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

Executives

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

John Mackey - Co-Founder, Chief Executive Officer and Director

James Sud - Executive Vice President of Growth and Business Development

Walter Robb - Co-President and Co-Chief Operating Officer

Glenda Chamberlain - Chief Financial Officer, Principal Accounting Officer, Executive Vice President and Secretary

Analysts

Maggie Gilliam - Gilliam and Company

Charles Cerankosky - Northcoast Research

Karen Short - BMO Capital Markets U.S.

Mark Wiltamuth - Morgan Stanley

Scott Mushkin - Jefferies & Company, Inc.

Joseph Feldman - Telsey Advisory Group

Colin Guheen - Cowen and Company, LLC

Meredith Adler - Barclays Capital

Edward Aaron - RBC Capital Markets Corporation

Charles Grom - JP Morgan Chase & Co

Andrew Wolf - BB&T Capital Markets

Neil Currie - UBS Investment Bank

Whole Foods Market (WFMI) Q2 2010 Earnings Call May 12, 2010 5:00 PM ET

Operator

Good day, everyone, and welcome to the Whole Foods Second Quarter Earnings Call. [Operator Instructions] And it is now my pleasure to turn the call over to Mr. John Mackey. Please go ahead.

John Mackey

Good afternoon. Joining me today are Walter Robb, Co-CEO; A.C. Gallo, President and COO; Glenda Chamberlain, Executive Vice President and Chief Financial Officer; Jim Sud, Executive Vice President, Growth and Development; and Cindy McCann, Vice President of Investor Relations. Let me start off by congratulating Walter and A.C. on their well-deserved promotions.

Now for 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 risks identified from time to time in the company's public statements and reports filed with the SEC. Please note, our press release is now available on our website, along with descriptive portion of this call.

We are very pleased to report our second quarter results, which exceeded our expectations on the top and bottom line and are the best we have reported in several years. Average weekly sales per store for all stores increased 9% to $600,000, translating sales per square foot of $838. Our strong sales are driving stronger bottom line results, allowing us to better leverage certain fixed costs such as occupancy and depreciation, while maintaining our expansion inventory disciplines.

On a 13% increase in sales, we produced 191 basis point improvement in operating margin to 5.7% of sales, a 40% increase in EBITDA to $182 million, 102% increase in diluted earnings per share to $0.39, cash flow from operations of $182 million and free cash flow of $117 million. These results included a $3.2 million gain on the sale of a non-operating property in the current year and asset impairment charges of $13.1 million last year.

We have successfully emerged from this recession with better capital disciplines and a healthier balance sheet. Given our total cash and investments of $726 million at the end of the quarter, we subsequently repaid the floating $210 million portion of our $700 million term loan. As the economy and consumer confidence improves, we're gaining back customers at a faster rate than our competitors. Our two-year stack identical store sales increased 1.9% and our first positive two-year results since Q1 of 2009.

Our strong sales results were broad-based across most regions, age of stores and store teams. Our value work and perishables clearly has resonated with our customers as evidenced by our perishable comps showing strong rebounds year-over-year and outpacing our store average. Our 7.7% identical store sales growth was driven by healthy increases, in both transaction count and basket size, with about 2/3 of the increase coming from higher transaction counts. With the average price per item remaining flat, our first increase in basket size since Q4 of 2008 was driven entirely by our customers putting more items into their baskets.

Including LIFO, gross profit increased 37 basis points to 35.1% of sales due to an improvement in both cost of goods sold and occupancy costs, as a percentage of sales. We're continuing to see lower cost of goods, 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 third quarter in a row, year-over-year declines in inventory levels are driving improvements in inventory turns. Customers are still seeking value, as demonstrated by continued strong sales growth in promotional and private label items. However, branded product sales growth has now outpaced private label growth for the last two quarters. And we're seeing some indications of customer starting to selectively trade up to higher-priced items in certain areas.

We remain focused on continuing to strike the right balance between driving sales, improving our value offerings and maintaining margins. 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 along with robust promotional programs. Based on our strong sales growth alone, it appears we are getting credit for our hard work and that people are beginning to look at us differently in this area. This is backed up by our latest Nielsen study, which shows consumer sentiment around our value efforts and shows positive sentiment in our pricing continuing to increase. And while it hasn't disappeared, we are shipping away at the negative.

Lastly, based on our internal benchmarkings, we believe we improved our price competitiveness, relative to our regional and national competitors during the quarter. The improvements we are seeing in store contributions as a percentage of sales are being driven by our higher average weekly sales, continued profitability gains at the former Wild Oats stores and our new stores having less of a drag on our overall results.

Customers have clearly welcomed the changes we have made in the former Wild Oats stores over the past two and a half years. Comparable store sales growth is in double digits and sales per square foot have increased to 20% to $639 over the past two years. Strong sales growth and improved in-store execution have driven healthy increases in store profitability to 7.4% of sales. The percentage of sales from new stores declined to 6.1% of total sales in the quarter from 6.6% of sales last year. This combined with their improvement in performance resulted in less of a drag on our overall results.

Compared to the class of 21 new stores in the second quarter last year, our class of 19 new stores this year was approximately 9% smaller in size, averaging 47,000 square feet. Each store's produced 25% higher average weekly sales per store of $662,000 or a 39% increase in sales per square foot to $736 and a 375-basis-point higher store contribution as a percentage of sales, due primarily to lower occupancy cost and direct store expense, as a percentage of sales. We are also seeing significant reductions in certain areas of our development costs, which are driving healthy improvement in EVA [Economic Value Added] as well.

During the quarter, we opened three stores in Maui, Dallas and Long Island. Today, we announced two new leases in Wellesley, Massachusetts and Oklahoma City. And we announced plans to purchase two stores in Chattanooga and Asheville, both of which are new markets for us. Given our strong new store performance and the favorable rents we are seeing, we are focused on rebuilding our pipeline and expect the signing of new leases to accelerate over the coming year.

I will now turn to our raised outlook for the fiscal year. Please refer to our press release for more detailed information. Our new fiscal year range for identical store sales growth implies 6.5% to 8.5% growth for the second half of the year. The low end assumes identical store sales growth on a two-year basis remains in line with the 3.6% two-year idents we have produced in the third quarter today. The high end assumes some level of momentum and two-year identical store sales growth continues throughout the remainder of the fiscal year, moderating in the fourth quarter as we cycle over more difficult year-over-year comparisons.

Our new diluted earnings per share guidance of $1.33 to $1.37 imply $0.61 to $0.65 per diluted share for the second half of the year, which at the midpoint is $0.04 above the Street's current $0.59 consensus. We typically see higher average weekly sales in the third quarter, which drive stronger bottom-line results. And then sales tend to drop in the fourth quarter, which is seasonally our weakest quarter.

In closing, I would like to elaborate on the other announcement we made today, the promotions of Walter and A.C. Glenda, Jim, Walter, A.C. and I have worked together leading the company since 2001. During this time, our total sales, profits and stock price have increased tremendously. My goal in proposing these promotions was to keep this executive team together for what I hope has many more years to come. Walter and A.C.'s contributions to our company success are numerous and immeasurable. One of their most important joint accomplishments however, is the high level of voluntary collaboration they have fostered between our 12 regional leadership teams. I believe this was instrumental and are successfully managing through 2009, which was the most difficult time in our company's 30-plus-year history.

There are many reasons to be optimistic about Whole Foods Market's future growth potential. Our business model clearly has been highly successful with our company recently moving up to number 284 on the Fortune 500 list of the largest U.S. public corporations. Our new stores are performing very well, and we are in the process of rebuilding our store development pipeline in anticipation of reaccelerating our square footage growth in the future. We believe the best has yet to come for Whole Foods Market and look forward to working together to see our collective vision realized.

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

Question-and-Answer Session

Operator

[Operator Instructions] Our first question will come from the line of Scott Mushkin with Jefferies & Company.

Scott Mushkin - Jefferies & Company, Inc.

I'm just wondering how Walter and A.C.'s jobs will actually change with the announcement today?

John Mackey

Well, their jobs are not going to significantly change and that all of the reporting relationships will remain the same. In a sense, Walter and A.C., Glenda, Jim and I have been joint CEOs of Whole Foods Market. We make our decisions by consensus. We treat each other with mutual respect and equality. So in some ways, we're merely letting the external world recognize what has already been the case for the last several years. And Walter and A.C. have been essentially Co-CEOs for the last few years. So we're merely making public, which has already been sort of the case. So in a sense, their duties and responsibilities aren't going to really change. Walter will be reporting directly to the Board, along with myself and he will be a voting member of the Board of Directors. So those are sort of changes. But otherwise, it's pretty much same division of labor as we've had the last few years, Scott.

Scott Mushkin - Jefferies & Company, Inc.

And so, is Walter going to still be running the West? Is he going to be in Austin now? Or is he remaining out West?

John Mackey

Walter's mostly on airplanes. I'll let him answer that question, but he's still going to be running the West. But Walter?

Walter Robb

Scott, I'm in Austin actually today. But no, I think essentially the way that A.C. and I have shared the operating responsibilities, we'll continue that with the 12 operating regions. We each have six and it'll continue the same way though. West is literally defined as it does extend in Toronto there, but very similar.

Scott Mushkin - Jefferies & Company, Inc.

Second question was the CapEx. I noticed you guys took it down to $300 million, $350 million. I guess my first question is why? And then the second thing, I know you talked about reaccelerating stores. How quickly do we think we can get that done? The store growth?

Glenda Chamberlain

Scott, we took down the CapEx guidance simply based on what we've seen so far in the first half of the year and what we project now for the rest of the year. So we had pulled back CapEx budgets very tightly last year, and we encourage people to continue to spend on a very disciplined basis and that's what we've seen happened. So there's nothing more to it than that.

Company Speaker

And as far as ramping up the openings, as we've experienced good trends in comps over the last few quarters, it's given us more confidence in ramping up our store development pipeline. And so we've been starting to focus on that quite a bit the last couple of quarters. We currently have 12 leases in negotiation, and we're bringing, probably on average, 8 sites to real estate committee per quarter. So as we get those leases signed and as we continue to add nuance to the pipeline and that will inevitably cause us to grow faster. But for the time being, we're keeping our guidance the same, but expected to ramp up in the future.

Scott Mushkin - Jefferies & Company, Inc.

So for 2011, I think you guys gave us the tenders you're expecting. Is it potentially we could get more stores in '11 than that? And can that happen that quickly? Or is it going to be tougher to get it done in '11?

John Mackey

Well, there is a lag period between when we signed the lease and when we get it opened. So we anticipate we are going to begin accelerating our signing of leases over the next year or two. And then eventually, that will move through the pipeline. But I think our guidance is 15 to 20 stores and for the time being we're sticking with that guidance. We may change that guidance in a year or two though, Scott.

Company Speaker

But it's fair to say that it could be 20 up or in that range in 2011.

Walter Robb

I do think another factor to this number, Scott, is the extraordinary discipline that regional presence, the display and their capital spend, and actually the progress that we're making as a company and building stores more efficiently for lower cost per square foot. We've talked about that on previous quarters and some of that has come in to bear now. Both the discipline on spending and then also the new stores, we're making some really good progress there as well.

John Mackey

In the meantime, we've got a lot of free cash flow that's piling up, which is a good thing.

Operator

And we'll move next to side of Charles Grom with JPMorgan.

Charles Grom - JP Morgan Chase & Co

I was wondering on the quarter-to-date trends up 86%, which are impressive on an absolute basis. But when you look at it on a two-year stack, actually it's very impressive. Just wondering if you could kind of break down what's changing and why we're seeing an uptick from the second quarter?

A. Gallo

Well, we've done a lot of it last two years, just wondering if it'll start going down to really work on our value image and really give our customers a lot of more reasons than ever to want to shop in our stores. And I think that what we're seeing is that, as the customer confidence has come back and people realize how much more value they can get in our stores and other things that we've improved, we're really seeing a big swing back, especially in the perishable areas where we've worked really hard on our value image. We've seen a really big -- when the recession first hit, we saw the comps were more shifted to center store and our non-perishables. But as things are picking up, we're really seeing our perishables growing quite dramatically. People are coming to our stores. We think that customers are coming back. We think that customers who stayed with us are coming in more frequently. We're seeing quite an increase in our transaction counts. Because our price per item has really stayed flat, we're seeing people who are shopping putting more items in their basket. And the great thing is that the growth is really across -- we're seeing it across the countries, not just in certain places. We're seeing good strength everywhere. And so it's been a real steady and strong growth, and we seem to be on this positive trend right now.

Charles Grom - JP Morgan Chase & Co

And may I just walk in on the P&L, my second question is with regards to gross profit margin. And if I recall last quarter, you spoke to the buying environment being almost ideal for you. But you had a little bit of caution towards the back half of the year. Just wondering if you could kind of flush it up for us? Or do you still have that caution? Or is the buying environment still puts you guys in a good position?

Walter Robb

The buying environment is still there and we're going to continue to take advantage of it. Just checking with some other folks before the call and that's the word there. It's still out there. And I think, there's reason to stay cautious on gross margins because we still produce a nice gain over last year. Not as quite as great as last quarter, but you still have the question mark about where sales go. And I think we're still continuing to invest in our value and our pricing as A.C. just talked about, which is delivering us tremendous momentum. There's not a lot of inflation out there. And so, I think that all in all, I think they continue this buying and buying opportunities, and we're going to take advantage of those to continue to invest in pricing.

Charles Grom - JP Morgan Chase & Co

And my last question is on the direct store expenses up 13% in the second quarter, up 7.7% in the first quarter. Your back half compares got a little bit easier. Just wondering if you could kind of help us out embed it in the $0.61 to $0.65 back half. What are you thinking on that line item?

Glenda Chamberlain

Well, we don't talk about DSE guidance specifically, but our operating margin guidance for the year and for the back half of the year is consistent with the year-to-date operating margins, which makes sense because we have a strong quarter ahead of us generally in Q3 and a weaker quarter ahead of us in Q4. So flat operating margins compared to what we've had on the year-to-date basis.

Operator

And our next question will come from the side of Mark Wiltamuth with Morgan Stanley.

Mark Wiltamuth - Morgan Stanley

I wanted to ask a little about the Wild Oats store divestitures. Am I reading that right that you're going to get to keep 29 out of the 32 stores that were slated for divestiture just because there weren't enough bidders to show up?

A. Gallo

You got it. That's exactly right.

Mark Wiltamuth - Morgan Stanley

And so is that contemplated in your guidance now, that return of those stores into the outlook?

Glenda Chamberlain

Those stores continued to operate, so yes, that's implied in our guidance.

Mark Wiltamuth - Morgan Stanley

And of those three stores, only two of them are operating stores and one was a closed location.

Walter Robb

And of the 29 coming back, 18 are non-operating.

Mark Wiltamuth - Morgan Stanley

So you still have to do some divestitures just because they're non-operating stores anyway. But that's still has got to be a little bit of a relief relative to the some of the forced divestitures you were looking at there?

Glenda Chamberlain

It's a relief to have this process almost behind us.

John Mackey

Yes, it's been. As far as I can remember, we've been dealing with this issue.

Walter Robb

Not to mention the legal cost. It started over three years ago. Three and a half years ago now. So...

John Mackey

Yes, we will be very clad when this is finally behind us completely.

Mark Wiltamuth - Morgan Stanley

Just going back to the cost question, we have seen, if you look at the CPI numbers, there is some inflation showing up in the Perishables and Vegetables in general. Your comments seem to imply that you're still seeing great deals out there. But are you seeing the overall curve moving upward a little bit? And does that hurt the value effort at all?

A. Gallo

The one area that we've seen things turn around is in the Meat area, beef prices especially are high right now. So some of the buying opportunities we saw in the last two years in Beef category are starting to shift on us. We're still seeing some good opportunities in other areas, in other Perish [Perishables]. Certainly in the Non-Perishables and in some Perishable areas and Produce, we're seeing some opportunities. We have seen a little bit of inflation. We started seeing in Q1, we started seeing some cost increase, minor less than 1%. And we have, in certain areas, we have past some of that through where the competitive environment has allowed us to do it. We've also gone back and lowered prices in other areas where we needed to. We're really trying to be very careful and disciplined. Whether our costs are going up or not, we're watching really closely our relative competitiveness in each market we're in and making sure that we've maintained a competitiveness that we've established over the last year and half.

Mark Wiltamuth - Morgan Stanley

At least two of the conventional grocers have announced that they've had trouble passing through the cost increases in milk, eggs and meats. But sounds like you have a little bit of a mixed story there?

Walter Robb

I was just going to add to what A.C. said that we don't really see inflation being a major factor for the least of balance of this fiscal year. It's just really Produce, you mentioned Produce, and yes, it jumped up because of the situation in Chile and the weather, but it's come back down again. And of the Meat, which A.C. mentioned, it's just not, when he talks about cost increases, we're something in the order of 1%, we're not talking about something that's major here. So I don't think we see that as a major factor at the balance of this fiscal year and maybe not until 2011. Maybe a couple of areas, but even Produce has come back down to being less effect. And now remember, we sell less conventional commodity items than the other grocers and that's where you're going to see bigger swings in pricing. But on our internal tracking index, we just don't see it being very much right now.

Mark Wiltamuth - Morgan Stanley

And do you anticipate any disruptions from the loss of some of the Gulf supply for the Seafood side?

A. Gallo

No, we don't. Right now, we're in pretty good shape. The primary things we get from the Gulf are shrimp, some red snapper, mahi, things like that. Right now, in the short term, we have all the shrimp we harvested before this happened and it's frozen, so we're fine supplies. If this goes on for a long time, we might have some shrimp disruptions for a Gulf shrimp, but we certainly can get shrimp from other places in the world. Most of the other species that we source from there are readily sourceable from other places. So it might be inside the higher prices but not a disruption in availability.

Operator

And our next question comes from the side of Karen Short with BMO Capital.

Karen Short - BMO Capital Markets U.S.

Just a follow on Scott's original question on the promotions, I guess, I'm just wondering with management promotions, does this mean anything, as it relates to your future involvement, John, with the company?

John Mackey

Well, yes, it does. It means sticking around a lot longer. If you look on my blog, I got more detail on this whole decision process that wasn't included in the script. So if you go to wholefoodsmarket.com, my blog is now posted and now you can go see some detail about the thought process behind this. But essentially I made the decision about 18 months ago to recommit to Whole Foods for the longer term. And after I made that decision, I wanted to make sure I could keep this executive team with me for the next several years. And quite frankly, Walter and A.C. are both capable of being CEO of Whole Foods Market or some other company. So we had to think through how can we restructure this thing, so that there's enough room for all of us to make our contribution to Whole Foods. I recognize that Walter and A.C. have just done an incredible job. The whole executive team and the leadership throughout the company has done a great job for many years now. I'd like to say I've gotten way too much credit and way too much blame at Whole Foods Market. Our leadership's been a shared consensus type of leadership. And in some ways, I'm trying to let the world recognize the reality of the way Whole Foods Market company operates. And so Walter and A.C. have been really equivalent for the last few years anyway. So we're just trying to give them the public recognition that they've earned and deserve. So as far as I'm concerned, this enables us to be able to work together, and I'm planning on sticking around for -- honestly, I'm healthier and I feel better than I did 20 years ago. My vitality is really high right now. And I'm really jazzed about our healthy eating initiatives and getting out of this FTC [Federal Trade Commission] stuff. And the company's moving forward, I'm really jazzed. So I'm very excited about the next several years and working in partnership with Walter, A.C., Glenda and Jim. I think we are a terrific team and I think we're going to be doing it together for another decade or so.

Karen Short - BMO Capital Markets U.S.

And then just looking to your longer-term sales and I guess, unit goals, I know I asked last time and you didn't want to go there, but your current number of store potential and your net sales total goal is a bit stale. Any chance you want to update us on what you think you can achieve longer term?

John Mackey

No.

Karen Short - BMO Capital Markets U.S.

UNFI just announced...

John Mackey

I mean, Karen, I make that as a joke. Obviously, we're very bullish when your comps are exhilarating like ours have been accelerating. And we have a lot of stores that were struggling a little bit that are really kicking butt. It's really encouraging. But one thing we're not going to forget anytime soon is that, we're going to stay very focused and disciplined, we want to produce a lot of free cash flow, we will be accelerating our growth, in terms of square footage I think, over the next few years. But in general, we don't want to get into a prediction gain of how big we think the market could potentially be and how many stores that might be. I think a lot more than we have now. But how many? Time will tell.

Karen Short - BMO Capital Markets U.S.

And then just lastly, UNFI [United Natural Foods, Inc] announced that they were acquiring SunOpta's Canadian Natural Distributions business. Is there any impact to you guys from that or benefit?

Walter Robb

Karen, only positive because we've been growing in Canada, a small positive, but positive nonetheless. Because I mean, we're really bullish on Canada. We're doing some good business in both Vancouver and Toronto. This obviously improves our cost in Toronto because in general, the Canadian infrastructure is less evolved than the American infrastructure. And we have a strong partnership with UNFI and it brings all those skill sets and all those attributes to our business up there, which we intend to grow aggressively over the next 10 years. I think you're Canadian, aren't you?

Karen Short - BMO Capital Markets U.S.

I am, yes.

John Mackey

More stores in the Vancouver area, Karen. That's going to happen in the next few years.

Operator

And we'll move next to the side of Ed Aaron with RBC Capital Markets.

Edward Aaron - RBC Capital Markets Corporation

John, I guess I wanted to just ask you a little bit more about your role. I remember quite a while ago, but when you announced the WholePeople.com, I remember you're making a comment at that time that you're really looking for this new different challenge after having built that business over, however, many years. I guess I'm just curious especially with the roles changing or with the titles changing around a little bit now and the company having recovered through the recession, I mean what's kind of your new big challenge as you look forward to how you can kind of help take this company to an even higher level from here?

John Mackey

Well, I've always been a very creative person. And I'm kind of an idea-generative kind of guy. And so I've been kind of in a creative space, now that I got out of the FTC stuff. I've been coming up with lots of new creative ideas for the company. And the thing that I've been most jazzed about recently has been our healthy eating initiatives, which -- we started launching that in our stores in January. And although it's impossible to know, to break down all the drivers for our strong sales acceleration, I wouldn't underestimate the efforts that we've made in that area. I do think there's strong statistical evidence of some of our sales categories, and that's actually having a pretty good impact on our sales growth right now. And we've barely gotten started, in terms of what we're going to do there. Whole Foods is going to be pioneering some pretty -- I'm not going to talk about it today because it's pretty immature, but we're going to be doing some pretty cool things in the next few years in this healthy eating area that I think are pretty revolutionary. So I am very pumped up about that and I am helping lead those efforts. I still have a very important symbolic role as the co-founder of the company. So it's very good for the morale of the organization, and for me to get out and travel around, and meet the team members, visit the stores, talk to customers, talk to suppliers. And so I'm doing more of that. I still have some investor relations responsibilities. So I'm trying to engage with all the different stakeholders and connect with them. And Walter will be doing a little bit more IR stuff probably. He's done a lot in the last few years, but I expect he'll be doing even more. He'll probably having more media calls. He's welcome to it. I've had a mixed record with the media in the last couple of years, so he's welcome to some more of that. But I'm really excited right now. I'm probably as excited about my work at Whole Foods, as I've been in the last decade. So I think lots of challenges, going forward. And I'm having a blast right now. And for me, that's very important. It's so hard to get paid that much, so I got to have a lot of fun for the work to be really meaningful for me, and I am.

Edward Aaron - RBC Capital Markets Corporation

The gap between your comps and comps for sort of a conventional supermarket space is about as wide as we've really ever seen it. And so clearly, your value efforts are paying off. But I was intrigued by your earlier comments about, I think, you said you saw further improvement in your relative pricing proposition, which, it surprised me a little bit just because the conventional food space has become just probably more promotional. When you made a comment like that, are you talking entirely on products that are apples to apples? Or are you sort of taking into consideration just the broader food landscape, which does seem to be getting more price competitive?

John Mackey

Walter and A.C. may want to comment on it. But let me say one thing, that to restrain the comp euphoria that might be out there a little bit. Remember, we are comparing, in the second quarter, against a very -- and we had a negative comp in 2009 that we were comparing against at. That made it an easier comparison. Those comparisons are going to get tougher in Q3 and Q4, although obviously, we're off to a pretty good start in Q3. But we're also going to see the spread between our comps, and our idents are going to narrow and then eventually disappear here, so we don't have -- the relocations are going to cycle over. So that will also restrain our comps, although obviously, not our idents. So it is important to pay attention to that two-year number, which we're pleased that we're in positive territory and that's accelerating. But that big spread you see between us in the conventional, most of the conventional operators didn't drop as much as we did either. So part of it's just the rebound effect here. And hey, I hope we're going to say in high single-digits comps. I'm hoping that we return to what we did for the first 28 years of our history, which was high single-digit comps year after year after year. So we're living in very weird times. We don't know what's happened with the economy, and you got stuff going on in Europe and it's very bizarre economic times. So it doesn't really pay to make too aggressive predictions about what might happen because nobody really knows. So we're going to stay disciplined and cautious. And hopefully, we'll see our continued strong sales growth that we've seen in comps continue in Q3, Q4 and into fiscal year 2011. Walter and A.C.?

Walter Robb

Yes, let me make some comments, and then, A.C., if you could add to that. In terms of your specific question, look, we check 70 competitors and 12 markets on a 400-plus basket items. We do that on a regular basis. Chris Taylor and her team here in Austin do that for us now, and that's where we -- we're primarily checking like for like items. So when we say these numbers and the relative gain to share them, that's where that data is coming from. Although there's other studies out there by some of the different houses that have different metrics, they don't necessarily reveal the items they're checking. So it's harder for us to tell. But they all directionally seem to point in the same way, which is to say that we've made some nice gain, with respect to our pricing image and also the actual prices. And I think that's translating into a higher degree of sales, higher degree of confidence in Whole Foods, a sense that things have turned and all that's very positive. I just also want to say that I think that spread comes because not only have we been doing the work in value, but we've also been doing the work to continue to move our value support as a grocer, which is to say, we're working in the seafood area, in terms of greater transparency; we're working in the meat area with greater transparency; we're working with whole trade, which we continue to build up a number of SKUs there and there are over 300 exclusive items now. So continuing to make decisions that give our customers clear choices about what we stand for as a company and those sorts of things. So I think they're both part and parcel of how some of these results are coming. But as John says, it's hard to see too much further down in three or six months out because I don't really see the competitors right now. They're peeps or folks who are fairly rational right now. There's not a lot of thrashing around like there was 12 months ago. But who's to say how it'll unfold over in the next 12 months. So A.C., you want to add anything to that, or...

A. Gallo

Yes. The items that we check, we do, first of all, look for like items. Like if we sell Silk soy milk, and most other stores do, that's on the list. Some of the cereals like Kashi cereal on the list. But we also include items like, what are we selling our private label conventional milk for? And what are our supermarkets selling for? If they have a private label, say, macaroni and cheese, and we have a private label macaroni and cheese, how does that price compare? We also include perishables. I mean, we put our meat and seafood, which generally have high standards and are higher quality. We put that. We compare that price lives to what the conventional markets are selling. And we're generally higher there, but we're constantly working to try to figure out ways to improve that value in that area. The same thing goes with produce. So we try to keep it real. We're not just limiting it to items that we know we do well on. We're really trying to make that basket broad enough, so that we can really get a clear picture of how a customer would perceive the relative cost of shopping in our store versus some of our competitors. And we're constantly working on trying to -- we've made good progress there. We've made another 2% progress, we saw it like, in Q2 from Q1, in that area. And we're continuing to look at ways so we can improve that even more.

Operator

And we'll move next to the site of Chuck Cerankosky with Northcoast Research.

Charles Cerankosky - Northcoast Research

I guess, for Jim, a question about store development activities. You bought a couple of The Green Life stores. Are you seeing acquisition opportunities increase? And will that be part of the reacceleration of chain growth?

James Sud

No, we're really not, Chuck. We're not expecting that to be part of the program, going forward. This was an opportunistic situation in two attractive markets that we took advantage of, but we're not seeing much out there on the horizon.

Charles Cerankosky - Northcoast Research

How big are those two stores? And will they immediately can have their name changed?

James Sud

They will not have their name changed. Asheville is 17,500 and Chattanooga is 27,000.

John Mackey

They will eventually have their name changed, but not anytime soon.

James Sud

Right.

Operator

And our next question will come from the site of Meredith Adler with Barclays Capital.

Meredith Adler - Barclays Capital

I have a question for Jim Sudd about some of the new developments that you're looking at. We've heard, in the real estate environment, that there's not a lot of new construction. So are you looking at second-use space? Or are you finding places to do brand-new construction?

James Sud

Well, it's mostly second-generation space that we're seeing. But we are starting to see some increase in the amount of development deals that have been going on, and that's a recent phenomenon. But for the most part, it's second-generation space, and we're getting very attractive proposals on that type of space.

Meredith Adler - Barclays Capital

And then just another question for you that some of the stores that were bigger than it may be that you opened in the last couple of years, I think there was a mention that the new stores, some of the ones that had been particularly sluggish are performing very well. Are you feeling a little bit better about maybe a handful of stores that seems like they were too big, but are performing nicely now?

James Sud

Yes. Definitely. We have been very pleased with some of those stores that fit in that category. There's just a couple in Florida that have grown into their space very nicely. But for the most part, we're still focused on the 30,000 to 35 000, to 40,000, 45,000 square-foot range stores. That's our sweet spot, 35,000 to 45,000.

John Mackey

However, Meredith, it has been very encouraging to us, as we opened a lot of 50,000 square-foot stores that, because of this recession, weren't getting the same kind of comp sales growth that we usually saw in years two and three. And we're now seeing that same kind of growth that we've historically seen in those stores again. And that's very important because our compounding on those stores is very important for getting us the returns on our invested capital that we had originally projected. So we're very encouraged by that. The number of stores that have negative EBITDA on Whole Foods is a very small number at this point.

Meredith Adler - Barclays Capital

And then one final question, just about G&A costs. I think on the last call or the fourth quarter call, you talked about having created quite a bit of efficiency in G&A. But as the comps get stronger, cash flow is very strong, do you feel that you ought to or there's an opportunity to add back people and expense?

Glenda Chamberlain

We haven't done that selectively and do believe that some of that is built in to our 2.9% for the year. So yes, in a very careful way.

Operator

And we'll move next to the site of Neil Currie with UBS.

Neil Currie - UBS Investment Bank

The only one I would like to put forward is, a couple of years ago, you did away with the dividend that you were paying. And I was wondering, with all the cash that you're generating that whether you would consider re-establishing a dividend?

John Mackey

It's something we have not yet talked about with our Board of Directors. And what else to say about it? We didn't make an announcement about it today and future is undetermined around such dividend. We are piling up quite a bit of cash and it feels pretty good. Right now, we'd like to get -- we never want to have to go on raised capital again. So hopefully, it's going to have much bigger reserves in cash, on a go-forward basis. Also, the government's changing the dividend tax rates. And that makes it far less attractive to see those dividends double taxed at a high rate. So I'm not sure we're going to do about dividends at this point. No, nothing to announce. But we still have $490 million due on our term loan. And that's going to come due by the fourth quarter of 2012. So probably, until we pay off those, until we don't have any debt and any term loans or whatever on our balance sheet, to talk about a dividend might be just a little bit premature. We'll probably want to pay those term notes off and have a nice, large, fat reserve of cash. And after that, if we're still continuing to produce the same kind of strong free cash flow we're producing, we certainly might consider a dividend, depending on what the government's doing with dividend taxes.

Operator

And we will go next to the site of Colin Guheen with Cowen.

Colin Guheen - Cowen and Company, LLC

I just want to focus in a little bit on the cash investment cost per square foot. Even on kind of a longer-term basis, what the trends are today, how much of that is the environment versus how much is you focusing development maybe on smaller stores and the impact that, that's had on the cost per square foot, on a cash basis?

Walter Robb

Yes, this is Walter. And it's some of all those things. I mean, some of it is -- I would say the [indiscernible] (45:56) here in Austin and all the development folks in different regions have really, really -- and the regional presence of all, focused on bringing these costs down. So we're actually spending less per store to build every new store. And yes, some of the stores are smaller, and so that certainly helps that. But this is broader based than that. The cost per square foot is coming down. We're making great progress in our goal. We've said before, we'd like to get down to around $250 a foot, and we're making tremendous progress in that direction. Even from last year to this year, we've made progress. We're not giving you the specific numbers, but some of that is coming from these deals, some of that is the fact that there's deals out there in construction like that. But some of that is just the focus, laser-like focus on being able to build the stores for less and better decision-making around the spend.

Colin Guheen - Cowen and Company, LLC

If you would accelerate unit growth, you don't see any reason why there'd be a spike back up in those cash box per square foot?

Walter Robb

I really don't know then the cost of materials, which we can't control. But I mean, we're trying to convey to you, I think, the way it feels here is that we've learned a lot from the last couple of years. We've worked extremely hard, and we feel a little more grown-up and a little more disciplined around these things. And we weren't trying to make the case that those disciplines are going to continue. And obviously, being able to build the stores for less, which is our largest spend, that helps our efforts in cash. It helped our efforts in lots of ways. So we are very optimistic that we have learned these lessons, and we can continue to improve in this area.

Operator

And our next question comes from the site of Andrew Wolf with BB&T Capital Markets.

Andrew Wolf - BB&T Capital Markets

A lot of my questions were broached, but on the development pipeline and your illusion to perhaps ramping up if circumstances are right. At one point in time, you changed the EVA break-even year number, and some people saw that it's not a good signal because it increased. Is it fair -- it sounds like from everything you're putting out there if you were to ramp up new store growth and given the kind of work you're doing internally, I would have to assume you're kind of signaling to us. If you were to talk about an EVA breakeven in years, that would probably contract to a lesser number. I think the last number you put out there was seven years.

John Mackey

Well, we changed that a couple of years ago to five years. So it's now a five-year EVA breakeven. And that's been a good discipline for us, and I think that's helped contribute to the fact that we're spending less money on building in our stores. If the regional presidents have got to produce a positive EVA on a five-year present value basis, then they have to watch their capital a lot closer than they do if it was seven years. So I do think it was a good thing for us to go to five years. And initially, we saw fewer projects or good sites coming. But that seems to be changing now, and I think that's because they're getting the capital costs down. And so the five years becomes more achievable. So it's have a kind of a happy, I guess, the intended [ph] (49:14) confidence has been that we're at some sensing on a region or presidents to develop stores, and thus, less capital, in order to hit the five-year EVA targets. And so five years is what we're using, and we don't anticipate changing that anytime soon.

Andrew Wolf - BB&T Capital Markets

And the follow-up is on the customers returning. Have you tried to figure out, or is there any way to ascertain if that's more of folks who were, many years ago, let's say, cross shoppers? And then as conventional supermarkets got a little more commitment to the category, some of them curtailed that. And now that the conventionals, as you talked about, not only is their pricing maybe not as good as it should be, but some of them have shown less commitment to the categories. So is it more of the cross shoppers you lost coming back? Or is it more kind of a core customer who might have gone more to a pure price player, like a Trader Joe's? Have you tried to figure that out, which means you're returning shoppers [ph] (50:19)?

John Mackey

Well, we're doing our best to figure that out, but I'm not sure -- it's pretty hard. That's a pretty squishy question. And so, I think our gut tells us, first and foremost, that the recovery started with our customers who left and came back. And the cross shoppers were never that loyal, and I'm not sure they're back yet. But we're hearing a lot in the stores of why, I really notice the difference, really appreciate the value work you're doing. I'm back. I'm back to say. I'm here. That sort of thing, which suggests to me, anecdotally, that it's some of the customers that were with us that we lost so many times. So I mean, I don't know if you want to add, A.C. You feel that [ph] (51:02)?

A. Gallo

Yes. That, combined with the customers who were shopping with us, are buying more items now. The people who stuck with us are finding there's more -- because we've known for a long time that our customers really only -- the percentage of groceries they buy with us is much lower than it is in conventional markets. And so we're finding that people are discovering there's different categories and different departments in the store that they might have been not shopping with us that, as we've gotten more price competitive, they're doing a little more of their shopping with us than they were before.

John Mackey

I also wouldn't underestimate -- I think we've gotten a lot of new customers in the last year that we've never had before. So I think that's also a factor as well.

James Sud

Yes, I mean, let's try to do some work on that here in the next quarter. We'll see if we can get a better answer for you on that next time.

Operator

And we will move next to the site of Joe Feldman with Telsey Advisory.

Joseph Feldman - Telsey Advisory Group

Earlier in the prepared remarks, I think you've mentioned that the average ticket, I believe, was flat. And I was curious, if you're selling more branded product and see people trade up, what might have caused the prices to be flat. Was it still just some deflationary pressure? Or was it a mix issue? Or...

A. Gallo

So again your question is if -- just to be clear, if it was around the average cost per item or the average retail of the item, just could you rephrase the question for me [ph] (52:53)?

Joseph Feldman - Telsey Advisory Group

Yes, you were talking about 2/3 of the ID sales were driven by the higher transaction counts and the balance was basket and flat pricing.

A. Gallo

I think some of that comes in where we're seeing growth in all categories. Yes, we're seeing growth in, say, higher ticket items sale, but we're also seeing growth in lower-priced items, and in our private label, it's still growing, which tells me that we're seeing growth in all of these areas. So people are some regular customers or might be trading up a little bit. But we're seeing people who were -- these new customers are coming in often, really zero in, in our private label. So they're helping growth there. I think we're seeing growth across a lot of categories. Some costs or some things may be going up, but we've continued to invest in lower prices in other areas where we needed some competition. So there's a lot of moving parts here, which I think add up to more items in the basket. But the basket right now has, at least in the quarter, was flat.

Walter Robb

The private labels, what we're seeing is branded has rebounded definitely. But also private labels continue to be strong, which suggests to me that through this thing, that customers have grown to like the brand even more and are continuing to put those in the basket. But we're really focused on items in the basket. With the basket, we'll take care of itself. But we continue to make a compelling case, and we think that folks will continue to put additional items in their basket. And even if the average price is flat, the basket will go up, as a result of more items in the basket. And that's what we're seeing right now.

Joseph Feldman - Telsey Advisory Group

Are you seeing any changes in the competition, in terms of -- obviously, the more conventional guys have been going after organics a little more aggressively, meal replacement more aggressively. Anything different that you're seeing lately?

John Mackey

Well, we might argue the opposite, which is, when the recession occurred, we saw the conventional operators move away from it a bit to focus more on value and price. So we, in some ways, they are less aggressive than they were a couple of years ago. I don't know whether that will change or not. Certainly, as we keep producing these kinds of comps and growth, they'll probably start to reaccelerate their competition with organic foods. So competition is -- I mean, it's incredibly fierce. It's probably as fierce as it's ever been, from a price standpoint, and new change are opening up. And that's just forcing Whole Foods Market to get better and accelerate our innovation. And we welcome the competition, and we think it helps us and keeps us from being complacent and helps us evolve our business model. So you have to draw your own conclusions and reflect where we're holding our own now.

Operator

And it looks like our next question comes from the site of Maggie Gilliam with Gilliam & Co.

Maggie Gilliam - Gilliam and Company

I was just wondering if you could elaborate on some of the plans to expand in Canada and also in the U.K., and whether or not the real estate situations in those countries has improved? And in Canada, are you thinking of going into Quebec by any chance?

James Sud

Actually, we've got a real estate summit this summer in Canada or Midwest and in Pacific Northwest regions because as Walter said earlier, we really would like to expand, accelerate our growth in Canada. And we think there's opportunities, not only in our current markets, but also Ottawa and Montreal as well. So we are going to ramp that up. And as far as the U.K. goes, it's a little more challenging and continues to be a challenge. We are, however, seeing some opportunities that we hope to bring to our real estate committee in June. But the real estate market there is very difficult.

John Mackey

I'll put a little color on that as well. We're extremely successful in Canada, and we are definitely going to be rapidly growing in other markets in Canada in the next several years. The U.K. is trickier because they restrict competition there. They set a certain number of food consents that are allowed. So unlike the United States where if you want to open up a store, you find a location and you open it, in the U.K., you've got to do a lot more than that. You've got to find a location that's been allowed to have a food consent. And those food consents are scares, kind of like getting a tacky medallion in New York City. So we can't always get locations in the U.K. We find good locations, but we can't always find the food consents for them. And those are largely held by the U.K. multiples. So we're fighting an uphill battle there, but we have looked at a number of good sides. And I'm a little frustrated myself that we haven't been able to announce any new sights in the U.K. But we're diligently working on it, and I hope in the next quarter or two, we'll correct that.

Maggie Gilliam - Gilliam and Company

I would hope that you'd be able to persuade the powers in the fee [ph] (58:48) that you're a little different from the other stores that have more like 10 [ph] ....

James Sud

We're Americans and our persuasive abilities aren't that great over there. We speak a different language.

John Mackey

And if I could talk on just about our growth, I just want to point out, we signed another lease in Oklahoma City and we have a great store in Tulsa. So there's a lot in the United States that's still a wide open frontier for Whole Foods. And we're pursuing that aggressively as well.

Operator

And this concludes today's question-and-answer session. I would like to turn the call back over to John Mackey for closing comments.

John Mackey

Thank you for listening in. Please join us in August for our third quarter's earnings, at which time, Walter, as the co-CEO, will be reading our scripted comments. A transcript of the scripted portion of this call, along with the recording of this call is available on our website at www.wholefoodsmarket.com. We'll talk to everyone next quarter. Goodbye.

Operator

And this does conclude today's teleconference. Thank you for your participation. You may disconnect at any time, and have a wonderful evening.

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 Q2 2010 Earnings Call Transcript
This Transcript
All Transcripts