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Whole Foods Market, Inc. (NASDAQ:WFM)

F1Q2012 (Qtr End 01/15/2012) Earnings Call

February 08, 2012 05:00 pm ET

Executives

Cindy McCann - VP, IR

Walter Robb - Co-CEO

Glenda Flanagan - EVP &CFO

A.C. Gallo - President & COO

John Mackey - Co-CEO

Jim Sud - EVP, Growth and Business Development

Analysts

Mark Miller - William Blair

Charles Grom - Deutsche Bank

Stephen Grambling - Goldman Sachs

Ed Aaron - RBC Capital Markets

Sean Naughton - Piper Jaffray

John Heinbockel - Guggenheim

Ed Kelley - Credit Suisse

Karen Short - BMO Capital

Scott Mushkin - Jefferies

Operator

Good day everyone and welcome to the Whole Foods first quarter earnings conference call. At this time all participants are in a listen-only mode. Later you will have the opportunity to ask questions during the question-and-answer session. (Operator Instructions) And it is now my pleasure to hand the call over to Cindy McCann, VP of Investor Relations. Please go ahead.

Cindy McCann

Good afternoon and thank you for joining us for Whole Foods Market first 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.

As a reminder all forward-looking statements on this call are subject to risks and uncertainties that could cause the company’s actual results to differ materially from the expectations and assumptions discussed today. This may be due to a variety of factors that affect the company, including the risks specified in the company’s most recently filed Form 10-Q and 10-K. Please note our press release and scripted remarks are available on our website. We assume you’ve read our press release, so we’ll use this time to focus on highlights from the quarter.

I will now turn the call over to Walter Robb. Walter?

Walter Robb

Thank you Cindy and good afternoon everyone from Austin Texas. We are very pleased to begin the year delivering another quarter of consistently strong results. For the first quarter we produced 8.7% comparable store sales growth, average weekly sales per store of $667,000 translating to near record sales per square foot of $929. 9.1 % store contribution, 5.6% operating margin and our 11th consecutive quarter of year-over-year operating margin improvement, 8.3% EBITDA margin, a 28% increase in diluted earnings per share to $0.65; and 12.6% NOPAT return on invested capital.

Our solid execution, capital discipline, and increasing stock price generated over $340 million of cash during the quarter through a combination of $261 million in cash flow from operations and $80 million in proceeds from team member stock option exercises. We invested $111 million in new and existing stores, returned $18 million in quarterly dividends to our shareholders and repurchased $4 million of common stock. Our total cash and investments increased during the quarter by $209 million to just over $1 billion, a company milestone.

Turning to sales, given increasingly tougher comparisons and slightly moderating inflation, we are particularly pleased to deliver our 9th consecutive quarter of accelerating two-year comps which were 17.7 % for the quarter. Our sales momentum continues to be broad based across regions, departments and store age classes. Even stores over 15 years old comped at 4%, with strong transaction count increases of over 4%.

We are pleased to see increases in transaction count back over 6%, reflecting our ability both to attract new customers and to retain our loyal core customers. With the moderation in inflation, the breakout between our transaction and basket size increases was back to the 80:20 mix we were reporting prior to the sharp increase in inflation in the back half of last year.

Our core customers spend on average close to three times more than new customers, so as the increase in our average transaction count accelerated and inflation moderated in Q1, we saw the increase in our average basket size moderate as well to 2%. We were able to selectively pass through product cost increases while customers continued to trade up, resulting in higher average price per item which drove an increase in our basket size. This was offset slightly by a decrease in items per transaction. On a year-over-year basis, our customers have shifted their purchases towards organic products, higher price tiers, and several discretionary categories. We are nice growth in our 25 to 50 dollar basket and also continue to see strong increases in the 50 dollar plus-size baskets.

Excluding LIFO, gross profit increased 10 basis points to 34.7% of sales driven by an improvement in occupancy costs as a percentage of sales. Similar to our results in the fourth quarter, we did not see cost of goods leverage as we remained focused on balancing rising product costs with maintaining our relative value positioning to drive sales over the longer term.

During the holidays, it was important to get the center of the plate in order to get the rest of the holiday meal, so we were very sensitive to maintaining the right price levels in our meat departments despite sharp cost increases in beef. Inflation isn't going away, but we believe the moderation will give us additional flexibility to consistently deliver gross margin on an annual basis within our historical range of 34% to 35% while maintaining our sales momentum.

Turning to new store growth. During the first quarter we opened six new stores in Folsom, California; Jamaica Plain, Massachusetts; Minnetonka, Minnesota; Yonkers, New York; and our first stores in Oklahoma City and Scotland. Our new stores continue to generate a lot of excitement. In Folsom, we had a 1000 customers waiting for our doors to open, with some even camping out the night before or first. Folsom is about 20 miles outside of Sacramento and is one of the areas of the country that was hit fairly hard by the housing collapse. It's a good example of the success we are seeing with our broader real estate approach and our ability to go into some of the smaller, more suburban markets. In many cases, these markets offer less competition, allowing our differentiated store experience to stand out even more in the marketplace than it does in some of the larger, more competitive markets. The economic case is compelling because rent is significantly less and with the smaller size, our capital spend is less as well.

We believe our new store results are reflecting the success of our broader strategy. Our new stores showed strong year-over-year improvement in operating performance in the first quarter. Compared to last year's class of new stores, this year's class was 17% smaller in size, averaging 38,000 square feet and produced average weekly sales per store of $561,000 translating to 29% higher sales per square foot of $776. These new stores produced about 450 basis points higher store contribution versus last year's class.

In other news, we were extremely pleased to be ranked number 32 on Fortune's list of the “100 Best Companies to Work For”. To be one of only 13 companies ranked consecutively since the list was first published in 1998 validates our commitment to our core value of supporting team member happiness and excellence.

We encourage you to visit the Beyond the Number section of our Investor Relations webpage for more information about our Fortune ranking, videos from the new stores including our Giffnock opening in Scotland featuring the Red Hot Chilli Pipers and more.

Since our fourth quarter earnings release, we have signed eight new leases averaging 33,000 square feet in size in Frisco, Colorado; Miami, Florida; Orland Park, Illinois; South Bend, Indiana; Minneapolis, Minnesota; Jackson, Mississippi; Port Chester, New York; and Cleveland, Ohio. Frisco, South Bend and Jackson are all new markets for us. We have signed 34 new leases over the last 12 months and are on track to open between 24 and 27 new stores in fiscal 2012 and 28 to 32 new stores in fiscal 2013. We currently have 69 stores or 2.4 million square feet in development equal to 20% of our 12 million square feet in operation.

I will now give some additional color on our raised outlook for fiscal year 2012 which is a 53-week year. Please refer to our press release for more detailed information.

In the first quarter, we beat the Street estimates by $0.05. Based on our Q1 results and updated assumptions for the rest of the year, we have raised our operating margin to 5.9% and diluted EPS range to $2.28 to $2.32 for fiscal 2012. This implies six% operating margin and EPS of $1.63 to $1.67 for the remaining three quarters of the year.

We also slightly raised the low end of our sales, comp and identical store sales growth ranges. We are seeing our sales momentum carry into Q2 with a 9.4% comp or 18.1% on a two-year basis. These are obviously great numbers, but keep in mind this is just a three-week period and that last year's results were impacted by severe winter weather. So several of the regions had a much easier year-ago comparisons. In addition, we do expect inflation to continue to moderate from here

As currently reflected in the Street estimates, we typically see higher average weekly sales in our second and third quarters, which drive stronger bottom-line results, and then sales tend to drop in the fourth quarter, which is seasonally our weakest quarter. We would like to point out that last year's Q2 and Q3 results were very strong, particularly the gross margin improvement. We expect our year-over-year improvement in gross margin for the remainder of the year to be more in line with the results we produced in the last two quarters.

In addition, our year-over-year EPS growth in Q1 was driven in large part by lower direct store expenses, and while we hope that trend will continue, certain expenses like healthcare costs are difficult to predict. On a 52-week to 52-week basis, our raised outlook reflects a healthy 17 to 19% increase in operating profits for the remainder of the year on an 11 to 13% increase in total sales; however, the EPS increase is less due primarily to the year-over-year change in our tax rate and share count.

In summary, it's great to start the year off on such a high note. There are some positive things happening on the economic front, which we are hopeful will continue. We have tremendous sales momentum as well as the capital and expense disciplines in place to leverage that momentum to the bottom line.

We see great opportunities on the real estate front and are focused on continuing to build our new store pipeline. Our broader real estate strategy is bearing fruit as evidenced by the strong performance of our new stores.

The marketplace remains highly competitive, but we believe we will continue to gain market share through further differentiating our shopping experience, reinforcing our position as America's healthiest grocery store, and maintaining our relative value positioning.

Before we turn our call over for Q&A, we would like to congratulate Michael Besancon on his upcoming retirement and thank him for his 17 years of outstanding leadership. Michael has served as a Regional Vice-President, a Regional President and most recently as our Senior Global Vice President of Purchasing, Distribution and Communications in addition to leading our Green Mission task force. Having worked in the natural products industry for 41 years, Michael is one of the most knowledgeable, natural and organic foods pioneers, and his wisdom and compassion will be greatly missed.

We will now take your questions. Please limit your questions to one at a time so that everyone has a chance to participate. Our call will end at 4:45 Central time. Thank you very much.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question will come from the side of Mark Miller with William Blair. Your line is now open.

Mark Miller - William Blair

Hi, congratulations on a great quarter. I wanted to dabble a bit further into the improvement in the store operating expenses. I know you can be coming across in tougher comparison but can you just talk about where you have been achieving some of the greatest gains. You did call out on wages and depreciation but how much of these are incremental improvements due to your program you put in place because it’s a great level of improvement?

Glenda Flanagan

Hi, Mark its Glenda here. We are very proud of the results and that we’ve seen the leverage in direct store expenses. There are a lot of discipline that we put in place over the last few years and our operations team is very focused on leverage that we did. Back in the days of 2007, 2006 we had direct store expenses in the 25.5 25.7% range. It’s reasonable that we can certainly get back to those levels and we’ve guided to and our philosophy all along has been continuous improvement. So there is no reason why we can’t expect to continue this improvement from here particularly like I said with disciplines that are now in place on the operation side.

Mark Miller - William Blair

And then, if I can just squeeze in another quick one. On the transaction count accelerating in the period early, as component of the comps, as you look at that, what you think is causing the frequency to go up?

A.C. Gallo

Mark, this AC. I think that a lot of what was going on is that we continue to put in very aggressive programs essentially through Q1 on different kinds of promotional programs. We saw that, definitely with inflation that was happening last year especially towards the end of the year, going and coming out of Q4 and the Q1, we are very concerned with customer’s reaction, as we worked on some very strong promotional programs. We held our pricing in a lot of places and I think that recharge really had an effect to bring lot of new customers in.

When we go through periods like this, we tend to see a stronger growth in the transaction count and then usually the much more and then what happens with the basket, size tends to be smaller or at levels off because it doesn’t grow as much because the new customers are buying as much as the experienced customers do. But I think a lot of it was that, we really focused a lot specially going to the holidays. We wanted to make sure that customers felt it really comfortable especially with some of the economic uncertainty in the fall, really felt comfortable during the holiday shopping with us.

Walter Robb

This is Walter, I am just going to add a couple of things which I think that AC stressed the value representing that. I think the difference here plus the secrete sustainability that meets standard. I think these things are really landing and I think it all starts here in particular. We got over 15,000 customers signed up for the 20-day challenge that’s happening right now in the company. And I think our brand, our name of the company, what stands for is getting stronger and these customer accounts, these transaction accounts is a stunning number and it’s very encouraging. It’s pretty broad-based.

Operator

And we will move to our next question. It comes from the side of [Robby Ums] with Bank of America. Your line is now open.

Unidentified Analyst

Hi, this is [Kelly Bean] actually in for [Robby Ums]. Just a follow up on that. I was wondering if you could comment on the redemption rate you are seeing in the Whole Deal coupons. I am curious if that has moderated in recent quarters as we’ve seen trade-up accelerate or is there still a segment of your customer base that continues to utilize that program?

A.C. Gallo

Hi, this AC some update on Whole Deal. The average basket containing our Whole Deal coupon, coupon for the Whole Deal is $73, with 20 items compared to an average basket for [Dennis] store is about $36 for eight items. So, we’re still seeing really good results for that and in Q1 we had 1.2 million in store redemptions, which was up 22% year-over-year. So, we’re still seeing very good result with it. We’re continuing to develop that based on the types of items to see they are working well. So, it’s clearly refining. I think we’re just getting better at using that vehicle.

Unidentified Analyst

Thanks and then can I just follow up real quickly on the comp acceleration into Q3. Can you give us any color with that of continued acceleration in the transaction count?

John Mackey

This is John Mackey here. Your slices and dice has been only been a few weeks in quarter and it is really always the external events are going to factor in any particular weeks. We have Valentine week coming up next week and Super Bowl. So those can be factors and so I just want to read too much in that event and wait and see how the quarter turns out. So comp here.

Operator

And we will go to your next question, it comes from the side of Charles Grom with Deutsche Bank, your line is now open.

Charles Grom - Deutsche Bank

Thanks on the quarter. Just on the cost of goods sold lack of leverage. Just wondering if could just dig into how much of that is self-inflicted on your part and also if you want to quantify that for us?

Walter Robb

First of all thanks for the complements Chuck. We are pretty much doing, I think what we said we were going to do which is to get the continue to manage that right in the range there and so while there wasn’t any leverage on the sales, we are navigating through a time where, I think inflation peaked during this quarter, and so we are navigating at higher prices with the price investments and the percentage of stuff we sold on discount of the company was still around 15% and with stiffness I think we are managing our investments and promotions a lot better. So it didn’t really have an impact on the gross respect. You want to add to that AC?

A.C. Gallo

We feel like we have got to the point especially with some of the increases we have been getting in our cost of goods from vendors based on lot of commodity prices going up and these prices have been very high. The US cattle herds are at 60-year low and that’s really affected the beef price especially with our antibiotic free and organic beef cattle.

So we just felt like going through this period that most important thing to do is to keep investing in our prices, so that our customers feel like while there maybe certain products that are going up, they are finding plenty of good deals in specials and other areas and to keep the momentum going and I think its been working really well with the growth in our transaction count.

Glenda Flanagan

And I’ll just add to that, that the results in the first quarter were very consistent with what we produced in the fourth.

Charles Grom - Deutsche Bank

And then if I could just sneak one, second one, and just on the guidance here, in the quarter your store contribution margins ex-life were up about I think 74 basis points and I feel over the past five quarters its been up about 60, roughly 70 basis points on average. Your guidance looks like it suggest a lot less expansion and I may have missed, I know you talked a little bit about the tougher comparison on the gross line, but are you guys just being conservative on your part or is there something out there that's going to lead to less gains on the store contribution line? Thanks.

Glenda Chamberlain

Well, we’ve seen very, very strong DSE leverage over the last seven or eight quarters and it’s just hard at some point to continue to expect that and particularly there are line items like healthcare where we have been managing that cost really well and seeing really great results, but there are a lot of macro factors that affect that and so its difficult to predict. So to a certain extent, we’re being conservative, but to a certain extent it’s difficult to predict that on an ongoing basis we’ll see the kind of DSE leverage that we have produced recently.

Operator

And we’ll move next to the site of Karen Short with BMO Capital. Your line is open. Karen Short your line is open. Would you mind checking the mute function on your phone? Our next question will come from the side of Stephen Grambling with Goldman Sachs. Your line is now open.

Stephen Grambling - Goldman Sachs

Hi, thanks for taking my question and congrats on the quarter as well. Just to follow up on some of the other questions, but in some of the competitive environment you know have you seen any change in terms of the pricing that’s going on with the conventional as well as just the increased focused on organic and natural?

Walter Robb

We just look at the, you know because we’re doing that comp shop report every month and just looked at a little earlier today there is really no change in anybody’s strategies out there as far as we can tell. You know that the inflation is moderating, but its just looking where they passing on and that seems to be works out right now, a little stability is not a bad thing.

Stephen Grambling - Goldman Sachs

And then I guess one other quick follow-up, you referenced that, I think that you referenced that the cattle herds and multi-year loans with the supply; is there any concern about just overall organic and natural kind of farmland and supply becoming an issue at any point or how do you think about that?

Walter Robb

I mean, periodically there are shortages that come up; right now there is a pretty good shortage on organic milk. But you know you have these production fluctuations and demand fluctuations, sometimes are hard to you know balance, they don’t balance out; you know organic milk was over produced a few years back and so some of the herds were cutback and demands gone back-up again now, so it will take a while for that to catch-up.

But other than these periodic kind of shortages that you might get because of the change in demand or I mean, one of the reasons that the big reason the calories down that’s because of the extremely dry weather that the Southwest got hit last year. But other than that we don’t see any real shortages in terms of the crops that will be available for us. We think that so far we’ve not really had issues sourcing product. And to be clear we’ve got all of our organic crop under contracts, so we don’t have any shortages from this sector.

Operator

And we’ll move next to the site Ed Aaron with RBC Capital Markets. Your line is now open.

Ed Aaron - RBC Capital Markets

You’ve been talking for a few quarters about selective trading up in some categories. Now I was just wondering if you’ve seen in recent weeks any signs of a broad menu that trend through the store?

Walter Robb

Aaron, this is Walter now. I’ll start out and maybe you’re supposed to add John. I think what was neat about this quarter we are seeing the strength in the $25 to $50 basket too, I mean, that’s a number one thing about this quarter is the growth in transaction counts. It’s huge and to flip back to the 80-20 thing. But then to see if that landed not only in the continued strength in the $50 basket but also the $25 to $50 basket which suggest to me that the customer is moving along the sort of continuing with us is willing to continually add and increase the basket. And so I would see this as more broader based strength for the company and I think reflects the momentum around our, not just our value but our differentiation programs and Health Starts Here, I think these things are really gaining some traction, that’s what it suggest to me.

Ed Aaron - RBC Capital Markets

And then just one quick follow-up if I could, on the price investments, you know when you kind of benchmark your pricing versus your competitors, have you seen any kind of incremental changes in your overall level of price competiveness in the last few months?

Walter Robb

I mean, it’s a dynamic thing. It’s constantly moving in lots of markets where Europe for example, is highly competitive market from retail price points. So it moves around but in very minimal tolerances in terms of the changes. So we continue to feel very good about where we’re positioned.

Operator

Your next question comes from the site of Sean Naughton with Piper Jaffray. Your line is now open.

Sean Naughton - Piper Jaffray

Maybe you could just talk a little bit about your prepared foods category? Is that something that continues to comp ahead of the chain overall? And then, maybe secondly, any sort of discussion around your non-food categories, whether in personal care or in the vitamin supplement section, how that’s doing within the store base? Thanks.

John Mackey

Well, prepared foods is a very strong category for us, but we generally don’t like to, every quarter kind of divide out which ones are doing better than others. So it’s been strong category for us and it’s still a strong category for us.

Sean Naughton - Piper Jaffray

And then, I guess, moving forward on the store level margins, I think there has been a lot of discussion around that. But…

John Mackey

Try the question again.

Sean Naughton - Piper Jaffray

Sorry about that. So, just on the store level margin line, you talked about DSEs being a little bit more difficult moving forward. Is there opportunity on the gross margin line still as you move throughout the year?

John Mackey

I mean, there is always opportunities; so complex because the markets are local and you’ve competition and we’re going always do the best we can to get the optimum mix between increasing sales and getting the best gross margin possible, leveraging our expenses and it’s really hard to guide more than what we’ve already provided in a way which is very general guidance. So our strategy is in philosophy is continuous improvement, so we’re certainly hopeful that we’ll see some leverage but we’re not changing our guidance on it today.

Operator

And we’ll move next to the site of John Heinbockel with Guggenheim. Your line is now open.

John Heinbockel - Guggenheim

So guys a couple of things of real estate I wanted to drill down on. If you look at the kind of the sites you are looking forward today, the smaller boxes, when you think about supply of those coming on line or being available versus those who are pursuing them, how is the supply-demand dynamic today; is it getting better and thus may be pricing getting a little better or no?

Jim Sud

Hi John, this is Jim Sud. We are seeing a very abundant supply of second generation space and smaller space; I think our average stores that we signed this quarter was 33,000 square feet and six of the sites are distinct second generation states. So we are continuing to see lot of our opportunity and at really good prices in terms of branch and of course with smaller stores come lower capital spend and we’re getting great results so it’s really a great combination.

John Heinbockel - Guggenheim

Where are second generation, is that mostly old traditional supermarkets or no?

Jim Sud

It’s a number of things; to a less extent old supermarkets, but Circuit City, Best Buy, Borders, different companies that have gone out of business or are giving up space.

John Heinbockel - Guggenheim

When you think about what you have done with the value proposition, where do you think you pushed the envelope now in terms of average household income or per capita income, you know the areas you might have not targeted in the past that you can today, is there a certain level you are not going to go below in income level?

Jim Sud

Well, John we think we have broadened it to be sure. But again we don't think of it that way. We don't really approach our business in those kind of categories in terms of income levels and I mean again we are this mission-driven, purpose-driven company who is trying to fulfill our mission of selling really high-quality natural organic foods. We want to do that as inexpensively as we can and I think what's happened is the markets come our way, it’s people are more interested or a higher percentage of Americans are interested in eating healthier food.

And I mean people complain about food prices but of course the facts are that Americans are spending less money on food today than any time in our history. We are down to 8% of our income on food. So it’s really a question of people’s priorities and where they want to spend their money and increasingly what we are seeing is, is that a higher percentage of the American population is interested in eating healthier and the baby boom generation continues to age which works in our favor and we also see the Millinneal generation. We have a lot of people in their 20s now who grew up eating at Whole Foods Market and so it’s the natural store they go to.

So it’s a continuous shift in our direction and it’s not like we've got a 25% market share of the food industry in America. It’s a small sliver, but it is continuing to grow every month, every quarter, every year and we anticipate that to continue that way for the foreseeable future.

John Heinbockel - Guggenheim

Alright and John it’s one final thing. With the billion of cash, I know it probably doesn’t make sense to go out and buy a company because of our cultural differences. Do you see in theory an opportunity to buy real estate, you know to buy a business or a part of the business that has the right real estate, that over time you can turn into your stores, but you would want the franchise?

Walter Robb

This is Walter, John. You know I remind you last quarter, we kind of went through the four uses of capital that we’ve been thinking about which is to accelerate our store growth and remember we are moving that forward this year, continue to invest in the stores and the dividend and the capital repurchases which we did and then also to build up a little bit of cash over in a nice situation to I guess whatever happens. But Jim, maybe you want to speak to the real estate thing and all that.

Jim Sud

Yeah, so John if you are suggesting that we buy a real estate company, I don’t think that is something that that makes sense for us. But from time to time, we do look for opportunities and we do capitalize on opportunities to buy locations. But first and foremost we are looking for the best sites to buy and to expand our stores. But that’s a store that we have an opportunity to buy, then we will take advantage if it makes sense to do so.

Walter Robb

John, here is the good news on the real estate front. You got to look at the macro trend here. The internet continues to penetrate wider and wider in America and more and more sales are migrating through the internet and as a result more retail space is just being freed up and I don’t think that trend is going to go way anytime soon and that’s going to be a good thing for all food market. We think that out particular businesses is possibly the least vulnerable to internet incursions of any retail business out there. And as a result we are seeing softening and we are getting better deals today than we got five years ago and we are getting better rentals, we are getting lots of very strong offers from strip centers and developers of all kinds. So I do think you will see a higher percentage of our sites going forward albeit kind of a secondary space that is getting recycled. I think we are going to do a lot more deals that way at very favorable risk and that is going to be a good thing, any dollar we save in risk, just falls right to the bottom line.

John Heinbockel - Guggenheim

Okay, thank you.

John Mackey

And when you combine that with the lower cost of capital to build those stores it’s a nice formula.

John Heinbockel - Guggenheim

Yeah, definitely.

Operator

Okay. Our next question will come from the site of Ed Kelley with Credit Suisse. Your line is open.

Ed Kelley - Credit Suisse

Yeah, high. Good afternoon and nice quarter as well. I like to follow along the same lines that John was just asking about. From a M&A standpoint, does it really make sense that we should assume, at some point it doesn’t make any sense to go, buy another company to get to your sort of 1000 store mark.

A.C. Gallo

Well, I mean, we are opportunistic acquirers and if the right deal came along in a good price, particularly I mean, to enter a new market place, smaller network of stores is a good foundation piece to grow on. But I don’t anticipate we are going to do any major acquisitions, we are sure not going to buy any supermarket chains, just try to get real estate that was something John might have been hinting at.

There is a lot of crummy real estate that we don’t want in those packages and certainly don’t want to take over their franchises or their labor contracts or things like that. We’ve a pretty formula to get to the 1000 stores. It’s a power countdown. We’re going to continue to grow the number of stores that’s going to open every year, the foreseeable future and if you just turn that out, five, seven, eight years, you are going to, we will start opening a lot of stores and so, we’re not going to get to the 1000 store mark in this decade probably, but hopefully before I hang them up, we’ll be at the 1000 stores.

Ed Kelley - Credit Suisse

So, along the lines I was hoping that you can maybe give us a little bit more color on the economics of smaller markets. I know that you mentioned that cost stood lower and the rent lower. What about other costs like labor, for instance? Distribution? Is that lower because it could be a little bit further away from a DC I guess, so, maybe it might not.

Walter Robb

I think everybody wants to comment on your question. I want to jump in ahead of the pack. One of the interesting things we discovered about the smaller store market is there is a lot less competition, and it’s very interesting. We’ve done surprisingly well in some of the secondary markets, a lot better than we thought we were going to do when we projected the stores out.

And when you combine that with lower rents, lower build out and smaller total footprint, with high sales per square foot, it’s a very powerful economic model. So, I think we are going to open a lot more of those type of stores and it’s, we actually haven’t done a rework on real estate model because the stores are outperforming our projections so much.

A.C. Gallo

Hi, this is A.C. As far as other expenses, it really depends on what part of the country they’re in. obviously, certain places in the country have much lower utility cost and that can make a difference. We opened a small store in south Florida and it has high utility cost and we open up a small store in some other part of the country it might be lot lower. So it really depends on the part of the country.

Labor cost are, labor is fairly stable, the labor rate that we pay across the country but again certain parts of the country have and some of places that we have been going into just kind of have lower overall state taxes and payroll taxes and things like that.

So we are finding that in some of these new markets that we are going into that overall operating cost and taxes and things like that are lower. I just wanted make one more point to remind you this is part of the broader strategy. We are continuing to accelerate our growth in all market, all parts of the country not just the smaller markets.

This is just so you can see if you look at the numbers Cindy provided on this script that the average store sizes may be down about a 1000 or 2000 square feet in this upcoming batch of stores but bear in mind we are opening them in all the markets and I just want to make sure that this small market discussions in that context is actually to continue to grow like everywhere.

John Mackey

Some of the small starts has really been in in-field stores in certain neighborhood and large cities too. And we have some of those in San Francisco, [Haight], like Boston with the Jamaica Flame Stores so.

A.C. Gallo

There has been talk of Minnesota next quarter?

John Mackey

Right.

Ed Kelley - Credit Suisse

So thank you.

A.C. Gallo

That’s a three-headed answer for you right there.

Operator

And our next question comes from the side of Karen Short with BMO Capital. Your line is now open.

Karen Short - BMO Capital

Just wanted to touch base and talk about the average ticket a little bit using Whole Deal. That average ticket seems to have increased quite a bit just from past comments it’s kind of in the 65 to 67 range for many quarters. Can you maybe talk a little bit of about what you think the drivers might be in that?

A.C. Gallo

Hi, Karen, it’s A.C. I think part of the drivers, as I said earlier is that we’re seeing as we've been doing the Whole Deal for a number of years. We are seeing the types of items that work better there, so we've been refining that goes into that vehicle; like for instance we ran last summer, we ran a big deal on Rotisserie Chicken and potato salad and it was like one of the best we've ever done. So we are starting to see what really works and I think that combined with just the customers just seem to be very reacting very positively to our specials and any kind of promotions we are doing. I think the combination of that has driven up the response we’ve had in the Whole Deal.

Karen Short - BMO Capital Markets

And then just on your ROIC, I mean obviously in all categories ROIC category stores increased, but it seem to be fairly noticeable in less than two years old sequentially at least same treatment in the ROIC, I am just wondering I know there is a slight change in the store base, but is there anything you can point to there?

Walter Robb

Well, I mean it’s all of the things it’s again the continued prints of the right size store for the right community there. I think the spend, I’ll look at those numbers the, we started out a number of couple of years ago $50 million a store and we’re now crossed over the $11 million on our way to sort of $10 million for the special stores so the actual dollars invested is lower. And then coming over the box with these better business models, the returns are up, look at the store contribution this quarter, so it all plays into that incremental improvement in the ROIC.

Karen Short - BMO Capital Markets

And then just the last question is, you didn't have a LIFO charge this quarter and you’ve said that inflation you know is going to be abating, why you guys guiding for a LIFO charge for the year?

Glenda Flanagan

Well, we did lower the guidance and it reflects what we think is a normalize rate of inflation for the rest of the year. We didn’t want to guidance to zero; we could see a small amount of LIFO charge for the rest of the year.

Operator

And we’ll take our last question from the site of Scott Mushkin with Jefferies. Your line is open.

Scott Mushkin - Jefferies

So I wanted to come back to the stores, we you know noticed actually a decent uptick its hard to believe because you guys executed so well, but it seems like the execution has got to even higher level. At the same time you are obviously processing a lot more people through with the tick-up in transaction count. So I guess as I look at the leveraging in the direct stores, how sustainable are we if that path were to continue you know the really good execution with a lot more people going through, is it some point harder to lever expenses?

John Mackey

It’s a virtual circle I mean we’re seeing good strong comp growth, at the same time we’re continuing to collectively learn as an organization. So we are getting better at what we’re doing.

Again, the way Whole Foods is structured is in this cause a decentralized model with a great deal and power men at the regional store levels with the internet connection altogether and so we make improvements in one store, it can easily be spread other stores and you can do that across 317 stores; you are able to make improvements faster; its like the fusion occurs quicker than it used too.

So can we continue to do it? Yeah, on an incremental continuous basis, I think we can, but I mean it’s going to be, it’s not -- as long as we can continue to generate 8.7% comps, I think you will see continuous improvement.

Walter Robb

I’ll just say, maybe because it’s the last question, last comment. And just what it feels like here for us as operators is that it feels like in collective way, it just feels like we’re getting stronger. So we learned a lot of the lessons from (inaudible) those lessons to put some new disburse in place. And so it does feel sustainable to me. It does feel like this is something, this is a path that we’re on now and I think our philosophy of continuing to make incremental progress and changes and it feels very sustainable to me and I think our decisions around growth, you know about particular numbers we pick rather than picking 50 or 60 or 70. These are numbers we can do and do well. So that’s our goal, that’s our hope. So we hope to be able to deliver.

So, thanks for your questions Scott and that brings us to the end of the call and thank you all for listening in today. Please join us in May for our second quarter earnings call. A transcript of the scripted portion of this call along with recording of the call is available on our website at www.wholefoodsmarket.com. We’ll talk to everybody next quarter. Thank you.

Operator

And this does conclude today’s teleconference. Thank you for your participation. You may now disconnect.

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