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Executives

John Mackey – Chief Executive Officer

A.C. Gallo - Co-President, Co-Chief Operating Officer

Walter Robb – Co-President, Co-Chief Operating Officer

Glenda Chamberlain – Chief Financial Officer

Whole Foods Market, Inc. (WFMI) Q1 2010 Earnings Call February 16, 2010 5:00 PM ET

Charles Grom – J.P. Morgan

Scott Mushkin – Jefferies & Co.

Edward Kelly – Credit Suisse

Karen Short – BMO Capital Markets

Mark Wiltamuth – Morgan Stanley

Meredith Atler – Barclays Capital

Neil Currie – UBS

Edward Aaron – RBC Capital Markets

Operator

Welcome to today’s program. (Operator Instructions) It is now my pleasure to turn the conference over to Mr. John Mackey.

John 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 Said, Executive Vice President of Growth and Development and Cindy McCann, Vice President of Investor Relations.

First, the legalities. The discussion we are having will include forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 and these statements involve risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated by such statements.

These risks and uncertainties include those outlined in today’s call as well as any other risk identified from time to time in the company’s public statements and reports filed with the SEC.

I hope you’ve had a chance to read our press release which is available on our website along with the scripted portion of this call.

We are very pleased with our first We are very pleased with our first quarter results. On a 7% increase in sales, we produced: a 116 basis point improvement in operating margin to 3.9%of sales; a 26 % increase in EBITDA to $186 million; a 62% increase in diluted earnings per share to $0.32; a 14% increase in cash flow from operations to $161 million; and free cash flow of $79 million.

Average weekly sales per store for all stores increased approximately 4% to $572,000, translating to sales per square foot of approximately $800. We are seeing much better results in our new stores due in part to the overall rebound in our sales but also reflecting the positive impact of smaller, less expensive stores.

Compared to the class of 21 new stores in the first quarter last year, our class of 17 new stores this year was approximately 9% smaller in size, averaging 47,000 square feet. These smaller new stores produced 27 percent higher average weekly sales per store of $650,000, or a 37% increase in sales per square foot to approximately $707, and produced a 418 basis point higher store contribution as a percentage of sales due primarily to lower occupancy costs and direct store expenses as a percentage of sales. We also are seeing significant reductions in certain areas of our development costs which are driving healthy improvements in EVA as well.

The percent of sales from new stores declined year over year and sequentially to 6%t of total sales in the quarter. This, combined with their improved performance, resulted in less of a drag on our overall results. As we hold our square footage growth relatively steady over the next few years, we expect the average age of our store base to increase which should help drive improved store contribution as a percentage of sales. If and when we accelerate our square footage growth, the growth paradox will likely resurface once again.

Our comparable store and identical store sales trends improved for the third quarter in a row and both are now back in positive territory. Comparable store sales increased 3.5%, identical store sales increased 2.5%, and for the first time since 2005, our comparable and identical store sales on a two-year stacked basis improved sequentially.

The recovery we have seen is fairly broad-based, with every region and almost every department producing positive identical store sales growth and sequential improvements. We are particularly pleased with the double-digit comps we are generating at the former Wild Oats stores and at our Kensington store in London.

The improvement in comparable and identical store sales continues to be driven by increases in transaction count. Our average basket size was down only slightly year over year, a significant improvement from the two percent decrease we saw in Q4. The improvement in basket size trends was driven by an increase in the number of items per transaction, with the average price per item down slightly.

In general, we are seeing customers celebrate holidays and special events, such as the recent Super Bowl, in a bigger way than they did in 2009. We also are seeing a shift in buying patterns around bad weather. Last year, customers didn’t “stock up” as they had historically.

This year, not only are customers stocking up, they are restocking afterwards as well. In comparing Q1 to Q4, we saw a slight shift in sales to higher price tiers which we attribute in part to the holidays, and to a lesser degree, to customers trading down less. We are still seeing strong redemption rates for coupons featured in our Whole Deal newsletter.

Excluding LIFO, gross profit for the quarter increased 84 basis points to 34.3% of sales. We are continuing to see lower cost of goods sold driven by better purchasing and distribution disciplines as well as improved store-level execution, particularly in terms of shrink control and inventory management.

For the second quarter in a row, we saw year-over-year declines in inventory levels of approximately five percent which drove improvements in inventory turns. Year over year, the margin improvements more than offset slightly higher occupancy costs as a percentage of sales.

Early last year, we made the shift from being fairly reactionary on pricing to being much more strategic. We have seen this strategy successfully play out over the last several quarters, as we have produced strong year-over-year improvement in gross margin and comps.

While many of our competitors have gone back and forth on their pricing strategies, we are sticking with our goal of offering competitive prices on known value items, day in and day out. Our internal benchmarking shows that we maintained our price competitiveness relative to our national competitors during the quarter. We remain focused on continuing to strike the right balance between driving sales, improving our value offerings, and maintaining margin.

We produced diluted earnings per share of $0.32. We beat our own internal forecast due primarily to higher-than-expected sales driving better gross margin results and leverage of G&A expenses. There was still some conservatism in our spending in Q1 resulting in some new G&A expenses being pushed to Q2. Our results included $10.1 million, or $0.04 per diluted share, in store closure reserve adjustments.

During the quarter, we opened six stores in San Francisco, California; Santa Barbara, California; Milford, Connecticut; Portland, OR; Plymouth Meeting, Pennsylvania; and Seattle, WA, ranging in size from 25,000 to 50,000 square feet and we closed one former Wild Oats store.

Since the fourth quarter, we terminated two leases for stores in development and today announced three new leases averaging 40,000 square feet in size. We are committed to producing positive free cash flow on an annual basis, including sufficient cash flow to fund the 51 stores in our current development pipeline.

In other news, we were extremely pleased to move up four spots to number 18 on Fortune’s list of the “100 Best Companies to Work For.” To be one of only 13 companies ranked thirteen years in a row validates our commitment to our core value of ‘Supporting Team Member Happiness and Excellence.’ We are very happy about this achievement and want to commend our regional and store leadership teams for the great job they did in staying focused on Team Member morale in what was a very challenging year last year.

We also want to take a moment to thank our customers and Team Members for their generosity in the wake of the tragedy in Haiti. Our customers donated $1.7 million toward the relief and rebuilding efforts in Haiti, and our Team Members contributed more than $93,000 to support our Haitian Team Members whose friends and family have been affected by the earthquake.

Through the Whole Planet Foundation, Whole Foods Market has provided $1 million to a microcredit organization that is providing banking services to the people in Haiti following the earthquake. While not surprised by the outpouring of cash donations, we are humbled and grateful that our customers and Team Members contributed to help so many others in need right now.

Looking back on why we started this business over thirty years ago, one of the things we were most passionate about was the idea of providing customers with healthier alternatives to the heavily processed foods produced through industrial agriculture and sold in conventional supermarkets.

While we fulfill a part of our mission every day through selling the highest quality natural and organic foods available, I believe we have the opportunity and obligation to do more in terms of educating our stakeholders about the benefits of healthy lifestyle choices. To underscore our renewed focus, we created a new Core Value last summer – Promoting the health of our stakeholders through healthy eating education.

On January 20th, we announced the official company-wide launch of our “Health Starts Here” initiative created to support this new Core Value. As part of this initiative, our stores are now offering free information, recipes, in-store lectures, events and support groups, with a selection of educational books and cookbooks offered alongside materials from our two partner programs – Dr. Joel Fuhrman’s Eat for Health program and Rip Esselstyn’s Engine 2 Diet.

In-store signage is focusing on education about nutrient-dense foods through Dr. Furhman’s Aggregate Nutrient Density Index, or ANDI scores, including how to prepare and incorporate these foods into your everyday life. Our Prepared Foods teams are now offering a selection of specially branded “Health Starts Here” items in the self-serve food bars and chef cases which are generating considerable customer interest. For more information, visit any of our stores or check out the video on our website featured on the front page of our press room.

Our “Health Starts Here” initiative includes two internal programs as well: the Team Member Healthy Discount Incentive, where Team Members can earn a higher store discount for achieving certain biometric testing scores in the areas of nicotine, blood pressure, cholesterol and Body Mass Index, and the Total Health Immersion Program, a voluntary intensive health and wellness education program offered biannually at no cost to our higher health risk Team Members.

So far we have had a tremendous response to these programs. We believe the upfront investments we are making now will deliver strong returns over time in terms of healthier Team Members and lower health care costs.

We have a loyal core customer base that is aligned with our mission and Core Values. We expect our “Health Starts Here” initiative will grow and evolve over time to become a key competitive advantage for us, and by offering an informed approach to food as a source for improved health and vitality, we will help change many more lives for the better. We believe our passionate support of causes and leadership in areas important to our customers reinforces our position as the authentic retailer of natural and organic foods, making us the preferred choice for customers aspiring to a healthier lifestyle.

I will now turn to the rationale behind our raised outlook for the fiscal year. Please refer to our press release for detailed guidance.

Last quarter, we guided to flat operating margins for fiscal year 2010, excluding unusual items last year. At that point, we had just reported 1.6% comps and 0.4% idents for the first five weeks of Q1. Our results for the last eleven weeks of Q1 were significantly better than this at 4.3% and 3.3%, respectively. We did not forecast this level of improvement, and our first quarter results exceeded our own expectations on both the top and bottom line.

For three quarters, we have produced sequential improvement in comparable and identical stores sales trends, driven by improving transaction count trends. We are now seeing increasing transaction counts year over year and sequential improvement in identical store sales growth on a two-year basis as well.

Second quarter to date, our results are better still at 7.0% and 6.0%, respectively, with 0.6% two-year identical store sales growth. We are very pleased to see our comps moving closer to the ranges we produced prior to acquiring Wild Oats and the onset of the recession and believe there are many reasons to be bullish about our future results.

It is relatively early in our recovery, however, and there is still a lot of uncertainty regarding where the economy, the consumer, and competition go from here. Our new ranges for comparable store sales growth of 3.5% to 5.5% and identical store sales growth of 2.9% to 4.9% encompass our cautiousness on the low end and our optimism on the high end.

We also want to point out that our idents improved 224 basis points from the first half to the second half of 2009, so while we continue to face easier comparisons over the remainder of Q2, we face a significantly higher hurdle in the back half of the year.

Our operating margin guidance range of 4.3% to 4.5% for the year assumes lower year-over-year improvement in gross margin, excluding LIFO, than we have produced on average over the last three quarters. We do not expect to sustain those higher levels of improvement once we anniversary the shift in our pricing strategy that occurred in the first half of last year.

Additionally, we have been taking advantage of buying opportunities to pass through values to our customers, but it is difficult to predict to what extent these opportunities will continue. We are committed to maintaining our relative price positioning, and this might mean a higher level of price investments going forward.

We also expect slightly higher G&A of 2.9% of sales for the fiscal year. Our expense discipline is continuing, and even with stronger comps, the lessons we’ve learned over the last two years are not going to be forgotten. That said, spending last year was limited to “must haves,” and certain costs from 2009 were deferred, so we expect some increases in our cost structure now that we feel more confident about our sales momentum continuing.

In the first quarter, we beat Street estimates by six cents. Currently, the Street consensus for the remainder of the year is $0.84. Our new EPS range of $1.20 to $1.25 implies $0.88 to $0.93 for the remainder of the year which, at the midpoint, is seven cents above the Street’s $0.84 consensus. As currently reflected in Street estimates, we typically see higher average weekly sales in our second and third quarters which drive stronger bottom-line results, and then sales tend to drop in the fourth quarter which is seasonally our weakest quarter.

Our business model clearly has been highly successful, with our company ranked #324 on the Fortune 500 list of largest U.S. public corporations. In 2009, we were one of the top 20 best performing stocks in the S&P 500 Index.

As the world moves out of this recession, our positive sales momentum, combined with our continued expense and capital disciplines, should produce strong returns for our shareholders. With fewer than 300 stores, I remain incredibly excited about the future growth opportunities for Whole Foods Market. We are well positioned to take advantage of changing demographic trends, and I expect our renewed emphasis on healthy eating to help further differentiate us and solidify our unique position within the food retailing universe.

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

Question-and-Answer Session

Operator

(Operator Instructions) Your first call comes from Charles Grom – J.P. Morgan.

Charles Grom – J.P. Morgan

Good afternoon. On the IB improvement from 1Q to 2Q a pretty big uptick like you spoke to. I was wondering if we could dig a little bit deeper into that and how much of that is coming from traffic versus ticket and then also if you could speak to any color regionally year to date results.

A.C. Gallo

It is a short period of time so it’s a little difficult to project out, but what we can say is that what we started to see in Q2 was in addition to the strong increase we’ve had in our transaction count, we started to see an actual uptick in our basket size which is driven mostly by an increase in the number of items in the basket as our average price per item is still flat to slightly negative.

So that was a big change. People are putting more eggs in their basket and it’s increasing our basket size.

Walter Robb

It’s pretty clear that the transaction count, the customer count is driving this gain. We are gaining customers back. If last year we were losing, we’re gaining them back now and they’re doing the things that AC just mentioned.

We also had some tremendous holidays, some great holidays that we referenced in the script, but we’ve got, two years ago we went negative on the holidays. This year we had nice incremental improvement on the holidays in terms of lift and we had that at Super bowl. We had that at Valentine’s, so all those things seem to be working differently this year than last.

Charles Grom – J.P. Morgan

And then regionally?

John Mackey

Like the script said, it was end to end. It was strong across the board. It was really heartening to all of us.

Charles Grom – J.P. Morgan

Regarding your gross profit outlook, you spoke to ‘taking advantage of the buying opportunities’. I was wondering if you could share some examples for us and what would prelude you from getting those opportunities over the next couple of quarters?

John Mackey

One of the big things we saw this past year, there was a kind of a flood in the market of organic fruit as some different stores pulled back on it and a lot of the supply was coming on the market. We’ve had a lot of buying opportunities like organic apples in the past year.

Another thing that we had, there also was a large supply of natural meats on the market. So we’ve been able to purchase a lot of, especially meat and produce at very good prices and be able to pas those along to our customers.

We don’t know. Some of that will still come along. Our projections going forward is that some of that over supply will start to dry up and that we won’t have as many opportunities for some of that same pricing, so that’s why we think that it might not be some of the same opportunities there.

Operator

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

Scott Mushkin – Jefferies & Co.

Just a clarification, that $0.04 adjustment, I haven’t seen the whole release, would that have been a positive for earnings or a negative for earnings if we adjust?

Glenda Chamberlain

Are you talking about the store closure reserve adjustments? That would have been a negative to earnings.

Scott Mushkin – Jefferies & Co.

So you would subtract out, so the earnings would be $0.04 less with that or $0.04 higher with that adjustment?

John Mackey

Higher.

Glenda Chamberlain

We had an expense in the quarter of about $10 million or $0.04 related to store closure reserve adjustment. That is included in the $0.32 that we reported. I just want to clarify that that is an ongoing expense for us. We have about $1 million of cash that we actually pay on those leases every quarter and we will continue every quarter to evaluate the reserve, and so it’s possible that there may be more adjustments in the future, so we don’t think of that as a one time item that needs to be added back.

Scott Mushkin – Jefferies & Co.

Was the adjustment a non cash or was it some cash and some non cash.

Glenda Chamberlain

We pay out about $1 million in cash every quarter. The amount in excess of that was an adjustment to the reserve balance to increase the estimate of the number of months that we believe we’ll pay to sub lease those properties.

Scott Mushkin – Jefferies & Co.

In our store walking we’ve noticed that some of the prepared food sections have had some adjustments. In the New York area work is being done at the Everitt Commissary. Obviously your gross margins were pretty nice this quarter. Is there still more opportunity as you look at the prepared food offering to get the shrink down or get the margins up to where you want them to be or is that really not a large opportunity going forward?

John Mackey

I don’t think that’s a meaningful opportunity. The shrink is always an opportunity. We talked about that on the last couple of calls where we definitely think we have opportunities to improve in that area, but if I was looking at the big picture I wouldn’t say that’s one of the biggest opportunities.

Walter Robb

You mentioned that you saw more items from the commissary in one of the New York stores. That’s a changing thing. There is a certain percentage of products that we provide for our commissaries and a certain percentage that comes from the stores and it really varies. Sometimes they shift it around, but the percentage stays fairly constant.

We have not been increasing the amount overall of goods in the store for our commissaries versus what’s produced in the store.

John Mackey

I think the bigger story really is the gross margin. It’s just the ability, the balance that we’re striking between the price investments. The price and competitiveness and the gross margins that we’re realizing through the improved disciplines, inventory control, which is a form of shrink control and those sorts of things. That balance is extraordinary right now and I think that’s the bigger story right now in this quarter.

Scott Mushkin – Jefferies & Co.

Are you seeing any, I noticed that the amount of prepared foods and perishable foods have been going down for a couple of years as a percentage of your sales. Are you seeing that trend reverse?

John Mackey

I don’t know why you say that. We don’t report that number.

Scott Mushkin – Jefferies & Co.

You did in the K I think last year.

John Mackey

Essentially, in the last year and a half the numbers showed the customers are eating more meals at home than they were eating out for the first time. That went below 50%. So we’ve seen some drift towards the center store. We talked about that on the last couple of calls. That’s true as people prepare their meals.

I will tell you we’re seeing in this uptick, we’re seeing such strength in produce in particular that we’re going to watch those numbers. I’m not sure we can say exactly where that’s going to land. We’re seeing extraordinary strength in product right now.

A.C. Gallo

I think we can say that at the beginning of the recession, we definitely saw a shift towards center store and what we have been seeing rebound now in the perishable departments, a lot of strength in the grocery departments we’ve seen in the last quarter.

Operator

Your next question comes from Edward Kelly – Credit Suisse.

Edward Kelly – Credit Suisse

Could you provide more color on just specifically the adjustments that you made in the gross margin strategy of reactionary versus strategic? And then as we think about the gross margin going forward, it sounds like the back half of this year maybe you could see some deterioration because you’re cycling and along those lines, but how do we think about the gross margin over the next couple of years. Is you goal flat or is there a modest duration? How should we think about that line item?

Glenda Chamberlain

I just want to start by clarifying that our guidance does reflect continued year over year improvement in gross margin just not to the same extent that we saw in the first quarter, so I wanted to clarify that since you said gross margin deterioration.

Walter Robb

When we talk about having a change from reactionary pricing to more strategic pricing, I think last year in the first and second quarter last year no one knew where the economy was going. Lots of people were cutting pricing. There was a lot of reaction to what we thought customers might be looking for, what other competitors were doing and so a lot of our pricing was in reaction to what we thought was going on in the marketplace.

As we went through this past year, and especially as we started to see things picking up last summer and into the fall, we realized that we could set a strategy for, we got to the point where we felt like we had adjusted ourselves to be competitive in the marketplace, in each marketplace we’re in, and then we could start setting a strategy for where we thought that we could really make our mark.

So we adopted, and each region is a little bit different, because we let each region really determine what’s the best mix for pricing in their area and we kind of adopted a strategy that’s been working for us obviously and we feel pretty good about it and don’t feel like we’re having to make a lot of adjustments in that strategy at this point.

A.C. Gallo

And your second part of the question was about the outlook for gross margins for the back half of the year and gross margin is always dynamic in the marketplace. Right now we’re seeing, we survey 63 competitors on 400 items across the country to just stay on track of where we are, and right now we’re seeing some of the competitors are actually taking back some gross margin.

So the market is, except for a couple of isolated metro’s has kind of been easing up a little bit. So that would argue for some stability in gross margins. We’ve already talked about the discount window for buying. It’s slightly closing. We’ll have to see how that plays out.

What I think will continue is our disciplines to our inventory management, order sales, those sorts of things which has served us well. I think it’s pretty clear all the operators feel they’re not going to forget those lessons and those disciplines that are in place.

So I think it argues for stability. In terms of how much, we’re just going to have to see how those other dynamic factors play out on the back half of the year.

Edward Kelly – Credit Suisse

Promotionally, on the environment that you see out there, is that on the conventional side or is that across the board.

Walter Robb

It’s across the board. We check all the competitors. It’s everything from sunflowers, sprouts, all the way up to Wal Mart. We’re checking them all.

Edward Kelly – Credit Suisse

Last question is on the whole cost side. You did a great job of controlling costs last year when you had to. Historically your growth has been pretty high, but now it sounds like this discipline will continue going forward. The question really is how do we think about growth in both direct store expenses and G&A because I know you had some catch up this year. But are direct store expenses really a function of square footage growth plus inflation now and is G&A somewhat less that that? I was just wondering how we should think about those line items over the next couple of years.

John Mackey

I don’t think you should expect to see much leverage in those categories. There may be marginal leverage if we have very strong comp sales growth, but in general we expect our growth in sales will drive our growth in earnings. So in modeling it out, I don’t think you should expect to see, it may slowly get better over time but it won’t be that noticeable I don’t think. So it’s going to be the growth in sales that’s going to grow our earnings, not leveraging direct store expenses or G&A significantly.

A.C. Gallo

That said, we’ve got marginal leverage this time even in the Ident stores because we’re cycling numbers with such deep leverage last year. But I think John’s right. I think we’ll have to go forward and see how we do with that given these new disciplines.

John Mackey

We hope to see some but we don’t want you to model it in because it’s going to be a hard fight to create it over the next few years.

Glenda Chamberlain

The disciplines that we put in place last year in areas of purchasing, inventory management, spending on new stores, overall CapEx spending, and overall spending, still exists and still remain a focus for us. 2.9% G&A that we are guiding to for fiscal 2010 is a great number for us relative to most of our history, and we do expect to produce continuing leverage in Ident stores, mostly likely although not significant. But for our total company basis, it’s very difficult.

John Mackey

What you’ll see over time is the expense discipline we have in terms of new stores will be probably what affects over time getting leverage in direct store expenses. We’re going to be opening smaller stores and we’re going to be spending less money to open them. That’s going to result in less depreciation and higher profitability and better cash flow.

So as we open more and more relatively smaller stores, that is going to have a long term positive impact. I don’t expect you should see that much occur in the next year or two. It will take time for that narrative to play out.

Edward Kelly – Credit Suisse

Is that assuming the same type of comp growth that you’re talking about now?

John Mackey

We don’t know what’s going to happen with comps. We’re in such a discontinuous world right now. We had high single digit, low double digit comp growth for like 30 years and then we went into this recession.

What we don’t know is we don’t know what’s going to happen to the economy and we don’t know whether or not we’re returning to our historical pattern or whether this is a, we just don’t know what’s going to happen with comps. We really can’t predict it.

We’re as interested to find out as you what’s going to happen. A year from now we’ll have a better indication of what our comps trends are going to be. We’re certainly excited right now after being wandering around lost in the wilderness for two years to see our comps moving in the right direction, so we’re very excited about that and we feel like we’re building momentum again, but we’re not prepared to make any predictions about where comps are going to level out.

We hope it will level out for many quarters, but we’re not making any predictions on that.

Operator

Your next question comes from Karen Short – BMO Capital Markets.

Karen Short – BMO Capital Markets

I have a big picture question and then a this quarter related question. Your new store productivity seemed to really improve sequentially. I’m wondering if you could share some thoughts on what drove that and then on your guidance, your original guidance I think you had originally said specifically it included 170 million shares which I didn’t really understand if you’re doing a weighted average by quarter, but what are you assuming in your new guidance in terms of total annual share count?

Glenda Chamberlain

We think the share count is going to be about 168 million for the year because it was lower in the first quarter obviously and will be higher in Q2, 3 and four subsequent to the conversion of the series A preferred.

John Mackey

Your second question was about store productivity. Could you say it again?

Karen Short – BMO Capital Markets

I’m just curious. If you kind of do the math on new store productivity this quarter, you definitely saw sequential improvement. I’m just wondering if you could add some color. Is it location specific? Is there anything you’re doing differently?

John Mackey

Probably the biggest shift is the slightly smaller stores and the stores that we opened in the class as is in the script went down to 47,000 square feet and produced higher average weekly sales and it costs less to build the stores. So all those things added to. We actually got leverage on depreciation for the first time in a long time in the Ident stores.

So I think it’s a combination of smaller stores producing better result, costing less to build.

Walter Robb

We’re also opening up stores in slightly better economic times than last year, and we saw a lot of our store openings where the customers were very excited and we had very large initial sales and a lot of stores and they’ve maintained. So it’s just a very different environment for opening up a store this year than it was a year ago.

John Mackey

This one is definitely an intangible, but there’s sort of a feeling in the company that the company is in a good place and there’s an excitement with the team members and with the customers about where Whole Foods is right now and I think that translates some of the pixie dust that’s settling in on the stores right now.

Karen Short – BMO Capital Markets

Looking at the 20,000 plus square foot opportunity, you talked about the fact that your stores are now, I think you said $542 per square foot. Do you think if you were to look forward and evaluate the 20,000 plus opportunity, what do you think the sales per square foot would be if you were opening your own stores. Obviously you would pick a better location.

John Mackey

It would be higher but we really haven’t tried to project out what sales per square foot would be but it would be higher for sure. Our smaller stores have higher sales per square foot on average than our larger stores do. But we haven’t done that calculation so I couldn’t say.

We’re excited to have the Wild Oat stores comping extremely strongly and well into double digits across the country and their sales per square foot are going up accordingly. We still haven’t invested very much capital in them.

We’ve improved the product selection and the team members, we feel like they’re doing a great job, but we still haven’t invested very much capital in those Wild Oat stores so we think as we begin to do so in 2010, we expect to see strong comp growth in those Wild Oat stores for many years to come.

And as we do, we do expect the sales per square foot in those stores to reach hopefully market averages in the next few years.

Walter Robb

Over the years when we’ve made different acquisitions, we’ve purchased quite a few companies that had small stores and a lot of those stores that are still around are some of our highest productivity stores. But they weren’t at the time.

When we took over the Wild Oats stores, I think it seemed like they took a little bit longer to get going and some of it was that some of them were in very bad shape and needed a lot of tender care to bring them up to the quality we wanted them to be. But also, we were doing it in the middle of a real recession when the economy was really slowing down.

So I think what we see now, now that we’ve had time to operate them for a couple of years and the economy is getting better, we’re seeing the kind of growth in those stores now that as John was saying, I really believe that a lot of those stores at some point in the future will be very high productivity stores very similar to a lot of other stores we’ve acquired over the years.

Karen Short – BMO Capital Markets

So bigger picture, kind of five years out, do you have any ability to project long term goals in terms of total number of stores or total sales five years from now? I don’t think you’ve talked about that for awhile.

John Mackey

We have that ability. We do it internally and we’re not going to tell you.

Operator

Your next question comes from Mark Wiltamuth – Morgan Stanley.

Mark Wiltamuth – Morgan Stanley

I wanted to ask about the London store. You said that one was comping double digits and I know this was highlighted as an area that was going to be an earnings drag a couple of quarters ago and just let us know what’s going on on the profitability side also.

John Mackey

We’re very excited to see the Kensington store move into double digit comps and also the other small stores in the U.K. have all shown steadily improving comps as well. I think it’s a combination of, this past year about ten months ago, we separated the U.K. as its own region and moved over Jeff Turner to be the regional President over there and then also David [Daughtry] moved over, a long term veteran of our North Atlantic region moved over to work with Jeff as the Vice President.

Those guys just made steady improvements and the customers are really reacting to it. It’s a good time. The economy is also picking up over there. So it’s been really exciting to see and as the sales continue to pick up over there, the profitability is as well.

Mark Wiltamuth – Morgan Stanley

Is it still in the red or is it turning the corner?

John Mackey

It’s still in the red. It will be in the red for awhile because of the high depreciation. Until some of that depreciation comes off and sales continue to go up, it’s got high rent, but we see a light at the end of the tunnel, and the power of compounding if you’re able to grow those comps say in double digits for the next several years, I’ll be on a call someday in the future and announce the profitability.

First I’ll announce the positive cash flow from the store and then we’ll announce profitability, but I’m not announcing it right now.

Mark Wiltamuth – Morgan Stanley

And to get back to the gross margin discussion on the broader company, you did mention you’re doing very well on your buys because of all the product that was out there with the organics. Were you passing all that through and really just the margin positive here was from being more disciplined on price relative to last year or were you pocketing some of the cost of goods savings for yourself.

John Mackey

I would say that the majority of the increase in margin has come through better disciplines. One of the things that happened in the first quarter of last year was that we had a lot of the holiday ordering was done before we were clear on how much problem sales were going to be. So when we moved into the holidays expecting our normal bump last year, it didn’t happen.

We were stuck with a fair amount of inventory and we had a lot of significant shrink in perishables and then we had lots of holiday items in our Whole Body department, so that really depressed last year’s gross margin and with better sales this year, better holidays, much better discipline, we did much better through the holidays. So a good chunk of that improvement over first quarter last year was because of that.

As far as your question of these better buys we have, I would say that most of that was passed on to the customer. There were a few places where maybe it helped the margin a little bit, but I think the majority of that margin improvement was based on better disciplines and much better holiday.

Mark Wiltamuth – Morgan Stanley

You look at the PPI numbers which is a little bit of a crude measure but we actually are starting to see some turn in dairy and some of the vegetables. Are you seeing that also?

John Mackey

We started looking at PPI as well as CPI and we’re not completely tethered to those numbers since it reflects commodity conventional agriculture and we have a mix of natural organic as well as conventional. We saw a slight upturn in the last period of the quarter. We still continue to look at the balance of this year we don’t see inflation being meaningful; somewhere in the 1.5% to 2% range at the cap is what our internal projections.

So yes, we did see a little bit. We still don’t think that for our business it’s going to be a meaningful factor this year. If anything, it will be a slight tailwind, but still not that meaningful.

Mark Wiltamuth – Morgan Stanley

You’re still in deflation mode right now versus a year ago.

John Mackey

Not deflation. The CPI was slightly deflationary but I don’t thing that’s where we are. I just don’t think it’s going to be a major factor in thinking about the business for the balance of this fiscal year.

Operator

Your next question comes from Meredith Atler – Barclays Capital.

Meredith Atler – Barclays Capital

I was wondering just talking a little bit following on Mark’s questions, you talked about very strong volumes in produce and I don’t know whether you have a lot of experience with the kind of inflation and deflation we’ve seen recently in produce, but is some of it people responding to the lower prices just generally? People are buying more produce because there are lower prices?

John Mackey

Last year when we started to have price deflation in produce and we wound up lowering a lot of prices, initially we saw produce volume actually dropping because we initially saw a drop in average transaction because of lower pricing and not an uptick in volume.

But then over the course of time we started to see the volume pick up and we’ve held at this point now, our pricing versus a year ago is staying fairly steady and the increase in tonnage that we’re selling in produce is really what’s adding to the volume.

Meredith Atler – Barclays Capital

Do you think the customers are perceiving better pricing or that’s just really not it.

John Mackey

I do believe that our customers are perceiving better pricing. We’ve been doing a lot of promotions, each region again slightly different. For instance our North Atlantic region has a program they call Madness Specials that they run two weeks out of every month. They also run weekend Madness Specials on unperishable's and those stores have very large dramatic displays of whatever the hot produce item is right and the sales have been tremendous on it.

So the feedback that we’re getting from our customers is that, we had this feedback a lot over the last year, it was visible to them that we were really reacting to the different economic times and they really appreciated it. But they saw that we were really making an effort to increase the value and make it easier for them to continue to shop with us, to shop with us more and again, we got a lot of positive comments from our customers about that.

Meredith Atler – Barclays Capital

When I look at your comp numbers it looks like the stores two to four years old which is also the biggest group when it comes to average store size, are the stores that are probably struggling the most. Any thoughts about what you do to give those stores a boost or get them back on track or I don’t know how well they’re performing from a bottom line perspective, but is there anything that you’d do if you’re not happy with that performance to make it better?

John Mackey

We think it will look different next quarter. This is a common problem because stores move in and out of those categories every quarter and I wouldn’t read too much into that. For example, you said the average size. But if you look at that chart, you’ll see that actually the stores that are less than two years old are actually bigger in size at 52,900 square feet to the stores that are two to five year and they have significantly better cost.

So there are lots of factors. We don’t have as many good stores and they don’t comp as well or they’ve been cannibalized by other stores that have opened up or competitive entries. I wouldn’t read too much into it. Next quarter we could see that number be much higher.

Glenda Chamberlain

You’re talking about the two to five year old category. Comps in that category were slightly negative, so now we’re at 4.4% for this quarter.

John Mackey

So we are showing some progress. We’ll show more progress in Q2.

Walter Robb

In terms of what we’re doing to create that movement, I can tell you that in that group of stores there are some that are underperforming and we’ve been pretty disciplined about using best practices within our individual regions to compare the metrics and really try to drill in on the P&L and also work aggressively to build sales. So there is no stone being unturned with respect to comparing stores and looking for ways to keep their costs down and to build their sales, and that’s happening on an ongoing basis.

Operator

Your next question comes from Neil Currie – UBS.

Neil Currie – UBS

Where have you seen improvement in sales? It seems that you really have turned the corner in the last quarter and particular in the last four weeks. Is there any particular segment of your customer base where you think the turn around is most pronounced whether it’s the foody customer or the natural foods customer or whether it’s the high end customer relative to the middle income customer who may still be in some financial pressure.

John Mackey

We’re seeing a little bit of change in each category. We have seen, as you saw our transaction count is up quite a bit and we’re definitely seeing a lot of new faces. Especially over the holidays I had a lot of regional Presidents telling me that either a lot of customers that are new, comments like, you know I usually came here and bought my Thanksgiving turkey but last year I didn’t because I didn’t think I could afford it and I realize it was a mistake. I’m back here this year again.

So we think we’ve had some returning customers who may be people who stopped shopping with us at the beginning of the recession. They were afraid of what was happening, not sure if they could afford it.

We also have some of our, we know that a large majority of our customers only spend a certain amount of their basket at our store so with our improved value offerings this year, we think we’ve gotten even our regular customers to buy more than what they had before.

The other thing I think is happening, especially since the beginning of the year, we started this new healthy eating initiative, and we’ve had really a lot of very positive response from our customers and team members on this, and we’re seeing a lot of excitement. We credit some of our strong produce comps to the fact that people are really focusing in on our produce.

We put these handy scores up in the stores and we’ve noticed a dramatic increase for instance in the amount of green vegetables that we’re selling. Customers are really reacting to it. So I think it’s a combination of a lot of different things and a lot of different customers.

Walter Robb

I just wanted to add something that some of you have asked about a more definable metric. We engaged Neilson and we got to get a positivity metric, positive sentiment drivers for value and this is tracking from the end of October to January, and we saw almost a 10% lift in people’s perception on that sentiment driver as well as a similar decline in the negative.

So I think the perception has shifted in terms because of the work that we’ve done. We’ve done good work on increasing the value offerings. I think we’re getting some credit for that. I think people are beginning to look at us differently and as we make this shift towards healthy eating, which I think John mentioned we can do uniquely well among food retailers, we’re getting a differentiation from that effort as well.

John Mackey

Let me just add that over the past three weeks I’ve toured three of our regions, our Northern California region, our Southern California region and our Southwest region, and what I found in common in all three regions, I talked to customers, I talked to team members, I talked to suppliers while I was in the stores.

There is an excitement level right now in our team member base and with our customers that I haven’t seen in many, many years. Maybe that sources back to our healthy eating initiative but it’s noticeable the company is gaining a lot of positive momentum right now, and I’m seeing it even in places you don’t expect to see it like our suppliers are generally excited I guess because they’re seeing their sales go up.

Having been in three different regions and seeing the same kind of positive energy, it’s got us all pretty excited. I know that’s sort of intangible and subjective but it is definitely happening. We don’t exactly know why. We’re just speculating but we are hopeful that we’ll see it continue.

Neil Currie – UBS

You alluded to on Meredith’s question that the big turn around seems to be in the stores two to five years old which tend to be some of your biggest stores or some of the biggest service areas. That would imply to me that maybe perhaps there’s been a more exaggerated improvement in some of these service counter areas and food to go, hot food. Should I read that into it?

John Mackey

No I wouldn’t read that into that. We are opening smaller stores so we do have quite a few 50,000 square foot plus stores that are perhaps not producing the same level of profitability, mostly due to their high depreciation level. Cash flow production is pretty strong, than our smaller stores have produced.

So they’re acting a bit of a drag, but as they comp and as they grow, then they’re acting as less of a drag. So one of the things that we’re hopeful about and perhaps even optimistic about. is that as our comps continue to hopefully accelerate, the bigger stores that due to the recession didn’t comp at historical levels that we used to see are going to begin to return to historical type of comps.

As that happens, that’s going to have a strong positive impact we think on our bottom line. I want to emphasize that our comp improvement has been across the board. It’s been in all eight stores and all sizes of stores so I think that’s important for people to understand.

Walter Robb

That being said, I think historically we do see a larger comp gain in this category. The stores are younger. They’ve got more comp to go and some of that potentially could help this category just because there’s more comp to get earlier in the store life. But the main things is the comps are strong across the board.

Operator

Your next question comes from Edward Aaron – RBC Capital Markets.

Edward Aaron – RBC Capital Markets

We heard some talk in the past year about vendors may be shifting in some cases product back down to natural versus organic just to bring the price point down, and I’m curious to know how organic is changing if at all in terms of your mix. And to the extent that organic might still be holding up better than the industry on a relative basis, would you draw any conclusions about market share trends that you might be seeing in terms of the share that you might be perhaps gaining in an environment where perhaps your competition might have pulled back over the last couple of years?

Walter Robb

Organics is a strong part of our business and I think the trade association just released new data on the size of the organic industry at $26 billion with a growth rate of 5% to 6%. Our internal numbers show very clearly, and you can look at the Neilson numbers too, that organic dollars and units, while they’re down from historical double digit, they’re still well ahead of conventional growth rates and that tells us, and we see it in our own data, that organic continues to be a lifestyle choice or a choice that people will continue to make even in the darkest of time.

As you point out, some of the competitors have in fact pulled back from some of that selection. That’s been a real positive for us. We continue to be an authentic organic retailer and offer those choices and that’s what the numbers show.

John Mackey

One thing that we haven’t really talked about but maybe this is a good place to do it at the close of the call, we’re seeing our meat departments right now undergoing an evolution and we are selling more and more, for example we’re selling a lot more 100% grass fed organic beef. We’re finding that from local sources with high animal welfare standards.

We’re seeing that garner a larger and larger share. In that sense, in the meat department, we’re seeing organic as a category grow. We’re seeing similar things in chicken, in our pork sales and lamb. As we get more local, more organic, more 100% grass fed or pasture raised, we’re staring to see some good share shifts under that category.

In that area at least, organic is definitely I think is growing for Whole Foods and will continue to grow in the future.

Edward Aaron – RBC Capital Markets

On the guidance revision, it looks like this guidance is coming up about $0.15 on about a 200 basis point revision on the comp guidance. That implies that a little bit of a higher marginal profit rate if you will than I historically thought your business would do on an additional point or two of higher comp, so I’m wondering how to reconcile that. Would you attribute the difference to just the new store productivity being better and the profitability of those stores being higher than what you might have thought when you first provided your guidance for the year?

Glenda Chamberlain

The new store profitability certainly helped, but the operating margins are implied for the rest of the rest of the year are 4.5% to 4.8% which is very much in line with, and still below what we have produced historically. So that seems to be a reasonable number.

John Mackey

Thank you for listening in. As we stated, we believe there are many reasons to be bullish about where our results go from here, but it is early in our recovery. We have tougher identical store sales growth comparisons as we move into the second half of the year, and there is still a lot of uncertainty regarding the economy. We look forward to updating you on our progress in May on our second quarter earnings call. A transcript of the scripted portion of this call along with a recording of the call is available on our website at www.wholefoodsmarket.com. Thanks for listening in. We’ll talk to you next quarter.

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Source: Whole Foods Market, Inc. Q1 2010 Earnings Call Transcript
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