams have done a good job of working through it. And now at least when we look at it week-to-week, we feel like we’re kind of pass that freeze and the port issues and things are getting back to normal.

Yes. I think the most important thing is we keep circling back to it, but you’ve seen the port issue, they signed the agreement, we’re passed it. Everything is moving north. The outlook, you can read it. For the spring season is good, so for us we’re just looking forward.

Okay. That’s helpful. So now when I look at your full year comp guidance and then your first quarter comp guidance and let’s just adjust it for produce, looking at the two-year number for the first quarter when I adjust for the produce impact when I look at your tier stacked number and then I look at your 2Q, 3Q and 4Q stacked on a tier basis, you are looking for a fairly meaningful deceleration every quarter from first quarter through the fourth quarter on your two-year stack. And I get that Sunflower is part of that, I mean is probably a decent component of that, but is there anything else that would contribute to the deceleration on a two-year basis?

Yes, I think it’s the three things I had mentioned. The first is Sunflower, the second, Karen, is lower inflation. Inflation is really starting to lap and subside fairly quickly and we’ve benefited from that in retail and comps last year. And then the third piece is specialty categories as we had talked about early part of last year, some of the specialty category growth were in the 30%, 40% while they were on a small base but just on fire. And as these categories start – while they’re not maturing they’re just not growing at the same clip or the same rate as they would grow in 2014. So they’re still strong but not quite, 20% and 30% and 40% in some of these smaller categories, so that impacts comps to a smaller degree.

And in Q1, Karen, if you remember the Sunflower comp was about 160 basis points and then it dropped to 80 for the rest of the second and third quarter.

No, I mean that definitely explains some of that.

I think Doug – Karen, Doug brought up an excellent point earlier on some of the sales initiatives that provided a strong tailwind for us in the past. Those do begin over time to not have that same high level of benefit.

Okay, that’s helpful. Thank you. And then just lastly in terms of the drag of the new stores in terms of overall deleverage, I guess the other thing I’m a little confused about is you’re going to be opening more stores early on in the year. Obviously, as you said that when they open later in the year, it is a deleveraging issue. But you’re opening many more stores in the first portion of the year this year and yet you’re calling for more deleverage and your new stores as a percent of the store base are continuing to come down a little bit. So I guess – can you help me understand why it would be more impactful in '15 versus '14?

Absolutely. So two things is the 15 – at 14% unit growth, that would be 27 stores, so when 27 stores are frontloaded and they generally start off at the 3%, 4% margin, right, when you have more sales months or sales weeks if you want to call it and significantly more sales week in 2015 because of the frontloading, you’re got pre-2014 vintage stores but then you’ve got a lot of 2015 stores which are dragging because they’re running 3%, 4% EBITDA margin. And then for the first half of 2015, we don’t have – the 14 stores that we opened in the third quarter of 2014, they didn’t exist in the first half of 2015 and so they’re still ramping, they’re not in years three and four, so they also have a lower margin rate. So when you look at the first and second quarter, we actually have probably I think 15 to 20 more store equivalents that are dragging that weight down. I know it’s hard to visualize, but hopefully that helped.

But by the back half, you should much more normalized?

That’s a --

Much better impact in the first half and much --

And should subside and get back to normal in the back half of the year.

Okay, got it. Thank you.

Thank you.

The next question comes from Stephen Grambling from Goldman Sachs.

Hi. Good evening, everyone. I guess sticking with the top line, how many net new SKUs both in terms of private label and branded did you add this year, kind of excluding some of the seasonal SKUs? And how many are you planning for 2015?

We’ll look at it in terms of the fourth quarter, because in terms of new items type [indiscernible] the grocery departments, there’s some unproductive SKUs that get replaced. So getting even a 2,500 SKUs is not really relevant. But incremental SKUs in the holiday were 300 and part of that was 76 private label of which 18 were holiday items specifically and projecting to have anywhere from 250 private label items in 2015, so continue to be excited. Penetration growth was up for us over 50 basis points in fourth quarter, so continue to see private label outpace the company on the top line in comp growth.

We ended this year, Stephen, with about – outside of the seasonal items about 1,500 private label items and we’re at this point looking for a 20% growth in SKUs to close to 1,800 towards the end of the year.

That’s very helpful. And then changing gears, when we think about the gross margin drivers in the quarter, you made a reference to buying benefits. Can you just talk about what some of those were and what should continue? And where there any renegotiated third-party contracts or any that are coming up for renewal?

In terms of margin benefit, no there’s no significant contracts that are coming up for renewal. We signed – the biggest one we had signed in the past was a secondary agreement with a smaller supplier and that was midyear last year.

Okay. And then I think in the past you’ve talked about some of the price optimization and some better inventory management supply software. What’s some of the timeline and milestones we should be thinking about for those in 2015?

Sure. Yes, we talked a little bit about it and we’re in the development stages of that today and it’s clearly a pricing tool for us. And I think just want to clarify, it’s an optimization sales and margin tool. So it’s not just to optimize margin rate, it’s also to optimize sales. So we’re looking at the Q2 launch. We don’t have obviously any history. I’m really excited about how it’s going to improve our overall category review process, but it’s going to take still about Q3 to really start to better understand the improvements that we’re going to get from either the sales side or the margin side. But we’re excited with what we see so far in the early stages of development.

All right, thanks. And one other quick clarification if I can sneak it in on the profitability of some of these new stores. How does the cost to operate the stores in the I guess new southeast markets compare to the cost to operate the core existing store base as it relates to both rent and employees?

In terms of rent and employees, depending on the location of course is rent is pretty average to the rest of our chain and sometimes even slightly benefits certainly better than what we’re seeing in the West Coast right now particularly if you’re in L.A. or San Francisco, of course. In terms of labor, it’s again pretty similar to Arizona, the middle of the country, which all look very similar. Dallas is a good example of what we compare it to from a rate perspective on labor.

I think if you look at the new stores, the one thing that’s of dramatic differences and we’ve talked about this as we’ve rolled out is just some mix change. A store matures, you get the different mix change, which really helps your overall margin. That’s what you kind of see in newer markets is a much different mix than you would open it and for example in Phoenix, we benefit from a much better balanced mix.

Also, as we run through the rest of the questions, we’ll try to limit to one question so that we can just --

I think we have time for one more.

I’m sorry. Susannah is now telling me we just have time for one more question from the next person, operator.

Thanks so much.

The final question comes from John Heinbockel from Guggenheim Securities.

Hi, guys. So two things. What are you seeing with regard to real estate availability? And in particular I’m thinking non-food, we thought about the office guys for a while, is some of that starting to shake loose and do you think we get a point where you do step up north of 14%, because the opportunities are that great or we’re not seeing anything like that today?

Hi, John. It’s Doug. As far as the – directly to your point as far as the office space, we haven’t seen a lot shake loose at this point. Obviously, with the Depot/Max merger, I don’t believe they were required to divest any stores through that. But now that – potentially that whole mix could change, there could potentially be some. Obviously, our head real estate came from that industry, so he’s well on top of making sure we’re aware what’s going on. So nothing has broken loose yet but we’re still tracking all the sites that we’d certainly be interested in. As far as moving ahead of our 14%, we’re not comfortable moving ahead of 14% at this time. Again, there is – like we said in the past, we want to make sure that we focused on the things that makes Sprouts proud and a lot of that centers around our team members and training and having knowledgeable staff. So like I noted in the script that we’re investing and expanding our training programs currently. But again at this point in time 14% is where we’re comfortable.

All right. And then secondly where do you think – you sort of put your strategy hat on. Where’s the biggest longer term – merchandizing opportunity and I think things like push the envelope on prepared foods a little bit, but do it cost effectively. Where are some of those big hits that can actually really make a big difference if there are any in the comp trajectory of the whole base?

Sure, great question. As you’ve seen in a lot of newer stores, we have put a lot of innovation and expanded in a lot of categories over the last couple of years. The one we’re working on now – outside of private label, the one we’re working on now like I mentioned in the script is looking and testing some expanded food service offerings in our deli. One of the stores we rolled out this year has a lot of features that we’re testing. And again, we’re going to test them, we’re going to see what works, we’re going to go back and make adjustments along the way. But we feel like that’s an opportunity for us there in addition to continuing to rollout private label and focus on taking those – expanding some of those initiatives back into some of the older stores. Jim, you want to add anything there.

From a product standpoint to Doug point, I’d just echo that. Obviously, private label is a huge focus for us. It continues to be successful. We’re ramping up the unit growth. We’re going into the global sourcing side of it, getting into the emerging categories, seasonal and analysis which were part of the success in Q4 and also in fresh foods. And looking at the deli, I guess it’s provided a great tailwind for us over the last couple of years. The team has done an amazing job of enhancing our mix and opened a store in Scottsdale. We have tested a lot of different elements; salad bars, carving stations, a breakfast bar in the mornings, full service center of the plate and the customer response has been fantastic. So we’re also looking to redeveloping our HMR program, which is already successful but continue to just enhance ingredients and packaging. So all of that is in the cue. We’re overweight in terms of where our focus is in terms of development in private label in the deli side of the business, which I think we discussed with you guys briefly.

Okay. Thanks.

All right. Well, thanks everybody for joining us today and for your continued interest in Sprouts, and we look forward to talking to you guys in the coming months. Have a good evening.

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