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Executives

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

A. Gallo - President and Chief Operating Officer

James Sud - Executive Vice President of Growth and Business Development

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

Walter Robb - Co-Chief Executive Officer and Director

Analysts

Joseph Feldman - Telsey Advisory Group

Colin Guheen - Cowen and Company, LLC

Meredith Adler - Barclays Capital

Scott Mushkin - Jefferies & Company, Inc.

Robert Summers - Susquehanna Financial Group, LLLP

Karen Short - BMO Capital Markets U.S.

Mark Wiltamuth - Morgan Stanley

Neil Currie - UBS Investment Bank

Andrew Wolf - BB&T Capital Markets

Edward Aaron - RBC Capital Markets Corporation

Whole Foods Market (WFMI) F3Q10 (Qtr End 07/04/2010) Earnings Call August 3, 2010 5:00 PM ET

Operator

Good day, and welcome to today's program, Third Quarter Earnings Call. [Operator Instructions] I'd now like to turn the conference over to Mr. Walter Robb. Please go ahead, sir.

Walter Robb

Yes, good afternoon. Joining me today are John Mackey, Co-founder and Co-CEO; A.C. Gallo, President and Chief Operating Officer; Glenda Chamberlain, Executive Vice President and Chief Financial Officer; Jim Sud, Executive Vice President of Growth and Development; and Cindy McCann, Vice President of Investor Relations.

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 that our press release is now available on our website along with the scripted portion of this call. We are very pleased to report our third quarter results, which once again showed strong top line and bottom line increases.

On a 15% increase in sales, we produced a 52 basis point improvement in store contribution to 8.8%, excluding LIFO; a 19% increase in operating income before pre-opening to $121 million, excluding LIFO; diluted earnings per share of $0.38 versus $0.25 last year; cash flow from operations of $118 million; and free cash flow of $65 million. Our balance sheet continues to improve, driven in large part by our improved expense and capital disciplines. After paying down $210 million of our $700 million term loan, we ended the quarter with $514 million in total debt, $575 million in cash and investments and $341 million available on our credit line.

The interest rate swap agreement on the $490 million balance of our term loan expires October 1, 2010. We expect to be in a position to repay the term loan prior to it coming due in August 2012, but our timing will depend on the economic outlook and our continued generation of free cash flow.

We are improving our price positioning relative to our competition. Our efforts are helping to drive our sales momentum, and we are gaining market share. Our identical store sales increased 8.4% in the third quarter, accelerating from the 7.7% we reported in Q2 and our highest increase since 2006. Our two-year stack identical store sales also sequentially increased by 272 basis points to 4.6%. We are pleased with these results, which compare very favorably to most other food retailers.

Given the volatility in the stock market and recent dip in reported consumer confidence, we know everyone is focused on trends during the quarter, so let me break things down a bit. Identical store sales growth for the first four weeks and the last eight weeks of Q3 was 8.6% and 8.3%, respectively. Given that idents improved 180 basis points from the first four- to the last eight weeks of Q3 last year, we attribute the expected and slight moderation in results this year to the tougher year-ago comparison rather than to any changes in consumer sentiment or the economy.

Our 8.4% identical store sales growth for the quarter was driven primarily by transaction count along with a 1% increase in basket size. We believe our transaction count increases are being driven by a combination of our loyal customers shopping with us more frequently, prior customers returning to shop with us and an increasing number of new customers entering our doors. Our increase in basket size was driven entirely by customers putting more items in their baskets. We have worked hard to improve our value image and believe our success in this regard has played a large role in the sales momentum we are seeing. The [indiscernible] (18:18) of selective product cost increases was more than offset by our continued strategic price investments. Net-net, our average price per item in the basket was down less than 1% year-over-year, not a big change from being flat year-over-year in Q2.

Customers are still seeking value, as demonstrated by continued strong sales growth in promotional and private label item; however, branded product sales growth is outpacing private label growth now, and customers are selectively trading up to higher-priced items in certain areas. Our internal benchmarking research indicates continued improvement in our price competitiveness during the quarter relative to our regional and national competitors. Whole Foods Market is being looked at differently in this area according to our Nielsen study, which shows improving trends in consumer sentiment around our value efforts and, even more importantly, as reflected in our continued strong sales growth relative to most other food retailers.

Excluding LIFO, gross margin increased 13 basis points due to an improvement in occupancy costs, which helped offset slightly higher cost of goods sold as a percentage of sales. As expected, now that we have fully cycled over the shift in our pricing strategy that occurred in the first half of 2009, we are no longer generating the same level of year-over-year improvements in gross margin. In addition, we made strategic pricing decisions on select items during the quarter to position ourselves competitively in the marketplace.

Direct store expenses decreased 39 basis points, driven by significant leverage in depreciation and in salaries and benefits. For the second quarter in a row, our health care costs decreased as a percentage of sales. Store contribution improved 38 basis points, driven by higher average weekly sales, continued profitability gains at the former Wild Oats stores and improved performance from new stores.

Compared to the class of 23 new stores in the third quarter last year, our class of 19 new stores this year was approximately 18% smaller in size, averaging 44,000 square feet. These stores produced average weekly sales per store of $561,000, a 17% increase in sales per square foot to $663 per square foot and a 74 basis point higher store contribution as a percentage of sales due primarily to lower direct store expenses and occupancy costs as a percentage of sales.

During the quarter, we opened six stores in Novato, California; Mill Valley, California; Tarzana, California; Darien, Connecticut; Chevy Chase, Maryland; and Schaumburg, Illinois; and acquired two stores in Chattanooga, Tennessee, and Asheville, North Carolina. As we mentioned last quarter, we are focused on rebuilding our pipeline and are excited today to announce six new leases averaging 34,000 square feet in size in San Francisco, California; Boise, Idaho; Minneapolis, Minnesota; Washington, D.C.; and two sites here in Austin Texas. We currently have eight leases in negotiation and anticipate an accelerated pace of lease signings in the future. Given the typical 18- to 24-month average lag between signing and opening, we expect this will translate into a higher number of new store openings starting in 2012.

I will now turn to our expectations going forward. Please refer to our press release for more detailed information. For the first four weeks of Q4, identical store sales grew 7.7% or 5.0% on a two-year stack basis. Please note that in the prior year, idents improved 50 basis points from the last eight weeks of Q3 to the first four weeks of Q4, and another 65 basis points from the first four weeks of Q4 to the last eight weeks of Q4.

For the full quarter, we expect idents in the range of 6.5% to 7.5%. The low end of this range implies a deceleration in the last eight weeks from the 5.0% reproduced in the first four weeks, while the high end implies a slight acceleration. Based on our year-to-date results and estimates for Q4, we are tightening our identical store sales growth range for the fiscal year to 6.0% to 6.2% from our prior 5.5% to 6.5% range, and we're raising our diluted EPS range to $1.37 to $1.39 from our prior $1.33 to $1.37 range.

We have not yet completed our budgeting process for fiscal year 2011, and various economic indicators suggest it is reasonable to be cautious and conservative about the future. With that in mind, we are sharing our preliminary expectations for next year, which we expect to update when we announced our Q4 and fiscal year results in early November.

Our sales growth range of 10% to 13% is based on identical store sales growth of 4.5% to 6.5%. Please note that this is a 10.6% to 12.7% [ph] ID (23:07) growth on a two-year stack basis. We expect to open 17 new stores, including six relocations. We are committed to producing operating margin at 4.8% or an incremental improvement of approximately 10 basis points. Assuming no significant change in interest rates, we expect interest expense to decrease by approximately $21 million next year due to the combination of the $200 million paydown of our term loan this past quarter and the expiration on October 1 of our interest rate swap on the remaining $490 million of our term loan.

Based on these assumptions, we expect preliminary diluted earnings per share in the range of $1.59 to $1.64. This range represents a year-over-year increase of 16% to 19% over the $1.38 midpoint of our fiscal year 2010 EPS guidance range.

Excluding the estimated $0.06 positive impact from the swap expiration, the $1.56 midpoint of our EPS range is in line with the current First Call consensus of $1.57, which does not appear to reflect the expiration of the swap. It is worth noting that the wide range in analysts' estimates of $1.43 to $1.70 for next year. In addition, the $1.57 appears to assume 9% sales growth, 5% identical sales growth and a 4.9% operating margin. This level of operating margin seems out of line with the sales growth assumptions, particularly given the competitive and economic environment.

Our preliminary guidance projects steady sales growth for the next year and reflects our commitment to delivering incremental operating margin improvement as well as earnings growth in excess of sales growth. We believe it appropriately reflects the tempering of our enthusiasm over current sales growth trends, with conservatism based on the competitive environment and uncertainty over the economy.

The economy aside, though, it's hard not to be enthusiastic about our future. We believe we have struck the right balance between increasing our value offerings and maintaining gross margin. We are improving our price positioning relative to our competition, our efforts are helping to drive sales momentum and we are gaining market share.

On the expense and capital side of the business, we are showing strong year-over-year leverage in our direct store expenses, and our new store performance has greatly improved driven in large part by a renewed cost discipline in this area as well as the smaller average store size.

Our strong top- and bottom line results are driving strong cash flow, which is resulting in a very healthy balance sheet. We're also excited about once again rebuilding our real estate pipeline and believe there are many reasons to be optimistic about our future growth potential.

We believe the best is 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.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Ed Aaron with RBC Capital Markets.

Edward Aaron - RBC Capital Markets Corporation

Walter, I wanted to just start by maybe just asking you to clarify a statement that you just made in your prepared remarks. I think you were saying that the numbers seem to reflect 5% [ph] IDs (26:34) for next year and maybe 20 basis points of margin expansion. But you talked about the margin expectations were out of line relative to the sales assumptions. It seems like that margin would imply maybe 20 basis points of improvement. And I would think that 5% IDs would be a rate of comps that you could get a little bit of leverage on. So can you maybe help me understand why that might not be the case?

Walter Robb

Yes, sure. Let me take a shot at it, then Glenda can add some color to it. I think, again, remember we're preliminary here in Q3, we haven't actually completed our work for all of next year. And so I think we're wanting to be conservative in what we're guiding you to in terms of thinking about next year. So there is some potential upside there, but I think it's reflecting sort of a conservative approach at this point in the year without having the rest of Q4 under our belts.

Glenda Chamberlain

We're just trying to, want everyone to remember that given the current environment that we're operating in, both economically and competitively, and our desire to continue to watch our gross margins, our pricing carefully, we are delivering expense leverage. But we think 20 basis points of operating margin on only 5% ID growth might be difficult to produce. So we're trying to put that perspective out there.

Edward Aaron - RBC Capital Markets Corporation

And then just one other question just on the P&L for the quarter. The store level metrics all came in very nicely, especially when you put it in the context of what's going on more broadly in food retail. The one number that was a little out of line relative to what I had thought was the G&A, which was a bit higher. So I was just wondering if there's anything that might have been more one-time in nature on the line item in the quarter and what we might expect going forward?

Glenda Chamberlain

The G&A sequential increase, about half of it was in stock-based compensation, and there were also some additional costs related to the FTC settlement because we had to pay the trustee during the quarter. So that one thing in particular would go away, but the stock-based compensation cost will stay there. I think the important thing is that we're guiding to 3% in 2011. We believe that's a reasonable number. And keep in mind that sales are lower in Q4, which makes the percentage of sales in G&A a little bit higher.

Operator

We'll take our next question from Mark Wiltamuth with Morgan Stanley.

Mark Wiltamuth - Morgan Stanley

Just want to dig in a little bit on the commentary about the softer sales. Are you seeing anything from your customers specifically? Or is it just some conservatism over what you're seeing in the economic indicators and consumer confidence?

John Mackey

Mark, John Mackey here. Softer sales? I don't see softer sales. I see our comps being very strong, idents very strong so I'm not sure what you mean.

Mark Wiltamuth - Morgan Stanley

Well just the slowing of the comp trend. And you've said you built in some conservatism there. Are you seeing anything from your customers or is it just your sense that we should be a little more cautious from the numbers you give us because of the macro indicators?

John Mackey

I think our costs have moderated as expected and as we've guided, due to the fact that our comparisons are getting progressively tougher. The thing to emphasize is that we're seeing continued acceleration of our two-year comps as we're going up against more difficult comparisons and there's some moderation going on, but our two-year comps are accelerating.

Mark Wiltamuth - Morgan Stanley

So then maybe that's the thing to focus on more, is the two-year stack, than the actual guidance here on the single comp. And then just also just wanted to focus a little more on your value focus. I mean as you go in your stores, you see a lot of the perishables signs up there as you go in really highlighting value. Are you still getting those attractive buys on product when you're out there in the marketplace?

A. Gallo

Hi, this is A.C. We still are getting some pretty good buys. They're not as attractive as they were a year ago when there was a lot of oversupply in beef and pork, and not a lot of fruit. But there still are pretty good buys. We got a really great buy this year on cherries and did a fabulous one-day sale in July, $1.99 and sold many truckloads. So we're still able to get deals. It's just not as broad as it was a year ago.

Mark Wiltamuth - Morgan Stanley

And just provide a little more color on some of the trading-up you're seeing, and what categories you're seeing some of that?

Walter Robb

Well actually -- this is Walter -- we actually analyzed our basket in quintiles (is a new word) this week, and we looked at it across five levels, and we saw pretty equal growth across all levels of the basket from top to bottom. So when we analyzed a little further, we saw actually people making incremental step-ups. So if they were buying a $10 bottle of wine, they might be buying a $12 bottle of wine now, that's sort of it. We looked at it pretty much across the whole business. So it seems to continue to reflect the sort of cautious careful customer, maybe. Maybe careful's a better word. I think they're improving, they're feeling a little more confident, they're still being careful, and that's what we're sort of seeing, incremental trade-ups across all categories, actually – floral, wine. We pretty much see that trend across the whole spectrum.

Operator

We'll take our next question from Karen Short with BMO Capital Markets.

Karen Short - BMO Capital Markets U.S.

A couple of questions just I guess to start with on your CapEx. I'm just wondering if you could give a little bit of a breakout on fiscal '11 CapEx between kind of discretionary spending per store, existing store and CapEx versus new store and remodel CapEx?

Glenda Chamberlain

Karen, Glenda here. We are proud of the quarter. And we haven't broken out next year's CapEx guidance between new store and discretionary. You can pretty much look at current trends and think of it as a good approximation of how that will work out for next year.

Karen Short - BMO Capital Markets U.S.

And then I was wondering, there's been some commentary on trends in the Oats stores and how they're benefiting your comps. I know that in your '09 annual there were comments on sales per square feet being up 5%. I'm just kind of wondering how that's looking for 2010 and then I guess the same question as it relates to the Oats' benefit to contribution margin improvement?

Glenda Chamberlain

Regarding comps, the Wild Oats stores did have higher comps overall than the rest of the store base. And so it did improve our number, but it was less than 100 basis points of improvement. And with regard to improvement, year-over-year improvement, in-store contribution percentage, that was a positive, also. But their sales are less than 10% of our total sales, so that doesn't have a significant impact on the number.

Walter Robb

Yes, Karen, this is Walter and I just want to add to that. I mean think of that more as a tailwind or as an extra tailwind at our back because, yes, we're continuing to see gains there, like we said over the last year or so, and there's more of those to come because we've really been pretty tempered with our CapEx on those stores. But make no mistake about it, this sales strength that we're bringing today is across the board in every region. It's not dependent on Oats in any way, shape or form. Oats is a nice add and tailwind, and it's been a nice lift, but this is strength across the company and these are significant. So I just want to respond to the softer sales comment from Mark, I think. It's just that these sales are strong, and it's across the board.

Karen Short - BMO Capital Markets U.S.

And then just quickly comment maybe on the UNFI contract that changes on the distribution center. I guess the first question is, did your Austin-D.C. lease expire? And then can you maybe elaborate on the benefits, the growth margin from the changes in the contract? And then maybe additional opportunities going forward from ongoing outsourcing?

Walter Robb

Yes. Again, there's two things at work here. One is, we signed an extension in June of seven years for the UNFI, the master contract between the two companies. And then later in July, we announced the sale of the dry side of our distribution in Austin and in Denver. And so, there's opportunities in both places. One, in terms of extending the contract. Obviously, the more volume we build, the more we pick up on the buy side in terms of our cost. And then with respect to the distribution centers, the opportunity is, I don't think we've quantified it publicly, but it is essentially there on the dry side, the boxes and cans. They do it better than we do and there's a nice incremental gain and savings on that, that we'll be able to pick and have available to reinvest or add to the bottom line. You want to add to that, Glenda?

Glenda Chamberlain

I just wanted to say that any improvement, the improvement there'll be incremental, not really anything that anyone notices particularly in a quarter or even a year. But it's just continued improvement as our volume increases.

A. Gallo

This is A.C. And I'd like to add to that. We're, as Walter said, we really just sold the dry side of both of those distribution centers. We really want to refocus those on the perishables side. We still think there's a lot of opportunity not just for those two regions but for all of our distribution centers, to increase the penetration of the perishable products going into our stores that are coming from our distribution centers, which allows us to usually save a lot on the distribution costs as we are able to distribute our perishables cheaper than outside distributors. And we could also -- either that gets applied to lower prices for our customers or improvement in the bottom line. So we see going forward good opportunities in the perishables side, in all our distribution centers across the country.

Operator

We'll go next to Scott Mushkin with Jefferies.

Scott Mushkin - Jefferies & Company, Inc.

I was hoping to get a little bit of perspective, at least your perspective, on taking a step back. The company used to run at about, I guess mid-fives operating margin and then I guess store contributions were over nine. If you guys were going to say like the couple things that would get us back there, is it simply productivity of stores like growing the sales to get us back there. What can we do to get back there as a realistic -- to think we could get back there?

John Mackey

Scott, I mean, yes, I think we'll eventually get back there. You said we used operate but I'm not sure that we had year after year of operating there. So we also, when we were operating at those kind of operating margins, we we're also producing 9%, 10%, and 11%, 12% comps. So we're happy that we've seen our operating margins go up, and we're happy that our comps have gone up. I think the key is, we have to continue to open good stores, stores that make money quickly. You see if you compare our stores, the cohort of stores we opened in the last 12 months compared to the previous cohort of stores have made great progress. They're opening smaller stores for less capital, higher productivity. That's part of what's driving our overall better operating margins, better new store performance. So going forward, I think that's the real key. We need to continue to open really good stores and because the stores mature, they're going to produce far better than 5.3% in operating margins. So it's a question of getting the new stores to perform at high levels. And if we do, we can get our operating margins back to those 5.5% range that we've done previously. To do that, we're going to need mid-single digit or high single-digit comps as well.

Walter Robb

So, Scott let me add -- this is Walter -- just to add to John's comments is, one, we are getting back there. We're on our way back there. And number two, we want to get there and are determined to get there as well. So you might notice in the script this time, we mention the commitment to the incremental improvement in operating margin. And again, this is a conservative guide for Q3 until we get a better handle on next year, but we like [ph] the five number two there (39:50) and we're determined to get there. So leave it at that.

Scott Mushkin - Jefferies & Company, Inc.

I appreciate the color and I guess the other thing I wanted to delve into a little bit and I guess somewhat it's subjective, but clearly, we have some fiscal changes coming down the pike that are aimed somewhat at your core customer particularly on the coasts. Do you feel that this is an obstacle for the company as you go forward or is it just the consumable purchase is not really going to be impacted in your minds by maybe some changes as of Jan 1?

John Mackey

That's a good question. I have to admit that's not one we really thought about, tax increases come from the pike. We do think our customers do tend to be lifestyle customers, they tend to make commitment. The only time in our entire history we've ever seen really our comps decline like we saw in 2009 was when there was a panic going on, and people were really scared. As that panic subsided, our sales began to climb back up again. And that's been true throughout our history. We've usually done very well in downturns, taxes increasing, income falling. Under almost all economic circumstances, Whole Foods has flourished. One exception being, when this panic hit, everybody just pulled in their oars and stopped rowing. So we're in discontinuous times and so it's a little hard to predict, but my feeling is, is that unless a panic occurs again, I expect Whole Foods to continue to flourish, and I don't anticipate higher taxes or anything like that really having much of an impact on us. I'd be very surprised if it did.

A. Gallo

I would agree. I think it might tend to impact investment decisions more than investment in peoples’ individual sells [ph] (41:44). And the evidence right now seems to suggest people are increasingly comfortable with incrementally improving their purchases, and that seems to be what’s showing up for us.

Scott Mushkin - Jefferies & Company, Inc.

I think the CapEx spending is going to be up $100 million to $150 million next year. Is that mostly just a ramp of new stores even though we can't see it yet in FY '11? Is that really where that money’s going or not?

Glenda Chamberlain

Yes. Currently, we see a lot of the fiscal '12 openings in the first part of the year.

Operator

We'll take our next question from Andrew Wolf with BB&T Capital Markets.

Andrew Wolf - BB&T Capital Markets

I just want to follow up on the guidance. It looks like you guys still feel good about sales, comparisons aside. So I just want to ask, the EBITDA margin guidance is essentially flat year-over-year and the EBIT margin up a little bit. Is that just more a function of, at this juncture, your conservatism given the uncertainty of the environment? Or is there actually -- and I’m kind of re-asking. I just want to ask this again. Is there something out there that you guys are saying, hey, we got to really ratchet down our outlook because maybe sales are getting a little irregular. One week is better. There’s maybe some more variability in the sales. Is there something you're actually seeing qualitatively? Or are you just taking a conservative early look?

John Mackey

Gosh, Andy, we say we’re taking a conservative early look, then you're going to factor that in. So we think we're taking a realistic look. These are very uncertain times, and we're not certain what's going to happen in 2011. I don't think anybody is. So being conservative or cautious or just prudent is a more positive word, I think. I prefer to use that one. I mean, I think we're going to produce -- we produced great EBITDA growth this year, but we are beginning to start accelerating our growth again, and we've got -- between 2011 and 2012, we've got a lot of new stores that we're going to open up. And we have a lot of initiatives that we’re launching to improve our customer experience. So those are going to impact EBITDA a little bit. So yes, I hope we do better than what we’re guiding for, but I think the guidance we're doing is based on all of the circumstances, and the information we currently have is a pretty realistic number.

Walter Robb

To your other part of your question, Andy, there's no skeleton in the sales closet. It's just a function of where does this go and our ability to leverage that into the result, and we think it's best to be conservative at this point. We still have to finish our planning process for next year and see how we go in the fall.

Andrew Wolf - BB&T Capital Markets

Yes. It didn’t sound that way. I just wanted to make sure we underlined that.Then on the competitive environment, what you’ve mentioned in the release, is that also kind of looking forward, that it could change? Or are you actually seeing either sharper pricing or -- you had mentioned that conventionals had really ratcheted back. Are they starting to restock in some of these areas? Is there any, again, any sort of real market competitive activity? Or are you just trying to get in front of what might happen?

A. Gallo

Andy, A.C. here. There hasn't been any dramatic change that we've seen in the marketing. We have seen some natural lines going into the mass market recently. Most of the conventional markets have held pretty steady on what they’ve had for natural and organic foods. And what we've seen too through our studying is that pretty much our competitors have been holding their prices over the last quarter, while ours came down slightly so that we narrowed our competitive gap even more. I think what we’ve got built into our guidance for next year is the ability to react to strategic investments in price where needed. We're not saying that there's a clear competitive new challenge that’s come up, but we expect there to be numerous small challenges like we always have and the need to react to them at different marketplaces and to make strategic, careful investments like we’ve made this past summer, where we really wanted to make sure going into the summer that we kept our momentum strong. So we really focused on produce and meat. We did a cherry sale in produce. We did a big hamburger sale at 4th of July. We really strategically wanted to really show really exciting value to our customers, and we want that ability to keep doing that and react to any type of new competition or unexpected that comes up over the next year.

Andrew Wolf - BB&T Capital Markets

Last call, I think, John, you mentioned that EVA hurdled back to five years. And now, just when you look at that equation, is it strictly or mainly because the capital charge, given you’re building the stores much more efficiently, that's much less of a drag or an anchor? Or is it also, I mean, are the stores actually just reaching higher rates of profitability sooner?

John Mackey

Well, it's both. We are more selective. We’re pickier in our real estate. By increasing our EVA, lowering the EVA hurdle to five years from seven, that makes some projects no longer pay, which means we're a little bit more selective. And so, our average, I think that is helping. We're opening stores that are, for the most part, reaching profitability quicker and sooner. But I also think we're doing a much better job on our capital management. We're also opening smaller stores, but we're also taking capital out of on a square-foot basis. We're really focused on -- we have a good team working on it. Lee Matecko’s doing a really good job on that for us as is our regional president. So this is really something we're focusing on. So those, together, the lower EVA hurdle rates, and we're pickier, combined with better capital discipline is getting us to quicker breakevens, quicker EBITDA, positive cash flow. And I think that trend’s going to continue. And if it does, we keep opening up some new good stores, we're going to see good growth in EBITDA, good growth in EVA and our operating margins will go up. So that's our strategy, and now it's about executing it.

Operator

We'll go next to Meredith Adler with Barclays Capital.

Meredith Adler - Barclays Capital

Maybe you could talk a little bit about what you're seeing in the real estate environment. I know you guys at one time had been open to doing somewhat more complex projects that were usually from the ground up. Are you still seeing some availability of those kinds of projects? Or is most of what you're doing more simple? Or even, are you doing any second-use space?

James Sud

It's more the latter, Meredith. This is Jim Sud. We're seeing very little new development. As a result, very few complex projects, and we're seeing a lot of second generation space -- predominantly, second generation space.

Meredith Adler - Barclays Capital

Okay, great. And then I have another question about your commentary about distribution that you were going to be -- you have a focus of getting the stores the [indiscernible] (50:12) perishable items that have been going directly to the stores, more than go through your own distribution centers. Can you just talk about whether there are any investments that need to be made either in trucking capacity or just in terms, I guess, of an expertise if you're going to be doing centralizing more of that at the DCs?

A. Gallo

This is A.C. As far as investments go, some of our DCs may need fairly modest investments to maybe expand some coolers in order to be able to move some fresh meat through them. So there are some small modest investments that we see needing to be made in a few of them. It's not significant money. As far as expertise, we have outsourced most of our trucking, so that's not an area that we have to worry about. A lot of our distribution centers already do. I mean, all of them sell produce and a good number of them already distribute meat and cheese and things like that. So it's a competency that we already have in the company and in order to move it in-house, there's not really any new things that we have to -- competencies that we have to develop or anything. We have that already in the company.

Operator

We'll go next to Bob Summers with Susquehanna.

Robert Summers - Susquehanna Financial Group, LLLP

Thinking about that 7% or so transaction number, do you have any visibility into how much of that stems from increased frequency per customer? Or whether it's new customers coming into the store?

Walter Robb

It's hard to get that exactly, Bob. You picked up, that’s the big uptick here in Q3 is that 85% from the transaction growth, which we think is a very positive sign and a sign that a lot of our activity is really working. But in terms of breaking it out the way you're suggesting, hard to do. But since it's a significant step up from Q2 across the board, we have to believe it’s a result -- it’s just better traffic. And that's the way we're reading it.

Robert Summers - Susquehanna Financial Group, LLLP

And then the basket being up, sort of in a dollar amount, where does this lie in terms of a historical perspective?

Walter Robb

The basket?

Robert Summers - Susquehanna Financial Group, LLLP

Yes.

Walter Robb

The dollars, the percentages, the growth? From what perspective?

Robert Summers - Susquehanna Financial Group, LLLP

Just dollars, like where the total basket is coming in, relative to where it was before, and maybe within that, tie in some of the experience you're seeing with, I guess, the Whole Deal and some programs and differences in basket size and how you kind of move the overall needle.

Walter Robb

Essentially, I think what's happening here is that we, as A.C. said, we decided to be very proactive this summer and wanted to drive additional traffic and drive additional items into the basket because we didn't see any inflation on the horizon, and we still don't see much. And as a result, I think we were concentrated more on the traffic and the items, and we figured that over time the basket would continue to take care of itself. So that's actually what's happened, and we're happy with the growth in the -- the items in the basket continue to grow as well, though not as quickly as in Q2, but the count growth was very strong, so you have information…

Glenda Chamberlain

The actual dollars were up a little over 1% compared to -- in the ident stores compared to the same quarter last year. And the dollar average basket size is a little over $33. There are some imperfections in that number. It's not an exact number, but we just use it for trending purposes. But it's close enough.

Robert Summers - Susquehanna Financial Group, LLLP

Okay. Obviously, I mean you're seeing continued price perception improvement. The value efforts are working. If we were to think of sort of a yardstick on how far you've come, what does it take to get to where you want to go? And then maybe within that, what parts of the store are sticking points? Or what have been huge successes so far?

A. Gallo

This is A.C. First, I was going to say before to your last question that you mentioned about the Whole Deal program. Glenda just said that our average basket was $33. But what's interesting is, in baskets where people use the coupons, the store coupons that are the Whole Deal, our basket size was $62. So it's obvious that customers are really still responding to that program. It's been very successful. Could you repeat your question?

Robert Summers - Susquehanna Financial Group, LLLP

Just trying to benchmark the price improvement -- how far you come. I know it's tough to quantify where you want to go, and you don't want to be explicit about that but maybe what it takes to get there. And then within that experience, what parts of the store are you seeing a big turn? And where have you had some challenges?

A. Gallo

I would say that the way we've approached the whole price perception thing is just incrementally. We realize that no matter -- we're always going to be perceived as being a higher-priced supermarket, no matter what we do, because we sell a lot of very high quality products that cost more like our organic meat for instance and some of our organic produce. But what we realize is that it always comes down to value perception, and we felt like a few years ago, we had gotten to the point where some of our customers had really felt that the value really wasn’t there for what we were charging. And we really needed to work on that. So we really started taking an incremental approach and trying things and giving our customers better deals in certain areas, bringing in more lower-priced private label and things like that. And when we see, where we see where customers react is where we continue to work. And if we notice that certain areas are seeming to fall behind, then we focus on those. So I can't really say that we have a specific measure that when we get there, we'll feel like we’ve made it. I don't think that way. I think that we can always continue to improve incrementally the value that we're giving our customers. Part of it’s price, part of it’s services, part of it’s just overall experience, and we need to continue to work on that. Specifically, a couple of areas I've mentioned earlier that we felt were very important this past year, and especially going into the summer, were produce and meat. We felt that those were two areas that a few years ago were perceived as being very high, and we really needed to work on them. And we've been working on those for this past year, and we've been very pleased with the results. Those are two of our leading comp teams right now. And if we see some others starting to lag, then we'll put the focus on them.

Operator

We will take our next question from Colin Guheen with Cowen Group.

Colin Guheen - Cowen and Company, LLC

A question on development. Maybe the quantity of deals you're seeing, the quality of the deals. And then longer term, is there a total number of openings where you wouldn't want to push it above? Historically, I think you’ve kind of capped out in the low 20s but given your capacities today.

Walter Robb

Well, I would say the quantity of deals that we’re seeing is picking up. We're bringing probably on average about 10 sites to committee every quarter. Obviously those aren’t all approved. So we're seeing a lot of opportunities in real estate. As far as the number of stores that we're going to open, we're back to filling the pipeline, and as they come out, we don't have a magic number that we want to ratchet it up – plan to ratchet it up to 25, 30 stores anytime in the near future. So I think we're planning on 19 stores in 2012 and 17 in 2011. And those numbers, they may go up a little bit. They may go down a little bit. That's probably a good level for the next couple of years.

John Mackey

As our base gets larger, it gets easier to open more stores because the infrastructure supporting the growth gets better -- larger and better. So it's easier for us to open 20 stores today than it was five years ago. That really would've stretched us. Today, we can do that fairly easily. The real thing is, is we don't want to open stores just to hit some kind of magical store growth number. We want to grow, but only if we can find good locations that we think are going to produce good returns for us. And the good news there is, is that we continue to gain market share. We continue to grow, and we think the markets continue to grow with us. So I think we're sort of bullish and optimistic about what our future potential growth is. But we really don't want to try to put numbers on that too far in advance because it creates -- you guys do your spreadsheets, and it shows -- I know you have to do that. That's your job. But we don't want to make hurdles that we can't possibly jump over. So as long as we can get good stores, we’re going to open as many as we can. We have the capital for it. Our balance sheet has been renewed. We've got the infrastructure in place. We have the leadership in place. We can grow faster. We intend to grow faster, providing they're all really good locations. And Jim’s got a great team, so I think we're going to see really good locations. But we're not going to predict it until we sign them.

Operator

We'll take our next question from Joe Feldman with Telsey Advisory.

Joseph Feldman - Telsey Advisory Group

Can you discuss just what the latest trends you're seeing in, say, sourcing and transportation? Any big changes from trend or opportunities you see going forward?

Walter Robb

Not sure I understand that question exactly. What do you mean? Sourcing in terms of the -- sourcing?

Joseph Feldman - Telsey Advisory Group

Just product costs. Sourcing costs. Getting stuff to the stores.

Walter Robb

We talked already about no real meaningful inflation at this point and no real changes in that, that we can see.

A. Gallo

Transportation costs. Fuel’s been fairly calm [ph] (1:01:27), so transportation costs are fairly constant. As our sales pick up, we get more leverage into or through our DCs, so that, over time, reduces our distribution cost per package going into the stores, which helps, so…

Joseph Feldman - Telsey Advisory Group

Got it. And presumably, getting a little more density to the stores would help on that whole distribution side as well, right?

Walter Robb

Well, that's true. I mean, we've got the 12 operating regions and don’t see another one in the foreseeable future, so as all these stores are announced and we keep growing, even though some of them are in new markets, it does gain volume for the distribution centers. You're right.

Operator

We’ll take our next question from Neil Currie with UBS.

Neil Currie - UBS Investment Bank

I just wanted to ask about the Canada and U.K. stores. Also the consumer in those markets and what differences you see to the U.S. consumer right now.

John Mackey

John on Canada. A.C.’s going to do the U.K. We've signed a couple more stores in Canada, and I know our real estate team has just reviewed several markets in Canada. So I think we're going to anticipate ratcheting up our Canadian growth. We're doing very well there. The two markets that we’re in, Toronto and Vancouver, are doing extremely well for us. So we do anticipate definitely many more stores in Canada. Our comps are good, and our Kensington store in the U.K., and A.C.'s going to give us a workaround.

A. Gallo

Yes. It's been going well in the U.K. I talked to Jeff Turnas, the regional president today, and he said he was a little concerned with all the new government there and with all the talks about all the cutbacks. He’s been concerned that, that would affect the customers' buying habits, but so far, we haven't really seen anything as a result of that, although he said it is in the news about all the government cutbacks but hasn’t seen it affect our sales. He's feeling good about our comps have stayed nice through the summer. We saw a little more softness last year. It's holding up pretty nice this year. And we're excited that we’ve got a number of sites that we’re real hot on over there, and we're hopefully -- not too far in the distant future, we’ll be able to announce a couple of new locations that we’re going to do over in the U.K.

Neil Currie - UBS Investment Bank

I’m just wondering, actually, what sort of sized store that you'd be looking to open in the U.K. Obviously, the Kensington store is somewhat of a flagship. Would you be looking to open similar sized or smaller stores?

John Mackey

Smaller stores. We thought right from the beginning that somewhere in the 25,000 to 35,000 square-foot size was the appropriate size for over there. And Kensington came along, and we did it. It was very exciting, but that's really what we've been looking at. We've been looking at that kind of 25,000 to 30,000, maybe a little larger sized store is what we’ve been focusing on.

Neil Currie - UBS Investment Bank

And a question just around Prepared Foods. In terms of the strength that you've seen on a one- and two-year basis over the past six months or so, has that translated across the store? Or is Prepared Foods showing anything different than from fruit and vegetables and loose product?

John Mackey

We don't really like to, as you know, Neil, we don't really like to break out kind of the departmental trends at least in too much detail. I mean, our produce sales have been really excellent and meat. Prepared Foods have -- I mean, our comps are up. So basically, we're seeing increases in every department. Some are obviously increasing a little faster than others. But in general, we're seeing our comp gains across the store.

Neil Currie - UBS Investment Bank

I was trying to get a sense, really, of -- obviously you've worked really hard and successfully in getting a better value image among customers, and I just wondered whether that was translating to some of the more, let’s say, discretionary products in the store like Prepared Foods, if one can call them discretionary, as opposed to the more staple fruit and vegetables and meat.

Walter Robb

Well, we’ve also done some work in that area, the value work in that area, Neil. We've done the two for $5 salads and the $3.65 sandwiches. And so some of that has been happening in that department as well. And yes, there's a nice result there with that as well as we started to develop our Healthy Eating product line. If you see in many stores, the salad dressings, those things are starting to come out, just starting to come out now as well. Within our salad bars, we've had an excellent result with those efforts. So there's lots of nice movement there. It’s more in the mid-tier and not in the top tier that A.C. talked about, kind of the produce and the meat, and those foods have been leading the way. And remember that we’re in a time where the data shows pretty clearly people are going back to cooking again, are cooking at home. So that's tempering all of that as well.

Operator

And that does conclude our Q&A session for today. I would now like to turn the call back over to Walter Robb for any closing remarks.

Walter Robb

Okay. Thank you all for listening in, and please join us in November for our fourth quarter earnings. A transcript of the scripted portion of this call along with the recording of the call is available on our website at www.wholefoodsmarket.com. Talk to you all next quarter. Thank you.

Operator

This does conclude today's teleconference. You may disconnect your lines. Thank you, and have a great day.

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Source: Whole Foods Market F3Q10 (Qtr End 07/04/2010) Earnings Call Transcript
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