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Executives

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

A. Gallo - President and Chief Operating Officer

Cindy McCann - Vice President of Investor Relations and Vice President of Construction and Store Development

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

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.

Joseph Parkhill - Morgan Stanley

Neil Currie - UBS Investment Bank

Edward Aaron - RBC Capital Markets Corporation

Charles Grom - JP Morgan Chase & Co

Whole Foods Market (WFMI) F4Q10 Earnings Call November 3, 2010 5:00 PM ET

Operator

Good day, everyone, and welcome to today's program: Whole Foods Market Fourth Quarter Earnings Conference. [Operator Instructions] It is now my pleasure to turn the conference over to Cindy McCann, Global Vice President of Investor Relations.

Cindy McCann

Good afternoon, and thank you for joining us for the Whole Foods Market Fourth Quarter Earnings Conference Call. On the call today are John Mackey and Walter Robb, Co-Chief Executive Officers; A.C. Gallo, President and Chief Operating Officer; Glenda Flanagan, Executive Vice President and Chief Financial Officer; and Jim Sud, Executive Vice President of Growth and Development.

I'd like to remind you that the discussions we are having today will include forward-looking statements within the context of federal securities laws. These statements involve risks and uncertainties that may cause actual events, results and/or performance to differ materially from those indicated by such statements. We undertake no obligation to update forward-looking 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 and scripted remarks are available on our website.

I will now turn the call over to John Mackey.

John Mackey

Thank you, Cindy. Good afternoon, everyone. We're very pleased to report our fourth quarter results, which once again showed strong top and bottom line increases. On a 15% increase in sales, we produced: a 17% increase in gross profit, including LIFO; a 26% increase in EBITDA to $165 million; a 63% increase in earnings to $0.33 per diluted share; cash flow from operations of $124 million; and free cash flow of $67 million. Our solid financial performance and capital expense discipline have resulted in a consistent generation of free cash flow and a healthy balance sheet.

For the fiscal year, we produced $585 in cash flow from operations and invested $257 million in capital expenditures, resulting in free cash flow of $328 million. We ended the year with approximately $645 million in total cash, including cash equivalents, restricted cash and investments with an additional $343 million available on our credit line.

With our excess cash, we paid off $210 million of our term loan in the third quarter and an additional $100 million subsequent to the end of the fourth quarter, bringing our remaining balance to $390 million.

Going forward, our priority is to pay off the remainder of our term loan prior to its maturity in August 2012. We also plan to step up the investment in our business. We expect capital expenditures to increase by approximately $90 million to $140 million this fiscal year and to increase again in 2012 as new store openings begin to accelerate.

All in all, we're very pleased to be consistently producing free cash flow and in such a favorable cash position, where we can consider various options, including the possibility of reinstating our dividend.

Turning back to our Q4 results. Average weekly sales per store for all stores increased approximately 9% to $583,000, translating to sales per square foot of approximately $810. Identical store sales increased 8.7%, accelerating to 6.4% on a two-year stacked basis. Our ability to continue to perform against increasingly tougher comparisons has surpassed our expectations, translating to results that were significantly higher than our guidance range of 6.5% to 7.5%.

Our sales momentum increased throughout much of the quarter and was broad-based across most regions and departments. The drivers behind our identical store sales growth in Q4 was similar to Q3. Year-over-year, transaction count increased approximately 7% and basket size increased approximately 2%, with the increase in basket size driven entirely by customers putting more items in their baskets.

Average price per item decreased slightly as our strategic price investments more than offset the pass through of some higher product costs. Customer behavior was also fairly consistent with what we saw in Q3. Customers were still seeking value as demonstrated by strong sales growth year-over-year in promotional and exclusive-branded items. At the same time, signs of customer confidence also continued as year-over-year branded product sales growth continued to outpace exclusive brand growth, and customers selectively traded up to higher-priced items in certain discretionary areas such as seafood, cheese and housewares.

Customers have also continued to shift toward organic products for sales growth and organic products outpacing sales growth in natural products year-over-year. Our identical store sales growth has averaged 8.3% for the last three quarters and was 8.9% for the first five weeks of Q1. We are proud that we are continuing to gain market share in a much faster rate than most public food retailers and attribute a lot of our success with the progress we have made in our relative pricing position and to continue to raise the bar in areas that matter to our customers.

A recent example is our announcement in September to become the first national grocer to partner with Blue Ocean Institute and Monterey Bay Aquarium and provide our customers with an easy-to-understand, science-based, sustainability rating system for wild-caught seafood. The system's green, yellow and red ratings make it easy for shoppers to make informed choices with green or "best choice" ratings indicating a species is relatively abundant and is caught in environmentally friendly ways.

We believe initiatives like this are aligned with our core customer base and reinforce our position as the authentic retailer of natural organic foods, further differentiating the Whole Foods Market shopping experience and making us the preferred choice for customers aspiring to a healthier lifestyle.

On the value side, our competitive price index continued to improve in Q4, resulting in our narrowest gap over the past year. We have maintained our commitment to offering highly competitive prices on known value items in addition to implementing targeted pricing and promotional strategies. We've balanced our value investments by taking advantage of buying opportunities and improved our distribution, shrink control and inventory management to produce higher gross margin throughout the year.

We are hopeful we will continue to successfully strike the right balance between driving sales, improving our value offerings and maintaining margin going forward.

Turning to new store growth. During the quarter, we opened one new store in Santa Rosa, California, bringing our total new stores to 16 for the year. These locations included expansions into four new market areas. Our new store performance continued to show strong year-over-year improvement with this year's new store class producing 151 basis points higher store contribution as a percentage of sales versus last year's class.

New stores this year were approximately 15% smaller in size, averaging 45,000 square feet and produced average weekly sales per store of $549,000, translating to a 11% higher sales per square foot of $642.

We also have seen a substantial decrease in our average department costs for stores opened in fiscal 2010 versus fiscal 2009 on both the per-store and per-square-foot basis of 35% and 18%, respectively. Our efforts in this area are driving meaningful improvements in EVA and return on invested capital.

We are pleased today to announce nine new leases averaging 33,000 square feet in size in Laguna Niguel, California; Miami, Florida; Minnetonka, Minnesota; Charlotte, North Carolina; Greensboro, North Carolina; Concordville, Pennsylvania; Lynnwood, Washington; and two locations in the U.K. in Glasgow, Scotland and London, England.

We have been talking for some time about expansion opportunities in the U.K. and are especially excited about these two sites, which we believe to be the right size for their markets at around 21,000 square feet each.

Our business has been highly successful, producing industry-leading comparable store sales growth, average weekly sales and sales per square foot. With just 301 stores today, we remain incredibly bullish about our future growth opportunities as consumer demand for natural organic foods continues to increase.

From a financial perspective, we are well-positioned to reaccelerate our new store growth. Our strong top- and bottom-line performance, along with our renewed capital expense discipline, have resulted in consistent cash flow, lower debt and a very healthy balance sheet.

We have signed 20 new leases over the last 12 months and expect to open a higher number of new stores beginning in 2012.

I will now turn to our updated outlook for fiscal year 2011. Please refer to our press release for more detailed information.

With our store-level planning process now complete, and with more visibility into the timing of new store openings, we have fine-tuned our outlook for fiscal 2011. We have tightened our sales growth range to 10% to 12%. We expect weighted average square footage growth of approximately 5%, and based on our Q4 and Q1 to date results, identical store sales growth of 5% to 7%, which is 11.5% to 13.5% on a two-year stacked basis.

Despite increasingly tougher comparisons, our identical store sales growth of Q3, Q4 and the first five weeks of Q1 has been 8.4%, 8.7% and 8.9%, respectively. Idents improved approximately 290 basis points from the first five weeks of Q1 to the last 11 weeks of Q1.

So it's reasonable to expect idents to moderate as we move through the quarter and then moderate even further in Q2, when we began to cycle over 8%-plus identical store sales growth. This tougher comparison is reflected in our 5% to 7% guidance range for the year.

For fiscal year 2010, our operating margin was 4.9%. Based on this better-than-expected results, along with our lowered estimate of preopening and relocation expense in 2011, we have raised our operating margin guidance to 5.0%.

We are lowering our net interest expense expectations to $1 million to $3 million based on lower interest rates resulting from S&P's upgrade of our credit rating along with the recent $100 million decrease in our debt.

Based on our better-than-expected fiscal year 2010 results and these updated assumptions, we have increased our diluted EPS guidance range for the year by $0.07 to $1.66 to $1.71, which is 16% to 20% growth year-over-year.

The current consensus estimate is $1.62. In terms of quarterly results, please keep in mind that our first quarter is a 16-week quarter and that we typically produce sequentially higher sales and earnings on a weekly basis compared to the fourth quarter.

Our guidance reflects steady sales growth on tougher comparisons, as well as our commitment to delivering incremental operating margin improvement and earnings growth in excess of sales growth. We are proud of our results for the quarter and pleased with continued momentum in our sales trends first quarter to date.

At the same time, we are mindful of the challenges we face as we start to compare against difficult 8%-plus comps beginning in the second quarter, and an economy that is still struggling to show clear signs of momentum. The economy aside, we are very enthusiastic about our future. We have struck the right balance between increasing our value offerings and maintaining 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 continued improvements in gross margin and direct store expenses. And our new store performance has greatly improved, driven in large part by our renewed cost discipline in this area, as well as smaller average store size.

Our strong top- and bottom-line results are driving consistent cash flow, allowing us to decrease debt and build a healthy balance sheet once again. We're also reenergized about our new store growth potential with the rebuilding of the real estate pipeline starting to materialize.

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] Our first question comes from Charles Grom with JP Morgan.

Charles Grom - JP Morgan Chase & Co

Just on the average development cost being down 18% to $261, I'm just wondering if you can go into a little bit more detail in terms of how you've been able to reduce that cost and if there's opportunities down the road, and in addition, if you could dig into the 151 bip, basis points, of better new store contribution margins in the class that you just did.

A. Gallo

A.C. here. As far as the reduction in the new store development costs, a lot of that comes from, some of that is favorable conditions we've had where there has been very little inflation on the construction side, which has really helped. But a lot of it's just come from -- we have a great team in place that we've had in place now for a few years led by Lee Matecko, and we've got all of the construction coordinators from the various regions working closely together to share best practices, kind of in a competition between them to see who can come up with a great way to build the stores more efficiently. We've got a national buying team on equipment. A lot of discipline has been put in place. And we also have worked really hard for the last year to try to what we call, de-glitz our stores a little bit. We felt like maybe our stores have gotten a little bit over the top in certain finishes that we were using and things like that. So we've tried to get a little more back to basics and build the stores a little simpler and a little more straightforward. And we've been able to find a lot of opportunities to save money.

Walter Robb

This is Walter. On the question about contribution margin. Really, it's again the same value of the buck being a little careful in terms of the spend going into the stores so they're spending a little less. The capital equation is a little simpler. But I think also the smaller stores tightening up the size. This is the first fruit that we're starting to bear from the efforts of the last couple of years to tighten up our real estate process in slightly smaller stores, and focus, focus, focus. I mean we have brought a very ardent and concrete focus to these results. And I think this is, that improvement is the example of that.

John Mackey

John Mackey. Also, I'll add that in any type of cohort stores, in some years you're going to have stores that, a few stores don't perform as well, in other years you have stores that you hit homeruns on. So part of it is our better discipline, our better capital management, smaller stores. And part of it is we just opened a better cost of stores this year. And hopefully, that's the trend that we'll see next year as well, but that doesn't always prove to be the case. So you ought to factor that in.

Charles Grom - JP Morgan Chase & Co

And then my second question is just looking at your guidance, 16% to 20% growth for next year, seems achievable particularly since the de-leverage looks like it's going to be about $0.08 of earnings growth year-over-year. And then digging in, it looks you're anticipating about 20 basis points of margin upside, which looks pretty conservative on an idea of 5% to 7%. Can you touch on may be what some of the puts and takes to be for you guys next year and areas where you could be or where there could be some downside as well?

Cindy McCann

Well, we certainly hope to see improvements in both margins and direct store expenses, but we don't have a clear crystal ball. So it could be better or worse in both categories. We have some continuance of our current trends, basically, built into our guidance along with a reflection of the fact that in fiscal '10, we're comparing against a very, in fact one of our worst years in history is fiscal year '09, and then in fiscal year '11, we're back to comparing against fiscal '10, which is a much more normal year from that perspective. So we expect to make continued price investments in the gross margin line. We will get some leverage and depreciation will continue and other of our expenses. One thing to point out about next year is we do anticipate that of our new store openings, six will be relocations. And so for those six stores, we'll be taking a lower store contribution percentage in the new store compared to what we're getting currently in the older store. So those are kind of some of the things that we thought about in our guidance.

Walter Robb

Let me take on that, Chuck. This is Walter again. I do think this group, the team here is incrementally more confident on our ability to find the right balance of gross margins in sales and price investments. I think we've got a year under our belt now of looking at that. We're continuing to find opportunities on the buy side that we were able to take advantage of. We're continuing to find efficiencies on our infrastructure side. We've talked some about that, and those are still there for us to find and it gives us the flexibility to move with the marketplace as we need to. So I think there's some confidence in our abilities in this regard reflected in this guidance.

A. Gallo

We think our guidance is realistic. That's why we gave it.

Charles Grom - JP Morgan Chase & Co

One quick follow up, on the gross profit of 55 basis points, can you just kind of break through how much of that is occupancy versus merchandise margins?

Glenda Chamberlain

It was both.

John Mackey

A slight decrease in cost of goods sold as well.

Operator

Our next question comes from Scott Mushkin with Jefferies & Company.

Scott Mushkin - Jefferies & Company, Inc.

I understand why you're so conscious on your compound look as a result of the compares getting tougher. But Whole Foods is really in history never had a hard time copping the comp. I remember three or four years ago, you guys were doing 10 on top of 10. And as I look at it, it actually appears the comping comps really have been dependent on one leg of a four-legged stool namely traffic. I was wondering like if we could get inflation back to normal levels, free up accelerates. And we get people to put some more items in their basket. Could we have an easier time comping the comp as you guys are expecting?

John Mackey

That happens, yes. We don't have a crystal ball that can absolutely predict comps. All you got to do is look at our history. And yes, we've had some years, where we got double digits over double digits, and we'd like nothing better than to have that continue. But we're not sure we want to bet on that yet in this uncertain economic environment. We do have tougher comparisons. A few years ago, the new stores were a greater percentage of the total stores. Our store base is getting larger. It's kind of a law of big numbers to a certain extent. It gets harder to continue to comp when you have a greater percentage of your stores are older stores. So part of our comps have been continued recovery from a very sort of dismal 2009 and whether we can continue to compound in our compounding. Hey, we hope we can. We put out comps that we think are fairly realistic. We hope we do better, but we put our guidance that we think is what's going to happen.

Walter Robb

This is Walt. I'm not sure I totally agree it's one leg on the stool. I think we've definitely had the traffic, but we've also had the nice items in the basket moving, too. And if you compare those numbers to some other numbers out there, we're converting the traffic into items in the baskets. So the stool's got a little more foundation there, but certainly, the traffic's been a good one.

John Mackey

We've got some good momentum. We hope it continues.

Scott Mushkin - Jefferies & Company, Inc.

Obviously, I wasn't trying to say it's not good momentum because it clearly is. How do you think inflation is going to play out next year? Are you seeing any inflation yet, both on the sales line against secondly, on the gross margin line?

Walter Robb

Here's the way we see it. We saw less than a point in this past quarter. Clearly, the greens and the real seeds have spiked up on the production side, but we actually had our research team headed up by Chris Taylor here, her team studied this. So we looked at inflation over the last five years. And here's what it looks like. Clearly, the PPI, the producer's index spikes up, but the CPI lags that. And looking at this chart, it looks to me like the PPI it's only up half to its highs in 2008. So net-net, I think that's going to be a factor next year. It's not happening through the end of the holidays for sure. It's going to go maybe somewhere, the STA is saying 2% to 3%. That's on the CPI side, not the producer side because it's a question whether this translates through to the consumers and what the marketplace will actually give the producer. So our best guess right now is somewhere between 2% and 4% in 2011, and we're going to have to see what the marketplace is at that time and what the marketplace will actually allow to take place in terms of pass-through.

John Mackey

It's really hard to know because we saw this past year where the some meat suppliers started to raise their prices and it didn't stick. I mean the consumers wouldn't accept it, and eventually, as soon as beef prices went up a little bit, consumers switched away from it. So meat prices eventually came back down a little bit. So it's really hard to say. It's hard to know in this environment what consumers are going to be willing to accept, and we just don't know really what will happen. We assume there will be some inflation this year. It seems like there will be, but we just can't really tag what it's going to be.

Walter Robb

We didn't bake any inflation in our numbers, so if it does happen to your question earlier that would be an upside because we haven't baked it in.

Scott Mushkin - Jefferies & Company, Inc.

Walt, you said last quarter that you were noticing some trade up. I think you used the wine example of the $12.00 one instead of $10. Are you seeing an acceleration of that pattern? I know John made some comments, but I hope you could talk about the sequential move there and how do you think this plays out in the holidays compared to last year?

Walter Robb

Yes, we did study that. We are seeing incremental improvement in that. We studied it in terms of the basket size. We studied it in terms of all the categories. In seafood and cheese, for example, we're seeing more trade ups into some of those higher dollar items, and it bodes well for the holidays. And I think it is our sense that we're going to see incremental gain in the holidays, but it's hard to say exactly. But it is a good sign for that.

John Mackey

Interestingly enough, as we continued to improve our purchasing, we get more scale. For example, we just introduced a new wine in our company called, Three Wishes. We've got that wine at $2.99 in most of the country and $1.99 in California. And frankly, the sales of it are phenomenal. So that's a counter-example of we actually have customers trading down to a lower price one. So there's some trading up going on to be sure, but as we get more value-priced items, our customers don't have any problem of grabbing them up and sticking them in their cart.

Operator

Our next question comes from Mark Wiltamuth with Morgan Stanley.

Joseph Parkhill - Morgan Stanley

This is actually Joe Parkhill in for Mark. I was wondering if you could talk a little bit again about your gross margin performance this quarter with it being up 55 basis points when last quarter, it was roughly flat. So I was wondering what the differences were between the two quarters off of roughly a similar comp?

A. Gallo

This is A.C. A couple of things that contributed this quarter were our strong sales really helped on our occupancy side. We really leveraged the expenses well there. We've had the expenses really well kind of locked down, and when you get a boost from sales like this, it really helps leverage them down. And then the other thing is that we've had a lot of things in place to try to really -- and on the purchasing side to really try to help our margins up, both to give us the chance to improve margins where possible and also to be able to be even more competitive. And we've seen some great results from our purchasing. Our facilities, like our distribution centers, had a very good quarter. We've been putting a lot of cost control things into our facilities. We've been moving around the kind of products that we distribute out of our own facilities to help with the better cost into the stores. So there are a lot of things we've done just to help on our cost side and our expense levered side.

Joseph Parkhill - Morgan Stanley

But the comps from last quarter was similar so the occupancy leverage would have been similar as well. Is that correct, or am I thinking something wrong there?

Glenda Chamberlain

There's no magic formula here, and I see they did a good job of talking about why in the quarter we might have had better results. It's not necessarily a fixed amount of leverage that you get with any particular sales comp. We did have very strong sales in the quarter. It's much stronger actually than we expected.

Joseph Parkhill - Morgan Stanley

In your chart also, when you have your pipeline of new stores for fiscal year 2012, is that 6% number, I mean, is that pretty much what we should expect for now? Or is there any opportunity for you to add a store to that?

John Mackey

There is some opportunity for that potentially, but that's our best guidance at this point.

Operator

Our next question comes from Ed Aaron with RBC Capital Markets.

Edward Aaron - RBC Capital Markets Corporation

It sounds like you think that some of your newer initiatives like healthy eating and animal welfare, are really kind of driving sales. That seems like a somewhat difficult thing to measure. So I'm just curious to know how you go about approaching measuring those initiatives to draw on that conclusion.

John Mackey

Well, obviously we don't know exactly. We're trying to improve our operation in all different aspects. And one of the things that our company has really focused on the last couple of years is increasing the differentiation between our stores and our competitors. As they've imitated us, as they've copied us in many ways, we talked about this before that we've focused on innovation cycle. And we think now our meat departments once again, are very differentiated from our competitors as we've added several new initiatives. I mean we have 100% grass-fed beef for example in 100% of our stores. That's something we didn't have a year ago. So we've got lots of pasteurized chicken. We've thought through, we're thinking through our department. We just use those as examples: seafood sustainability and animal welfare. When in fact, there's been differentiation in virtually every one of our departments as we continue to try to put distance between our stores and our competitors' stores. And we don't measure any particular differentiating elements to see if that's the critical one. Because we're differentiating so many different ways, we're not sure that would be particularly valuable information to have. We just believe that the differentiation that we're doing, combined with our value focus are becoming more competitive on price. The combination of those two, we don't know exactly the mix of the combination, is what's driving our strong comps and our strong sales growth. But that's as much information as we have. We've given you what we know.

Edward Aaron - RBC Capital Markets Corporation

And then just a couple of questions on new stores. I apologize if I missed it. But the script with growth guidance for 2011 looks like it came down a little bit. Is that a reflection of the two terminated leases? Or is it more of just timing issue on some of the other stuff that you've got in the pipeline?

Glenda Chamberlain

It's just timing.

Edward Aaron - RBC Capital Markets Corporation

And then just last one on the U.K. just with the leases out of there, just thought now may be a good opportunity to get an update on your recent experience in that market, how kind of things are dong, how you approached the site selection for those new stores?

John Mackey

Well, we've pleased in the U.K. For this most of this past year, we've seen a steady improvement in our comp sales over there. We've been happy with seeing Kensington has moved into double-digit comps and seems to be holding there, which is really great. Kensington continues to grow. We're starting to see the light towards getting closer to cash flow breakeven. And we were encouraged enough with what what's happening this year to really step up looking for additional sites, and we've been working on these for quite a while. So we're looking around the U.K., both in London and obviously in Scotland, looking for areas that we really feel fit our demographics. And we're also opening up the kind of stores that we probably when we first started thought of going opening up stores, we weren't really thinking about this 20,000 to 30,000 square-foot range. Kensington came along and we thought it was such a great opportunity that we opened a much larger store but kind of going back to what we thought would be our original strategy for the proper store in that market. And we're really pleased, we think we found a couple of locations that are in really fantastic areas and are right in that sweet spot of size that we're looking for.

John Mackey

Also I think that it's hard to overestimate the impact that the great leadership of Jeff Turner and David Atro [ph] over there. They relocated from the North Atlantic region about a year and a half ago and the level of execution, the quality of our operations have steadily improved quarter-by-quarter. So we think we've got some great leadership over there. And we're hoping that we are going to have other locations that we can hopefully announce in the next few quarters. So we hope that would not be the last two sites we announce. We do have a commitment to the market. And we're seeing our Kensington store, as A.C. said, it's closing in on that cash flow breakeven, and beyond that, it'll be a very self-sustaining operation there. So we're pretty bullish on it. And unfortunately, when we opened our Kensington store, pretty soon after that, the economy collapsed. So our timing wasn't great on that but we weathered that and there's some good things happening in the U.K. in their economy and the leadership there is cutting their government deficits and setting a good example for the United States.

Operator

Our next question comes from Karen Short with BMO Capital.

Karen Short - BMO Capital Markets U.S.

Just a couple of questions concerning the comp, I guess. It sounds like the driver of the acceleration in comps in the last eight weeks of the fourth quarter was basket. Can you may be just give a little color on what the driver, I'm looking at your stocks and average trends, what the driver would be in the first quarter? Is it again a further acceleration in basket?

Walter Robb

Karen, this is Walter. No, actually, that's not -- it's pretty much consistently been the 80% 20% transaction. The basket stays relatively flat, so the trends have continued in the same way.

Cindy McCann

Actually, the number of items per transaction by then did increase about 40 basis points from the third quarter.

Walter Robb

Can I just add one more thing on that to add a little bit more color on that? Because I wanted to say this earlier that our own research shows clearly, that what's different about this customer count is not only have we got our loyal customer base and they're here, and they're staying with us and they've stayed with us. But we have a whole new group of customers that are here now that we've never had before and that are coming to Whole Foods for the first time. Particularly, I think for the younger generation as well, they're looking at the company and looking at our offerings, both the value and the differentiation, as John said it. And what's very exciting is it's a very dynamic customer count. And we're digging in that more and more with our research team to understand that but that's a nice little bit of color in terms of this growth.

Karen Short - BMO Capital Markets U.S.

Do you have any sense -- can you split out what in terms of the traffic increase, what percent is new group versus your loyal customers buying more?

Walter Robb

We've just done this. We've been doing it with Nielsen for a couple of quarters now. So as we get a little more confidence on that, we could maybe share that. But right now, it's meaningful enough for me to say it.

Karen Short - BMO Capital Markets U.S.

And then, I guess also just looking at your comp guidance, there seems to be two areas discussed, I guess I don't know I agree with, but I'm curious on your thoughts, the first is just that your comp guidance obviously does assume an acceleration in the tier stack, an average comp. I guess I'm not sure we should still be looking at it anymore, but I'm curious to hear how you frame that. And then the second area is that the pricing environment in natural foods going forward could slow just because more mainstream manufacturers are trying to expand their natural food offering at lower price points and that could hurt your comps? Again, I'm not convinced that these are valid, but I'm wondering if you could give your thoughts on both of those.

Cindy McCann

We're not sure about the two-year comps anymore either, honestly. When we're looking at the last three quarters, really, in Q2, Q3, Q4 and so far in Q1, our comps have been within 20 basis points. But yet over that same period of time last year, comps accelerated tremendously. And so therefore, our two-year comps have accelerated. So I mean hopefully, over our history, we've produced 7% to 8% comps for decades really. And so it's hard on one hand not to believe that we're back to normal there. But on the other hand, we're facing significantly tougher comps once we get into the second quarter. So we certainly don't want to just assume that we're going to continue back at 7% or 8%. In fact, we think that, that would be unreasonable to assume. We try to find the right balance between those two perspectives, and we did it at a store level bottom-up basis. So really what we've given you for guidance is our very best guess, although certainly, we could be wrong on either side.

John Mackey

Karen, we're going to do the best we can just to continue to manage the business, continue to create value for our customers, focus on cost discipline, all the things we've talked about. The comps are going to be what they're going to be, and we can't control it. All we can try to do is operate our business as well as we can. We've given guidance that we think is the best guidance we can give when we factor in all these different criteria and circumstances. And hey, we've been wrong in our guidance before, we may be wrong here. We don't really know. I mean this is the best guess we've got based on the information we've got.

Karen Short - BMO Capital Markets U.S.

Can you just give some comments on how the Lancaster transition is going with UNFI? Has it been fairly smooth recently not losing any stocks or anything in your stores by that facility?

John Mackey

Walter?

Walter Robb

It's early in that transition. I won't say it's been perfect. We've had some ups and downs, but the teams are working extremely collaboratively together, our team and their team. And we're making good progress. It's the right decision. It's going to be a positive for both companies going forward. We still got a few ups and downs.

Operator

Our next question comes from Neil Currie with UBS.

Neil Currie - UBS Investment Bank

Just wanted to talk about in the past, before the [indiscernible] last, your previous performance was very solid. With the credit crunch, you almost [indiscernible] You've done a lot in the last year or so to change many aspects of the business, the pricing part of the business, the cost structure. And also, of course, you have your strategy out there. But what gives you confidence that if the same thing happened again in 2008, would you be closer to the period in the past where you'd been more acyclical? Or do you think that as you become a bigger business, you become a more cyclical business?

John Mackey

You mean if the economy melts back down again like it did 2008 and hopefully, we're not crossing our fingers. That's a once-in-a-lifetime financial crisis. I suppose as the economy melts down again, Whole Foods is vulnerable like every other corporation in the world. So I don't have any confidence that if the economy melts down, the Whole Foods Market won't be scrambling. There are always circumstances out of any corporation leadership's control and certainly, some type of total economic meltdown or cataclysmic event, I mean, things happen.

A. Gallo

The only thing I would add to that is that having been through it recently, we understand a lot of the things you need to do. We've developed new muscles on how to deal with that kind of stuff. So I feel very confident that if were to hit a similar situation, we would know what we do. And we would probably react quicker to it than we did last time.

John Mackey

I don't think anybody here has -- we're still carrying this experience viscerally. And we're pulling on that and learning that and keeping that memory alive in a positive way, so that continue to keep these disciplines with us going forward. I mean the macro thing is way bigger than us, but I think we are more aware of all those things now than we were two years ago.

Neil Currie - UBS Investment Bank

Do you feel as if you could be as robust as you have in the past?

John Mackey

We certainly hope so.

Neil Currie - UBS Investment Bank

I asked earlier about price inflation and the possibility of it occurring next year. If it does, what would be your approach to passing it through? Obviously, it depends how consumers respond it, but would you look to pass-through price increases and maintain margin or would you look to pass-through price increases and try to protect the spread?

John Mackey

Neil, one of the big things we've really tried to work on the last couple of years is improving our price competitiveness with an increasing number of competitors. And so we monitor and follow many more competitors than we did a couple of years ago. We regularly price against them every month. We look it really carefully. We've been able to increase our position versus them. We feel that the last year. And it will be our intention through any kind of inflationary period to maintain that same relationship. We think that where we've gotten ourselves in that relationship to our competitors is what's really helping driving our traffic right now. So what we do is really going to depend on maintaining that same relative position to our competitors. So a lot of that is going to happen with what the market allows. Keep in mind like I said earlier, we have a lot of buy-in initiatives in place. We have a lot of expense control initiatives in place so that we would hope that we can offset potentially some increases in certain areas if we're not allowed to be able to pass them through with better purchasing in other areas. So it's a very fluid and dynamic thing. But the overriding principle is maintaining our competitiveness in the marketplace.

Operator

Our next question comes from Meredith Adler with Barclays Capital.

Meredith Adler - Barclays Capital

I would like to just talk a little bit more about real estate and may be kind of talk about what the environment is right now, what you're seeing in terms of opportunities and how you've brought down the costs a little bit for this coming year, timing issues but may be talk about how you think that plays out in 2012. And do you have some vision about how quickly you would grow?

James Sud

This is Jim Sud. As you know, we announced our nine sites this quarter. Some of them we announced in the second quarter in 2007. And we have a very good size pipeline of stores that are ready to go to committee, as well as a large backlog of stocks that are ready to be researched. So we are seeing a lot of opportunities. It still continues to be mostly in the second generation space area, although there is some limited new development opportunities that we're seeing. So the bottom line is we've got a lot of opportunities in real estate and we expect to continue to add stores to our pipeline, probably maybe in the 6% to 8% per quarter range. As far as 2012, again, our guidance is what it is. There is some opportunity, I suppose, to add to that. We're early in the year and so there could be some sites that are approved that could get open later in the year. But they really wouldn't have a significant impact on our square footage number growth number, I don't believe.

Meredith Adler - Barclays Capital

Well I was actually thinking about the following year. I think John had said that he would anticipate that the growth would be ramping up. And I was just wondering kind of what you're envisioning in terms of that level of growth.

James Sud

Well, again, as John mentioned, the kind of the law of big numbers, the bigger you get, the harder it is to grow from a square-footage basis. But we do expect our number of stores to ramp up in 2012, probably to somewhere in 20 range.

Meredith Adler - Barclays Capital

I don't have any more questions. I would just say that it was really nice to hear you talk about maintaining that competitive position being focused on. It does seem clear that people are noticing that the value equation at Whole Foods has improved.

Operator

Our next question comes from Bob Summers with Susquehanna.

Robert Summers - Susquehanna Financial Group, LLLP

Just to leverage off Meredith's question a little bit, it looks like you have about 20-unit opening slotted for '12. Is that the speed limit? I think if I look back historically, that's about the absolute number that you opened in any given year or is there infrastructure in place to take that number to 25 or higher?

John Mackey

I think we've actually opened maybe 21 or 22 stores in the past. But again, as a decentralized company, we've got 12 geographic regions across the United States, Canada and the U.K. We have the scale to bump that number off by a good margin if we choose to do so and if we do get the opportunities in real estate, which we're starting to see again today.

James Sud

So we have the infrastructure, we have the cash, we have the cash flow, but we're not going to just sign stores to hit some kind of growth number or some kind of percentage or some kind of target. We're going to sign stores if we find good locations that we think are going to deliver good returns on capital for us. So we're, certainly, we've got the green light on, but and we think we can do it, but there are no guarantees in it. And we're not going to do it artificially just to hit some kind of expectation. The good news is that it's possible for us to grow faster, not maybe as a percentage but it's easier for us to open more stores today than it was say, three or four years ago because our company's got more infrastructure in place. We have a more seasoned leadership team. Our twelve geographical regions have infrastructure in place to enable them to open more stores. So we have the capacity to grow faster than we've ever grown before in absolute store numbers. Now it's a question of really finding locations that meet our very strict criteria. We're still very proud of the fact that in our 30-plus year history, we've never had a store that we opened ourselves ever fail. So we're really determined to keep that track record alive.

Walter Robb

Just an important Bob, because the last few quarters, you've heard us talk about we're going to do 15-or-so stores until we see where this thing is going. And I think you're hearing us show up today with a high level of confidence about that John just set the green lights on. Jim gave you some look into 2012. And so I think you hearing us say we've got more confidence, we've got the ability to do it and we're looking to grow.

John Mackey

There is a lag period between signing stores and getting them through the pipeline. I mean somewhere between, usually, 12, 15, 18 months. And beside nine stores, now if we start signing seven, eight, nine stores a year, pretty soon, you're got to have -- a quarter, then you add that up over the year. And you end up with 28 to 36 stores. Some time that will start coming through the pipeline. There will be a lag period here.

Walter Robb

And our development timeline I think has shrunk mostly as a function of the type of projects that we're seeing again with very little new development going on, second-generation spaces, easier and quicker to open.

Robert Summers - Susquehanna Financial Group, LLLP

I mean are you seeing increased competition for sites? I mean, I'll call it a similar-type retailer out there, although a smaller box. And I was just wondering if you start to bump up against them a little bit in any way?

Walter Robb

We are still a very highly desirable tenant for all of the real estate community. And so we are not bumping up against any competition really on the grocery side.

Robert Summers - Susquehanna Financial Group, LLLP

You talked about the price gap being the narrowest it's ever been. I'm sure we're not done yet, but I'm assuming a lot of the heavy lifting has been accomplished. I mean how much further do you think you have to go or is this just a constant evolution?

John Mackey

I think it's a constant evolution. What we've been trying to do is we've been trying to use the gain that we've been able to get on the buy side and through better efficiency to drive more and more values. As John was saying earlier, we just introduced this great new value wine program, Three Wishes. And we've got other things like that in the pipeline. I mean we're always looking for additional opportunities to improve the value equation for our customers even more. So we don't have a certain target that we want to get to, but we're continuing to look for opportunities to be even more competitive.

Operator

Our next question comes from Colin Guheen with Cowen and Company.

Colin Guheen - Cowen and Company, LLC

May be just some commentary on the prepared foods business, how that's evolved especially as your opening more and more smaller stores and how that's mixing as a percentage of your sales? I think you only get that number on an annual basis. Maybe just a commentary around that.

John Mackey

So it's delicious and we're open for business for the holidays. Actually, we don't break out the percentage of sales on these businesses. Do you want to answer the question?

Cindy McCann

No, I mean we do break that on the 10-K, as you were saying, but we don't break it out quarterly.

Walter Robb

I thought that he was asking for the quarterly break down so ...

Colin Guheen - Cowen and Company, LLC

No, the question was more rounded on smaller store footprint and is there any color commentary around initiatives that are going on there that are different and maybe historically?

Walter Robb

I was just going to say, we're starting to take some of our health start efforts with the prepared foods. That's pretty exciting to see the salad bars and the prepack areas are starting to show some exciting initiative there, But the ones you've...

John Mackey

I would say that as our stores are getting smaller, I mean we're maintaining approximately the same square footage in prepared foods. When we opened up some very large stores a few years ago, we experimented with some additional food concepts like some of the sitdown venues and some of that stuff. And as the stores get smaller again, we go back to traditionally, what we would normally incorporate in the stores for prepared foods, and we're finding that percentage of sales is very similar to what it's been traditionally over the years. It shifts a little bit from say, the service case to the pre-pack case. And we've been, as Walter said, we've got a lot of initiatives with our healthy eating program in there. But I would say that the new stores, even though they're smaller, they have approximately the same size and break out of prepared foods that we experienced traditionally.

Walter Robb

One of the really exciting things that's happening is people are cooking again. And we saw that shift to people eating at home versus eating at restaurants. And that is really people are interested in food, interested in ingredients, interested in preparing meals, interested in cooking classes, interested in all those sorts of things. And that's also creating an overall interest in cooking and meals in prepared foods and so that's another aspect of all this.

Colin Guheen - Cowen and Company, LLC

A lot of talk about maybe increasing the total number of stores that are being opened each year. Are we at an inflection point as a leverage opportunity given that you might be backfilling with smaller stores now with a lot of construction place or will G&A and overall fixed cost be growing commensurate with some of the program?

John Mackey

We're not quite sure yet we understand your question. We don't think we're just backfilling because the market's continuing to expand. So we're continuing to enter new markets and we're continuing -- we still don't think there's any market we're in the United States that's completely saturated. Hey, we've been in Austin 30 years. A quarter or two ago, we announced two new stores in Austin. So we don't think we saturated any of our markets and the markets continue to grow. So we don't know where that limit is when we'll saturate the market. It will have to be when the overall market begins to slow down. And I'm not sure what the questions were about.

Colin Guheen - Cowen and Company, LLC

As your adding more stores in the market, you're leveraging people. I'd imagine also leveraging fixed cost.

John Mackey

There's no doubt that when you're already in the market that the biggest gain you get is when you open a new store. You've already got a good percentage of the team member base is already trained and enculturated, high level of efficiency and a lot have been transferred to the new store. So when you go to a brand new market, you're hiring a much bigger percentage of your team member base. You don't have the background with Whole Food. So that's a harder field decline than a new store in an existing market. Plus, you don't have the same brand identity and brand knowledge with the market. So you have less risk when you open a store in an existing market. But our brand now is so well known, I've been surprised the last few years, whenever we go into to a new market, it tends to take off pretty well. We used to have to take a couple of years for people to discover us. And now, we go into a new market, they're lined up. It's a big deal. So I think that just shows how strong Whole Foods Market's reputation and our brand is around the United States now. We'll find out if it's a good one in Glasgow and Scotland when we open up there.

Operator

This concludes today's Q&A session. I'd like to turn it back to our speakers for any closing remarks.

John Mackey

Hey, thanks for listening in. Please visit Whole Foods Market for everything you need to enjoy great meals over the holidays and join us in February for our first quarter earnings call. A transcript of the scripted portion of this call along with the recording of the call is available on our website at www.wholefoodsmarket.com. Everybody, have a great holiday. We'll talk to you in February. Goodbye.

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