Susannah Livingston - J. Douglas Sanders - Chief Executive Officer, President and Director Amin N.

Maredia - Chief Financial Officer and Treasurer James L. Nielsen - Chief Operating Officer

Vincent J. Sinisi - Morgan Stanley, Research Division Scott Andrew Mushkin - Wolfe Research, LLC Meredith Adler - Barclays Capital, Research Division Charles Edward Cerankosky - Northcoast Research Jerry Wallace Gray - Cowen and Company, LLC, Research Division William Kirk - RBC Capital Markets, LLC, Research Division Karen F.

Short - Deutsche Bank AG, Research Division John Heinbockel - Guggenheim Securities, LLC, Research Division Kelly A. Bania - BMO Capital Markets Equity Research David G.

Magee - SunTrust Robinson Humphrey, Inc., Research Division Andrew Paul Wolf - BB&T Capital Markets, Research Division

Thank you, and good afternoon, everyone. We are pleased you have taken the time to join Sprouts on our first quarter 2015 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' 10-Q, the earnings release announcing our first quarter 2015 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 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 the forward-looking statements.

For more information, please refer to the risk factors discussed in our filings with the Securities and Exchange Commission, along with the commentary on forward-looking statements at the end of our earnings release filed today. In addition, our remarks today include references to non-GAAP measures.

For 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 first quarter ended March 29, 2015, we reported diluted earnings per share of $0.24 and adjusted diluted earnings per share of $0.25. Adjusted diluted earnings per share increased 9% from $0.23 in the same period in 2014.

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

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

We are pleased to report another quarter of strong top line sales growth as we continue to expand our Healthy Living for Less philosophy to an even greater number of communities across the country. For the first quarter, our net sales grew to $858 million, up 19% from the same period in 2014.

Comp store sales for the quarter were 4.8% as we cycled our highest comp quarter of 2014 at 12.8% resulting in a 2-year stack of 17.6%. This comp sales growth was slightly below our guidance of 5% to 6% and primarily driven by 3 factors that occur during the quarter.

First, and as we noted on our previous earnings call, we experienced tightness in produce quality and supply early in the quarter, driven by adverse weather conditions and challenges associated with the L.A. port.

This negatively impacted our promotional opportunities in produce, which, as you know, is the primary traffic driver for Sprouts. Second, we began experiencing accelerating produce deflation in mid-February as supply improved, which increased significantly throughout March.

While our produce tonnage improved on a comp basis from Q1 of last year, the lower retails impacted our overall comps by over 100 basis points for the quarter versus our guidance. And third, extreme weather conditions in several markets including Texas, Oklahoma and Colorado negatively impacted traffic and sales in late February and early March and impacted our comps by 50 basis points for the quarter versus our guidance.

Despite these headwinds, the team did a great job continuing to generate positive traffic through strong promotions and solid execution throughout the store. For the quarter, our comp performance was driven by a 40-60 split between traffic and ticket.

This is slightly below our historical 50-50 split, which reflects the impact of the challenges we faced during the quarter. With the port and weather issues now behind us, produce availability and quality are returning to normal levels for this time of year, resulting in improved traffic and sales.

New store productivity for the quarter was near 90%, above our 2015 forecast of 85%. During the quarter, we added 10 new stores including our first new stores in Alabama and Missouri.

In year-to-date, we have opened 15 new stores at 8 markets across the country. We have an additional 12 stores planned for the remainder of Q3 and Q2, including our first new store in Tennessee.

We continue to be pleased with the performance of our new stores and the new states we've entered this year. Our current real estate pipeline includes 65 approved sites and 45 signed leases for the coming years, keeping us well on track to meet our 14% long-term growth target.

Our aggressive growth and strong traffic continue to make us an attractive anchor tenant, enabling us to secure great locations as we expand into new markets and grow our market share by expanding deeper into existing markets with a greater number of stores. Now let me shift to strategic initiatives.

Our 2015 initiatives are well under way as we continue to focus on expanding our private label and specialty product assortment, testing new and expanded deli offerings, growing our digital capabilities, improving customer service through training and incorporating many of the offerings from our 2013 prototype into our existing store base. Private label continues to be a key differentiator, driving customer loyalty and brand awareness by offering great quality and value on natural, organic and specialty products.

This quarter, we introduced 60 new and innovative private label products like our new Sprouts raw foods line, bringing our total count to over 1,600 items throughout the store. We have another 150 items in the pipeline for the rest of this year focused on the key attributes our customers are looking for including non-GMO, organic, raw, gluten-free and vegan.

This also includes our ongoing efforts around improving our product and ingredient standards and we're excited to report that, today, over 50% of our private label packaged foods are now certified non-GMO or organic. Our attribute-driven specialty categories continue to provide sales momentum throughout the store, experiencing comp growth above the company average and sales growth that is well outpacing the overall industry.

Whether private label or national-branded, we continue to improve our depth of product offering in these fast-growing categories, staying ahead of emerging trends to meet the needs of our customers today and tomorrow. We are excited about the early positive response to the new and expanded deli offerings featured in our newest prototype launched earlier this year.

New features include a salad bar stocked with ready-to-eat healthy and flavorful salads as well as prepared protein and healthy side dishes. These new selections offer our customers a convenient selection of innovative products with quality ingredients to satisfy their lunch, dinner and anytime-snacking needs.

We plan to introduce these expanded offerings into a select group of new and existing stores this year in what will determine how best to incorporate them into a greater number of stores in 2016 and beyond. On the sales initiative and store remodel front, we are 75% complete with our 2015 projects.

Once done, all of our stores will feature some or all of the expanded product offerings found in our new stores opened since 2013 and we look forward to the sales benefits these investments will produce as the year progresses. In 2015, we continue to grow our digital marketing technologies to engage with customers in a more meaningful and relevant way.

Because we have always targeted the everyday grocery shopper, our print distribution of more than 14 million weekly circulars is still our most impactful advertising vehicle. But we also know that growing our customer engagement outside of print is an extremely important part of connecting with the next generation of shoppers.

Today, we actively engage with more than 2 million customers across a variety of digital platforms including social, e-mail, web and mobile. This includes 1.2 million Facebook fans, 750,000 e-subscribers, 250,000 unique weekly visitors to our website along with approximately 100,000 downloads of our mobile app.

Additional investments include adding NFC functionality throughout the company where we've seen transactions through Apple Pay and Google Wallet grow by more than 250% since January, now representing over 2% of our total credit transactions company-wide. We plan to continue these efforts over the next year as we work to expand our customer engagement both inside and outside the store.

Our strategic investments to enhance the customer experience through team member training is going -- is well underway. Providing knowledgeable resources to engage and assist our customers remains one of our core tenants at Sprouts.

Therefore, training -- our training programs are focused on improving product knowledge, operational execution and developing leaders to support our continued growth. These programs are being well received by our team members who appreciate the investment we're making to prepare them for the advancement opportunities our aggressive growth continues to afford.

Now let me touch on industry dynamics as we continue to receive questions and seeing varying reports on competition and pricing. With regards to competition, we have seen a greater number of stores taking varying approaches to natural and organic foods over the past several years.

In response to growing consumer demand, certain retailers have made greater investments in the selection and merchandising of natural and organic foods. On the pricing front, we have also seen certain retailers make price investments within different markets and at different times.

But to be clear, we've seen these types of investments periodically over the past 2 years. With all that said, operating in a competitive environment is really nothing new to Sprouts.

The grocery industry has always been a competitive environment and it's in that environment that we have successfully competed for the everyday grocery shopper for more than 12 years. At Sprouts, we remain focused on providing a broad assortment of healthy and differentiated products, knowledgeable customer service, a unique customer experience and affordable prices across the store.

We continue to invest in all of these areas of our business while adding new and innovative offerings to meet the needs of our growing customer base. So in summary.

Produce quality and availability is improving, our strategic initiatives and store expansion plans are on track and we continue to be one of the most dynamic food companies in the retail grocery industry with a proven business model, broad customer appeal and the ability to successfully compete in both the natural foods and traditional grocery sectors. With that, let me return a call over to Amin to talk about our financial results and guidance.

Thank you, Doug, and good afternoon, everyone. Following Doug's highlights of the business drivers, let me cover the operating results and guidance.

For the first quarter, gross profit increased 15% to $258 million, resulting in a gross profit margin of 30.1%, a decrease of 90 basis points compared to the prior year period. This compression in gross margin was primarily driven by, one, the timing of a greater number of stores still in the first 12 months; two, cycling elevated produce gross margins from the exceptional produce season in the prior year; and three, our continuing investments in price in certain markets to maintain our competitive positioning.

Direct store expenses were $163 million for the quarter. DSE included pretax loss on disposable -- disposal of assets of $200,000 in 2015 and $700,000 in 2014.

Excluding these items, DSE as a percentage of sales was 19% for both periods. The leverage from higher sales in our pre-2014 vintage stores was offset by higher expenses from stores open less than 12 months.

We were very pleased with the continued leverage of our direct store expenses in our pre-2014 vintage stores. SG&A totaled $24 million for the quarter.

SG&A included pretax secondary offering expenses of $300,000 in 2015 and $1.4 million in 2014. Excluding these items, SG&A as a percentage of sales was 2.8%, an improvement of 10 basis points compared to the same period last year.

This improvement was driven by lower bonus expense, partially offset by higher advertising expense to support a higher number of new store openings in the first quarter of 2015 compared to the prior year. Adjusted EBITDA for the first quarter totaled $84 million, up 9% from the same period in 2014.

EBITDA margin rate was 9.8%, a 90 basis points decrease compared to the prior year, driven by the store opening timing and the produce impact discussed above. We expect the timing of the new store openings to continue to impact gross margin, DSE and EBITDA margins in the second quarter and normalize in the back half of the year.

Adjusted net income for the quarter totaled $38.6 million, an improvement of 9% from 2014. This increase was driven by higher sales as well as reduced interest expense as a result of additional voluntary paydown on our term loan.

Let's shift to balance sheet and liquidity. Our balance sheet remained strong as we continue to generate strong operating cash flows.

For the quarter, we generated $68 million of cash flows from operations and invested $22 million in capital expenditures net of landlord reimbursements for new stores. The principal balance on our term loan was $260 million.

And our net-debt-to-adjusted EBITDA leverage ratio, excluding capital and financing leases, was 0.3x. We ended the quarter with cash and cash equivalents of $178 million and $57 million available under our undrawn revolving credit facility.

Due to our strong balance sheet and the significant deleveraging we have accomplished over the past few years, last month, Sprouts was able to secure a new credit facility at attractive rates. We completed a new 5-year $450 million revolving credit facility that replaced our existing term loan and revolver.

Upon completion of this refinancing, we had approximately $260 million of total debt and $2.5 million of letters of credit outstanding. The revolver has an initial drawn pricing of LIBOR plus 175 basis points as compared to LIBOR with a floor of 1% plus 300 basis points under the previous term loan.

At today's interest rates, this pricing is expected to reduce our annual interest expense by approximately $5 million. While we plan to continue to self-fund our targeted 14% unit growth, this new facility preserves financial flexibility and reduces our ongoing debt service expense.

Let me now turn to 2015 guidance. Our annual guidance for 2015 remains unchanged with net sales growth of 20% to 22%, driven by 14% unit growth and comp store sales growth of 6% to 7%.

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 with a range of $0.84 to $0.87.

And we expect to -- CapEx to be in the range of $100 million to $110 million for the year. Our focus on driving sales has greatly improved our average weekly sales over the last few years and we believe our 2015 focus on new product innovation, private label growth, rolling out tested initiatives to more stores and focus on customer education and experience will continue to drive sales and a more profitable store and business model.

Let me add a few additional notes on the 2015 guidance. First, we will continue to make price investments, as necessary, to maintain our pricing strategy and have considered that in our guidance.

Second, we are now expecting inflation to be in the 1% to 2% range for the entire year as compared to 2% to 3% stated on our last call. As you will note, on a sequential basis, overall, basket inflation slowed to 1% for the first quarter of 2015 compared to 4% in the fourth quarter of 2014.

With the lower inflation range in 2015, it's expected to impact our comp sales. However, we are seeing strong traffic trends into the stores as the produce availability has normalized, and as a result, we are maintaining our sales guidance of 6% to 7% comp for the full year.

Third. We continue to expect our pre-2014 store vintages to bring positive leverage to the EBITDA margin line, including leverage in the gross margin and DSE lines for the full year.

However, the timing of back-ended 2014 store openings and front-loaded 2015 store openings are expected to offset the leverage from the pre-2014 vintage stores. Based on this, we expect a compression in gross margin, DSE and EBITDA margin rate in the second quarter, which will normalize in the back half leading to a slight compression in EBITDA margin rate for the full year.

Fourth, with the refinancing of our debt complete, we expect to have approximately $20 million in interest expense including capital lease and other interest expense. In addition, we will incur a $5.5 million write-off due to the extinguishment of our former credit facility in the second quarter.

And our weighted average share count will be approximately 157 million shares for 2015 and our corporate tax rate will be approximately 39%. Lastly, for the second quarter to 2015, we expect comp sales growth to be in the 5.5% to 6.5% range as we continue to gain momentum into the spring and summer season.

As mentioned earlier on the call, during the second quarter, we are still lapping a strong produce season from 2014, the Sunflower store benefits, as well as higher inflation in the prior year, which all benefited comps in 2014. Inflation in the second quarter of 2014 was around 3% compared to approximately 1% forecasted for the second quarter of 2015.

Given these items, we are pleased in the comp guidance and momentum driven by strong traffic counts into the stores, demonstrating the desire for more and more [indiscernible] customers to come to Sprouts for their everyday healthy grocery shopping. In conclusion, we are very pleased with our top line and overall performance for the first quarter, especially in the face of the difficult produce season and lapping the strong performance from 2014.

Our focused 2015 initiatives are off to a good start, our development pipeline remains strong and we continue to remain excited about the business as we grow the Sprouts brand across the country. With that, we would like to open up the call for questions.

Operator?

Wanted to just ask on the inflation, specifically. Obviously, it was, as you said, about 100 basis points different versus your initial forecast on produce.

But can you guys, can you just give a little bit more color on maybe what you're also seeing in some of the other categories? How you are thinking that 1% to 2% kind of evens out for the full year?

That's my first question.

Sure. Vinny, this is Amin.

We were expecting full Q1 inflation of about 2% and we ended up actuals closer to 1% range and that was really driven by, we began seeing in the middle of February acceleration and deflation in the produce area through the end of February as well as all the way through March and continuing into April. So our quarter inflation ended up being 1% rather than 2%.

What we see right now is, in Q2, we're calling for something in the 1% range, perhaps slightly lower given some of the deflation we're seeing in produce currently and then in the back half of the year normalizing closer to the 2% to 3% range. So right now, based on what we're seeing, we're keeping -- we're saying the full year expectation of 1% to 2%.

The full year would probably be in the middle of that range, but the second quarter would likely be towards the bottom end of that range, if not lower.

Okay. And then just as a quick follow-up question, if I may.

Regarding the price investments, I know you've said that, obviously, it's part of the business. But specifically for this quarter and with the produce supply as well as with the pricing, the specific price adjustments that you had impacting your gross margins this quarter, can you give us just a little bit more discussion around was that largely within produce or was it across-the-board?

Any further help would be great.

Yes, as far as the compression in margin for the quarter, most of the compression was caused by two things: first is we had a great produce season last year and we had -- our margin last year was up 70 basis points over the previous year, the year prior to that; and then second, it was also the timing of our new stores; and a smaller portion was continuing to invest in certain categories and maintain -- and markets to maintain our competitive positioning. And outside that, it was sort of across the store, but more on the perishable sides than not and I'll also ask Jim to see if he wants to add any color on this.

Vinny, it was most specifically, obviously, in the produce side of the business and obviously deflation didn't help us there. But what we also saw within the quarter was an increase in promotional penetration from our consumer, which really, really speaks to the consumer's search for value today.

So it was primarily produce.

Just want to -- you seem to be pretty upbeat on the current sales and I just wanted to know if you would confirm if you're within your guidance right now? I think it's 5.5% to 6.5?%.

Yes, based on what we're seeing right now, that's where -- yes, we think that, for the quarter, we would be within that guidance. We're seeing good traffic into the stores, as Doug mentioned, in his remarks with produce coming back to normal, traffic has really picked up.

As Doug talked about, we saw 40-60 traffic ticket in the first quarter. In the second quarter where traffic is looking very strong.

And also Scott, this is Jim, one thing I'd like to add is that our sales initiatives actually started a bit earlier last year and we started probably tail end of P3, starting P4, so the majority of our sales initiatives as well as our remodel will be completed Q2, Q3 and Q4. So we're very optimistic about that.

They've all have proven success in prior years.

Okay. So you're in your range right now.

I guess, a broader question is we had thought that Sprouts was somewhat different than the channel, obviously a value format, and then somewhat immune to what was going on in the channel. Clearly, if you kind of take a step back, the channel is slowing, With what you guys just reported, I would say, Scott, you're kind of wrong.

They seem to be somewhat going with the channel, the channel is slowing. What am I missing?

Do you think I missing something?

Yes, I mean, I think that based on what we're seeing in the store, as we talked about, is the produce availability and deflation are probably the 2 areas where we're different in terms of when we look at our specialty category, when we look at some of our other departments. Specialty is a good example, we're continuing to outperform the channel.

But at the end of the day, as you know, driving traffic into the stores is really driven by produce and that was obviously a challenge for us in the first quarter. So I think if you look outside of produce in many of our other departments like vitamins, packaged goods, specialty goods, we're continuing to outperform the channel so we feel pretty good on that side.

I mean -- Scott, this is Doug. I guess all I would add to that is don't discount the impact of produce on our business.

Again, if you remember, that's 25% of our business and it is the traffic driver for our entire company. So again, when we're impacted by promotional opportunities within produce, it does impact the entire store because that is the traffic driver.

So just keep that in mind. Again, produce drives our business and when we run into weather issues or supply issues and we're not able to promote like we normally would be able to, it impacts the entire store.

So you can't necessarily say we're immune to that, but that is really what drove our challenges in the first quarter.

I'd like to focus a little bit on the impact of deflation, specifically in produce on gross margin. I mean, you've already said that it drives -- and maybe I'll talk about gross profit dollars, not just talk about margin, you said it is driving volume.

I think the market has an assumption that inflation lowers comps then it automatically lowers profits. What are you guys seeing?

Yes, we're -- broadly across the store, Meredith, that's an appropriate assumption. We're continuing to see the margin -- we're continuing to see the impacts stay parallel in terms of people passing on the deflation into the category, and like Jim mentioned, is in certain cases we're also seeing people being more aggressive in certain departments and categories.

Meredith, this is Jim. Now as it relates to how it impacts our margin in a deflationary environment relative to produce, when you look at the veg category versus the fruit category, the fruit category in a deflationary environment causes a little bit more pressure and the only reason that this is, is because it's the items that typically are promoted and you just become a little bit more overweight as opposed to the veg category, which is traditionally a flow business and you'll pick up gross margin.

Okay, great. And can you comment at all about any other perishable categories because I don't know that there's a lot of inflation or deflation for that matter in, say, the packaged goods.

Maybe I'm wrong.

Yes, Meredith, I think Amin kind of alluded to it earlier. Our primary deflation numbers were driven by produce.

As you look at throughout the other categories in our department, it's not material and we don't anticipate it to be. Whether we look at bulk or we look at meat, we've hit those -- we'll call them highs, if you will.

And the only potential downside in that would be the avian flu that might impact the poultry supply. But early indicators are slight inflationary, but normalizing over the course of the quarter.

If we can take a look at the store opening pattern for this year, you've mentioned that it's first half loaded. How will that look -- or how will that affect the second half store closure and store opening or preopening costs?

Yes, so I think we're currently expecting 10 stores -- we opened 10 stores in the first quarter, expecting another 10 stores in the second quarter and then the remainder of our 7 stores in the third quarter. So what we will see is a heavier preopening costs in the second quarter than last year.

And then in the third quarter, we have fewer openings. Last year, we had 10 -- last year, we had 14 openings in the third quarter and this year we would have closer to 7 stores in the third quarter, so we would expect a lower preopening cost in the third quarter of this year.

And we would also expect then, starting the third and fourth quarter, for our compression to start normalizing again from the weight of the new stores starting to normalize as we move through the third quarter and into the fourth quarter.

Anything in the fourth quarter we should be aware of as you prepare for 2016 openings, Amin?

I think that our goal is to -- we like this pattern -- and this business to the extent that you can open stores in the first half of the year when produce is plentiful and crops are good. It's sort of the best representation of the brand and Sprouts.

So our goal is, for next year and going forward, is to remain on a similar pattern to this year. From an opening perspective, is to have a heavier opening schedule in the first half of the year every year.

I was just wondering if you could give us a little more detail on the breakdown of what was hurting your margins in terms of the store -- the compression from the store opening costs and then also decompression [ph] from the tightness in produce, just so we can get an idea of how that's going to move in the next few quarters,

Yes, so the biggest item that drove compression in the first quarter was we had a great produce season last year. As I'd mentioned our produce -- not produce, I apologize, our margins in the first quarter of 2014 were 70 basis points higher than the previous year, so we gave a lot of that back this year.

The timing of our new stores, that's going to continue into the second quarter from a compression perspective, because now we'll have the stores that were opened in the third quarter of 2014, stores that are open in the first quarter of '15 as well as the second quarter of '15 all weighing down our margins and then followed by continued investments. So we would expect a decent, perhaps a little bit lower than what we saw this quarter -- I shouldn't say perhaps, lower than what we saw this quarter, but still a compression to gross margin, DSE and EBITDA margin rates for the second quarter and then normalizing starting the third quarter.

I'll also touch that we continue to -- our pre-'14 vintages continue to leverage well on the DSE line and the selling line and down the line. So we're expecting that through the year.

And then just on the comps, getting a little bit better running in the second quarter here now that the produce availability is a little bit better. The guidance seems to imply that, that's going to continue to accelerate into the second half.

Just what gives you the confidence that the comp trend can continue to improve throughout the year?

Yes, I think a couple of things. For the second quarter, obviously, produce is sort of back to normal.

And then in the back half of the year -- as we move to the back half of the year, we'll be lapping slightly softer comps from last year. If you recall, in the second quarter last year, we had 9.5% comps and then in the third and fourth quarter, they were 9% and 8.5%, respectively.

So those comps start settling down and we lap the Sunflower benefit that we had in the first -- heavy in the first 2 quarters and also the third quarter of the year. As we lap that benefit, that should normalize.

In addition, the last thing I would point out is, is last year, inflation was accelerating as we went through the year, so that will also be the offset going into this year.

And the only thing -- this is Jim, the only thing I would like to add to that is, and I talked about it a little bit earlier, is the sales initiatives. They are kind of weighted in the second and third quarter, so all the sales initiatives that we're doing whether it's a vertical product -- projects and grocery expanded multi-decks and produce as well as deli, all those have a proven track record.

And again it's Q2, Q3, is when they'll be completed as well as 6 remodels.

So just one question from me. The last time you spoke, I guess, was early March.

It sounds like that the 3 headwinds you cited for the slightly weaker comp, produce shortage, produce deflation and extreme weather, had kind of already happened at that point. Did anything happen after early March that impacted results versus guidance?

No, this is Doug. The tightness in produce supply and availability that was driven by weather and the port were actually prior to our call.

But the impact of deflation and the extreme weather we had in the middle part of the country happened after our last call, so those were not anticipated in our guidance.

Within your guidance for comp, and I guess, inflation for the year, what are you assuming produce inflation does for the year? If you gave that number, I missed it.

Yes, so we're -- currently we're seeing high, Karen, in March and April, we've seen high single-digits, touching close to double-digits produce deflation. And as we move to the middle part of the country and middle of California growing season, we think that deflation and the causes of the deflation will subside as we move through the second quarter.

So we would expect -- if we look at our overall inflation number, 9%, 10% deflation in produce given that it's 25% of our business does weigh in pretty heavily. So we think as we work through the second quarter and into the third quarter, it would come back to closer to the 2% range and then maybe slightly above that in the back half of the year.

So 2% inflation in the third quarter and then higher in the fourth? In produce?

2-plus percent overall, I apologize. So specifically, to produce, Karen, in the back half of the year, it's probably a little bit early to tell.

But last year, we had some produce inflation. So we'd probably be -- we would expect it to be fairly moderate if we have another normal season in California.

So not a huge amount of deflation.

And Karen, this is Jim Nielsen. Obviously, when produce seasons shift every year a little bit, you'll get movement on a growing season, and for example, this year, soft fruit has moved in about 14 days early.

So the availability is abundant, the costs are obviously much lower at this same time last year. So depending upon when those start and end impacts that number.

So that's where we're seeing a little bit on the early half of Q2 and anticipate picking that up on the back half of Q3 -- early part of Q3.

Okay, that's helpful. And then, I guess, just in terms of your fliers, your promotions.

I guess, with the produce challenges that you had in the first quarter, can you maybe help clarify or quantify like how your first page promotional stance might have changed from the standpoint that it obviously impacted your comp this quarter. But maybe just walk through like what you had to adapt and why, just to get an understanding on why it dampened your comp?

Yes, so relative to produce, I mean, all other departments supported the ad and the plan that we had put together for 2015. Obviously, produce is very dynamic.

The only challenge we had is there was availability of what we call the anchor products before [ph] the ad. So if we wanted to promote blueberries or grapes or asparagus, that's our strong traffic drivers, they were not available.

They were available from a flow perspective, but they weren't readily available in an abundant capacity that would support an ad. So those are kind of key traffic drivers, just a few samples.

They weren't available to drive the ad. So you replace it with grapefruit, for example, that doesn't have the strong tailwinds that you would get in those other categories.

Right, okay. And then just last question, I guess in terms of you've talked a little bit about the opportunities to expand deli and prepared food, I guess, stations and items.

Maybe can you just talk about what percent of the store base you think can support the more -- a slightly more expanded offering in prepared food, expanded deli, expanded salad bars? And then can you just explain what your pricing philosophy is going to be in these categories as you broaden them out?

Yes, those, I mean -- this is Doug. Let me talk to part of that question.

Obviously, we've been testing a lot of that innovation out in the newest prototype that we launched in January of this year. Early signs are it's doing very well.

We're going to be incorporating those into a handful, a select number of stores this year, some of our existing stores and actually some of them are our new stores. So we can gauge the impact on existing store versus before and after we put those components in.

And then we're going to take a look at what are the stores that we can put these in. Obviously, from a size perspective, some stores will be able to accommodate a lot more of the pieces that we're putting in and some may or may not.

But we don't have that full percentage for you right now. So again, we're still kind of testing and studying some of these things to find out exactly what we want to move forward with.

Jim, you want to...

Yes, I think to echo Doug's point, I mean, obviously, some of the key drivers that we've seen success in are our salad bars, our juice bar and our protein case, front-facing sandwich station, just creating more of a destination and deli. Again, to Doug's point, we're going to test it in multiple markets this year, which, based on our success, we accelerated it to add those markets this year to test that in different geographies.

And now, we're putting it into some stores in the future, to new stores as well as going back. And over the course of the next couple of months, we'll know how many stores we're going to do in 2016 as part of a sales initiative.

In terms of your overall question around retail pricing, I can only say, I'll bucket all those together, that we are at market or better than market relative to our competition in all those areas.

So if you think out over the next 5 years and kind of take a longer-term view, what do you think happens to rent cost? Does that stay about the same or does it go up if there's more competition for locations?

And is there room -- because you guys run lean, is there room to further tighten up labor cost at the store level to either counterbalance if rent goes up or if the competitive environment gets a little tougher and margins and pricing end up a little bit lower than you might have thought before?

John, it's Doug. I'm going to tackle the first part and probably Jim will chime in on the other pieces.

But as far as rent goes, we haven't seen a material change in rent over the last, call it, 1 year, 1.5 years, 2 years and we're not seeing that today moving forward. Again, there continues to be availability in existing properties.

And while new development is coming back, albeit it's not at 2006 levels, it is coming back and because of the amount of traffic we drive, we continue to be a desirable anchor tenant for a lot of shopping centers. So again, I don't see a material change.

If anything, hopefully, when some of the additional real estate breaks loose from some of the M&A activity that may, at the very least, put some downward pressure maybe even on rents, so time will tell. But we're not seeing a lot of change in that right now.

And as far as making adjustments to payroll in order to support a potentially higher operating cost -- occupancy cost, we're obviously investing in training as an organization not only on the product side, but the business side as well. So not only is that helping us with productivity and retention, but the market's difficult, you see the unemployment numbers, you see the jobless claims.

So I wouldn't anticipate significant leverage over time or a tailwind there. What I would tell you is that we're continuing to work on our supply chain efficiencies in order to help our gross margin.

We now -- our vendor partnerships on our promotions as well as product innovation, we're in the best place we've ever been as an organization, partnering with some of the biggest manufacturing companies and partnering in a win-win, which is definitely going to help us on the margin side as well. And then just the mix, we talked about the deli mix.

There are some retailers out there that do a lot of business in the deli side and it is accretive to the bottom line and so that will provide some level of enhancements over the next 5 years as you had mentioned and then a slight increase with private label penetration as you look forward into the next 5 years and into that horizon.

All right. And then, Doug, do you still think that 14% is about as high as you want to push the growth rate in any year?

When you think going forward, would you -- what kind of balance do you want between new markets, flag planting and clustering? Is there -- as you think going forward, would you like to do more clustering in the next couple of years as opposed to new market entry?

Or how do you -- what balance do you want there?

Yes, I mean, I think the 14% unit growth target, it continues to be kind of our sweet spot right now. As far as our growth, 70-30, again, continues to be where we feel like the right balance is between existing markets and new markets.

The thing to remember is the stores that we open in existing markets and the infill strategy that we've been using, incorporating some of our mature markets, has been extremely accretive to the markets and to our company. If you look at the stores we open in existing markets, they open up faster, they ramp faster, they are far more accretive to the bottom line, they leverage existing infrastructure.

So again, the balance of 70-30 is about where, I think, we're comfortable today and again the 70% that we're opening in existing markets has been very accretive to our bottom line.

Just back on the produce deflation. When you talked about high single digit to double-digit produce deflation, was that all in fruits or vegetables?

Is there different trends going on between the two? And any color you can provide us on what the mix of your produce sales, when you think about that 25% of produce sales?

What's the mix between fruits and vegetables?

Kelly, this is Jim Nielsen, I'll obviously -- we won't disclose what the mix is between fruits and vegetables. However, what I will tell you, relative to your first question around inflation and deflation is that on the veg side, we did not see any type of real significant deflation.

It primarily came from fruits and that's the soft fruits, the berries, grapes, some of the categories that I mentioned earlier and then also some of the early season stuff of that we're starting to see now with the peaches and the soft fruit, the cherries coming out a bit early.

Okay, that's helpful. And then just curious if you could talk a little bit more about vitamins and supplements trends.

I think you mentioned you're continuing to outperform the industry. What does that mean?

We saw some pretty, I guess, weak results from some of the pure-play vitamin and supplement players. And maybe if you could just talk a little bit more about the trends you're seeing there.

We've kind of discussed this as a team not to really get behind too many trends and disclose those as an organization that we'd continue to capitalize on. But what I will tell you is that, as we look at our syndicated data, we're definitely outperforming the natural industry.

And I read your article and I appreciate it, but we attribute it back to the buying team we've assembled here. It's very difficult to put together a strong team with the depth of knowledge that we have.

And we not only have very strong business people, but a very knowledgeable product team as well. Our store layout makes us uniquely different and I think has provided strong tailwinds.

And then the customer engagement that we have and the knowledgeable team members as well as the innovative promotions, which you've seen the E4 [ph] is a great example of that, which has continued to grow over the course of the last couple of years. So it's all of those and if you probably pull your syndicated reports and look at those growth categories, those will be some of the same categories that are driving our business.

We're just typically outperforming the natural segment.

You had mentioned the impact of deflation on comps being 100 bps, I think, and weather being maybe 50 bps. Did you give a number for just the impact of tightness in produce?

Did I miss that?

No, I think when you look at the combination of the early part of the quarter between the port issues and the weather issues, overall it was between about 100 and 150 basis points in totality.

Okay, okay. And would you -- did you give us an EPS impact of that?

Yes, that's probably a little bit -- I don't have that number off the top of my head exactly how that would flow through because the margin dynamics -- the dynamic on margin side also, based on what Jim talked about, is we've also seen the promotional penetration being different as well.

Okay, fair enough. And then lastly, Doug, you talked about the competition growing, sort of being a fact of life in your sector over time.

Are you seeing anything more recently that makes your competition more effective than maybe in the past?

No, I wouldn't say of late. Like we were saying on the original script, we've seen retailers adding assortment, we've seen some retailers investing in price in certain categories and certain markets, but we've even maybe seen a slight uptick in maybe even just some of the number of stores, if you will, on a year-over-year basis, the number new entries into the market.

But overall, it's been fairly stable and again, this -- because we've always been focused on being a value leader, we spend a lot of time and a lot of effort doing a lot of pricing surveys and really studying the markets and we make adjustments as we go and as we need to on a market-by-market basis. And we feel really good about where we are from a positioning standpoint today, not just driving the leadership in produce, but throughout the store.

So we really haven't seen a material shift to note that would impact our comps.

I just wanted to get back to the gross margin and tie it to competition because I think the last thing you mentioned in the press release was some price matching, and Doug, you just spoke to that. But sounds like the way you're characterizing it may be a little higher than normal, but nothing completely different.

So is it fair to say that was the least of the issues that impacted gross margin in the quarter and the tightness of supply was the most?

Yes, that would be a fair statement. Yes.

I guess, as you guided to gross -- well, I want to ask directly, Q2, do you expect the gross margin contraction to be of the same order? And -- if you're willing to go there.

And secondly, what are the factors that you're baking into your assessment of the gross margin carrying over now that the tightness of supply has been remedied?

This is Amin. There's 2 sort of competing factors there.

One is with produce normalizing, that should help improve the overall gross margin structure into our numbers and stores. Offsetting that is with the number of stores that we're opening in the second quarter also, second quarter is sort of our deepest impact of the 3 quarters of heavy openings of the stores.

So when you look at those 2 net combined, we still expect sort of the gross margin, the delta -- the gross margin differential to go down from the 90 basis points this quarter. But it really starts ticking down once we get into the third quarter.

And just one other thing. On the new store productivity being 92%, I think you said, I'm not asking you to-- only because the Southeast is a new market to you, could you just speak a little generally to how the stores that you recently have opened there are faring?

And I guess, if you factored out produce, I'm surprised as you saw in produce that impacted earnings versus your expectations, how those stores are doing on their P&L versus your budget?

Yes, overall our stores are doing pretty well in the Southeast. I think in terms of being able to market produce, even though we had produce challenges, it's not that difficult to take a handful of stores like the Southeast and other new stores and be able to promote heavily even in produce there.

You might be taking slightly lower margin than normal for a new store, but you can do it for a handful of stores. It's when you have tightness in supply, the challenge becomes when you're trying to do it across 200 stores.

So we continue to be aggressive on new store openings despite what the produce market's doing.

Okay, because I think it's -- in Atlanta, the stores might have been a bit too close and maybe a little of cannibalization on the openings and I think the stores you've opened are in different states. So have they opened a little better than the Atlanta stores in terms of productivity?

Yes, I think, overall, our Atlanta stores, Atlanta and Birmingham stores as a the core, they're all performing pretty well. If one thing, we sort of -- when we looked at 2 sites in Atlanta, they were about 7 miles apart.

And being a new market, we knew we wanted to be in both of those locations over time and I think both those stores will do fine. They're continuing to improve as we're sitting here today and they'll do fine.

We could have waited on one and build up one volume and then hit the store a couple of years down the road, but that location may not be available so you've got to take the real estate when it's available in the marketplace. So those 2 are really good strong trade areas.

They're good neighborhoods and good trade areas, so over time I think they'll do fine.

I think what I would add, this is Doug, is obviously the newer markets are progressing well and we're very pleased with their performance. And in regards to the stores that opened up fairly close together, again, we take a longer view of this and there was an opportunity that we took advantage of because we knew we would probably -- long term, we'd probably do both sites anyway but they were available at the same time.

But again, taking a longer-term view of the stores and where the stores will mature to as that market matures, they're both going to do exceptionally well. And again, the thing to note is as we go into new markets, the first 1 or 2 or 3 stores that you open in a new market generally pulls from a very long radius because they're -- obviously, those would usually be the only Sprouts stores in the market.

So as you open new stores in a new market, even if they're a little bit further away, you're still going to cannibalize the sales from a newer store in a newer market from time-to-time, it's just going to happen. So again -- but we look at these as long-term investments.

The stores are doing well. The market's continuing to mature as we anticipate.

And as we open more stores in the market this year, we're going to continue to grow our brand and those stores will continue to mature.

Thanks, everyone, for joining on us today and for your continued interest in Sprouts. Have a great day.