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Executives

John Mackey – Chairman and CEO

A.C. Gallo – Co-President and COO

Walter Robb – Co-President and COO

Cindy McCann – Global VP, IR

Jim Sud – EVP, Growth and Development

Analysts

Ed Aaron – RBC Capital Markets

Neil Currie – UBS

Andrew Wolf – BB&T Capital Markets

Meredith Adler – Barclays Capital

Greg Badishkanian – Citigroup

Mark Wiltamuth – Morgan Stanley

Berkley [ph] – Jefferies & Co.

Chuck Cerankosky – FTN Equity Capital

John Heinbockel – Goldman Sachs

Whole Foods Market, Inc. (WFMI) F1Q09 (Qtr End 01/18/09) Earnings Call Transcript February 18, 2009 5:00 PM ET

Operator

Good day ladies and gentlemen. All sites are now on-line in a listen-only mode. Later on in the presentation to do there will be an opportunity to ask questions. I will now turn the program over to our moderator for today John Mackey, please go ahead.

John Mackey

Good afternoon. Joining me today are Walter Robb and A.C. Gallo, Co-Presidents and Chief Operating Officers; Jim Sud, Executive Vice President of Growth & Development; and Cindy McCann, Vice President of Investor Relations. Glenda Chamberlain, our Executive Vice President and Chief Financial Officer, will not be joining us today due to a family illness.

First for the legalities. The following constitutes a "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 risks 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, the successful integration of acquired businesses into our operations, changes in overall economic conditions that impact consumer spending, including fuel prices and housing market 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 28, 2008. The Company does not undertake any obligation to update forward-looking statements.

I hope you have had a chance to read our press release, which is available on our website along with the scripted portion of this call. Please note that the Wild Oats stores were included in our comparable and identical store base for the entire quarter of the current and prior year. Our historical results include the Wild Oats stores as of the last four weeks of the fourth quarter fiscal year 2007. We will no longer be breaking out the estimated impact of the Wild Oats stores on our results.

For the first quarter, sales were flat at $2.5 billion, or up one percent excluding $16 million of sales in the prior year from 13 subsequently closed Wild Oats stores. Average weekly sales per store for all stores were $551,000 in the quarter, translating to sales per square foot of $786. These stores averaged 36,400 square feet in size and had an average age of approximately seven years. Year over year, our ending square footage increased nine percent to 10.2 million square feet. Our 21 new and relocated stores produced average weekly sales per store of $510,000, translating to sales per square foot of $511. These stores averaged 52,000 square feet in size and on average had been open for approximately six months. Excluding the negative impact of foreign currency translation, comparable store sales decreased 3.4%, and identical store sales decreased 4.2%. Transaction counts drove the year-over-year decline, but average basket size was down slightly as well, with a decrease in the number of items per transaction more than offsetting a small increase in average price per item. Idents in almost every region decelerated from Q4, however, markets with higher foreclosure and jobless rates experienced a greater negative impact.

Competition continues to be a factor as retailers fight over fewer food dollars being spent. Cannibalization also remains a factor, but to a continuingly lesser degree. While hard to quantify, it is also reasonable to assume some of the decline was due to lower food costs, which are being passed on in the form of lower retail prices. December was a tough month for us as it was for most retailers. According to government reports, U.S. real consumer spending fell for the sixth time in seven months. Overall from the third to the fourth quarter of 2008, consumer spending on food fell at an inflation-adjusted 3.7%, the steepest decline in 62 years. Any gains from falling energy prices were saved, rather than spent, as the jobless rate rose and consumers remained extremely nervous about the economy. As other companies are reporting, we are also pleased to say our sales trends improved in January, and for the first four weeks of the second quarter ended February 15, 2009, our comps, excluding the currency impact, were negative 3.8%, in line with our average over the last 11 weeks of the first quarter. While both transaction count and basket size are still down, the decline in transaction count has improved slightly. While it is obviously still too early to say our sales are stabilizing, we are encouraged by these trends.

We have worked hard to increase the value choices throughout our stores, particularly in our perishable areas, while still maintaining our quality standards, and, over the past year, we have done a much better job of highlighting our commitment to value with signage, placement, and price. In this environment, all retailers prefer customers trade down within their store rather than trade out of their store, and we are proactively and creatively communicating to our team members and customers how well we stack up.

Examples within the store include value tours, displays comparing receipts with competitors on a comparable basket of products, and even contests where the customer who comes closest to guessing the total cost of a cart full of 365 products wins the basket, reinforcing that our customers can get a lot without spending a lot. Externally, regions are marketing their programs through radio, billboards, print, Internet marketing, etc., and are also working to change the focus of the media. Where our “foodie” offerings used to be the story, we are now seeing more stories positively focused on our value. While it is not going to be an overnight shift, we believe we are starting to change the dialogue about our prices, and hopefully the perception as well.

At the same time, we are making positive strides in differentiating our product selection in ways that speak to our core customers and to our authenticity and leadership role within natural and organic products. Our private label SKU count increased 11% year over year, accounting for 22% of our total grocery and Whole Body sales. In addition, through joint efforts with our vendor partners, we now offer 300 exclusive branded products, with more in the pipeline. We have more than doubled the offerings under our Whole Trade product line to over 1,000 products, ranging from bananas and chocolate to cleaning products and body care items. For Valentine’s Day, we featured Whole Trade Roses, which are grown by eight small farms in the Ecuadorian Andes and certified by TransFair USA. A percentage on each case of flowers sold will go directly to fund community development for farm workers. We are committed to helping create alternatives to the “factory farm” methods of raising livestock.

We have encouraged innovative animal production practices to improve the quality and safety of the meat and poultry sold in our stores, while also supporting humane living conditions for the animals. Our goal is to make it easy for our shoppers to make informed choices, and we plan to roll out a 5-Step Animal Welfare Rating system beginning in our U.S. stores later this year. We are being recognized for our efforts in this and other areas. Health magazine named us the healthiest grocery company in the U.S., and for the second year in a row, we made Fortune’s list of America’s Most Admired Companies. Our Food and Drug store peers gave us Number 1 rankings in innovation, social responsibility, and quality of products. Greenpeace cited our enhanced farmed-seafood standards as one of the reasons we were once again named the nation’s Number 1 retailer in seafood sustainability. We believe that by continuing to raise the bar on quality standards, we will retain our leadership position in natural and organic foods resulting in greater customer loyalty for many years to come. On another positive note, we were extremely pleased to earn the Number 22 spot on Fortune’s list of the 100 Best Companies to Work For. To be recognized a dozen years in a row validates our commitment to our core value of Supporting Team Member Happiness and Excellence.

We want to commend our regional and store leadership teams for the great job they are doing in terms of keeping the lines of communication open and staying focused on team member morale in these challenging times. Many retailers are announcing massive layoffs, store closures, and even bankruptcy. While we are disappointed to report the first negative comparable store sales figure in our company’s 29-year history, the difficult strategic decisions we made last August to contain costs and cut capital spending are helping us successfully manage through this period of slower sales growth. We implemented certain cost-containing measures at the global, regional, and store levels, including the elimination of 306 positions, saving an estimated $16 million in labor and benefits annually. We reduced our planned new store openings by 50% for fiscal year 2009 to 15 from a prior range of 25 to 30. We terminated 11 leases in development totaling approximately 570,000 square feet and downsized nine leases by an average of 10,000 square feet each. We cut all discretionary capital expenditure budgets not related to new stores by 50%. We suspended our cash dividend, and we received $413 million of additional capital.

As a result of these proactive measures, despite flat sales in the first quarter, our EBITDA was approximately equal to last year, we produced strong cash flow from operations of $142 million, we generated $32 million of positive free cash flow, our cash and cash equivalents increased to $273 million, and our total debt decreased to $748 million after we paid down our credit line with the net proceeds from our preferred stock offering. We believe our results demonstrate we can operationally adjust to lower sales volumes and believe this flexibility, combined with our improved balance sheet, will allow us to successfully manage through these difficult economic times and emerge a stronger company over the long run. While we have slowed our new store openings and the rate of new lease signings substantially, we plan to continue to prudently invest in our growth. We opened five new stores during the quarter, which averaged 53,600 square feet in size, including two relocations. One positive result of the real estate downturn is that it is producing some great opportunities, so we plan to continue adding selected stores to our pipeline. To get approved, however, stores must now meet a tougher EVA hurdle rate on lower comp sales growth expectations. We are also tracking landlord-related deadlines for each of our leases, and if a landlord defaults, we are revisiting the lease using new operating assumptions to determine whether to move forward or negotiate for a smaller store, a delayed opening, lower rent, etc. or whether to abandon the site completely. We expect some additional lease terminations and square footage reductions over the next few quarters.

Regarding our growth strategy for the U.K, when we made the decision over five years ago to enter the UK through the acquisition of our Fresh & Wild stores, it was made with the knowledge that the investment might lose money initially, as we did in Canada. We believe the long-term growth and return potential in the U.K. is much greater than in Canada, and we are taking some proactive steps to improve our operations there.

We have split our U.K. operations off from our North Atlantic region, forming a new region. Jeff Turnas, former president of the North Atlantic region, has been selected as president of the U.K. region. Additional headcount will be minimal as there is already a team in place, and as other regions we have split, certain functions will continue to be shared until the new region can fully take them on. In September, we closed one Fresh & Wild store and have since rebranded the other four to Whole Foods Market. Now in its second year, our Kensington store is showing a significant improvement in operating cash flow, and overall our operating cash flow in the U.K., on a currency-adjusted basis, improved to negative $1.7 million in the first quarter from negative $3.3 million in the prior year. We believe that dedicated and focused executive leadership will drive further improvements in sales, cost disciplines and financial performance and, as with our investment in Canada, will produce strong returns over the longer term.

Turning to our assumptions for 2009, as you know we did not give guidance for the year. Instead, we estimated various line items based on a flat comp scenario. We remain hopeful that during the fiscal year our comps will stabilize and grow driven by easier year-over-year comparisons, continued improvement in the Wild Oats stores, fewer self-cannibalized stores, continued execution of our differentiation strategy, and increased awareness of our values and competitive prices. We believe that over the last several quarters we have demonstrated that we have disciplines in place for managing our cost of goods sold, direct store expenses, and G&A in this challenging sales environment. Our cost-saving initiatives are broad-based, focusing on everything from better sales forecasting, purchasing, merchandising, inventory levels, to reduction of waste and supplies expense. Labor is, of course, a primary focus, and we are utilizing tools on a daily basis to monitor and adjust scheduling based on sales. We also continue to have a hiring and salary freeze in place, and are seeing additional savings through normal attrition. We have engaged our team members at all levels of the company to collectively find solutions and new approaches to running our business in a more frugal way during these unsettling economic times.

We have cut our new store growth plans and discretionary CapEx budgets by 50%. As you see in the press release, the average size of our stores in development is decreasing. Since Q3 of fiscal year 2007, when we selectively began rightsizing lease sizes or decreasing the build-out space for stores in our development pipeline, we have signed 27 stores averaging 44,400 square feet in size. Our construction and development teams are actively working to drive down our average development cost per square foot through smaller stores with simpler decor designed with smaller, less-labor intensive perishable departments. Based on our Q1 spend, we now expect our capital expenditures for the year to be in the range of $350 million to $400 million, or $50 million lower than our prior range. We are committed to producing free cash flow and believe we will produce operating cash flow in excess of the capital expenditures needed to open the 68 stores in our store development pipeline over the next five years. We believe the investments we are making in our new, acquired and existing stores will result in substantial earnings growth in the near future.

As was previously announced, the FTC has agreed to suspend its antitrust review regarding the Wild Oats merger through March 6, 2009. We are currently engaged in constructive dialogue with the FTC to find a mutually agreeable resolution, and while we are hopeful that we will reach a resolution, we cannot make any further comments at this time. We recently increased the size of our board of directors from six to ten. The four new outside directors bring unique expertise, and we are excited to have this fresh addition of intellectual capital, particularly in these are challenging times.

Our business model has been highly successful since we began in 1980, and with fewer than 300 stores today, we remain very bullish on our long-term growth prospects, as demand for natural and organic products continues to grow and as our company continues to evolve. We have a loyal core customer base that is aligned with our mission and our core values. We are dedicated to maintaining our leadership position as the authentic retailer of natural and organic foods. We believe continuing to raise the bar reinforces our authority and authenticity and makes us the choice for customers aspiring to a healthier lifestyle.

We are reexamining all aspects of our business and refocusing our efforts on what really makes us great and sets us apart in the marketplace. We believe we are making the right strategic decisions that will create long-term value for all of our stakeholders. We greatly appreciate your support and look forward to getting past this recession and back on an upward growth trajectory. We will now take your questions but ask that you limit your questions so that everyone has an opportunity to participate. Thank you. So operator we will take questions now.

Question-and-Answer Session

Operator

(Operator instructions) It looks like first we will go to the side of Ed Aaron from RBC Capital Markets, please go ahead.

Ed Aaron – RBC Capital Markets

Thanks good afternoon. Just hoping you guys could talk a little bit more about the trends that you are seeing in your stores and maybe covering three different areas. First where category wise sales might be trending relatively better or worse? Secondly how you are feeling about the overall service levels in light of the cost cutting that you have done at the store level? And then third maybe about your level of satisfaction with the pricing actions that you have taken to date, are there other areas where maybe you haven’t invested nothing on (inaudible) also maybe areas where you have perhaps over invested? Thanks.

A.C. Gallo

This is A.C. speaking. I am going to talk for service levels and we feel really good about our service levels. One of the things we have done is, even though we have reduced quite a few positions at the regional offices and at the global office in Austin, most stores did not have a lot of reduction in team members, it is been more through attrition that we have done that. So, we’ve been able to really protect most of our full-time team member positions and our team members are really appreciative of that. And what a lot of a reasons have done is they have actually done a renewed focus on customer service, so we have got a lot of training programs going on right now in the regions and team members are very appreciative not only that they feel like we really trying to protect their jobs by cutting cost in other areas, but also that we have renewed focus on customer service in the stores.

Walter Robb

This is Walter picking up the questions on the categories. I think the general trend of people cooking more for themselves preparing more at home, I think that continues in this quarter with strength in center store, but we have also seen some pickups in meat with trade downs to the poultry and the pork area and particularly the less expensive cuts of meat, the rounds, the groins, that sort of thing. And I think it has responded well to our value efforts and pricing. You know overall in the pricing question, I think we are really pleased, I think the sense across the company is that we have, you know we tack pretty hard the value last summer, early last summer and we are seeing – we are feeling, we are hearing from our customers more importantly that we are getting some traction with those efforts. That they are noticing it, I mean, I had a customer telling me other day in the store, I just want to know, I’ve been a long time customer and I notice what you are doing and I appreciate it. We are getting that sort of feedback, so it is always a dance to balance the investments to make sure you are getting the return and it is hard to judge that in this sales environment, but I think across the company we feel pretty good about the traction we are beginning to get on those investments.

A.C. Gallo

Yes and I will add to that. I think that the feedback that we have got from our customers for the most part is that they acknowledge the value that we have in our center store especially with our 365 products, but we are looking for more value in the perishables and that’s really been our focus. We spent a lot of time in Q1 really focusing on values especially in produce, meat, and sea food. And we have seen a lot of very good reaction to our promotions that have done in those areas and it is our intention to keep doing more in that area.

Walter Robb

I think just a final note, as private label continues to perform well and the demand there is stronger than the brand growth that private label is performing well and I think we are well positioned with – particularly the 365 line, we’ve seen good growth in the private label products.

John Mackey

Next question.

Operator

(Operator instructions) Our next question comes from the side of Neil Currie of UBS, please go ahead.

Neil Currie – UBS

Thank you and thank you for taking my question. I wonder I can ask about your work to try and improve the value perception, doing that in an inflationary environment, I imagine it is very difficult because you are trying to hold prices down whilst your cost prices are going up, is it easy to get some traction once that sort of inflation environment goes away and in fact some category you are seeing deflation that you are starting to get a little bit more traction on the value image that you are trying to improve?

A.C. Gallo

Very good example is in produce. This past fall we started to see some prices – our cost really coming down, especially in areas like organic apples and pears and other vegetables and we use that opportunity to really drive some really great promotions and I think it really helped us. It really helped, you know, when customers came in this fall and they saw that they could still afford to buy organic apples for their apples because lot of prices we were selling for 50% lower than a year-ago on our promotions. So, it has been an area that we have really been able to really get traction in. As far as the prices were certainly climbing last year in a lot of different commodities, but they really started to ease off, and while some are lagging and some are coming along, there is enough downward pressure on prices that we have been able to hold with most of our suppliers, we’ve been able to hold our costs and keep – just in the areas, in the meat areas, we’ve been able to pretty much hold our costs in line so we haven’t had to – in a environment like this we haven’t had to really raise many prices.

Walter Robb

Actually this quarter was less of a factor than was last quarter and as for all the reasons A.C. mentioned and another thing that we have been doing is to raise the visibility is to actually go to item pricing even on produce, apples three for 99 or grape fruit, or portion size so consumers can actually see the dollar that they are going to spend on the item. So, it cuts through all that this is what you are going to pay to get this item. Those things have been very successful sea food, and meat, and in produce in particular.

John Mackey

Next question.

Operator

Thank you. Next we will go to the side of Andrew Wolf from BB&T Capital Markets, please go ahead.

Andrew Wolf – BB&T Capital Markets

Hi good afternoon. Two quick questions hopefully if you can let me up to. Did you – would you talk about your customer account versus the basket-end, you know how that trend sort of has been on a – you gave a 15 week, you know last 15 weeks your sales appear to stabilizing, how about the mix between customer count and the basket, particular the customer account?

Cindy McCann

Hi Andy, it is Cindy. As far as the split, I mean again we are seeing declines in transaction count and basket size, I mean most of it is being driven by transaction count, so that is not really any different from what we have been seeing and then quarter-to-date the decline in transaction count has lessened, which is obviously a positive trend and then the decline in basket size is being driven both by lower and above item – and lower average price per item.

Andrew Wolf – BB&T Capital Markets

Okay. So, the minus 49 ID is it all or was it all the transactions or was it a combination or do you don’t want to say the – ?

Cindy McCann

I mean almost all transaction with some declines in basket size as well.

Andrew Wolf – BB&T Capital Markets

Okay and just to make sure I heard you right, that is – it is a little less negative now, so it is trending the way you want it to trend on transactions?

Cindy McCann

Quarter-to-date, so that is only four weeks.

Andrew Wolf – BB&T Capital Markets

Okay it is pretty good. And the other question I have is if you – could you talk about how the quarter came out versus maybe what you guys were expecting, certainly I think you did what I was looking for in others. And you know if you had backed the 11 million FTC legal cost, you know you had margin expansion on EBITDA and your EBITDA was up, so how did the, I mean, did you, you know on the outside I didn’t frankly think you’d manage down the cost this quick and realize the cost cutting would come this quick and maybe the exact amount of about, but how did, I guess it is an execution, how do you look at it internally versus what you were looking for in your first quarter budget?

Walter Robb

Less to say, we are pleased that the company is kind of a testament to Whole Foods and powered culture that we put the word out to our leadership and it has worked its way to the whole company to – we are really focused a lot more controlling our cost now and spending our capital carefully, more disciplined fashion, we are controlling our G&A cost a lot better and we are working to control our direct store expenses much better. So, we are very pleased that we are able to produce such strong EBITDA operating cash flow and free cash flow, at the same time our comps were negative. So, we are pleased that we are showing such good discipline and that discipline is going through the whole organization. So, we are really happy about that, obviously, I mean I have never reported we are doing this a long time and never had a negative comp before. But generally, we are pleased with the results and we don’t know what is going to happen with the economy, but whatever happens I think Whole Foods Market is flexible, adaptable, and resilient.

A.C. Gallo

Andy just back to your first question about the customer count transaction, I think as we read those, obviously it is still an unstable environment out there, but one of the suggestions at least is that we are finding a level of commitment amongst our core customers that they continue to find real value, real differentiation real quality of Whole Foods, and there is sort of flattening out if you will of the transaction account suggest that, you know, we really – there is a very loyal, very core customers that continue to believe in Whole Foods Market and find Whole Foods Market a place to do their shopping and that is – you will have to see how the patterns bear themselves out, but the suggestion is perhaps that’s what we are finding here. There is a flattening out here that suggest that loyalty that core customer is there and staying there and finds value in our offerings.

John Mackey

Next question?

Operator

Thank you. Next we will go to the side of Meredith Adler from Barclays Capital, please go ahead.

Meredith Adler – Barclays Capital

Thanks for taking my question can you hear me? Hello?

John Mackey

Yes we can hear you.

Meredith Adler – Barclays Capital

Okay. You obviously are doing a great job in terms of managing expenses and putting discipline into the capital budget, I think the only concern that I would have is to think about the stores that have been opened over the last three year say, and whether you feel like there are any kind of albatrosses and are there things that you can do either on the expense side or perhaps talking to landlords to maybe reduce the negative impact of stores that have already opened?

Walter Robb

Well, I mean, do all of our stores perform at the level that the very best stores perform in? Of course not, it’s like anything, it is on a bell curve and some stores perform better than others and some are slightly disappointing. I mean, in our company’s history we still never had a store, we opened or sold never failed, we never closed one down that we opened our self. So our track record is still in tact. Do we have a few stores that were less than happy with and wish we can get our money back? I mean Yes sure I think that is true, not very many, but there are a few. I mean we’ve got 278 stores so those are very small percentage of those that I think, if we had normal economic times that we’ve experienced the past 30 years we’d expect those stores to be having really strong comp store sales growth right now. So, they are not growing as rapidly as we would like them to and so they are not ramping up quite as much as we would like to, we – obviously when we signed those stores they were signed in a different economic environment. I mean yes, we would like to give lower rents and – if we can, but in most circumstances we can. I mean landlords are not – they are all feeling the squeeze as well. So, in general we just don’t have very many stores like you are talking about Meredith, I mean we just produced very strong operating cash flow and EBITDA and free cash flow. So, I don’t know what else to say about it except that I wouldn’t say anything and A.C. is going to say something.

A.C. Gallo

That’s said there are – there is a few stores that we opened up that we, you know we are always experimenting and trying new ideas, new concepts, new venues, and there is some in some of the stores that we have opened up that haven’t been that successful and we obviously go back, one of the things we always do is we go back and continually try to improve our stores. Whether they are doing what we expect them to do, better than we expected, or not as much, so we’ve gone and adjusted and a lot of stores have opened up, things, and if there is a store that we have built and we put too much produce case in and we are having external loss or it is talking too much labor we pulled some of it out. Or if you put in a sit down venue in a store that is not producing enough sales to be profitable, we are closing it down and moving it around. We are constantly adjusting the stores in the existing stores and making a lot of changes and I – especially, you know in these times especially where we might be a less labor savings or help protect our margin.

Walter Robb

Another factor here that can’t really be discounted is that the Wild Oats merger is a year and a half old and the stores are fully integrated now in the Whole Food Systems and we are seeing better results from an operational standpoint now in the former Wild Oat stores than we saw a same year-ago and we are not breaking it out anymore, but they are proceeding as we expected them to and I expect will continue to see improvements in those stores, as their sales per square foot increase and their productivity goes up over time. So that’s also helping us at this time.

A.C. Gallo

Also Meredith just quickly we have – actually in a couple cases actually reduced the store size in addition to what I said about the produce departments or meat departments and in a couple of cases we went back and renegotiated the lease rental rate with the landlord as a result of the sale. So, we have done that a couple of times as well. And finally, let’s make a positive thing here within this group of 21 stores over the last 12 months. We have got some real crankers [ph], we have got some that have really outperformed, some cases two times our projections. I know that we are talking both – all parts of the country from the West Coast to the East Coast we have some stores, the new Venice store for example has done extremely well, other stores have done extremely well, so we have still got some more John.

John Mackey

Crankers.

Operator

Great thank you. Next we will take our question from the side of Greg Badishkanian from Citigroup, please go ahead.

Greg Badishkanian – Citigroup

Great thanks. Two part question. First is, maybe just a little bit on the – and you’ve alluded to it throughout, but just the impact from the weak consumer on purchases, you know private label, prepared foods, things like that you see there are some benefits and some negatives where there is trading down, and also just on comps stores, you know it is good to see that they have stabilized one area the five to eight year olds have pretty light comps, just wondering is this more cannibalization or is there any other impact on that group of stores?

A.C. Gallo

Thanks, Greg.

John Mackey

We’re figuring it out –

Cindy McCann

Hi, Greg.

Greg Badishkanian – Citigroup

Okay.

Cindy McCann

It’s Cindy and the answer is that category had the higher percentage of stores being cannibalized.

Greg Badishkanian – Citigroup

Got it. Hopefully you’ll keep the New York stores open too. By the way, I think they’re doing well here.

John Mackey

We’re happy with out New York stores.

Greg Badishkanian – Citigroup

Good.

A.C. Gallo

Does that do it for your question, Greg?

Greg Badishkanian – Citigroup

Yes, just the tough consumer environment. Just some take away of color. It’s private label I know you said that’s been strong prepared food and just some anecdotes just in terms of how that’s been impacting.

A.C. Gallo

Greg, I have one for you?

Greg Badishkanian – Citigroup

Sure.

A.C. Gallo

We got a letter from one of our customers in our Hingham, Massachusetts store. And the letter basically said that she’s been shopping in our store, primarily, her primary shopping was in our store. She’s spending about $350 a week for her family. And she got in a situation where she now needed to cut her grocery budget down to about $225 a week. And friends of hers told her, “Well, you won’t be able to shop at Whole Foods anymore.” But she came in and she really focused on buying our 365 products in our center store and realized how much promotion and value we were now giving in the perimeter departments and the perishables. And she said she has no problem now shopping, continued to buy most of her groceries in our store because she realized that she could readjust and she really appreciated that we were offering a regular customer like her an ability to continue to get good food for her family at a lower price. So that’s the type of feedback we’re starting to get from a lot of our customers and we’re excited about it.

Greg Badishkanian – Citigroup

And are you seeing a little bit in terms of prepared food, especially, around holidays? Just anecdotally, Valentine’s Day solve a lot of traffic at your stores or people eating at home more and preparing that or is it more from scratch? Just a thought there.

A.C. Gallo

That’s where we’ve seen – people are definitely making more at home from scratch and I can tell you just from our office in Cambridge that more people are bringing their lunch. Brown bag in their lunch and going out to eat in lunch lots. So, we are definitely seeing a drop in people coming to our store at lunch time and dinner time. And I mean I think our prepared food sales have weakened because of that, and we definitely seen an uptick in the center store, largely around people are buying more ingredients than cooking more whole meals at home for their family.

Walter Robb

I think if we were – this is Walter. I think if the – we had a particular spike the last couple of years called the Age of Excess or whatever, and everybody was taken out. I think we’ve seen our leveling off of that. But at the same time, we are also getting an advantage of the restaurant trading substantially down, so in some cases we represent a nice way to go out and have a meal without having to do the white table thought restaurant. And so, we are seeing some, I think balancing there on that side.

John Mackey

What we saw at the holidays, we definitely saw people buying less of the already prepared meals at Thanksgiving.

A.C. Gallo

That’s right.

John Mackey

But more buying more of the whole turkeys and buying more of the ingredients. We definitely saw a shift in that at the holidays.

A.C. Gallo

To your question about Valentine’s Day, we had a tremendous holiday at Valentine’s. We really had a good holiday. I think we’ve got our mix right, our pricing right. And we had – as you pointed out, we had tremendous traffic and I also like the creativity of our regions. We have some great promotions or happenings. It’s not just price, price, and price. It’s priced in a – we got a kiss the fish thing in one region where if you kiss the fish you get the lobster tail. Buy one, get one. We had the madness sales where if you come in a certain hours, you get a certain prices. I mean, we have some creative merchandising going on that’s making it fun to come in the stores and do your shopping, which is a nice things in these times as well. But hopefully that helps – answers your question.

Operator

Our next question comes from the side of Mark Wiltamuth from Morgan Stanley. Please go ahead.

Mark Wiltamuth – Morgan Stanley

Hi, good afternoon. I wanted to explore a little bit where your biggest opportunities are for cost control. I mean, to all the things you’ve laid out you’re doing so many things at once here. You’re cutting store sizes down, G&A, cost controls, labor scheduling, what do you think your biggest buckets are and how far into it do you think we are on cost controls right now?

John Mackey

Mark, John Mackey here. I’ll take a stab at it and Walter and A.C. can add. Well, first, we’re really focused on the development process and taking capital out of the new stores. This has got major attention at the most senior executive level. We’re focused on it. We developed a team to work on it and that consciousness is now throughout the regional leadership team as well. So I think our biggest opportunity is continue to work to build our stores, spend less money building our stores on a per square foot basis. That’s a major focus point. That’s the thing we can do – that can help preserve our cash and maximize our free cash flow, and still allow us to open great stores. So that’s a major focus.

Jim Sud

On the operating side of the business, we’re focused on rethinking our labor only by far our most expensive part of our cost structure is the labor cost. And what Whole Foods is trying to do there is what I would call “smart service” and Whole Foods does a lot more service than typical supermarkets do, so we have higher labor cost. And we’re thinking it through as what services do we provide that the customers most highly value? And what services are not so highly valued? Particularly in a different economic environment were they are seeking to be more frugal. An example might be, an anecdotal example might be in some of our stores, we have service bakeries and that raises the labor costs for the bakery department substantially. But how much value does that really create for the customer? And in many cases, it doesn’t create that much value so you can reengineer that bakery department to make it more self-service and reduce the labor cost significantly. So, we are thinking it through collectively, systematically in attempting to where it is appropriate to take cost out of our, particularly labor cost, out of our operating stores, but want to do that in an intelligent way so that we are not reducing service levels that the customers really value. I know Walter and A.C., you guys want to add on to that?

A.C. Gallo

You talked first about how we are really working on a cost per squarer foot of new stores and obviously another part of that is we are also shrinking the size of stores. Stores that are in development that we think are too large, really have the opportunity either to give space back to the landlord or renegotiate or even sometimes just build-out lesser square footage, we are doing that as well. We still have a lot of large stores in the pipeline that are opening, will open the rest of this year, but we are doing what we can in all those stores to pull out unnecessary things that might be night, but not necessary for the store.

Walter Robb

There is a silver lining always in a downturn or a recession and it is creating opportunity for you. It creates an opportunity to rethink your business model and to add disciplines that may have been lacking when you are on a rapid growth phase. And you put those disciplines in place. You get your cost down. You reengineer a lot of your departments and stores. And then what inevitably happens, when you move out of the recession and the economy turns upward, then your position to make rapid gains – rapid gains in sales, rapid gains in – particularly rapid gains in earnings because your sales are going up, while your cost are more controlled. And what is most pleasing I think to the management team here at Whole Foods is how quickly Whole Foods has made the shift. That we have been able to make a shift in a way we think about our business and the way we approach it so that we can continue to produce good cash flow and EBITDA for our customers. This is a group effort of team members throughout the company and it is a testament to the, I think, the team structure and the empowerment culture that Whole Foods has that we are resilient and can respond to changing economic conditions.

Operator

Great. Thanks. Our next question comes from the side of Scott Mushkin from Jefferies and Company. Please go ahead.

Berkley – Jefferies & Co.

Hi everybody, this is Berkley [ph] actually in for Scott. First question, are you considering a loyalty program?

John Mackey

No.

Berkley – Jefferies & Co.

Okay. And I think you already touched on this before a little bit but I just want to go through again, I mean, in terms of – did you talk about trying to negotiate terms on leases, it sounds like stores are in the pipeline. Have you looked at the existing fleet and gone back to the landlords to try and renegotiate leases there and the other terms?

Jim Sud

We’re in constant dialogue with our landlords over the last eight months. We have terminated 11 leases, we’ve reduced the size of nine, we’re currently working on about another ten or so leases that we may be reducing the size on. And so, all those dialogues include a discussion about rent, about capital, about size, about timing of opening, timing of tender, and so I think we’ve got good dialogue, good relationships with our landlord and we are real pleased at where we’ve moved our development pipeline in terms of the size, the number of stores, the size of the stores and the pace of opening.

Berkley – Jefferies & Co.

And last one, as I look back, and I am just affirming this – I think this is the first quarter since, maybe the second quarter of ’06 where your cash flow from operations actually beat or was ahead of total CapEx. Any thoughts from the sustainability of that for the next three quarters you are looking out – ?

John Mackey

We’re committed to that. That’s the goal the company has set for itself now, to produce free cash flow. I told about how fast we grow, I mean Whole Foods hasn’t been focused on free cash flow because we’re focused on EVA and we didn’t mind borrowing money to invest in these stores provided those stores were going to have good EVA for us. With this economic environment, we think it’s important for us to basically to moderate our capital expenditures to the level of cash that we can produce from operations to fund them. So we cut our growth count 50% in 2009 and that’s lot of extra cash flow that would have been going into new stores that now is not going into new stores. So we have, I think, a modest growth plans for the next several years, so we think we’ll continue to produce free cash flow on a go forward basis. It may not be absolutely every quarter because sometimes we may open more new stores in a quarter and the next quarter, we’ll open fewer. But over the year, and over the next few years, we do anticipate producing a significant amount of free cash flow.

Operator

Our next question comes from the side of Chuck Cerankosky from FTN Equity Capital. Please go ahead.

Chuck Cerankosky – FTN Equity Capital

Good evening everyone. Couple of things, first, can you comment on maybe what you’re comps were on prepared foods or like thereof? Can you just take that as a category within perishables?

John Mackey

I’m sorry. We don’t – for competitive reasons, we don’t like to give comps on a per department basis. I think we’ve already given some color on it that there has been some shift away from prepared foods. So, I’m not going to give any actual numbers on it.

Chuck Cerankosky – FPN Equity Capital

All right. And then you have used some couponing in your circulars in a few stores. Can you talk about how that has worked in the promotional strategy, how successful it has been, and how receptive vendors have been to work with Whole Foods in this effort?

John Mackey

Yeah. I mean, the coupons – we’ve gone a couple of experiments around particularly around new store openings where, you know, we’re doing the targeted mailing or targeted thing around the opening, but in particular, the whole deal circular that has become our sort of value platform across the company, which we have double circulation of that in just six months, that contains coupons from a number of manufacturers, which is by the way paid for the manufacturers and that has been highly successful portion. It has really – we only just put our third issue there since it is a quarterly, but I think we’re thinking about going to bi-monthly or even monthly depending on how this next issue plays out. So, that has been the principal place where venues and the coupons in addition to the new store. The redemption of those coupons particularly when they are the right items at the right price have been really above expectations. I just looked at the numbers for this last flyer and we’re really pleased with the redemption that we’re getting on those.

A.C. Gallo

In fact, this last flyer run right out, but we from having to do reach some reprints – reprinting to have more of them in the store.

John Mackey

Yeah, exactly.

A.C. Gallo

It is very popular. And this has been really a change for us because we, you know, we’ve done different types of coupons over the years especially about new store openings and we haven’t, you know, it’s never been a big redemption thing, but we’re finding now that customers are very open to finding all different ways to save. So, people are clipping coupons they never did before and people are looking for a bargain.

John Mackey

Of course, that is only one leg of our value stool. I mean, we don’t – we’re not putting all our bets on coupons, but a lot of it, the value tours, the continuing education of both our team members and the customers, the item pricing, the other things that we’ve been talking about on the call today are all parts of how we are trying to present our competitive front. Even just taking being a lot more proactive about showing how competitively priced Whole Foods is. We’ve talked on past calls about how we’re not sure we get the credit for the pricing we do have and we’re getting a lot more aggressive by letting you know that you can get a fair price in Whole Foods and I think it is starting to get some traction. So, coupons are just one part of that.

Operator

Great. Next, we go to the side of John Heinbockel from Goldman Sachs. Please go ahead.

John Heinbockel – Goldman Sachs

Yeah. A couple of things. Have you guys yet seen falling input costs has (inaudible) from your vendors to you and then secondly as part of that, how much price elasticity do you think is out there today such that as those input costs come down maybe promote more? Will the customer respond to that or is it hard to get them to respond to that in this economy?

John Mackey

John, welcome back. We talked earlier about the inflation actually has decreased in quarter to quarter from Q4 to Q1 and so while it is still out there, it is much less of a factor than I would say six months ago. And to your second question, so we’re able to pass it on. It’s fairly minimal, really it is in the 2% range sort of thing based on our tracking. But the – in terms of what we are seeing is particularly in produce A.C. mentioned earlier, we are seeing some nice elasticity as there are some price deflation in produce and levels we haven’t seen in a number of years. We are actually seeing a nice uptick in tonnage as the item price comes down. You want to add any more colors to that?

Walter Robb

Yeah. In fact, in produce, we have been analyzing that in the first quarter, even though our comps in produce were down, you know, our comps were down, our overall tonnage was up and it is because we have been able to offer these really good deal to our customers and we’ve got really good response to it.

Jim Sud

The other thing that is interesting is we’ve been, again, tracking over a thousand items quarterly here as the organic prices have not gone up as quickly as conventional prices and perhaps that is vendors being more careful relative to the demand but we’re still seeing strong organic demand in many categories, demand for organic products is what I meant to say.

John Heinbockel – Goldman Sachs

Secondly, can you talk about the cost opportunities capital operating expenses well, what about procurement and how much opportunity is there either to do some vendor consolidation or maybe little more centralization, SKU rationalization, maybe talk about the opportunities that would seem to be significant?

John Mackey

You know, we’re always analyzing each one of these categories to see if we do think there are opportunities there. Because of our structure, we are careful – we still have a lot of incentives in place and have a direction of adding more local vendors and local products to our stores. We feel that is really important, our customers want that. So, sometimes that flies from the face of consolidation and SKU rationalization because there’s more products that the customers want. So, we try to balance that really carefully and at the same time we have a strong program going to find more local vendors and carry more local products. We do have – we are working also very diligently on making sure we do consolidate our volume from our national and global vendors and the team here in Austin is doing a really good job finding more and more opportunities for us to purchase better, to help with our profitability and to pass along some of the savings to our customers.

A.C. Gallo

Yeah Mackey we are also looking at areas like in particular John mentioned the bucket around store development. I think we are really – we are finding some opportunities there, aggregating our volume and that team is working aggressively on lighting, refrigeration cases, some areas like that which there are dollar opportunities there and I think as we look at the total cost structure of the company John mentioned earlier, we are looking at that and where are the areas where we can potentially take cost out in a measured way that doesn’t disrupt the magic of this company. I think we are looking at those areas. And, so, I mean, I think it is fair to say there are some more significant opportunities across the whole spectrum for us to find cost savings. I think on the buy side though specifically you talking about purchasing and we have done a pretty good job. We have gotten excellent contact with Unify on our dry goods. We have made incremental progress on our perishables. We continue to – most recently, like in seafood leverage shrimp and farm resale and offering tremendous deals to consumers. I think we are making some good incremental progress on that. But, yes, I think it is fair to say there still remaining opportunities for us to address.

John Mackey

Next question.

Operator

It looks our last question tonight comes from the side of Ed Aaron from RBC Capital Markets. Please go ahead.

Ed Aaron – RBC Capital Markets

Thanks. Just one quick follow-up if I could on the SG&A when you guys talked recently about managing that percentage back down to historical averages and if you fact out what you spend on the FTC stuff, it looks like it’s probably actually falling a little bit below the historical average. So, I’m just curious if you see incremental opportunity on the SG&A line above and beyond what you’ve previously targeted with us.

John Mackey

Well, not if our costs stay negative. I mean, we can get some leverage once our comps turn positive, which we hope will be later on this calendar year as we get into easier comparisons and this cannibalization lessons. And, of course, we don’t exactly know what’s going to happen with the economy, but it’s really hard to see the percentage dropping if we don’t see sales increases. So, if we get sales increases, we’re going to get some leverage, but I don’t anticipate – well, hey, if we can come to an agreement with the FTC, that’s going to be a cost going out of the G&A line that we’re paying right now; so, we’re hopeful that we can reach a settlement. That will certainly help from that angle; otherwise, we really need to get the leverage from increased sales rather than going in and we’ve already made the cuts we needed to make. We don’t want to make additional cuts in our G&A at our global support or our regional offices in any kind of systematic fashion. There might be opportunities on a limited basis, but in general, Whole Foods is – we’re committed to our team members and we don’t – this is a time where we think we need to pull together rather than figuring out how to throw people of the lifeboat.

Ed Aaron – Capital Markets

Thanks. And then, one more, if I can squeeze in one last one, the change in your regional operating structure in (inaudible) London. Actually, it’s a bit contrary to a couple of my assumptions; one of which is that London might not be as much of a focus going forward as you had once planned and the other being that tiny, incremental changes in the operating structure might even be a move more toward a more centralized as opposed to what you’ve in the past. I know those were my assumptions not yours, but if you can maybe comment on how you came to the decision to split up London into its own separate region, that would be helpful.

John Mackey

I mean one other thing Whole Foods does is that maybe, some of the people following our company won’t do the same degree, but we really think long-term. We manage this company for the long term. We’ll manage it for next quarter, the next two quarters, or even the next year. We’re really thinking about what kind of returns we’re going to get over the long term? And so we make our decisions always on that perspective and that’s how we’re approaching the UK. That’s the way we approach Canada. That’s how we’re approaching the UK and it’s about making incremental, continuous progress quarter-after-quarter, year-after-year; and that’s what’s happening in the UK. We’ve – Kensington’s not that old a store and it’s doing good sales despite what anybody else says. The sales are good there and the UK’s a good market, and so we think that Whole Foods will do well over the long term in the UK. So, we think that it’s been managed from the North Atlantic region for the last several years and we think it’ll do better if it has focused leadership that’s – focused executive leadership that has a full-time presence there, so that was the major decision of why to break it off at this point. We’re sending one of our top young regional presidents to the UK. Jeff Turnas, he’s smart; he’s creative; he’s energetic. I hope he’s listening in on this call. We’re confident that we’re going to do very well over the long term in the UK. We’re making good progress even in a terrible economy in the UK right now. So that’s how we think about our business and we’re hopefully attracting investors that think that way as well because that’s the kind of investors we want to be partners with, those who are in it for a long haul. And if they are, we think we’re going to produce good results for them. A. C., you want to add on?

A. C. Gallo

Yes. In fact, I was over in London last week with Jeff and we were touring our existing stores and looking at some potential future locations. And despite the fact that it’s really tough over there right now, the economy is not great over there and people are definitely being very cautious, we still feel really good about what we’re doing in the Kensington store. Jeff’s got a lot of ideas of things we can do to improve sales there and he’s very excited to be moving to London and moving his family over there. He sees tremendous opportunities there and I think we’re excited. We’re not – we’re talking about slow, steady growth. We’re really thinking long term. We’re not going to turn around next year and open up five new stores over there or something. We’re really looking at it over the long term. We think we can improve operations there. We think we can find additional locations that’ll be really good for us over the long term and we’re really committed to the UK, and we think we’ve got the right guy going over there to make it successful.

John Mackey

And also, as we look to expand in the UK, I mean, we’re not going to be opening any other additional stores as big as Kensington. That store is too big and its biggest challenge is the scale is immense, and I think we’ll probably be in the 25,000-square-foot range. 25,000 square feet to 30,000 square feet will probably be the sweet spot for us initially in the UK going forward and that’s the kind of size we’re looking for right now.

Operator

And it looks like we’ve run out of time. No further questions for tonight, so I’ll go ahead and turn the program back over to Mr. Mackey for any closing remarks.

John Mackey

Okay. Thanks for listening in. While these certainly are tough times for retailers, we believe we’re making the right strategic decisions that are going to allow us to successfully manage through this period of slower sales growth and that will create long-term value for all of our stakeholders. We look forward to speaking with you again in May on our second quarter earnings call. A transcript of the scripted portion of this call, along with the recording of the call, is available on our website at www.wholefoodsmarket.com. I will talk to everybody in May, bye-bye.

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Source: Whole Foods Market, Inc. F1Q09 (Qtr End 01/18/09) Earnings Call Transcript
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