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Whole Foods Market Inc. (WFMI)

F1Q07 Earnings Call

February 21, 2007 5:00 pm ET

Executives

John Mackey - Chairman and CEO

Walter Robb - Co-President and COO

A.C. Gallo - Co-President and COO

Glenda Chamberlain - EVP and CFO

Jim Sud - EVP of Growth and Business Development

Analysts

Simeon Gutman - Goldman Sachs

Mark Husson - HSBC

Meredith Adler - Lehman Brothers

Steve Chick - J.P. Morgan

Ed Aaron - RBC Capital Markets

Mark Wiltamuth - Morgan Stanley

Greg Badishkanian - Citigroup

Andrew Wolf - BB&T Capital Markets

Operator

Welcome to today's teleconference. At this time, all participants are in a listen-only mode. Later, there will be an opportunity to ask questions during our Q&A session. I would now like to turn the program over to Mr. John Mackey. Go ahead, please.

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John Mackey

Good afternoon. Joining me today are Walter Robb and A.C. Gallo, Co-Presidents and Chief Operating Officers; Glenda Chamberlain, Executive Vice President and Chief Financial Officer; Jim Sud, Executive Vice President, Growth and Development; Lee Valkenaar, Executive Vice President, Global Support; Cindy McCann, Vice President of Investor Relations.

First the legalities. The following constitutes Safe Harbor statement under the Private Securities Litigation Reform Act of 1995. Except for the historical information contained herein, the matters discussed in this press release are forward-looking statements that involve risks and uncertainties, which could cause our actual results to differ materially from those described in the forward-looking statements.

These risks include, but are not limited to, general business conditions, the timing, development and opening of new stores, the impact of competition, and other risks detailed from time to time in the Company's SEC reports including the reports on Form 10-K for the fiscal year ended September 24, 2006. The Company does not under take any obligation to update forward-looking statements.

The tender offer we will discuss today has not commenced. We have agreed in the merger agreement to commence a tender offer on February 27, 2007. Our description of the tender offer today is neither an offer to purchase nor a solicitation of an offer to sell shares of Wild Oats Markets. At the time the tender offer is commenced, we will file with the SEC a tender offer statement on Schedule TO containing an offer to purchase and related materials. These documents will contain important information about the tender offer that should be read carefully before any decision is made with respect to the tender offer.

We have two announcements today. Both press releases are now available on our website at www.wholefoodsmarket.com along with the scripted portion of this call and additional supplemental financial data. I'm hoping that you all had a chance to read our press releases. I'll briefly recap our first quarter results and then turn to our announcement of a proposed acquisition of Wild Oats.

Our sales for the first quarter increased 12% to $1.9 billion. Average weekly sales for all the stores increased 6% to $620,000, translating to sales per square foot of $926. We had 174 stores, or 92% of all stores set new weekly sales records during the holidays. Our comparable store sales grew 7% on top of a 13% increase in the prior year.

Our year-over-year average transactions per week increased approximately 5% to $3.2 million and our average basket size increased approximately 2% to $34.43.

Our 13 new stores, including three relocations and two new markets, averaged 53,000 square feet in size, produced average weekly sales of $571,000 in the quarter and had sales per square foot of $559.

Due to seasonality, our gross margin is typically lower in the first quarter than for the remainder of the year, averaging 34.3 in Q1 over the past five years. For the quarter, our gross profit was in line with this average, decreasing 24 basis points year over year to 34.3% of sales. For stores in the comparable store base, gross profit improved two basis points to 34.5% of sales.

The Whole Foods Market brand is synonymous with beautiful stores, exceptional customer service, the highest quality natural and organic products and a fun shopping experience. What we are not as well known for are the low prices that we currently offer our customers.

While our core customers are not primarily focused on price, our price image is important in terms of appealing to a broader customer base, especially as select natural and organic products are becoming more available through various retail formats.

Our strategy has been to approach pricing on a market-by-market basis, and to be competitive on the same or similar items in grocery and Whole Body.

Our perishable areas such as meat, seafood, produce, prepared foods and bakery, have typically been priced at a premium, reflecting the higher quality of our offering.

Going forward, we expect to further differentiate our product offering throughout our stores, and where differentiation is not possible, continue to selectively invest in lower prices on branded products to help enhance our value perception and broaden our appeal.

The good news is that being a young and relatively small company, we have many opportunities to lower our cost of goods sold. We can use these savings to help offset our price investments. Therefore, we believe our historical annual gross margin rate of 34% to 35% continues to be the best indicator of our future results.

In the quarter, our private label SKU count increased 21% year-over-year to just over 1,900 SKUs, and our private label sales increased to 17% of our total grocery and Whole Body sales.

We have committed additional resources to our private label team, including creating a new Global Vice President of Private Label position. We expect private label to play a key role in our product differentiation strategy and to grow to a much higher percentage of our sales over time.

Direct store expenses increased 35 basis points to 25.8% of sales, which is higher than our five-year average and above our five-year range. The increase was primarily due to higher share-based compensation expense and health care costs as a percentage of sales.

For stores and the comparable store base, direct store expenses improved six basis points to 25.4% of sales.

For the quarter, operating cash flow per share increased a very healthy 30% to $0.79 from $0.61 in the prior year. This takes into account approximately $10.2 million, or $0.07 per share of share-based compensation, pre-opening rent and accelerated depreciation was expensed for accounting purposes, but was non-cash, compared to $4.4 million or $0.03 per share in the prior year.

In other news, we were extremely pleased to learn last month that for the tenth consecutive year we made FORTUNE's list of the "100 Best Companies to Work For." We ranked number five, our highest ranging ever, and we are one of only 18 companies to be named every year since the list's inception.

I will now turn to our announcement on our planned merger with Wild Oats.

Wild Oats and Whole Foods Market have both had a large and positive impact on the natural and organic foods movement throughout the United States, helping lead the industry to nationwide acceptance and to becoming one of the fastest growing segments in food retailing today.

The growth opportunity in the category has led to increased competition from many players, most of whom are not dedicated natural and organic foods supermarkets, but are considerably larger than we are.

Our companies have similar missions and core values, and we believe the synergies gained from this combination will create long-term value for our customers, vendors and shareholders as well as exciting opportunities for our new and existing team members by making us better positioned to compete in this rapidly changing food retailing environment.

In our history, we have made 18 retail acquisitions, many of which we have considered to be platform acquisitions from which we have been able to accelerate our growth geographically. This will be the largest acquisition in our history. Wild Oats is a great geographical fit as all of our 11 operating regions will gain stores and three of our smallest regions, Pacific Northwest, Rocky Mountain and Florida regions, will gain critical mass. We will also gain immediate access into a significant number of new markets.

It has been our experience that most acquisitions take up to two years to transition to our decentralized operations and implement our incentive programs. We expect this acquisition to be similar and that over time we will recognize significant synergies through G&A cost reductions, greater purchasing power and increased utilization of support facilities.

We are particularly excited to gain many talented team members, who will provide valuable support in reaching our growth goal of $12 billion of sales by the year 2010. We will be carefully evaluating each banner as well as each store to see how it fits into our overall brand and real estate strategy.

Wild Oats has been rationalizing its store base over the last several years, but we expect we will close some additional stores as well as relocate others to stores we currently have in development. We would also expect to make significant investments in remodeling stores before eventually re-branding them as Whole Foods Market stores.

Our company continues to evolve at a rapid pace. We have always learned from past acquisitions and look forward to building on our combined strengths of cultures and historical routes. We approach this acquisition from a strategic as well as EVA perspective and believe we will become a much stronger and better positioned company that will produce strong returns for our shareholders in the future.

As stated on our press release, our tender offer is conditioned upon at least a majority or 50.1% of the outstanding Wild Oats shares being tendered, as well as customary, regulatory, and other closing conditions. Wild Oats' Board of Directors has unanimously recommended that their shareholders to tender shares in this offer.

The Yucaipa Company, Wild Oats' largest shareholder with approximately 18% ownership has committed to tendering its shares. Approval of the transaction by our shareholders is not required. If all goes according to plan, we hope to close this transaction in April. We believe we are well positioned to finance this transaction as well as fund our capital expenditures, ongoing cash dividend program, and any future stock repurchases.

We have committed financing of $700 million in place to closing, and we also intend to upsize our revolving credit facility to $250 million from $100 million. With $222 million in total cash and investments, only $3 million of current long-term debt and very strong consistent cash flow from operations, we are very comfortable taking on this additional debt and hope to maintain our investment grade credit rating.

Our guidance for fiscal year 2007 excludes any impact from the pending merger, as the transaction has not closed. Our business model is very successful and continues to benefit all of our stakeholders. We are executing at a high level, continuing to produce much higher sales comps and sales per square foot than our public competitors. Given our strong historical sales growth, record store development pipeline, continued anticipated acceleration in store openings and this merger, we believe we are well-positioned to achieve our goal of $12 billion in sales in the year 2010.

Over the longer term, however, we believe that sales potential for Whole Foods Market is much greater than $12 billion, as the market continues to grow and as our company continues to improve. We have grown our stock price at an average compound annual growth rate of 23% since going public, and we encourage our shareholders to stay focused on the long term. We are constantly evolving, innovating, and maturing, and have a demonstrated track record of competing, executing, and delivering strong results.

Operator, we will now open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions). We will go ahead and take our first question from Simeon Gutman of Goldman Sachs. Go ahead please.

Simeon Gutman - Goldman Sachs

It's Simeon Gutman. Hey, John, can you elaborate a bit on your comments about the store and the asset base? Can you put some numbers around how many you think you might close write away, how many you might replace over time, or how many you might keep as it relates to Oats?

John Mackey

Yeah, I'm sorry, I really can't do that. We are going to be, the transaction is not going to close until April probably, and we are going to be evaluating all the different strategic opportunities. We are going to be evaluating each of the banners, each of the stores, and we haven't developed our strategic plan in detail that we are ready to disclose today to the investment community. So, probably we will have to wait until after the deal closes. We received all regulatory approvals before we announce any type of exact plan for what stores we are going to open, what stores we are going to close, what stores we are going to convert into Whole Foods Market stores, etcetera, etcetera.

Simeon Gutman - Goldman Sachs

And then maybe we can speak to ahead of time the assimilation of cultures. Clearly you guys have a special culture in place, whether or not it's superior to Oats you guys decide. But do you have a plan of attack, how do you think about that going into this?

John Mackey

We've done a lot of retail acquisitions at this point. And we are going to study Wild Oats and we are going to study how they do things. And we are not going to take an arrogant attitude that we have all the answers. We want to understand how Oats does things and we want to look to do best practices between the two organizations. We are organized in the 11 geographical regions so it's not going to be something Austin, Texas is doing. Every one of our major acquisitions, Bread & Circus, Mrs. Gooch's, Fresh Fields, Harry's, and Wellspring Grocery.

They've all had an impact on the combined culture. And it's impossible to predict exactly how this can involve the Whole Foods future. We are a much larger company than Wild Oats. We are five times larger than they are. So I suspect that more of our culture is going to emerge from this thing. But I don't think we are open to learning, and we have a learning organization and we are looking to see what Wild Oats can teach us and we think there's a lot of things we can teach Wild Oats and we think this combination is going to make both companies a lot better.

Simeon Gutman - Goldman Sachs

Okay. And last one if I may. The older stores, the comps in the older stores, those stores over five years old continue to moderate. Do you have any predictions on when those stabilize? Was there a particular rebuttal or two in those basis that are causing those numbers to moderate?

Glenda Chamberlain

The comps in all of the categories declined. This is Glenda. And of course that is the most vulnerable category since those stores are the smallest and the oldest. And in this particular quarter it did happen that we have the highest percentage of stores in that category that are being impacted by a combination of the factors that are affecting all the stores, competition, cannibalization, some remodeling disruptions, etcetera.

Simeon Gutman - Goldman Sachs

Could those go negative before they get better again?

Glenda Chamberlain

We are not changing our comp guidance which is annual comp guidance and we don't talk about comps for the future related to any of those categories.

John Mackey

So we are reiterating our comp guidance for 2007 at between 6% and 8% for the year.

Simeon Gutman - Goldman Sachs

Thank you.

Operator

Thank you. We will take our next question from Mark Husson of HSBC. Go ahead please.

Mark Husson - HSBC

Good evening. Talking about the acquisition of Wild Oats, when you repose your entire business management philosophy with an EVA view all the things, you mentioned EVA in relation to Wild Oats. What has to happen given the price that you're paying for it in order for this to be EVA positive?

John Mackey

Based on our internal work, this will be EVA positive for us on a present value basis over the long term. I mean the strategy is pretty simple. There is a lot of redundant, corporate overhead between the two companies that's not all going to be retained. We are going to be able to significantly reduce the corporate overhead. We will rationalize the store base to a certain extent, and we think that we will be able to improve the operations of the Wild Oats stores significantly which will increase comps and sales. And, we think we are going to have a very positive impact on Wild Oats and we think they are going to have a good impact on Whole Foods. So based on our internal calculations and we took a fairly conservative approach to it, as our Board insisted that we do. We are pretty optimistic that this is going to be a long-term EVA home run for our shareholders.

Mark Husson - HSBC

Will you be changing any of your own shorter term EVA targets as it relates to bonus payments for executives over the next two years while you're assimilating this?

John Mackey

That hasn't been discussed yet and probably just raises questions for our management team. Honestly, we haven't been focused on our. It won't affect my compensation so I guess I haven't thought too much about it.

Glenda Chamberlain

Will come at $1 to $1.50.

John Mackey

We will look at that. But honestly we just don't think about, I mean I guess maybe we are just different than on the management teams. It's the first time that idea has even been raised. So the bottom line is that this is a good move for the company. The executives need to stand behind it on an EVA basis and if there's some short term hit for it, then it's a good deal. It's going to be a long-term EVA gain. And I actually would argue there shouldn't be any adjustments for the management team. They got to live behind their decisions. They shouldn't be asking for adjustments. I'm only making $1 a year, so easy for me to say that.

Mark Husson - HSBC

And just a final question on that. The amount of cost savings that come out of this, any thoughts intellectually, about, whether those drop to the bottom line or whether those go into providing sharper value in a more competitive environment?

John Mackey

Some will drop to the bottom line, some will pass on to customers and more competitive prices and better services. So I think the answer to that is both.

Mark Husson - HSBC

Thanks very much.

Operator

Thank you. We will go ahead and take our next question from Meredith Adler of Lehman Brothers. Go ahead, please.

Meredith Adler - Lehman Brothers

Hey, guys. I'd like to start, I don't know if this is what Simeon's question was getting at. But, if you could talk a little bit about the strategic rationale for the acquisition because I have some memory that in the past you felt that the stores were kind of small for you, and that your focus was on bigger stores. So, maybe just a little bit about why do this now, if the store base has so many small stores?

John Mackey

Well Oats has been upgrading their store base. Last time we looked to maybe make a deal with Wild Oats was about six and a half years ago and their company is completely different. They have written-off a lot of stores in the last six years. If you look back over the last six years, they've taken, including the write-off they are going to take in Q4 they pre-announced. We are looking at $80 million in store closures and write-offs and many of the new format of outlet stores they have opened in the last few years have been larger stores that are doing very well. It's a different company than when we've looked at it in the past several years ago and stores are bigger. But Whole Foods continues to operate a number of large stores. I mean a number of small stores.

So it's not like all our stores are large. In some cases, the Wild Oats stores over the intermediate and long-term will be relocated. We will take their smaller store and improve it and then we will probably relocate it to a bigger store. So it serves as a good platform or a good foundation that we can. If you open a larger store and relocate a smaller store to it, the risk that you take in the larger store is not nearly as great as if you build a larger store in a new market where you don't have a market presence yet. So it actually takes a lot of risk out of doing any larger stores because they already have a solid smaller store in the market.

I just think Wild Oats operations have greatly improved in the last few years and it's a much stronger, much better company. We are really happy to be acquiring it, and we think it's going to be a -- and the strategic rationale, I kind of already explained. But I will reiterate some of the main points. There is significant duplication in corporate overhead here that can be eliminated. We don't need two Chief Financial Officers. Actually they don't have a Chief Financial Officer at this time. He had already resigned.

Glenda Chamberlain

Bad example.

John Mackey

Bad example. But there is just a lot of duplication that's not going to necessary. There can be significant corporate G&A reductions, A.

Number two, they are in a lot of markets we are not in. So, we are going to be entering into a lot of new markets where we will get a market presence. In addition, all of our 11 regions gained stores. So, this gives additional sales volume and critical mass in terms of leveraging our distribution centers, our produce, and our bakeries. All of our facilities get additional volume which makes them more efficient and more productive.

Particularly, three of our smallest regions are in Rocky Mountain region, the Pacific North West and Florida. Those are three of our very smallest regions. They happen to be the regions where Wild Oats has no stores. So, it's going to give us critical mass in those three regions which is going to enable to us provide better infrastructure support for all of the stores in those regions. So, those three regions particularly benefit, although all of our regions will benefit from this.

Our team is very excited about this. And we really think that Wild Oats has improved their stores quite a bit in the last few years. But we think we can help them improve even more. We think with our retailing intellectual capital that we can put jet propulsion under a lot of those stores in the next year or two and get their comps into double-digits.

The fact that we have a decentralized structure and have incentive programs, whenever in the past we've implemented those incentive programs we've seen comps go up. Pretty much every acquisition that we've ever done or a year into that acquisition; comps are very strong. And we don't anticipate it will be any different in this transaction. We think that we are going to see strong sales gains from the Oat stores. So, the deal makes a lot of sense for Whole Foods from a number of standpoints.

Glenda Chamberlain

I just want to add on to that to say that we still have 68 stores that we are operating that are less than 30,000 square feet in size. And those stores are highly profitable for us. So, even though our average store size is growing, the Whole Foods Markets still loves those stores. And in this case, we believe that we can improve the profitability of those stores to the same level or close to those of our own stores.

Meredith Adler - Lehman Brothers

Okay. And if I may ask just a couple more questions. You mentioned that healthcare costs went up. If you could just talk a little bit about that and what the outlook is, how you manage it?

Glenda Chamberlain

Our healthcare costs did go up greater than our sales in the quarter, and similar for us as to most other companies in the United States that are dealing with increases in healthcare costs. So, nothing beyond that really to talk about.

Meredith Adler - Lehman Brothers

Okay. And then, my final question is about your price point. And I know you've talked about branded products being more aggressive. But has the company ever thought about changing your positioning in terms of perishables? Not the quality, but instead of having the premium item in every category that you may be move down the notch and would that help do you think the price perception?

John Mackey

Walter, A.C., do you guys want to tackle that question?

A.C. Gallo

Sure, I will. This is A.C. We are doing that to a certain extent. For instance in seafood, we sell the highest quality fresh seafood. And it isn't easy in seafood to say that drop your quality on fresh. You either have great seafood or you don't have great seafood. But what we have done is we've introduced over the last few years a whole line frozen seafood under the Whole Catch label. And that is priced very competitively with all our competitors. And we are seeing a tremendous lift in those products. And customers are really responding well to that.

So, within categories in the perishables, we have taken certain selections and offered them at a really great price point. But overall, what most of our customers really expect is the highest quality perishables, produce, meat, seafood. And we are going to maintain that quality. We are not going to drop that. But we can work within certain categories that can make it more affordable for our customers.

Meredith Adler - Lehman Brothers

And does that impact labor? Because all of these categories are labor-intensive and yet the price point is coming down, so presumably the sales will come down?

A.C. Gallo

Sure. If people just transfer from say a fresh fish item to the frozen item and into the lower price point, our sales will go down unless we get great lift. What we have seen in a lot of areas is that we are getting great lift in order to hold our sales. In some cases that may not be true right away. But we think over the long term, we are going to be building overall sales even greater.

Meredith Adler - Lehman Brothers

Okay. Thank you very much.

Operator

Thank you. We will go ahead and take our next question from Steve Chick of J.P. Morgan. Go ahead, please.

Steve Chick - J.P. Morgan

Thanks. That's so surprising. I have a few questions if I could. Can you discuss may be the bidding process that took place and how long your due diligence was as you looked at some of the books and did your analysis of Wild Oats? And may be discuss just how the process started, first off?

John Mackey

We try to pay the lowest price possible and they try to get the highest price possible and we compromised on it. Honestly, I initiated the contact by calling up their Interim CEO, Greg Mays. I mean, Perry Odak, the CEO's contract wasn't renewed at Wild Oats and their CFO that they had hired also resigned. And I thought maybe this would be a good time to approach Wild Oats because they don't have a new CEO in place, they may not have a new clear definite strategic direction for where they want to go.

And when we looked at it from Whole Foods' perspective and we did that general strategic analysis that I just gave a minute ago, we've seen continued operating improvement by Wild Oats in the last few years. These guys were definitely getting better. They were getting to be a stronger competitor. They were doing a much better job. They were doing a better job in the real estate. And we just thought it was a good time to take a look at it.

So, I basically gave Greg a call and floated the idea out there. And basically he said, what's your price is going to be? And we danced around that for a couple of weeks, and we went back and forth on it and there you have it. We are giving a good premium over the market price and we think it's a good transaction for the Wild Oats shareholders. And we think it's going to prove to be a very good transaction for the Whole Foods Market shareholders because of the value-added that we can bring to Wild Oats we think from Whole Foods. So, we are very excited about it.

Steve Chick - J.P. Morgan

I can see the potential value. It was just interesting that it sounds like the conversation maybe had taken place on the heels of your recent, a quarter ago where you discussed some competitive things within the industry. So, I'm wondering a bit if it's a reaction or somewhat of a defensive type of acquisition or if you would characterize it as offensive?

John Mackey

No, Steve, actually we are just highly opportunistic. A lot of times the deal is about the right timing. When is the right timing? And the timing was right because of this strategic gap at Wild Oats. Without a new CEO, they are in an executive search looking for one, without a clear sense of where they are going to go, we thought it would be a good time to approach. And it was. So, I really don't have much else to say about it.

Steve Chick - J.P. Morgan

Got you. Okay. That helps. All right. And then, in terms of the synergies, you mentioned some line items of synergies here, and G&A costs and so forth. It seems like the most material one would be the fact that your stores' productivity are double that of the Wild Oats base. And I was wondering with your due diligence, can you speak a little bit about to what the SKU overlap is? Broadly of course at this point, but SKU overlap and remerchandising and can some of Oats stores structurally take $450 sales per square foot and get it closer to where you are?

John Mackey

Steve, you just gave the rationale for the merger better than I articulated it, which is, yeah, our sales per square foot are practically a 100% higher. And there is no intrinsic reason, why with a lot of shared intellectual capital and best practices and hard work we can't get those sales per square foot at the Wild Oats stores comparable over time to what Whole Foods Markets' is. You can really understand that. You can understand the tremendous upside this deal has for our shareholders.

Steve Chick - J.P. Morgan

Right. That's why I was surprised you didn't label this as a number one in terms of synergies?

John Mackey

We talk about shared intellectual capital. But we don't want to come out there and say we are going to double the sales per square foot in the next year. So, it's a pretty high hurdle to jump over. But we do think we can improve the productivity of the Wild Oats stores significantly. But, it will take time. We did emphasize in the script that it usually takes a couple of years to fully integrate stores. So, we are not going to work miracles here the first month after we take control of the stores. It takes hard work and time and lot more than you can see in this spread sheet. But a year from now, we will definitely seeing be very good progress. And it might take fully two years before you really see all the synergies beginning to play out.

Steve Chick - J.P. Morgan

Right. Okay. And as I walk into a Whole Foods store and when I go to a Wild Oats store, it seems like the SKUs and the merchandising are just vastly different. Critically, is the idea here that you take a US sign, your merchandising expertise and maybe revamp their SKU base to look more like yours, is that the initial thought?

John Mackey

We want to understand what Oats is doing as well as possible. We don't want to be too presumptuous. But, yeah, I do think that we will undoubtedly, a lot of our intellectual capital is going to flow to Wild Oats and some of its going to flow to Whole Foods Market. And it's hard to predict exactly how that's going to mix before we get in there and start doing it. We can't get in there and start doing it until the transaction closes. So, there is going to be a lag period here.

Steve Chick - J.P. Morgan

And is the FTC an issue or they are even going to look at this in light of competition from traditional grocers. Do you think that the FTC needs to look at this closely and will that be an issue?

John Mackey

Yeah, to me, I think they should. I'm the wrong guy to answer that question. Obviously, we want the government to bless this transaction. So, the sooner they do the sooner we can move forward and begin the integration. But, I'm not the one to ask about how the government or regulators are going to view this.

In view of the fact that this a highly competitive market and there are no barriers to entry. And Safeway, and Kroger and Super Value and Wal-Mart are massive companies that are multiple times bigger than Whole Foods and they are all selling these products. I just don't anticipate why there should be any problems here. This is a highly competitive market and this transaction is not going to make it less competitive

Not to mention Trader Joe's, which has grown from 120 stores to 270 stores in the past six years. They are very formidable competitor and it flies under the radar because they don't talk to the media and their private company. But they are financed by one of the richest families in Germany with billions of dollars of assets behind them. They are a very large. Their company has more stores than we have and is growing very rapidly.

So, this is a highly competitive market. This is a big acquisition for us. Our current growth rates will grow even without this transaction. We basically are growing about every year and a half equal to what we are getting in this deal in terms of increased sales. So, it's going to accelerate our growth. But it's something that we can integrate these stores. We can make them better. We are excited about it and it's a very competitive market out there. This is something that's in the best interest of Wild Oats shareholders and in the best interest of Whole Foods Market shareholders. We need each other.

Steve Chick - J.P. Morgan

Good points. Two others, if I could, just last. Glenda, you reiterated your operating income guidance that grows in line or slightly lower than sales. But this quarter it looks like your contribution profit grew below sales for the first quarter of the year. Am I looking at something differently? I was a little surprised. I don't know why you didn't get a little more conservative with the new store openings that are coming on through the year and so forth?

Glenda Chamberlain

Our guidance is annual guidance, not quarterly guidance. And what we said in the press release, we reiterated our growth goal for FY 2007 and beyond, and stated that we have not changed our guidance or that our guidance does not reflect the merger obviously.

Steve Chick - J.P. Morgan

Right. Okay. But just looks on the core base, that maybe you need an acceleration in that operating earnings number as the year goes on, I guess that's what's implied in guidance, right?

Glenda Chamberlain

Slightly, yes.

Steve Chick - J.P. Morgan

Okay. And last one and I will let you go because I've taken a lot of time. John, you don't usually speak to EPS dilution or EPS generally and you speak to EVA, which I can appreciate. But just to, once this deal closes and we have our thoughts right. It does look like that $700 million, I don't know what borrowing rate we should use, but if I use a 6% pre-tax borrowing rate and current operating earnings of Wild Oats right out of the box, it looks like it might be EPS dilutive with the idea that it will become accretive over the course of the year or two-year plus timeframe as you said. Is that the way I should think about it?

John Mackey

We are not giving any guidance on EPS here in this transaction. By the time the deal closes for our fiscal year, it's all going to already be significantly over. And there is going to be a transition period in terms of rationalizing the corporate G&A and deciding what stores to close, etcetera, etcetera. So, it's going to be a bit of messy for a quarter or two I think. But I think a year from now when we will be having this call one year from today, the value or the synergies of this merger are going to start appearing very strongly.

We really appreciate and we really want to encourage our shareholder base to look at least a year or two down the road instead of a couple of months down the road here. This is a very good strategic intermediate to long-term transaction for our shareholders, for EPS, for our EVA. But I'm not going to make any predictions about first quarter or two after the deal happens.

Steve Chick - J.P. Morgan

No, that's fair enough. I can appreciate that. It's just to maybe as you close a deal, it might be helpful right out of the box. We can all do our math, I will do it and everybody else will, but just to maybe have a first call thought process consistent with what you think, but whatever, we will go from there. But congratulations. Thanks.

John Mackey

Steve, we are working hard to try to get people to think long-term on our stock. And so, we are really trying to not do minute quarter by quarter guidance. We really are trying to give ranges looking out into the future. Hey, it's up to you guys to do the quarterly stuff.

Steve Chick - J.P. Morgan

No, thanks. Good comps for the quarter, by the way.

John Mackey

Thank you.

Operator

Thank you. We'll take our next question from Ed Aaron of RBC Capital Markets. Go ahead, please.

Ed Aaron - RBC Capital Markets

Great, thanks for taking my question. Actually I wanted to touch on a couple of things. There seems to be kind of a growing perception, at least in the investment community, that Whole Foods is starting to more and more beat up vendors in a way that's unsustainable. And just with that is kind of the backdrop and now with the Oats acquisition coming together, can you talk about how you are going about managing your supplier relationships?

John Mackey

Ed, I want to make, for the record, I don't beat my wife, and we don't beat up vendors. So, I don't really know how to respond to that question. Vendors are part of our stakeholder group, and we try to deal with them is with integrity and as fairly as possible. At the same time, we're trying to create value for our customers and our shareholders. And so, I don't know what else to say about it. We feel like we are treating our vendors very fairly and we've created tremendous value for our suppliers overtime and have allowed many of them to flourish and sell out to rich companies for lots of money due to primarily Whole Foods volume. So, we are always seeking to get a better deal for our customers and for our shareholders. So, I think that's just the dynamic of business.

Steve Chick - J.P. Morgan

That's fair. It wasn't my opinion necessarily; I just wanted you to address the perception that I think seems to be out there. Secondly, you've always I think taken a philosophy with your business of investing to drive comps and you spend a lot of money on your stores, you don't skimp on labor and as long as you've had good comps, which you really always have its worked very well for you, just with comps having slowed somewhat of late, now I was just wondering, if you've kind of thought strategically since this past quarter or so about any kind of contingency plan that you might have in the event that the competition out there has increased to a level where your comps do slow further from where they gone at this point?

John Mackey

I want to apologize for 7% comps. We think our comps are very good, and if do you a two-year number that's a 20% comp over last two years. Any other food retailers close to that? No, the answer is no. Our comparisons have been very difficult and over the next few quarters, we are going to start getting easier comparisons, so it's going to get easier. Also of course, we think a year from now when this transaction is closed and we've been able to as Steve Chick very perceptibly noted our productivity for Whole Foods stores is much higher and as we are able to transfer that productivity to Wild Oats stores we expect significant gains in their comps, and as we rationalize the store base to a certain extent there will be some comp gains as a result to that as well.

So, I don't think Whole Foods has a comp problem. It's only that we have three years of very high comps that apparently has gotten people thinking that we weren't going to revert to the mean, although we always sort of indicated we would. So, we've given 6% to 8% guidance for the year and I feel confident we are going to hit that number. And I think those are good comps and we are proud of that. I think we are in a very competitive market; Whole Foods is doing a very good job of producing real good comps in a very competitive market. So, if they are not good enough I don't know what else to say. We are happy with them.

Steve Chick - J.P. Morgan

Thanks, fair enough. One more question, I was just hoping if you could maybe address kind of your managerial bandwidth. This acquisition is coming on at the time of the significant acceleration of square footage growth, and just how you are tackling that, I know you have a decentralized management structure that's quite adaptable but just want to get your thoughts?

John Mackey

Yes, it's a good question. It is hard to please the investment community sometimes because first we have got our growth slowing down and maybe we are growing too fast, can we handle the accelerated growth. We've got 11 geographical regions, and I think Walter and A.C. should answer this question because they are really positioned well to say whether they think the regions can handle the Wild Oats integration combined with the addition of stores we are opening up, A.C. and Walter what do you think?

A.C. Gallo

Walter, do you want to take that one?

Walter Robb

Yes sure. I think that this thing lines up nicely with where the growth is, the regions that have the greatest growth in the next two years actually don't have or have the lower amount of stores in this acquisition and the regions as John mentioned that are kind of on our smaller side have the nice growth from this acquisition. So, it actually lays up nicely side-by-side from that respect. So, it gives us the critical mass to really accelerate those three particular regions and on the other ones, they are able to continue on and focus on their new store growth.

A.C. Gallo

Some ways I'll answer that, too. In some ways it really helps the smaller regions because by getting this volume where all of a sudden we are able to build up the infrastructure for those regions, a little bigger right now, which allows us to handle the growth that they are going to be having over the next three years in opening up new stores, but it does, as Walter say it match-up pretty well with different needs around the company.

Walter Robb

Wanted to just make one other comment to Steve Chick's question which is that, remember that Wild Oats and Whole Foods have very similar quality standards. It's not like we are buying someone that has merchandise that we are going to put that on the sidewalk. These standards, they are very similar to core values and cultures. So, the remerchandising that happens that there's a lot of the similar product and that makes this sort of movement forward much, much easier in a situation where we'll have to rethink things.

Steve Chick - J.P. Morgan

Great. Thank you and good luck.

Operator

Thank you. We will go ahead and take our next question from Mark Wiltamuth of Morgan Stanley. Go ahead.

Mark Wiltamuth - Morgan Stanley

Mark Wiltamuth with Morgan Stanley. I just wanted to know, if you think there is going to be any upfront transitional spending in the first year and do you have any thoughts on what the CapEx will be to go through remodeling?

John Mackey

We've only done some initial thinking about it. We don't have anything to announce today about it. We are going to make some capital expenditures on some of the stores but we don't have a complete plan for it yet, and we won't before the transaction closes. So, hopefully next quarter we'll be able to throw little more light on it.

Mark Wiltamuth - Morgan Stanley

Okay. And getting back to some of the productivity issues, are the sales per-square-foot for your smaller stores of a similar average as your entire base relative to the Oats stores? I know obviously you have bigger stores that are probably more productive, just trying to get an apples-to-apples store size comparison on productivity?

John Mackey

We don't actually have that data from Wild Oats. You'd have to appreciate Wild Oats' position for sharing data with their largest competitor. Needless to say they will have to be conservative in terms what they showed us in the event the deal didn't get agreed upon by the Boards of Directors and in the event their shares don't get fully tendered. So, we don't have that information yet, and probably won't have all that detailed information until after transaction closes. We only know what Wild Oats reports in terms of sales per-square-foot, and they do it on a roll-out basis. I expect that when we look at it, it will probably be somewhat similar to Whole Foods. Yeah, smaller stores tend to have higher sales per-square-foot on a general average, but also the smaller stores are older and so they are also more mature. I expect that rule probably is similar for Wild Oats.

Mark Wiltamuth - Morgan Stanley

And maybe if you could go through looking at merchandising opportunities, what categories do you think you can really improve upon in the Wild Oats stores? Just give us an idea of where you will be working?

John Mackey

Walter and A.C. Where we are going to be working?

Walter Robb

Primarily in the perishable departments, in the center store, the SKU counts are fairly similar in the natural and organic foods. We tends to carry more, say, foodie brands and maybe more little upscale foods in the center store. But we feel like we have a lot of experience and a lot of great talent in the perishable areas. And because each one of these stores lines up with one of our operating regions, we can give really great support with our facilities. We have distribution centers for produce and we do a lot of our own seafood distribution. So, we feel like we've got the infrastructure in place to really upgrade the perishable qualities and all the perishables and we think that we also can improve tremendously their prepared foods and bakery.

A.C. Gallo

There is some things that Wild Oats does extremely well, as John mentioned in their private label is sharp, their brand has some equity. So, I think we are going to take the approach that John outlined of just trying to learn and see what's really going on there under the hood when we get in there. But if you look at their perimeter, I think that's where the greatest opportunity to compare the two companies and that's probably the greatest opportunity to incrementally improve.

And again, I just want to make an overall comment on behalf of us is that we know how to do this. We've done acquisitions before and they've always been a tremendous help to the company in terms of us learning and growing and we always try to honor the traditions of the company that we've acquired and made it a good two-way street and this is right up something we know how to do very well. These are stores that are similar to ours, even if they are on the slightly smaller size. We know how to do this and it's going to be very, very exciting time for Whole Foods.

Mark Wiltamuth - Morgan Stanley

And on the distribution side, is there anything notable there in terms of what Oats brings to the party or will you just role them into your distribution?

John Mackey

We have to look at that and make sure we understand exactly what they have, but I don't think their infrastructure is as developed on that side. So, most likely roll it into ours but we have to look. We haven't really studied all that yet.

Mark Wiltamuth - Morgan Stanley

Okay. Thank you.

Operator

Thank you. Due to time constraints, we no longer have any time to take any further questions. I would like to turn the call back over --

John Mackey

Operator, we are going to extend the call. We have a lot of people in the queue. So we are going to extend it to another 5 to 10 minutes. Okay?

Operator

Okay. No problem. Then we will go ahead and take our next question from Greg Badishkanian from Citigroup. Go ahead.

Greg Badishkanian - Citigroup

Alright, thanks. Greg Badishkanian. Just ask one quick question. And congratulations on the Oats deal, by the way. When you look at the new stores that you've opened recently over the past year or so, how would you compare those to the ones that you opened up maybe two or three years ago? Are they as successful? And when you look at the different markets that you plan to focus ongoing forward, any changes there? Do you think you can open up more and say, the urban formats or are there some geographic areas that you think you would want to focus more on, given performance of new stores?

John Mackey

Greg, basically we are happy with the new stores being opened. A couple of years ago, we opened up Union Square in Manhattan and we opened up our Austin store. When you open up stores like that, they really drive up the overall sales, profitability and productivity in of new store base. And guess what happens after 12 months, they are no longer new stores. They go into the comp base. They do help comps but they no longer help the new stores.

So, we haven't opened up any stores in 2006 that were or so far in 2007 that were comparable to those two blockbuster stores. We are actually thinking in 2007, we think our new store in Manhattan at Bowery House and Houston is going to open up in March and in June we are opening up our store in London. We think those are going to be blockbuster stores, both of them. So, we may see good new store productivity numbers kind of skew up as a result.

So, I don't think you should read too much in from any particular, or try to get too much about trend lines because it's so dependent upon the inventory. What stores have actually come in and which ones have gone out and they don't reflect any overall change at Whole Foods Markets. We are happy. Our stores are performing in terms of sales, where we estimated them to do or above in almost every case. So --

Glenda Chamberlain

This is Glenda. When we are a larger company and we are opening a lot more stores on an annual basis, then that will be a lot more meaningful. But because the number of stores we are opening in any one year is small, one or two outliers either direction can have a significant effect.

Greg Badishkanian - Citigroup

Right, and would you say that the opportunity to open up new stores is, there is still an opportunity in all types of markets? There is not any one type of market that you would be focusing more heavily ongoing forward, there's just a lot of opportunity out there?

Jim Sud

Yes. This is Jim Sud. We are continuing to see a lot of opportunities, as you can tell from the materials. We've currently got 88 stores in development, slightly under 5 million square feet and continue to add to the pipeline every quarter. So, one of the stores we announced today was actually another new location in Manhattan. So, there's a lot of opportunity that we are continuing to see in new markets and existing markets. And so, there is a lot of growth ahead in that regard.

Greg Badishkanian - Citigroup

Thanks. Look forward to shopping in your downtown store when it opens up. Thanks.

Operator

Thank you. We will go ahead and take our last question from Andrew Wolf of BB&T Capital Markets. Go ahead please.

Andrew Wolf - BB&T Capital Markets

Thank you. Can you speak to the Wild Oats contract for distribution with United Natural Foods? I think it has a few years left. Is there any opportunity for a change in control or other means to get the terms of that to be what Whole Foods, its terms are, or do you have to wait for that period of the contract term?

John Mackey

Andy, that's a fair question, but we are not prepared to answer it yet because we haven't even talked to Unify. They just heard about the deal probably the same time you did. So, we will have, maybe a little more color on that next quarter. No comments on it today.

Andrew Wolf - BB&T Capital Markets

Okay. I can understand that. When do the acquired stores typically enter the comp base, 12 or on the 13th month?

John Mackey

Yeah. We don't treat them as new stores. It's a good question. We hadn't actually thought of that whether we will break out the Wild Oat stores for reporting purposes on comps. We might do that. We have to talk amongst ourselves and decide how we are going to report the Wild Oats results, the first two or three quarters. It's a real close to Whole Foods numbers, we might just integrate them or we might break them out for a while, so the investment community can see the trend lines in terms of comps and what not. But certainly by the 53rd week, they will all be in the comp base. So, we'll have to figure that one out. That's good question. Thanks.

Andrew Wolf - BB&T Capital Markets

And in terms of the schedule that you guys put out which is a terrific schedule for investors, by age and how the stores are comping and other statistics, their size and so on, do acquired stores? The Wild Oats stores that go into the comps base, do they enter that schedule when they were opened or will they all be two years or less?

John Mackey

Another good question. I don't know.

Glenda Chamberlain

What we have done historically like with Harry's is we put them into their actual age category. We didn't put them into the new store category. And what we will probably do, what we will attempt to do is take our historical results and to the extent we can, we will move them. We will put some information on our website with the combined historical results in those categories, so that it helps to give a perspective on the going forward numbers.

Andrew Wolf - BB&T Capital Markets

Thank you very much and congratulations.

John Mackey

Thanks.

Operator

Thank you. This does conclude our Q&A portion of today's call. I would like to turn it back over to our moderators for any closing remarks.

John Mackey

Okay. Thanks for listening in. Visit our website for a transcript of the scripted portion of this call. A recording of call will also be available on line through a link on our website at www.wholefoodsmarket.com. We will talk to everyone next quarter. Take care.

Operator

Thank you. This does conclude today's conference call. We appreciate your participation and you may now disconnect.

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Source: Whole Foods Market F1Q07 (Qtr End 1/14/07) Earnings Call Transcript
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