Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

John P. Mackey – Chief Executive Officer

A.C. Gallo – Co-President and COO

Walter Robb – Co-President and COO

Glenda Chamberlain - Executive Vice President and Chief Financial Officer

Jim Sud – Executive Vice President, Growth and Development

Analysts

Analyst for Edward Aaron – RBC Capital Markets

Robert Summers - Pali Research

Simeon Gutman - Canaccord Adams

John Heinbockel – Goldman Sachs

Charles Grom - J.P. Morgan

Scott Mushkin - Jefferies & Co.

Karen Short - Fbr Capital Markets & Co.

Andrew Wolf – BB&T Capital Markets

Neil Currie – UBS

Meredith Adler – Barclays Capital

Analyst for Greg Badishkanian – Citigroup

Whole Foods Market, Inc. (WFMI) F2Q09 Earnings Call Transcript May 13, 2009 5:00 PM ET

Operator

Good day ladies and gentlemen. (Operator Instructions) I will now turn the program over to our moderator for today, John Mackey.

John P. Mackey

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 & Development; and Cindy McCann, Vice President of Investor Relations.

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 Web site along with the scripted portion of this call.

We are pleased with our second quarter results. We believe we struck the right balance between sales and gross margin while exhibiting strong cost and expense controls, particularly in terms of wages and G&A. Despite flat sales we produced: a 10% increase in income from operations and a 9% increase in EBITDA, including non-cash asset impairment charges; strong cash flow from operations of $173.0 million; $98.0 million of positive free cash flow in Q2 and $130.0 million year to date; and an increase in cash to $363.0 million.

In addition, the former Wild Oats stores continued to comp positively and showed strong sequential improvement in store contribution.

For the quarter, our sales were flat at $1.9 billion year-over-year. Our average weekly sales were $155.0 million, in line with the first quarter. Average weekly sales per store for all stores were $552,000, translating to sales per square foot of $786.

Year over year, our ending square footage increased 9% to 10.3 million square feet. Our 21 new and relocated stores produced average weekly sales per store of $530,000 and averaged 52,000 square feet in size, translating to sales per square foot of $531.

Excluding the negative impact of foreign currency translation, comparable store sales decreased 4.1%, and identical store sales decreased 5.1%. We are seeing some positive trends with regard to comps. The sequential decline in our comps narrowed from 440 basis points in Q1 to 80 basis points in Q2, driven by stabilizing sales in some regions and some teams.

In addition, in contrast to Q4 and Q1 when our comp declines were driven almost entirely by decreases in transaction count, in Q2 our comp breakout was roughly 50/50 split between transaction count and basket size, with some recovery in our transaction count.

Whereas, historically, increases in average price per item drove increases in average basket size, we are now seeing a decline in basket size with little to no change in average price per item year-over-year.

Consistent with market reports that indicate consumers continue to be value driven in this economy, our customers are taking increasing advantage of our value offerings. We started pushing hard on our value programs last May and while it hasn’t been an overnight shift, we believe we are starting to change the dialogue about our prices and hopefully the perception as well. While this has a negative short-term impact on our comps, we believe we will be well positioned to drive further comp increases through increased basket size when the economy rebounds.

For the first four weeks of the third quarter ended May 10, 2009, our comps, excluding the impact of currency, declined 3.3%, an improvement from the 4.1% decline we saw in the second quarter. Our breakout in comps continues to be roughly evenly split between transaction count and basket size. While it is still too early to say our sales are stabilizing, we are encouraged by these improving trends.

While increasing our value image is a key focus for us right now, we are also continuing to differentiate our product selection in ways that speak to our core customers and to our authenticity and leadership role within the natural and organic products. Our private label SKU count increased 5% 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. One example is our recently introduced Carolina Classics Catfish. This farm-raised, channel catfish meets our strict farmed seafood standards, the highest standards in the U.S. The production process is managed by the same farmer, resulting in complete control over the production process and traceability from pond to plate, and it’s a great value as well.

We recently won a 2009 Green Choice Award from Natural Health magazine for our commitment to substantial, earth-friendly initiatives that inspire other companies and consumers to follow suit.

For example, one year after becoming the first U.S. supermarket chain to eliminate disposable plastic grocery bags at all of our store checkouts, we have seen reusable bag use triple and estimate that we have kept 150.0 million plastic bags out of landfills.

In addition, we were recently honored to receive Greenopia’s highest rating as the country’s greenest grocer. We believe that by continuing to raise the bar in areas that matter to our customers we will retain our leadership position in natural and organic foods, resulting in greater customer loyalty for many years to come.

Over a year ago we decided to focus on our online presence, starting with our Web site but including other social media as well. Today we have over 70,000 fans on Facebook as well as over 600,000 followers on Twitter, which we believe is the highest of any retailer.

Many of our stores are now setting up their own Twitter and Facebook accounts. Hop online to see great discussions around items like camembert cheese, catfish, and Mother’s Day.

We think this is a powerful new way to communicate with our customers that gives us insight at both a local and global level as to how we are viewed and what our customers want and expect from us.

During the quarter we opened three stores in Paramus, New Jersey; Santa Cruz, California; and Dallas, Texas. The new 42,000 square foot Dallas store was a relocation of our 23-year old Greenville store, our oldest store in the company. While the store has only been open six weeks, customers have welcomed the upgrade, with average weekly sales increasing over 50%.

Our new Santa Cruz store, at 32,000 square feet, is a great example of our focus on opening smaller stores with simpler décor designed with smaller, less-labor intensive perishable departments. The store takes full advantage of its location with close to 100 direct farm-to-store deliveries, and that is just in produce alone.

Other highlights include Kombucha on tap from Kombucha Botanica, one of our local loan recipients. The store’s lower-priced prepared foods, with no item in the case over $10 per pound or $10 each, has gone over extremely well with customers as has the expanded bulk with returnable containers and the return of dried fruit to produce.

As previously announced, we are awaiting final approval of the settlement agreement we reached with the FTC resolving their antitrust challenge to our acquisition of Wild Oats Markets, Incorporated. Under the terms of the agreement, a third-party divestiture trustee will market for sale: leases and related assets for 19 non-operating former Wild Oats stores, 10 of which were closed by Wild Oats prior to the merger and nine of which were closed by Whole Foods Market; leases and related fixed assets, excluding inventory, for 12 operating acquired Wild Oats stores and one operating Whole Foods Market store; and Wild Oats trademarks and other intellectual property associated with the Wild Oats stores.

A third-party divestiture trustee has until September 6, 2009, to market the assets to be divested. For any good faith offers not finalized by that date, an extension of up to six months may be granted. The only other obligations imposed by the settlement agreement are in support of the divestiture trustee process. We are not obligated to close any stores.

After receiving final approval by the FTC, we expect to record a non-cash charge of up to approximately $5.5 million relating to the potential sale of the 13 operating stores. This is lower than our original estimate primarily due to the non-cash asset impairment charges we recorded during the second quarter to adjust 4 of the 13 operating stores to estimated fair value, as determined based on long-term discounted cash flow projections.

Turning to our assumptions for 2009, as you know, we did not give guidance for the year due to the uncertain economic environment. Instead, we estimated various line items based on a flat comparable stores sales growth scenario.

For the first four weeks of the third quarter, our comps declined 3.9%, including the negative impact of currency. Now that we have 32 weeks of sales behind us, we believe it makes sense to update our sales assumptions for the fiscal year.

If our comparable and identical store sales results in the second half of the year are in line with our first-half results of negative 4.4% and 5.3% respectively, we estimate total sales in fiscal year 2009 of just under $8.0 billion, including the opening of seven new stores in the second half of the year, three of which are relocations.

While there is an opportunity for our comps to improve in the second half of the year due to much easier year-over-year comparisons and continued improvement in the Wild Oats stores, and a lower number of cannibalized stores due to fewer new store openings, we are not there yet, and barring any significant economic changes, we believe a stabilization in comps driven by these factors, as opposed to further deceleration, is a more reasonable assumption at this time.

Year-to-date, our sales have averaged approximately $154.0 million per week, a level at which we have demonstrated strong discipline around gross margin, direct store expenses and G&A, a discipline we hope to maintain for the remainder of the year.

However, we expect new store sales to increase as a percentage of total sales, and we may choose to increase our value offerings to drive sales, both of which could negatively impact store contribution as a percentage of sales.

In addition, we historically experience lower average weekly sales beginning in the summer months through September and this typically results in lower gross margins and higher direct store expenses as a percentage of sales, particularly in the fourth quarter.

For these reasons, we expect store contribution as a percentage of sales in the second half of the year to be approximately in line with the 6.9% we produced in the first quarter.

We are maintaining our prior fiscal year ranges for estimated EBITDA, EBITANCE, and diluted earnings per share, assuming just under $8.0 billion in sales, based on our strong year-to-date results excluding asset impairment charges.

We continue to make progress on our development pipeline, terminating three additional leases and reducing the size of three others this past quarter.

We are committed to producing free cash flow on an annual basis and believe we will produce operating cash flow in excess of the capital expenditures needed to open the 60 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.

In other news, we are pleased to announce that we moved up 45 spots, to No. 324, on the Fortune 500 list of the largest U.S. corporations in terms of annual revenues.

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.

While these are certainly tough times for retailers, we are pleased with our second quarter results. We believe we have made strategic decisions that have allowed us to maximize our short-term results in this period of slower sales growth, while remaining focused and staying true to our longer-term mission.

We are well-positioned to take advantage of a rebound in the economy 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.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Analyst for Edward Aaron – RBC Capital Markets.

Analyst for Edward Aaron – RBC Capital Markets

I think you were talking a little bit about reinvesting some of the margin in the business. Can you elaborate on how you think about the trade-off between margin and trying to drive higher comps and what tactics you might deploy in doing that?

A. C. Gallo

There are a couple different strategies that we have employed this year. We want to be really first of all to make sure that, especially on commodity products, important items in dairy or grocery, for instance, that we're competitive within the marketplaces that we are in. So we have been watching that really closely. And if we notice a change in the overall everyday pricing we adjust to that.

And there have been a lot of opportunity buys that have come up, especially in areas like produce and meat, where there have been some fantastic values available and we have been using that opportunity to push some really strong promotions. So we found that our customers have responded really well to promotions.

Some regions are doing these Madness specials for two weeks every period. A lot of regions now have developed the Weekend Special program where we are taking the hot item, the hot buys for that week, and really running with those items and seeing really good results from that.

Walter Robb

I think the strategy is selective and it's focused and taking advantage, as A. C. said, of the opportunities that are there on the buy side now with the build-up in inventories, particularly in produce, where we are seeing a lot of availability and also recognize it's a very dynamic marketplace right now.

So selective and focused I would say is how we are looking at it. There is a constant dance between sales and margin and the fact that we're seeing some nice trends in our customer count suggests that we are finding the right balance.

Analyst for Edward Aaron – RBC Capital Markets

And dovetailing onto that answer, how much did lower inflation hurt comps this quarter?

Walter Robb

Inflation overall in the country is about 4% on food, which is down from where it was, 6% I guess a number of months ago. But I don't know that it's—

A. C. Gallo

One area we have really seen significant deflation is in produce. There has been a significant drop in produce costs. We have used that as an opportunity to give some fantastic buys to our customers, like $0.99 organic apples this year. So we have definitely seen a drop in produce in average price per item.

But also have seen a pick-up in overall tonnage in produce, so some of that has partly offset that.

Operator

Your next question comes from Robert Summers - Pali Research.

Robert Summers - Pali Research

Again, just on the value program, I am sure you're measuring customer perception. Kind of curious as to what you have seen in those scores over the last couple of quarters.

Walter Robb

Interestingly, we just talked to Chris Taylor on our research team. She's at a Nielsen conference right now and they just told her they had been tracking our perception over the last three months and the perception about our pricing, the negative perception, has dropped from 20% to 10% in the last few months. I'm not sure I have the full context on that number, but I think the feeling is both anecdotally, intuitively.

And even based on that little bit of a data point from Nielsen that our value efforts over the last 9 to 12 months are definitely gaining some traction. We are seeing it in the lift that we get on these efforts, we're seeing it on the edges of looking at the different teams, and that survey was an online survey but I think we're just going to keep chipping away at it. I think we are starting to turn the dialogue around that.

Robert Summers - Pali Research

Is there any difference between center store performance and the perimeter? Just generally speaking.

Walter Robb

Well, we don't bust out the department results for you but let us just say this, that we are—you know, A. C. mentioned the special work in produce in for the tonnage and the meat and we are seeing a nice response to the value work we're doing on the perimeter.

And center store has stayed pretty steady because you do have people cooking at home and that's traditionally a good place during a downturn for people preparing more food. So we are pleased with the combination between the two.

Operator

Your next question comes from Simeon Gutman - Canaccord Adams.

Simeon Gutman - Canaccord Adams

We talked a little bit about balancing the sales and the gross margin, can you talk a little bit about the direct store line. I know this quarter was unusually good, it looks like because of the workers comp issue but is there a balance that you're learning as well or is that something that you are already comfortable with?

Glenda Chamberlain

We were very pleased with our results in this quarter on direct store expense line items. The operators are doing a great job with disciplining their spending at this level of sales. Yes, as we mentioned, we did see unusually good results in workers' comp this quarter, which certainly is not a trend at this point so we're not counting on that for the future. But we're very happy with where our direct store expenses came in for the quarter.

Simeon Gutman - Canaccord Adams

I guess in drilling down a little bit, if you look across stores that may have had direct store expense rates, is there a difference among stores in terms of how the top line performed relative to that rate of direct store expense or is that not detectable across the chain?

Walter Robb

That's a tough question there. We had across the whole system, if you leave out workers comp, we have 35 basis points of improvement in DSCs across the whole system. Ex workers comp. There is good discipline across the whole group of stores. Make sure you're looking at the right numbers.

Simeon Gutman - Canaccord Adams

I think the number was excellent. The question is are you finding that there might be opportunities to further manage some of the direct store expenses out without harming the top line.

Walter Robb

Never say never. There's always opportunities. We think we have made tremendous progress on labor and DSCs, capital spend and right now there are more opportunities but we're pretty happy with the balance that we're finding right now.

A. C. Gallo

And we're also feeling that we are coming in, especially as we hit the summer months, we have usually a dip, our normal traditional dip in sales in the summertime and so with lower sales, a lot of these comps are fixed so we don't really expect to see any kind of a dramatic improvement. We may even see some areas where we have a little less leverage because sales dropped and we have fixed costs.

But we feel really good about what we've done so far. Sure, there are other things that we could crank down further but we don't think that that would be smart at this time. We think we've a good level at this point, that for where sales are. We have shown that we can adjust if we have to. There are more tricks we could pull out of the bag if there was, say, a significant drop in sales because of the economy.

But we feel good where things are right now and think that that we'll be positioned coming out the summer into the normal pick up in sales in the fall to continue with these really good disciplines and these really good numbers in DSC.

Walter Robb

We have done a lot of scenario planning. We have, as A. C. said, identified the levers we could pull if we needed to pull them, but we're really happy with the balance right now.

Operator

Your next question comes from John Heinbockel – Goldman Sachs.

John Heinbockel – Goldman Sachs

If you looked at comps and then the unemployment rate in the areas around those stores that the comps that they produced, how much correlation do you think there is and have you seen, up to this point?

John P. Mackey

It's pretty high. The regions that have been hardest hit by the economic downturn, higher unemployment, biggest drops in housing prices. Those do correlate very closely with the regions where we are experiencing our lowest comps. So there is a direct correlation almost across the board.

Although interestingly enough Florida, which had very weak comps has trended up well for us the last couple of quarters so that may be the exception to that general, unless the whole Florida has turned up, which I'm not aware of. So Florida, right now, is going against that general rule.

John Heinbockel – Goldman Sachs

And when you look at that correlation is it in areas where there is higher unemployment is the drag more on transaction count or basket size or is it still that 50/50 split, even in those areas?

Walter Robb

The turn up in transaction comp was across the entire group of stores. I would have to drill into that a little bit to get a more specific answer but the turn up was across the whole set of stores.

John Heinbockel – Goldman Sachs

When you look at the price elasticity of your customer, your product, I know by department, by category there is going to be a lot of variation but if you look in general, how do you look at the price elasticity today, particularly in this economy where it doesn't look like comp retail has a lot of success getting people to buy if they're not in the mindset to buy. So how do you look at price elasticity today and how does that impact how you chose to invest the gross profit dollars?

A. C. Gallo

I think what we have seen is that people are willing to buy provided they feel like they are getting really good value. So that's why we've seen really probably our best results investing into really strong promotions. Promotional items. Throughout the store but we are focused on the perimeter, rather than trying to reduce—as I said before, we want to make sure we're competitive in the marketplace but we would rather invest in a strong promotion where people are clearly getting a value than say just trying to drop prices, everyday price here or there.

So that's where we think—it really seems that people have really responded well to good value and good promotions and that's what we plan on continuing going forward with.

Walter Robb

And we know that because we are tracking our investments and we are seeing lift of 200% to 400% on those selective investments that tells us customers are responding well to that. We also are continuing to track private label and that is still running about 3x over branded growth right now, although both are positive.

And the other thing is that we have a more robust system for tracking and adjusting pricings now. We've gotten better at it. We're tracking a market basket internally of about 1,400 items and we are on top of these. And we are being able to manage those and track those carefully as we go quarter to quarter.

Operator

Your next question comes from Charles Grom - J.P. Morgan.

Charles Grom - J.P. Morgan

You noted that in-store wages were better levered in the quarter. I was wondering if you could flush this out a little bit more in terms of how you are measuring it and if you think it's sustainable over the next couple of quarters.

A. C. Gallo

We actually are really pleased with the way that the in-store labor is going. One of the good things we have is because of our gain-sharing program, labor and wages is largely self-managing in our stores. The team has managed them based on a budget that they have and they have the incentives to come within that budget, or even below that budget, so they can get gain sharing.

That has worked really well, that program, through this whole process. And teams labor who are in good shape, they are getting their gain sharing payouts and as I said earlier, we think that we are in really good shape there, however, traditionally in the summertime as we go through our normal sales slump for a couple of months, typically we don't get as much leverage in labor because we have a fixed set number of team members. Hours don't adjust that much so that can go up for a bit in the summertime, but again, we expect that. As when sales pick back up, as they normally do, end of August and September, that we would be running similar to the way we are now.

Walter Robb

We have really got to give the compliments to the regional presidents and their teams this quarter. I do think it's sustainable as long as we have stable sales because our focus on scheduling, our focus on overtime, all these disciplines have continued to improve, resulting in these results. And interesting, our turnover is actually down nicely this quarter, or productivity is up and so we like, again, where we are right now with respect to the managing response.

Charles Grom - J.P. Morgan

On that discipline front, it looks like G&A came in at about 2.9% of sales. I believe the guidance a couple of quarters ago was about 3.1% for the full year. is the 2.9% a good number we should think about for the next couple of quarters or should we expect a little bit of catch up to kind of get back to that overall 3.1% for the year?

Glenda Chamberlain

Yes, we are maintain our 3.1% guidance for the year in G&A. We do think that the G&A dollars in the back half of the year will increase just a little bit from where they are running currently. So that will be higher as a percentage of sales.

Charles Grom - J.P. Morgan

On the I.D. front, it looks like the two-year trend from Q2 to Q3 is about 240 basis points worse. I know there's a little bit of FX noise in there but was the 1.9% I.D. from Q3 a year ago, did it start off really strong and tail off so you have a tougher comparison in the beginning of that period. I'm just trying to understand why there is a little bit of deceleration on the top line.

Glenda Chamberlain

The two-year ident was negative 0.7% in Q2 and it was negative 0.05% so far in Q3. So we have seen a little bit of improvement in Q3. Last year when we saw the real drop off in comps it was in June when gas prices went way up.

Operator

Your next question comes from Scott Mushkin - Jefferies & Co.

Scott Mushkin - Jefferies & Co.

I just wanted to look a little bit more medium term here and try to understand kind of where the store contribution margin may be going over time. I know you guys said about 6.9 for the rest of this year. And if sales improve or we get a positive comp going forward what do you think a kind of normalized store contribution margin is for the company at this time? I know it used to run over 9.

And the other thing I wanted to know is a kind of revenue growth rate as we normalize and get out of this economic period. Do you have any thoughts as you guys are planning because you're still opening new stores, what the long term growth rate we should be looking at for revenue for the company?

And then just as a clarification, the pre-openings ran a little higher than we were expecting and I was wondering is that going to really curtain at the end of the year or is that number up? I think you had forecasted before $55.0 million to $60.0 million for the year and I just wanted some thoughts there.

Glenda Chamberlain

If you go backwards, that we maintained our pre-opening guidance for the year of $55.0 million to $60.0 million so that implies I think $17.0 million to $22.0 million for the back half of the year.

John P. Mackey

Regarding the first question about store contribution profit percentages, you said if things normalize again. I mean, if we get back to the way it was, then I expect our store operating profit percentages to get back to where they were. But we're living in kind of a discontinuous economic time so it's hard to say what normal is anymore. We are going to have to wait and see what happens over the next few quarters. However, we are slowing down our rate of growth and as you know from the past, as our rate of growth slows down and the age of our stores starts to go up instead of going down, then we will see that percentage tend to track upwards because the older stores have higher contribution profit percentages than new stores do. It takes a while for them to mature.

Also, we are seeing improvements in the acquired Wild Oats stores. As we said all last year, it takes a couple of years to completely integrate acquired stores into our operating model. So we are well into the second year now, a year and a half into the merger and we are beginning to see, get real traction on those operating margins at the acquired stores.

So it's hard to say what's normal but I think there is basis for optimism based on what I just explained.

Scott Mushkin - Jefferies & Co.

And one follow-up to that, in just the revenue growth rate, your thoughts there for the company going on a more normalized basis or out in the future. I guess another way to say what I said before was it sounds like you are going to be making some gross margin investments with the value price so it sounds like that gross margin, which used to run about 34, 34.5, may be coming down. Will you be able to make that up, maybe consolidating some regions on the direct store expense line to get us back to a more 9 contribution margin or is that not possible?

John P. Mackey

I definitely think that's possible and I'm not sure that I would buy the premise that our gross margins are coming down. We haven't guided towards that so I'm not sure I would reach that conclusion on gross margins.

Glenda Chamberlain

Not over the long term.

John P. Mackey

Not over the long term. And we are showing good discipline on our direct store expenses, on our G&A expenses, we are managing the expense side of the business better. We are also very dedicated to managing our capital better for the cost of our new store build-outs and as we focus on that and become more successful at it, we will see our depreciation costs decline, which will have an impact on direct store expenses as well.

So I don't think we're going to see gross margins erode, or we don't anticipate that, and we expect to show good discipline on direct store expenses in G&A.

So the real question is, and the biggest variable, is sales. And we're not certain about sales for the rest of this fiscal year or next year or the year after. We don't know what inflation rates are going to be. We know money supply is being increased. It doesn't pay to make predictions at this point about what's going to happen with sales. But as sales go, that will obviously have an impact on the other categories since that's the most important driver and predictor of performance.

I'm going to dodge the [inaudible] question.

Scott Mushkin - Jefferies & Co.

That's okay. With that, though, is there any thought to just curtailing store openings period since there is no visibility or is that really not on the table?

John P. Mackey

Well, we don't see any reason. We have slowed down our, we dropped our new store openings for this year about 50% and as you see, with the decline in our new store opening rate, we're beginning to see a lot of free cash flow being produced. We are producing more cash than we're investing at this point so we are seeing our free cash flow go up.

We want to continue to open stores that we think are going to produce superior returns on invested capital over the long term so I could not see us stopping opening stores.

We have raised the hurdle rate for stores to get through our pipeline. We are look to try and do all deals now that are going to be a five-year EDA returns for us. So we have increased the hurdle for a new store to qualify and we are re-evaluating the stores that are in the development pipeline. If landlords miss certain criteria that are in the lease, we have an opportunity to review them.

So I don't think we are going to grow as fast as we grew the last couple of years but, I mean, we've opened some fantastic stores in the last few months that certainly got us all pretty jazzed up at Whole Foods.

Our Paramus store in New Jersey is doing a phenomenal volume. We just relocated our Annapolis store last week and it had incredible sales in the first six days it's been open, first seven days it's been open at this point. Santa Cruz is a smaller store that's off to a great start.

And probably the best store that we will open in fiscal year 2009 opens up next week. It's the relocation of our original Chicago store in Lincoln Park to across the street to Kingsbury location, which will be a 75,000 square foot store that we think will be the best food store in Chicago when it opens up, and it's getting a lot of good buzz prior to the opening.

So there's no reason to stop opening stores if the stores we keep opening up continue to do real well for us.

Operator

Your next question comes from Karen Short - Fbr Capital Markets & Co.

Karen Short - Fbr Capital Markets & Co.

A couple of questions related to your guidance. What is the tax rate that you have embedded in your guidance?

And then the second question just on new store openings in the second half of the year. How many do you think will actually cannibalize your existing stores and do you have any sense of what the negative impact might be on the comp from those?

And I was wondering if you could talk about the cadence of sales in the second quarter.

Glenda Chamberlain

The tax rate guidance is 41% to 42% for the year.

Walter Robb

On new store cannibalizations, we have more in the fourth quarter than we do in the third quarter, your question is how do we think about that in terms of the impact on sales and I think it's sort of a balance between—we are seeing cannibalization has been slightly exaggerated by the reduced customer account over the last six to nine months, but on the other hand it will be a little greater in Q4 than it will be in Q3 because there are going to be more stores affected.

John P. Mackey

But I don't think we're giving specific guidance about it.

Karen Short - Fbr Capital Markets & Co.

And just wondering if you look at your regions, in general are there regions that are comping positively now?

John P. Mackey

Yes.

Karen Short - Fbr Capital Markets & Co.

And that basically if we look at the rates and see who has the lowest unemployment or best housing markets, is that pretty fair to say?

John P. Mackey

Yes, pretty fair.

Karen Short - Fbr Capital Markets & Co.

In comps in the third quarter, in terms of the improvement, has it been more traffic- or basket-related?

John P. Mackey

It's too early. I mean, we're only four weeks into the quarter and we've given those first four-week comps, but we don't want to slice and dice them any further than that at this point.

Karen Short - Fbr Capital Markets & Co.

Any comments or update on the performance in the U.K.?

John P. Mackey

That's interesting you should ask about the U.K. since I was there yesterday. I just flew back from London yesterday so I spent the week touring our stores in London and looking at new store location opportunities, as well.

And my last trip to London was back in November and I was very impressed with the progress I saw in our Kensington store in the last six months. We've got Jeff Turnas, we've broken off the U.K. and created a separate region for it. We have two outstanding top leaders who are going to be heading those operations up for us.

Jeff Turnas who was previously the regional president for the North Atlantic region has made a move to the U.K. with his family, and David [Daughtero] who was a VP in North Atlantic in the purchasing perishables area is going to be going over there as the number two guy. Plus we have some real talented people already over there so we've got a strong team that's in the U.K. and A. C. was just over there recently, too, so he may can add some color.

A. C. Gallo

We definitely are very excited about having Jeff and David over there. They are two very strong, experienced leaders. Jeff has already made a lot of really positive changes for the Kensington store and at the smaller former Fresh and Wild, now Whole Food Stores.

Karen Short - Fbr Capital Markets & Co.

Can you elaborate on some of the changes?

A. C. Gallo

A lot of them are merchandising changes in the store. A lot of merchandising changes in different departments, some slight changes in the product mix in departments, some changes to the pricing in some of the departments. An increased focus on specials and promotions is primarily what he's done. He's only been over there for about six weeks now.

And we continue to be encouraged by how we're doing considering how the economy is over there. We think that we're really holding our own and as John said, we're looking for some potential new locations for what we would consider the right size store for Whole Foods over there. And we have a few locations we're working on and hopefully we will be able to bring one of them to the real estate committee and have an approval at some point.

Operator

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

Andrew Wolf – BB&T Capital Markets

Walter, I think you talked about private label sales being 3x, or over 3x, branded. I think at the end, if I heard you right, you said but both are positive. And is that on a total basis or same store basis? And I assume that is just a middle of the store, non-perimeter that you're talking about? Just trying to get an idea of when you talk about those larger groupings and positive sales just what you are referring to.

Walter Robb

That is right, those are growth rates for the center store area, the branded group and the private label group and those are relative growth rates. But they are both positive.

Andrew Wolf – BB&T Capital Markets

But is that total or at same stores?

Walter Robb

No, that's total.

Andrew Wolf – BB&T Capital Markets

Would you care to share with us what that number is? Or a sense of what it is.

Glenda Chamberlain

We don't break it down.

Andrew Wolf – BB&T Capital Markets

Is that improving? As your comps are slightly improving, is that gap narrowing? I would assume it is because it sounds like you're talking about that but I'm just trying to confirm that.

Walter Robb

Actually the gap has slightly narrowed because we got as high as 4x at the height of this thing and I think also we have been talking a lot about the brands as well and wanting to drive the brands and finding the right balance between—private label has been a wonderful growth engine for us but we think there's also growth in the brands as well and finding the right balance there. So actually that number got as high as 4x but it's been sitting between 3x and 4x so it's the lower end of that range but it's still fairly robust, in terms of the gap.

Which suggests that to John Heinbockel's question earlier, there is definitely a response on the value offerings.

Andrew Wolf – BB&T Capital Markets

What I wanted to ask and I might now have phrased it well, was the gap in total growth inside of the store where you're positive and perimeter, as your comps have sequentially gotten a little better, less negative, has the gap in the growth rates, if you just looked at them as an absolute number, has that shrunk. In other words, is the perimeter doing better relative to the middle of the store?

Glenda Chamberlain

It's difficult for us to try and give you a lot of information when what we are trying to say is that we don't want to talk specifically about the comps of the perishable departments versus the non-perishable departments. I think Walter has already given you some good color there by saying that it's positive in the grocery.

Andrew Wolf – BB&T Capital Markets

But the produce has, you did call out the produce having better [inaudible] results and driven by promotions. Sorry to keep harping on this but—

Walter Robb

Again, remember, when we started talking value with you last May and June we talked a lot about A. C.'s and my conclusion, after really studying this, was we thought our price image was worse on the perimeter than it was at the center store and so we attacked that area and we have continued to attack that area aggressively with value and selectively, I might say.

And so what A. C. said earlier about produce, that's the one area where we do see significant deflation but as a result in investing there we are getting good tonnage movement, good response on the tonnage. And we are seeing nice response on the meat and the sea food but I think we ought to stop there in terms of going any further on the numbers detail. But hopefully that gives you a little more color for what's happening.

Operator

Your next question comes from Neil Currie – UBS.

Neil Currie – UBS

I just wanted to focus on a couple of points that have been raised and try and bring them all together. One is that there obviously has been some deflation in produce and I think in dairy as well, but you talked about the opportunistic purchases that may have been available because of excess inventory as well.

What I did notice is that your gross margin was a little bit better than I thought it would be. Maybe it's just bad forecasting on my part. But it does seem that in your attempts to improve price perception, and produce has been one part of it, that ignoring the deflation on the price side, the deflation on the cost side of produce may have been pretty helpful enabling you to get prices down without squeezing those gross profit dollars too aggressively. Would that be a fair way of reading it?

A. C. Gallo

Yes, that is accurate that there was enough of a reduction in cost in produce that allowed us to offer some really good pass-throughs to our customers, some fantastic promotions and lower prices, while at the same time being able to maintain a reasonable margin.

Neil Currie – UBS

And of course drive some tonnage, as you mentioned earlier. So in some ways even though your ID sales showed a little improvement and maybe some were hoping for some more, actually profits were probably better than the ID sales suggested.

Glenda Chamberlain

Well, if this helps at all, our average price per item in the first quarter was up 2.5% and it was basically flat in the second quarter. Somebody asked earlier about the impact of deflation on comp. I don't know if that's the exact answer to that question but maybe that helps you with what you're asking.

Neil Currie – UBS

I think what I'm trying to get to is the deflation actually is potentially more of a help than a hindrance right now, in what you're particularly trying to do, which is to lower price perception.

John P. Mackey

That's right and it's most pronounced in produce. You see a little bit. But what you also see is a moderation of inflation. And particularly you see that in some areas like meat and dairy. It's not across the board. It's a combination of deflation in produce and the moderating of inflation and the settling down of some of the commodities that's been helpful.

Neil Currie – UBS

Again, that moderation is driven by just the commodity cost moderating as well.

John P. Mackey

That's right.

Operator

Your next question comes from Meredith Adler – Barclays Capital.

Meredith Adler – Barclays Capital

I know you talked about having sort of contingency plans or having done scenario analysis about expenses. I'm just wondering whether is a point where you kind of foresee you run out of variable costs and you talked about the summer and that there is a certain amount of fixed costs when the sales slowdown. So if sales continue to be negative next year, when do you think you run out of the ability to continue to cut variable costs? Or how aggressive do you have to be in doing other things?

John P. Mackey

Let me try to interpret your question. Since our costs are negative but we're still producing pretty good EBITDA and cash flow and free cash flow and earnings, despite the negative comps, it's because we're maintaining good gross margins and we're doing it on the expense of the business.

Your question is what if the negative comps continue next year when you are comping negative on negative and do we have any other tricks up our sleeves we could pull to maintain good earnings and good EBITDA. It's a good question and we are thinking about it and we have certain contingency plans to put in place if that's what happens.

But that's not what we think is going to happen. We think we are going to start to see stronger comps and we've already begun to see stabilization in our comps here in Q3. And the comparisons begin to get easier and easier as Q3 goes on and then Q4 last year, I think our comps were 0.4% and then they went negative in Q1 of 2009.

So as those comparisons get easier, we do not anticipate negative comps on negative comps. So do we have a plan? The answer is we have a contingency plan but I don't want to talk about it because I don't think we're going to have to use it. So if we have to use it I'll talk about it then.

But in general, we expect to see some sales growth in comps and we think it's probable in 2010. I would be very surprised if that's not the case.

Meredith Adler – Barclays Capital

I have heard some people talking about the potential for Whole Foods to centralize more activities and that there would be a substantial improvement in the operating margin if you did that. I always think of decentralization as one of your great strengths but I was just wondering if you could comment on how you were thinking about it.

John P. Mackey

Well, let's see, do we want to change our 30-year business strategy at this time because some people are critical of the way we do things? I think that answer would be no. We think our overall strategy is a very good strategy and it has produced great results over the long term. So the centralization versus de-centralization is a little bit of a bogus argument because almost every company is a combination of the two, and Whole Foods certainly is and sometimes centralization waxes and at other times de-centralization waxes and centralization wanes.

And it changes, your relative mix changes, over time. What might be a good strategy for a few years might, over time, be less of a good strategy. So in general, we probably increased our centralization in purchasing overall over the last five years. But as we have done that we have also become aware in certain categories how important it is to have local and regional purchasing in certain categories. Like we're getting a lot more produced, for example, on a local basis now than we were doing, say, five years ago.

And the real important one right now is meat. As we are really working our supply chain to develop local and regional suppliers of fresh meat products. We think that's something the market wants. We think it creates a greater freshness. We also think it has less food-safety risk from having too much meat in a central area that could get some type of contamination. We would like to de-centralize that.

But in other areas, such as private label and centralized center-store buying, we're doing more centralization there. So it's a mix of the two. And paradoxically in some ways we are centralizing and de-centralizing simultaneously. It sort of depends on the category.

I know that's a little bit vague and ambiguous.

Glenda Chamberlain

You know, we agree with you that de-centralization in operations is one of our great strengths. But there are areas of the company, such as IT and accounting and HR and legal, where we are highly centralized and where we continue to look for more opportunities to do things one time instead of twelve times and to be efficient as possible.

So it's kind of a continual dance at Whole Foods, is always looking for ways that we can improve in whatever area it is.

Walter Robb

Make no mistake about it, we are actively looking at places to leverage our growth and we are getting it in distribution, we are getting it in lots of places but I think fundamentally we just think it's a better way to compete by having the other things de-centralized. Some of the pricing and buying, it makes sense to do it on a regional or local basis. That's a better way to fight the fight where the fight's happening.

And that's our view of it. It's different than others but that's how we like to compete.

Meredith Adler – Barclays Capital

Becoming more promotional is kind of a change for you and your long-term strategy and I understand that doing it now. Is there a cost, sort of an incremental cost structure, to being more promotional, more labor in the stores, to handle that?

And this is a hard question to answer, but do you change customers' way of shopping because you are now doing more promotion?

John P. Mackey

I think that's something that we're looking at really carefully. We are doing promotions right now because we really feel that it's the right thing to do. I mean, we've always done promotions but I can say that we're doing deeper promotions right now. We have got a few new programs going on. We've got even some global programs like our Whole Deal program that we're doing through the Internet.

So we are looking at the impact of these on shopper behavior. Does it require more labor or expenses in different areas? We are evaluating the whole thing and the thing about the marketplace is dynamic that it's so hard to project that what we are doing right now is what we're going to be doing six months from now. We are really going to try to react to the marketplace and we're going to—and we do react market by market so this isn't just the whole company doing one thing.

If a region decides that they want to change the way they are doing promotions or their program, that will happen on a region-by-region basis. So it's a very dynamic, fluid thing.

Operator

Your final question comes from Analyst for Greg Badishkanian – Citigroup.

Analyst for Greg Badishkanian – Citigroup

Looking again at the improved comps in the third quarter, how much of it was a function of improving natural food industry sales versus some of the other items you mentioned, like improvements at Wild Oats or lower cannibalization?

John P. Mackey

Well, we've only reported the first four weeks of Q3 on comps. So we are not prepared to really discuss anything more about Q3 comps on that very low data point. So sometimes I wish we didn't report the first few weeks of the next quarter so people wouldn't want us to give a lot more information on something that we just don't really have yet.

So the trend line is stabilizing and looking pretty good so far in Q3 but it's only a third of the quarter in terms of sales. So we're not going to say anything else about it.

Walter Robb

What's the part of our question about natural products? I didn't really understand.

Analyst for Greg Badishkanian – Citigroup

How much of that was driven by improvements in the overall industry, I guess, versus some of the other items you mentioned?

Walter Robb

Could you be a little more specific? That's a hard question to answer.

Analyst for Greg Badishkanian – Citigroup

Are you seeing improvements industry-wide or is it more just some of the other factors, like easier comps.

John P. Mackey

I'm wondering if we're getting quarters confused here. Because we've only got four weeks into Q3 for Whole Foods. And we don't really know what the industry is doing right now in Q3. We don't have insight into the industry on that short of a time period. We do kind of keep track of the overall industry and compare ourselves to it but we haven't done that thus far in Q3, which is only four weeks into it.

Walter Robb

One of the things that is interesting is that you've got very mixed results out there if you look at the other public companies that report. You have some going forward, you have some going backwards. It's really kind of a scatter shot out there right now. So we like our progress, as we told you, stabilizing and some encouraging signs. That's what we know best, so that's what we're talking about.

Analyst for Greg Badishkanian – Citigroup

And Oats comps were positive there in the quarter. Would you be able to quantify that at all?

John P. Mackey

We quantified Wild Oats for all of fiscal 2008 and we announced we weren't going to break it out going forward any further. So I don't want to change my mind about that because they are fully integrated but I guess the point is that we had said that an integration takes a couple of years to do so basically we are giving that information that we're showing positive comps at Oats and people can see that we are continuing to make progress on that integration. But no, we're not going to break it down any further. I'm sorry.

Operator

There are no further questions in the queue.

John P. Mackey

Thank you very much for listening in. We believe the strategic decisions we have made have allowed us to successfully manage through this period of slower sales growth and will create long-term value for all of our stakeholders.

We appreciate your support and look forward to speaking with you again in August on our third quarter earnings call. A transcript of the scripted portion of this call along with a recording of the call is available on our Web site at www.wholefoodsmarket.com.

Operator

This concludes today’s conference call.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Whole Foods Market, Inc. F2Q09 (Qtr End 04/12/09) Earnings Call Transcript
This Transcript
All Transcripts