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Executives

John Mackey – Chairman and CEO

Walter Robb – Co-President and COO

A.C. Gallo – Co-President and Chief Operating Officer

Glenda Chamberlain – EVP and CFO

Jim Sud – EVP, Growth and Business Development

Analysts

Neil Currie – UBS

Scott Van Winkle – Canaccord Adams

Mark Wiltamuth – Morgan Stanley

Ed Aaron – RBC Capital Markets

Nicole Miller – Piper Jaffray

Josh Dexter [ph] – Soak Bee [ph]

Andrew Wolf – BB&T Capital

Chuck Cerankosky – FTN Midwest

Greg Badishkanian – Citigroup

Whole Foods Market, Inc. (WFMI) F4Q08 (Qtr End 09/28/08) Earnings Call Transcript November 5, 2008 5:00 PM ET

Operator

Good day everyone and welcome to the Whole Foods fourth quarter earnings conference call. At this time all participants are in a listen-only mode. (Operator instructions) And it is now pleasure to turn the conference over to Mr. John Mackey; please go ahead sir.

John Mackey

Thank you. Good afternoon, joining me today are Walter Robb and A.C. Gallo, Co-Presidents and Chief Operating Officers; Glenda Chamberlain, Executive Vice President and Chief Financial Officer; Jim Sud, Executive Vice President of Growth and Business Development; and Cindy McCann, Vice President of Investor Relations.

First to the legalities; the following constitutes the Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995. Except for the historical information contained herein, the matters discussed in this press release are forward-looking statements that involve risk and uncertainties which could cause our actual results to differ materially from those described in the forward-looking statements.

These risks include but are not limited to general business conditions and successful integration of acquired businesses into our operations, changes in the overall economic conditions that impact consumer spending, including fuel prices and housing markets trends. The impact of competition, changes in the availability of capital, the successful resolution of ongoing FTC matters, and other risks detailed from time-to-time in the SEC reports of Whole Foods Market including Whole Foods Market’s report on Form 10-K for the fiscal year ended September 30, 2007. The company does not undertake any obligation to update forward-looking statements.

Our press release is now available on our website at www.wholefoodsmarket.com along with the scripted portion of this call and additional supplemental financial data. Please note that the fourth quarter this year was 12 weeks versus 13 weeks last year and then our earnings results include Wild Oats for the entire quarter versus the last five weeks of the quarter last year. We have adjusted percentage increases to exclude the extra week to allow for proper year-over-year comparison.

I hope you have had chance to read our press release. We recognize that this quarter is a bit confusing, given the higher than ordinary effective tax rates for the quarter and year as well as various unusual charges. We have broken out these charges in dollar and per share amounts and have broken out the estimated impact of the Wild Oats stores to highlight the results of our existing stores.

I will first recap our results then turn to our announcement of $425 million in new equity financing and our updated outlook for fiscal year 2009. For the fiscal year sales grew a healthy 24% driven by comparable stores sales growth of 5%. For the fourth quarter sales increased 16% to $1.8 billion excluding $49 million in sales from the 35 subsequently divested Henry's and Sun Harvest stores and 13 of the subsequently closed Wild Oats stores in the fourth quarter of last year.

Comparable store sales grew 0.4% versus an 8.2% increase in the prior year and identical store sales declined 0.5% versus a 6% increase in the prior year. These are challenging economic times and Whole Foods Market is not immune to the country’s economic issues. U.S. retail sales declined in September, the third consecutive monthly decline and the first such consecutive three month decline in more than a decade.

We believe our core customers remain committed to Whole Foods. However, the unrelenting negative economic news appears to be shifting buying behavior to making fewer trips and to making more value conscious decisions. For comparable stores our transactions count declined approximately 1.5% and average basket size increased approximately 2% in the quarter.

While some regions still performed relatively well with idents in the low-to-mid single-digits, idents in every region decelerated in Q3. Cannibalization continues to negatively impact our comps, although to a lesser degree than in Q3, and as you would expect markets that have seen the sharpest real estate downturn such as Southern California, Las Vegas, Phoenix and Florida have seen the greatest negative impact.

The Whole Foods Market brand stands for the highest quality and over the last several years, we have worked hard to increase the value choices within our grocery and Whole Body departments without sacrificing our standards. We believe our efforts have been successful, since these departments are continuing to produce positive comps. While we saw a decline in average transactions in grocery, our average basket size is up, which we believe is a reflection that customers are making fewer trips but stocking up with more on each trip.

Our Whole Deal program launched in July has helped to highlight the values we offer within perishables. The program includes a quarterly in-store guide providing specialty price product discounts, money saving coupons and tips as well as budget recipes. For the July to September period, we saw a lift on all items included in the Whole Deal program, with perishables driving significant majority of the sales list.

There are some sale signs of customers trading down within the store as evidenced by sales in our own brands growing three to four times that of branded product. While we realize we are not going to change perceptions overnight, our efforts are gaining some traction in the media, which we hope will help positively reinforce to our existing customers that we are offering great values in terms of high quality at a competitive price, as well as helping educate and entice perspective new customers.

At the same time, we are trying to help meet our customer’s needs by increasing our value offerings. We are also fighting rising food costs, which is having some negative impact on our gross margin. For stores in the identical store base, excluding Wild Oats stores, our gross profit in Q4 decreased 106 basis points primarily due to higher occupancy costs driven by an increase in utilities and property taxes as a percentage of sales and to a lesser degree, increases in cost of goods sold as a percent of sales.

We believe that strengthening our value image throughout the store is the right strategy over the short-term and long-term. We are making positive strides in differentiating our product selection with a major emphasis on expanding offerings under our own label, our control brands and exclusive branded products.

Our SKU count for offerings under our own label increased 27% year-over-year to just under 2600 with sales at 21% of our total grocery and Whole Body sales, and we now have close to 300 exclusive branded products with another 20% in the pipeline. We are pleased to announce that Michael Besancon, formal President of our Southern Pacific region has accepted a newly created position of Senior Global Vice President of Purchasing, Distribution and Marketing, reporting to our Co-Presidents Walter and A.C.

Our goal with this new position is to create a collaborative vision for our purchasing, marketing and distribution teams at the regional and global levels. With over 30 years experience in purchasing, Michael has created a regional program that has produced strong margins primarily through offering differentiated products and effectively telling a story behind the products within the store. We are excited about Michael spreading his vision and best practices throughout the company.

Identical stores continue to deliver healthy improvement despite decelerating sales and direct store expenses, which decreased 43 basis points in the quarter primarily driven by leverage in the wages. We opened eight new stores, including two relocations in the fourth quarter; these stores averaged 52,000 square feet and included three new markets, Venice, California; Honolulu, Hawaii and Richmond, Virginia.

Our Venice Beach store is off to a very strong start ranking as the highest volume store in our Southern Pacific region. We are also opening our first four stores in Hawaii, our Honolulu store, opened in Kahala Mall opened, with over 20% of its inventory in local product, which has been a key factor in differentiating our store from the competition and has been a big hit with customers. Just under 30,000 square feet stores producing excellent sales per square foot.

For the quarter, our 26 new and relocated stores averaged 54,000 square feet in size and we’re approximately seven months old. We produced average weekly sales of $582,000 translating sales per square foot of $553. As a class, our new stores during the quarter produced a higher store contribution as a percentage of sales in our class of new stores in Q4 last year and accounted for approximately 9% of our core sales versus 10% last year.

We are now one year into our merger with Wild Oats and as many – as with many of our past mergers we have made many of the upfront investments in product quality, labor, pricing and repairs and maintenance to raise the overall shopping experience in the Wild Oats stores up to our standards. Sales at the 55 continuing Wild Oats stores for the quarter were $159.3 million and comparable store-sales growth for the last four weeks of the quarter was 4.6%.

Continuing stores produced a 54 basis points improvement in store contribution from the third quarter. To-date 45 Wild Oats stores have been re-branded. The estimated dilutive impact from Oats was approximately $0.09 per share in the quarter. Our dilution run rate is primarily due to non-operating charges of approximately $0.06 per share, relating to idle Wild Oats properties and asset impairments at two continuing Wild Oats locations.

For the quarter our effective tax rate was 90.3%. Net income was $1.5 million, diluted earnings per share was $0.01. These results include approximately charges of $0.15 per share that were not part of our guidance as follows; One, idle Wild Oats properties, we increased our store closure reserves to 40 closed Wild Oats stores by $14.7 million or 27% to $64 million.

These increases in reserves for estimated higher net lease obligations were required due to the downturn in the real estate market and the economy in general, because these adjustments are reflective of current market conditions rather than conditions existing at the date of the acquisition, this $14.7 million or $0.05 per share was expensed rather than allocated to goodwill.

Number two, tax rate; our higher tax rate for the quarter was primarily due to the repatriation of $60 million in cash from our Canadian subsidiary and the catchup adjustments to bring our effective rate for the year to 41.6%, which impacted earnings by $0.05 per share. Number three; lease terminations, we recorded approximately $5.5 million or $0.02 per share in non-cash charges related to 13 lease terminations of Whole Foods stores that were in development.

Number four; asset impairments, we recorded approximately $1.5 million, or $0.01 per share, in non-cash charges to write down assets for two Wild Oats locations based on current expectations of future cash flows for these locations, which were not sufficient to support our recorded asset balances. Number five; closure cost, relocations, store closure and lease termination expense include $2.6 million or $0.01 per share related to the closure of two regional bake-houses and one Fresh & Wild store in Bristol in England..

Number six; legal cost, G&A expenses include $2.5 million, or $0.01 per share, in legal cost related to the FTC lawsuit. Approximately $75 million relating to depreciation and amortization, share based payment, LIFO and deferred rent was expensed for accounting purposes, but was non-cash. We produced approximately $82 million in EBITDA and $97 million in earnings interest, taxes, depreciation and amortization other non-cash expenses or EBITANCE.

While we are still producing strong cash flow, challenging economic environment is negatively impacting our sales and bottom line. The uncertain environment combined with our commitment to maintaining financial flexibility and investing prudently in our long-term growth, has led us to announce that we have raised $425 million of additional equity from the sale of the Series A Preferred Stock to Green Equity Investors V, L.P., an affiliate of Leonard Green & Partners, L.P.

We are pleased that Leonard Green & Partners, one of the most experienced and successful investors in the retail industry, has decided to make a significant investment in Whole Foods Market, we view it as a strong vote of confidence in our business model and our long-term growth prospects, despite the tough current economic environment.

This equity infusion combined with our strong cash flow from operations gives us the financial flexibility to manage through these difficult economic times while continuing to prudently invest for -- in our long-term growth. From both an operational and capital expenditure standpoint we have confidence that our current store development pipeline of 66 stores is very manageable over the next four years.

Now I will turn to our updated outlook for fiscal year 2009. For the first five weeks of the first quarter ended November 2, 2008 comparable store-sales decreased 2.1% versus a 9.0% increase in the prior year and identical store sales decreased 3.3% versus a 6.7% increase in the prior year. The uncertain and rapidly changing makes it very difficult to forecast -- this uncertain and rapidly changing economy makes it very difficult to forecast future results.

Therefore we are not providing comparable store-sales growth guidance at this time. However, flat comparable store sales assumptions combined with the expectation of eight net new store openings, would translate to total sales in the range of $8.3 billion for fiscal year 2009. Our year-over-year comp comparisons are very difficult in the first half of the year at 9.3% in the first quarter, they become less difficult on a quarterly basis throughout the year.

Based on the sales assumptions along with the more detailed guidance provided in our press release, we estimate EBITDA in the range of $525 million to $545 million and EBITANCE in the range of $580 million to $605 million. Diluted earnings per share are estimated to fall in the range of $0.95 to $1 excluding approximately $0.06 to $0.08 per share in estimated dilution from FTC-related legal costs and an estimated $0.19 per share impact from the Preferred Series A stock.

To conclude, these are certainly challenging economic times. We are hopeful that our sales trends will stabilize and improve as we continue to execute on our differentiation strategy, while gaining increasing credit for the value that we offer. While we cannot completely control the impact of the economy on our sales, we can control many of our cost.

We have the financial flexibility to manage through these difficult economic times, while continuing to prudently invest in our growth. From both an operational and capital expenditure standpoint, we consider our current store development pipeline of 66 stores to be very manageable over the next four years. We are an adaptive and resilient company that will continue to adapt in a prudent manner to these uncertain economic times.

We will now take your questions, but ask that you limit your questions, so that everyone has an opportunity to participate. Thank you.

Question-and-Answer Session

Operator

(Operator instructions) Our first question comes from Neil Currie of UBS; please go ahead.

Neil Currie – UBS

Good afternoon, thank you very much. Just want to talk about the last five weeks of trading. Obviously, there’s been deterioration since the quarter end. Was there any part of that due to maybe an attempt to be a little bit more rigorous on inventory levels given perhaps the tight cash situation and maybe less availability than has been historically?

John Mackey

No, I don’t think so.

Neil Currie – UBS

Okay. So, you don’t, because there are some stores that we have seen some patchy inventories and it’s hard to say whether that’s a trend across the company. So, there’s not been any problem that you have seen?

John Mackey

No trends; just anecdotal observation on your part.

Neil Currie – UBS

Okay. Thanks, that clears up. Certainly the other question was, you said that the fewer trips, that people are stocking up and just that the basket was up 2%. What do you think inflation was in that basket, would it have been positive without inflation?

Walter Robb

Neil, this is Walter. Depends on which inflation numbers you are using, but our internal market basket, which is about a 1000 items at 4% on natural items, 6% is a number that’s a CPI number. So, relative to other competitors I thinks it's less of an impact than some other competitors and, by the way in terms of your first question, I think that we are doing relatively well in terms of comps in the last four weeks relatively to what I see out there with other retailer.

Neil Currie – UBS

Okay, I just wonder whether any sort of cash issues may have forced you just to pair back a bit which may have damaged sales a bit further, so maybe ?

Walter Robb

No, just really to support what John said that’s just not a good avenue to go down that’s just not true, definitely an effort to be -- to manage our inventories carefully relative to sales, but there is no effort in that regard.

Neil Currie – UBS

It was a small sample of store. The Idol stores – the last question Idol stores, what are the chances of getting out of those soon?

Jim Sud

Well, it’s becoming more and more challenging obviously as the economic – as the economy is not cooperating with us, so we have hired an outside firm, a company called Excess Space to work with this and they are in charge of disposition of excess properties and they are taking a very conservative approach based on current economic conditions.

Walter Robb

We will package them up for you Neil if you make us an offer.

Neil Currie – UBS

I will talk to my bank manager. Thanks a lot.

Operator

And our next question comes from Scott Van Winkle of Canaccord Adams. Please go ahead.

Scott Van Winkle – Canaccord Adams

Hi, guys thank you. I wonder, with the changes you are making in-store on the value proposition, have you seen any effect on kind of the more higher lease proceed of quality perishable items, meaning pushback from customers about the changing quality?

Walter Robb

Scott, this is Walter. I am not sure I understand your question, could you take another run at it?

Scott Van Winkle – Canaccord Adams

Walt, I am under the assumption that some of the changes you made in the perishable side, I know you are pushing the value proposition, in the center of the store, but on the perishable side, a change in the perceived quality of the products. You know, you talked last quarter about taking out a higher priced item for a lower priced alternative, have you seen any pushback from customers?

Walter Robb

Okay, so our efforts really are in two directions, first is to try to get more credit and more visibility for the value that we think we have always offered, and the second thing is an effort to be more visible with more value for the same quality products. For example, offering maybe a different size of an apple or a certain size of piece of fish or meat. So, there is no compromise in the quality standards in any of these efforts. Our definition of value is quality at – our quality at competitive prices. Did that answer your question?

Scott Van Winkle – Canaccord Adams

It does. And with some of the boards you have in the stores talking about the deals you can get on products relative to comparable retailers, have you had any specific response from your customers? Has it worked in some stores and not in others or did you test it first and then have a response from customers and then roll it out broadly?

Walter Robb

Well, it is not in every store, but it is in certain stores where the competitive market is particularly intense, but it is – it has been extremely well received by the customers and I think it is to the first point of just trying to help people to understand that there is a lot more, our pricing is competitive and there is a lot more value there perhaps than they realize and that’s been the main reaction as well. I didn’t really realize that compared to the other retail choices in the market.

Scott Van Winkle – Canaccord Adams

Great, thank you.

Operator

And our next question comes from Mark Wiltamuth of Morgan Stanley. Your line is opened.

Mark Wiltamuth – Morgan Stanley

Could you just give us some progress update on how you’re doing on downsizing stores in the pipeline and any other efforts you have on expense control that you could update us on?

John Mackey

As far as downsizing, we are for the most part pretty much through that process. There is a few sites that were currently working on, but again for the part, we are currently through it and getting the size of the stores in the pipeline where we want it to be?

Walter Robb

With respect to expense controls, I think the results in Q4 and the item [ph] stores in particular show reasonable discipline in the gross margin and discipline in the labor and other direct store expenses, which I'm happy to say are – those trends are continuing in the fiscal one and also reflected in our guidance.

Mark Wiltamuth – Morgan Stanley

And could you see any scenario where you would cut store growth further, or you just feel like with this equity investment you are just going to keep moving forward with these store openings?

Walter Robb

You'll notice in the press release that we spaced out the 66 stores that we still have in development over the next four years and we should have operating cash flow adequate to open those stores at a measured rate. So, we don’t anticipate adding that many new stores to the inventory unless there is a simultaneous elimination of stores from landlords who weren't able to get their financing or haven’t been able to meet the covenants of the lease. So, I think the way we have got it organized and that we are growing in a very measured sustainable pace that we should have adequate cash flow from operations to cover. So, we are not looking to gut our development any further.

Mark Wiltamuth – Morgan Stanley

On the leases that you have had to exit, et cetera, is there a total number you can give us on lease termination costs et cetera?

Walter Robb

Good question. Is that in our press release?

Glenda Chamberlain

Well, we had the lease termination cost in fourth quarter broken out separately, is that what you are asking?

Mark Wiltamuth – Morgan Stanley

Is that the total for all the ones that you have exited or is that going to be it, I guess?

Glenda Chamberlain

No, that was the total for the ones we exited in the fourth quarter.

Walter Robb

We gave $5.5 million, $0.02 per share for 13 lease terminations. That is all we have terminated. I mean I think those are the stores that we terminated for the most part.

Mark Wiltamuth – Morgan Stanley

Okay and you think you are done now at this point?

Walter Robb

No, I wouldn't say that. Jim said that he didn’t anticipate we would be downsizing very many more stores. There is possible more lease terminations ahead. If landlords are not able to get financing, then we can't develop a store if landlord can’t finance the shopping center. And in some cases, we made as -- concluded it's on our best interest to exit from those situations.

Jim Sud

This is Jim again. There is a number of deliverables on both sides of equation from our side and also from the landlord side. From the landlord side, they include entitlements, certain construction obligations, timeline obligations, co-tenancy lease subs that type of thing. And then certainly, the capital markets have an impact as well in terms of their ability to get financing for these projects. So I wouldn’t be surprised if there were some additional projects in the future where they would possibly fall out as a result of certain landlords not being able to deliver on those deliverables.

Walter Robb

Maybe important point to make here is that, Whole Foods Market still considers itself a growth company and we are still producing excellent operating cash flow. We are intending to continue to grow even in this downturn, but just at a more measured pace and a more prudent way.

We have reexamined the sites that we have in development. We put in reduce comp assumptions and we believe worked kind of our long-term plan as a result. We think – and there will continue to be great market opportunities for us that we may seize upon. But one thing we have done is we've cut our -- previously the hurdle rate for a new store to get to our real estate committee was a seven year present value EVA positive number, and we have now reduced that to five years. And we have also put in reduced expectations for comp sales growth for new stores to reflect our more current experiences.

So, store with lower comps has to hit that five year EVA hurdle or doesn’t get to real estate committee, so it is a tougher hurdle to get through, but hey, we signed three new stores last quarter. So, we are getting the higher quality, sites are going to still get through our process. So, hopefully to slowing this growth down, but we are continuing it.

Mark Wiltamuth – Morgan Stanley

Okay, thank you very much.

Operator

And our next question comes from Ed Aaron of RBC Capital. Your line is open.

Ed Aaron – RBC Capital Markets

Great, thank you. Just some question on the preferred investment. The $425 million just for modeling purposes, is that net proceeds and then can you also talk about the use of those proceeds; will you pay down debt immediately or do you plan on keeping the cash on the balance sheet for now? And then finally, how it affects your debt covenants, the dilution that is?

Glenda Chamberlain

We will pay down our line of credit immediately and the rest of that will just remain on the balance sheet. We have two debt covenants; one is our leverage ratio and of course it has a positive impact on that because it reduces our debt, although we certainly had tremendous amount of cushion anyway on that one. The other one is FX fixed charge coverage ratio, it has less effect on that, but it does have a slight improvement because of that investment income that would be included in the calculation of earnings before interest and taxes, and because the denominator would be lower as your interest expense goes down. We also weren’t in any trouble at all on that covenant. So, it helps both covenants, but neither one of them were in trouble.

Ed Aaron – RBC Capital Markets

Okay, thank you. And then, so you withdrew the comp guidance, but you did offer framework with a flat comp assumption. Is that assumption – should we view that as your best guess based on your outlook or is that basically where you think the comps would be for the year, assuming that the trends over the last few weeks or how you want to look at it persisted, and then you got some benefit of easier comparisons as the year progressed?

Glenda Chamberlain

That is not guidance on our part; it’s not intended to give you a reflection of any thinking on our part. We don’t really know what comps are going to be, so we are not trying to give guidance on those, but what we did want to do is give you the information, and that's information where you could develop your own comp assumptions and then flow that through the rest of the income statement.

Ed Aaron – RBC Capital Markets

Okay. And then finally, can you just with the lease terminations, you’ve done a few of them, can you talk about the cases where or maybe you do want out, but the landlord doesn’t have any financing constraints, so it’s more. You happen to go to the landlord and getting their consent to tax out of the lease, how those discussions have gone in your relative ease of being able to get that done in cases where you’ve wanted it?

John Mackey

We haven’t done that, so there is zero cases that meet the criteria you just outlined.

Ed Aaron – RBC Capital Markets

Thank you.

Operator

And our next question comes from the Nicole Miller with Piper Jaffray. Please go ahead.

Nicole Miller – Piper Jaffray

Hi, just for housekeeping purposes, could you tell us where the bulk of these or the buckets – the four buckets you outlined, where they are, so would pull some of these charges out and true up earnings? And then just as it relates to the guidance, if I have backed into everything correctly, it looks like the store level margin with -- again on that base case comp, which I understand could change, but it would imply moderate store level deterioration when in fact store margins were down over a 100 basis points this year. So, I just need to better understand, is there something that you are strategically attacking to bring – to make sure you don’t have further de-leverage on the comp coming down, or is there some sort of input like a cost input that has changed?

Walter Robb

Okay Nicole, Walter. You made the statement that store margins were down 106 basis points; that’s not correct. The press release says that the margins are 106 basis points for the quarter, but the detail there on that is that there is three components to that; the higher occupancy costs, non-retail costs, which are about $2 million, $1.7 million of that which are one-time costs, and then a moderate increase in cost of goods sold. And what I said is, we’ve got our fiscal one results and are ready with full inventories and those trends are positive. So, it doesn’t imply that sort of margin deterioration at all.

Glenda Chamberlain

And the answer to your second question, the asset impairment is in direct store expenses. The legal costs are in G&A expenses, the closure of the two bake-houses and the one Fresh & Wild store is in relocation store closure and lease termination costs. Also in that line item is the lease termination costs and the $14.7 million charge on the idle Wild Oats properties, and of course the two charges related to taxes both for the cash repatriation and the fourth quarter catch up entry are in that provision for income taxes line item.

Nicole Miller – Piper Jaffray

Thank you. That will obviously make a difference into the margin question, so understood. Thank you.

Operator

And our next question comes from Josh Dexter [ph] of Soak Bee [ph]. Please go ahead. Unfortunately, Mr. Dexter, we’re unable to hear you. Could you check your mute function on your phone?

Josh Dexter – Soak Bee

Hello.

John Mackey

Hello, what's your question?

Josh Dexter – Soak Bee

Sorry, guys. Just stepping away from the model questions for just a second, what I’m a little confused on is that, if I look at your market cap today of about $1.4 billion, $1.5 billion and I just say that each of your stores has a value of say $5 million or $6 million in the current market and you are spending $20 million to open new stores, I wonder why would we sell or want to sell stock to a new party at that level, why does that make sense?

John Mackey

It makes sense because we are in very uncertain economic times and we are not certain what is going to happen. So, management team in looking out over the long-term wanted to be as prudent as possible to make sure we had adequate liquidity to see us through whatever comes down the pike.

Josh Dexter – Soak Bee

John, why don’t you just stop growing? I mean, I understand that the format that has made you guys very successful, but the world has turned over and the need to grow stores given that your – the current evaluation of a store is one-forth what you put into them. I can’t figure out why growth at this point in any fashion when you have enough cash flow to cover everything versus diluting shareholders by 20% plus interest, I can’t figure out why that will make a lot of sense given you have plenty of cash flow to repurchase shares and I would never encourage you to do that unless the valuation was so extreme, which you would admit right now $6 million one of your stores sounds pretty extreme? Strategically, I am really lost, I might be doing [ph] experience, but maybe you can help me, because I would think that was the greatest use of your cash.

John Mackey

It is a very good question and it is one we have had strong internal debates within both our management team and with our Board of Directors. We believe that right now Whole Foods Market is very undervalued and it is a temporary phenomenon. We are trading at three to four times our EBITDA right now.

We do not think that is a permanent or long-term solution. In terms of buying back our stock right now, it is a good suggestion. I urge you to write a letter to our Board of Directors encouraging the – sharing them your perspective on it. My strategy right now is to be as prudent as possible given the uncertain economic conditions. We are not certain what is going to happen over the long-term.

Josh Dexter – Soak Bee

Just so I understand now, if these aren’t the worst movements you have ever seen, what would stop you guys from growing and putting up stores? Is there anything in the world that could stop you from doing that?

John Mackey

Well, we want to stop putting up stores, if we don’t think they are going to be profitable and produce EVA and --

Josh Dexter – Soak Bee

Is that EVA per share or EVA per store?

John Mackey

Both.

Josh Dexter – Soak Bee

Okay, so EVA per share you think is positive?

Walter Robb

We believe that the stores that we have in development will produce positive EVA on a present value basis, for both the short term and the long term.

Josh Dexter – Soak Bee

Okay. Let me ask you one other one and I will get off, but let me just say if you decided to stop fighting the government and you said look, we don’t want to spend $5 million a year fighting for something that in effect right now the market values at nothing, what happens if you decide to say to the government you are right, give us our money back, we don’t want your stores at Wild Oats, what happens?

Jim Sud

We can’t get our money back. If I could get my money back, I would take it back. We can’t get our money back, so if we start fighting the government, they take all the stores away from us.

Josh Dexter – Soak Bee

And we get nothing?

Jim Sud

We'll only get whatever the government decides is fair and just in their minds.

A.C. Gallo

So we really have no recourse other than to just keep fighting it?

Jim Sud

That’s correct.

Josh Dexter – Soak Bee

Alright, well listen I know this is an incredibly challenging time and although I am not worried about the model, I know all of you are suffering with the share price coming down, I just ask you to think about as you put up the stores that you have plenty of cash flow to keep this company running without borrowing 8% from anybody and if we just didn’t grow as much, you could effectively take the company private before the recession turns over and I just think it’s hard to swallow as we give up 20% of the firm to allow ourselves to continue putting up stores, in which the market takes 80% of the value away day one. Just doesn’t make a lot of sense.

Jim Sud

Okay. Thanks very much for your input.

Operator

And our next question comes from Andrew Wolf of BB&T Capital. Your line is open.

Andrew Wolf – BB&T Capital

Thank you. Just a quick follow up on the Leonard Green investment, can they convert that currently at $14.50 a share, or is that already convertible?

Glenda Chamberlain

What we are going to do is put all of the terms on. We know there are a lot of questions about the investment and the term, so rather than going through all of those on this call, what we’re going to do is put up the term sheet, the summary term sheet on our website either tonight or in the morning. So everyone will have all their answers, all their questions answered.

Andrew Wolf – BB&T Capital

Okay, but what about such a simple question, if they felt like tomorrow getting converting, is that investment to convertible tomorrow?

I just wanted to know about that, okay, because I see there are some stuff of, puts and so on –

John Mackey

If you can persuade him to covert, so we would depreciate that.

Andrew Wolf – BB&T Capital

Well, maybe they will. Secondly, you’re EPS, you beat your guidance. If you add back what you weren’t expecting in the -- or wasn’t in your guidance, I got some guesses as to where you beat, but I would rather hear from you, where did you guys come in better -- on unexpected [ph] sale I guess it’s obvious, which expense items beat and if you think that’s sustainable?

John Mackey

One factor was a strong reduction in G&A percentage, which had been running high on the year. We invested ahead of our growth to integrate Wild Oats as well as the 20 stores we opened in this fiscal year and we had a reduction in force to cut back some of our G&A in the quarter, we also have had a salary-free. So, we’ve trying to manage our G&A number down and we were successful in Q4 with a reduction to I think 3.1% of sales. That was definitely an important factor.

Glenda Chamberlain

Preopening was also slightly lower.

Andrew Wolf – BB&T Capital

Yes, I saw that. What about, I mean the store expense, it is an incredibly stable number as a percent, but it was down a lot sequentially, which suggest pretty tight cost control. I mean you guys have been talking about that, but is there a limit how much that can go down without – how do you feel about the service levels on the– to the customer, which I think is obviously one of the attributes of Whole Foods that people like?

John Mackey

Obviously that, we have been talking about the disciplines and thank you for recognizing that because, as the comps we’ve been learning to operate with better disciplines at the lower sales level and I think the consistency in these numbers is reflecting the excellent efforts of Regional Presidents in doing that. Obviously, at some negative point, we are not talking about leverage here in the case of negative sales, we are talking about good disciplines because you know positive sales to leverage, but at some negative points, it becomes more difficult.

We are not there yet, we hope not to get there. Maybe we will be better able to answer that question that time, but right now, I think we are finding the right balance and I would say that part of the great opportunity at this time for us has been as a company to kind of reexamine and bring ourself back to those things, which I think really make us great in the first place, which is the – and set us apart in the marketplace, which is the individual customer service and the store experience, and I think we are refocusing on those things and in a sort of ironic way, using this time to find our way back to really reemphasizing, taking care of the individual customer, taking the individual team member and delivering a better store experience

Andrew Wolf – BB&T Capital

And if I could just squeeze in one more. On the 13 leases you got out of, I'm really interested in, here where I live in Richmond, where you own a new market and the store seems to be doing quite well. You mentioned Venice Beach. So, what I want to ask about 13 stores that -- where you got out of the way for, is there any, should we be thinking these are more in markets that were maybe reached saturation or where the stores that were too big or that your landlords want to downsize them? Could you just talk about the what kind of, if any point the commonality they had and I am really thinking about in the context of saturation which (inaudible) earlier question of whether you should open more stores or not?

John Mackey

They had two points to commonality. One point is, we went back and we reexamine all the stores we have in development and we model then lower comp sale expectations and we have to look at what that did at the EVA for the store. And if it wasn’t going to be a seven year EVA deal any longer for stores that we had already signed up, that was the first factor. So, it if wasn’t going to produce a seven year EVA, went into a list of stores we'd like to divest it possible. And then the second factor was the stores that we would like to divest, could we divest them? Meaning, have the landlord not met their covenants in our agreement, have they met their tender dates, have they produced all the things that they had agree to do.

And if they haven’t and the store was in a seven year EVA deal, then we terminated the lease or we gave notice to terminate. And leases that were under contract and landlords met all their obligations, we’re under legal obligation to fill that contract. I mean not to say we just stop growing just to save cash, but that’s not what we agreed to do when we signed the contract and there is a certain ethical and legal obligation to fulfill your commitments, in my opinion, as long as you are under legal obligation to do so. So, it had to meet those two things and it had to be stores that when no longer are going to be EVA positive in the seven year time period due to reduced comp expectations, and then secondly, it had to be a store that landlords had not fulfilled their lease obligations with. So, Jim, do you want to -- anything else you want to add to that?

Jim Sud

No, that pretty much covers it.

A.C. Gallo

This is AC, there is one other thing that I would like to add, and as John talked about the stores that we’re able to terminate and how we evaluated the investment, it was still a seven year EVA. Just want to also point out that even on the stores that are still on our pipeline that we still have in development, Walter and I have gone back and we’ve looked at every store and kind of reassessed where we think the sales and the comps might be based on current conditions, and we have done both reducing size of stores, but also working with regional Presidents to reduce the capital that we’re going to invest in those stores, so that we can still meet our seven year or better EVA hurdle.

Andrew Wolf – BB&T Capital

Okay, all right. Thanks.

Operator

And our next question comes from Chuck Cerankosky with FTN Midwest. Your line is open.

Chuck Cerankosky – FTN Midwest

Good afternoon everyone. I got a couple of questions about shrink and given the lowers sales pace especially on the IT [ph] side, was shrink more of a challenge and was that a significant factor in the lower gross profit margin?

John Mackey

Your question is about that the shrink and greater challenge with the lower sales?

Chuck Cerankosky – FTN Midwest

Yes, especially in the perishable categories.

John Mackey

Yes, it’s always a challenge to lower sales. I don’t know that -- I think that what you’re seeing in the gross margins, I think again the disciplines are improving and we have made it more of a focus to back half of the year to really work on that. So again, within a certain range, it's manageable. If it gets down in a serious negative range, it becomes more difficult.

I mean remember, we still reported a positive comp in the fourth quarter, so it's not like there is a huge gap between -- like all of a sudden our sales have -- the rate of growth have slowed down, that it is not like we've gone into serious negative territory so far in any reported quarter. So, until that happens, it hasn’t been much of a problem. However, it could be a problem if the economy was to continue to deteriorate and -- but again, our company is very resilient and innovative. We would no doubt cut back our perishable space dedicated to perishables in order to minimize spoilage if we needed to do that. So far, we really haven’t needed to do that.

Walter Robb

That’s a good point, John, and really the only place where that shows up more quickly is in the larger stores where perhaps the stores are a little larger for the sales and then you've got to just maybe reallocate some of that space to non-perishables to make your way through. But I think our look-see on inventory levels relative to the individual teams, our disciplines are better and improving and I think we've got a better handle on that right now.

Chuck Cerankosky – FTN Midwest

Was the shrink rate up in the fourth quarter versus year ago?

Walter Robb

Which team you’re talking about?

Chuck Cerankosky – FTN Midwest

Overall and perishables, if you have both.

Walter Robb

I don't have those numbers right here.

John Mackey

I mean they reflect in our gross margins and we didn’t see -- we had a little bit softer gross margins in Q4, but they were primarily due to occupancy costs rather than spoilage. So, it hasn't been a big factor yet, but I would say it's something to keep your eye on, if we were to see serious sales deterioration going forward.

Walter Robb

If you want more details, send a note to Cindy and we will get you the specifics.

Chuck Cerankosky – FTN Midwest

And then on the repatriation of the Canadian cash, was that driven by the uncertain economic environment?

Glenda Chamberlain

Well, we have that $60 million of cash, it really wasn’t doing us any good in Canada, so we – so yes, it seems like a good time to go ahead and recover it.

Chuck Cerankosky – FTN Midwest

Alright, thank you very much.

Operator

And our next question comes from Greg Badishkanian of Citigroup. Your line is open.

Greg Badishkanian – Citigroup

Great, thank you, just a few questions on the comps. Can you explain and kind of just give some color around how Wild Oats impacted comps for the quarter? I believe that they were in part of it and they are higher than Whole Foods base, is that right, or is that excluded in the comp number?

Glenda Chamberlain

They were included in the comps for the final four weeks of the quarter.

Greg Badishkanian – Citigroup

Okay.

Glenda Chamberlain

And we are not reporting them separately, but they did have a very minor positive effect on comp.

John Mackey

Greg, going forward, beginning this first quarter, with a whole year now past in the merger, we are not going to be breaking Wild Oats out separately any longer for comps or for dilution or anything else. They are – we are going to consider them to be – they are now completely part of Whole Foods. It is been a year and so you won’t see that separate breakout. They are still -- Wild Oats comps are running above Whole Foods Market's stores and we expect that trend will continue into throughout fiscal year -- probably for the next several years, but certainly through fiscal 2009.

Greg Badishkanian – Citigroup

Okay.

Jim Sud

And one other data point on that is the basket size of Oats is – it is a 15% lower than the Whole Foods basket size. So, the opportunity is to really grow, comps is also through the basket size as well. There is a nice pick-up opportunity there.

Greg Badishkanian – Citigroup

Good, thanks and with respect to you used the base case for guidance, to get to flat, is there anything – any initiatives or anything that you have that you plan to implement because the – obviously the current trend is down about 2% besides just kind of coming up with each of your comparisons in the back half of the year? Is there anything that you have that you plan to do differently?

Glenda Chamberlain

We weren’t trying to imply that we are going to be at 0% for the year. Again that number is not guidance, it is merely a place for you to be able to take those numbers, put your own comp assumptions and then you have enough information we hope to help you get to an informed projection for your own sake for fiscal 2009. It is not – it is not our guidance.

Walter Robb

It is true though that many positive things will happen as the year goes on that will probably act positively on comps. First we've got Wild Oats in the comp base, now that will have some positive effect. Number two, we are growing slower, perhaps not as slow as some of our investors would like us to grow, but we’ve lowered our growth from 25 to 30 stores to only 15 stores this year, and so that’s -- that rate of growth is slower than we have experienced the last two years and the rate of cannibalization is therefore going to be less in 2009 than it was in 2007 or 2008, and the stores that are being cannibalized now from the impact of openings in 2008, as fiscal year 2009 progresses, the rate of cannibalization will begin to anniversary. So there will be, particularly in the back half of the year, we’re going to start seeing anniversary of cannibalization in 2008. That’s going to have a positive impact on comps. So, we are not giving any guidance, but as a general rule, we are expecting to see weaker comps in the – particularly in Q1 where we have got a 9.3% comparison, it’s going to be tougher in the first quarter and we go to 6.7% comparison in Q2 and then it starts to get easier and particularly in the back half of the year Q3 and Q4. And then, when you add on the anniversary of some of that cannibalization and the – to the easier comparisons, we should see unless the economy continues to deteriorate deeper and deeper, I would expect our comps to be higher in the second half of the year than the first half of the year, but that’s not guidance.

Greg Badishkanian – Citigroup

Great, that’s helpful. And as I think about and I can run my own numbers, but you guys have better handle on the numbers obviously, if let’s assume that the current comp trend is down two continues throughout the year, what would that imply for EPS range?

Walter Robb

That’s your job buddy.

Greg Badishkanian – Citigroup

Okay. Great, thank you very much.

Operator

And gentlemen, we have time for one more question and that question comes from Ed Aaron of RBC Capital. Your line is open.

Ed Aaron – RBC Capital

Thanks. Couple of just quick follow ups, can you talk about the experience that you have with the $5 coupon promotion that you ran in the quarter? And then secondly, just circling back on the lease flexibility situation, recognizing that you have obligations and you can’t get out of every lease that you might want, are there any stores in the pipeline that you don’t think are going to meet your internal EVA hurdles as you look out?

John Mackey

I’ll take the second question first and Walter will take the first part of the question. Are there any stores that are in development that are not going to meet seven year EVA hurdle, yes, probably there are a few that are in that case, but great majority of the stores that we still have left, we expected to hit a seven year EVA target. We are certainly not going to give specific information about those particular stores. In addition, we’re hoping that in some cases, we may still downsize those stores or we may open them in slightly smaller square footage and keep additional square footage for expansion later on in more normalized economic times, so that’s it on that part.

Jim Sud

Yes, I would just add to that. We also have great flexibility as to the timing on when we open these stores. So, we’re not – we don’t really have a gun to our heads in terms of opening covenants or anything like that, which we still wait for the most part. So, we’ll open these stores in a manner that's prudent and consistent with our growth and what is going on in the economy.

Walter Robb

So, with respect to the coupons, I mean they are part of a larger effort to really the Whole Deal platform that we put together and launching the new website, which I hope you’ve had a chance to see. And there is some really exiting stuff happening there, including real-time blog conversations with our customers who are really offering up their own ides about value at Whole Foods now.

It's kind of exciting to see that happen. But the coupon was an experiment, we wanted to see what the traffic sort of looked like, what happened there? And it was a one-time thing that we did. We’ve looked at potentially doing it another time. At some point in the future we kind of tweak the business case, but it definitely drove traffic. Whether or not it drives traffic on an ongoing basis is less conclusive at this point. And I wouldn't look for a lot of that in the future, but it definitely drove some traffic and some interest, particularly I think for people maybe who have lapsed from Whole Foods and decided to come back and give us a fresh look.

Ed Aaron – RBC Capital

Walter, do you think it had a meaningful impact on the quarter to-date comp number in a positive way?

Walter Robb

No, I wouldn’t say so, we only ran it for six days and we had no idea what was going to happen when we ran it, but we just upgraded the website and so we wanted to sort of see what response and traffic we got from it. It did drive some traffic, but not enough in a meaningful period of time to affect the number.

Ed Aaron – RBC Capital

Thanks guys.

Operator

And unfortunately, that is all the time we have for Q&A today and I will turn the call back over to Mr. Mackey.

John Mackey

Okay, thank you very much for listening in today. We believe we have the financial flexibility to manage through these difficult economic times, while continuing to prudently invest in our growth. In the long-term, we remain very bullish on the growth prospects for Whole Foods Market as the market continues to grow and as our company continues to improve. We look forward to speaking with you again in February on our first quarter earnings call. A transcript or the scripted portion of this call along with the recording of the call is available on our website www.wholefoodsmarket.com. Talk to everybody next quarter, bye.

Operator

This concludes today’s teleconference. You may disconnect at any time. Thank you and have a great day.

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Source: Whole Foods Market, Inc. F4Q08 (Qtr End 09/28/08) Earnings Call Transcript
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